Before the week is over, I am going to write a blog post entitled “Imagine that SDN Did Not Exist, What Would Do with All the Free Time?” That is something I will find the time to crank out either on my current flight to SFO or the return flight. Until then, here are a few things I have been collecting in my SIWDT Evernote to write about.
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I am off to NYC to present at an SDN gathering hosted by Oktay Technology. I am going to change up my standard pitch deck, so I am curious to see the reaction. I have decided that I have been too nice and I plan to be more provocative and change the network dialog from speeds, feeds, ports and CLIs to a discussion about the network as a system and orchestrating the network from the applications down – opposed to the bottom up wires approach.
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It has been awhile since I have had time to think about stocks and since we are at the start of earrings today, I was looking through my stock watch list and thought I would pick out a few interesting charts.
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An odd week of news and notes. Truth be told, there is not a lot that I am really motivated to write about, but there were a number of noteworthy articles and videos during the week. Here is my run down of things I read or watched during the week:
1. About mid week I started to see all these hits on my blog from Networkworld. Jim Duffy had listed my blog on a list of useful Cisco blogs. Kind of cool and thanks to Jim. With that maybe I should write something about Cisco.
2. Here is a link to an interview that John Chambers did with Reuters. At the ~4 min mark he talks about market and technology (~7 min mark) transitions, the next big thing, etc. I really have to wonder what transitions they have organically caught over the years? The Flip phone? No. Cable business? No, they bought that in the form of SA. I think Cisco is a sales machine, but they bought Crescendo and rolled up the switching market in mid-1990s. They bought Webex, they bought SA, bought a bunch of optical companies that were a disaster. They buy a lot of companies, they are not innovators and they do not catch market transitions. They buy technology and market transitions. There is nothing wrong with that, but the company is not visionary in nature. They wait till customers tell them to buy into a market in the form of a company. As for what customers think of Cisco, this article is on a general level representative of what I hear in the market.
3. Yesterday I read this article on SDN. Speaking of Cisco, it is full of quotes from Cisco:
The operative word in the term software defined network isn’t software. It’s defined, said David Yen, senior vice president and general manager for Cisco’s data center group. He said networks need to be defined by the applications that are using them. ”It’s a change in perspective,” Yen said. ‘It’s really an evolution of this art of networking intelligence. And furthermore, a lot of the SDN idea is actually blending in some of the functions and features that traditional data center management software is doing. People are turning their attention more and more to the application perspective,” Yen said. “For the ease of developing applications and for the ease and effectiveness of deploying applications, it’s the right time for the underlying infrastructure to serve whatever the application desires.”
From Plexxi’s perspective, it is really great to read senior leaders at the marquee name in the industry adopting our view. We agree that networks need to be defined by the applications that use them, rather than those pesky distributed protocols trying to figure out state and we certainly think that the underlying network infrastructure should be reflective of the application requirements.
4. Sounds like a tough week for the Juniper QFabric team if this article is correct.
5. Did I mention that Plexxi was listed as a hot startup by the WSJ? Yea…#12.
Wrapping up what I wrote: Cisco does not get market transitions, they buy them. Cisco SVP of Data centers thinks SDN is about applications. Juniper QFabric team downsized. Plexxi next big thing and we think that applications matter, and the NFL finally fixed the mess and Goodell should not be back or I should get a refund for 3/16ths of my season tickets value.
/wrk
I think the latest Cisco Global Cloud Networking Report has flown under the radar. I read a few articles on it, but for the most part I think it was ignored with all the InterOp news. It is a really interesting report and summarizes a lot of what I see and hear in the world of IT. I have been posting about the frustrations of IT leaders with the state of the network. Despite what the skeptics have written about SDN, when you talk to IT leaders and then read a report like Cisco’s Global Cloud Survey, one conclusion is possible: the network is f’ing broken. Two additional corollaries: (1) all of us in the networking industry have had a hand in creating the mess and (2) the first people to innovate and fix the network will be the winners. The networking industry is divided into two groups: those perpetuating the mess and those who are trying to fix it. Here are some choice quotes from the report:
Thinking about Unicorns and six months, I spent some time listening to a Lightreading webinar on the Evolving the Data Center for Critical Cloud Success. On slide 11 the presenters have “A Facts-based Reality Check for Cloud Delivery” which includes the following facts about the “Largest Live Test Bed in The Industry:”
The more things change, the more they stay the same. Which group are you in?
/wrk
It has been awhile since I thought about CSCO in terms of the equity value. I read many reports on CSCO post their Thursday earnings call and most reports generally like the long term prospects of the company and think CSCO will do better as the macro economic conditions improve. Over the past year, I have written a lot about CSCO and it is all in the blog archive. Here a few thoughts on CSCO post their recent earnings call.
Chart: Below is a 10Y weekly chart of CSCO. Technical charts do not predict the future, but they do show a sentiment trend from the past and it is possible to map the trend to events. The three red circles from the center to the lower right represent the price peaks from mid-2007. They are a series of lower highs. There is a five year wedge developing and the astute observer will note that this wedge looks to be resolving around the Oct/Nov time frame, which is the end of CSCO’s Q1 FY2013 and early November reporting date.
It should be noted that wedges do not necessarily resolve to the negative. Below is a 10Y weekly chart of INTC and the breakout of a long downward channel is visible. I pitched INTC as part of the 1G to 10G server transition to the CEO and tech analyst at Alger in September 2011 when I interviewed for a position with the firm. I wrote about it here.
End of the Switching Era: I am firm believer that we are at the end of the 20 year run of the Switching Era (1992-2012) in networks. The network is changing and that is going to have an affect on CSCO. They will buy innovation through Insieme and/or others. The new networks will start small this year, barely noticeable to CSCO and become visible by mid 2013 and they will have a real affect on CSCO in 2014. All you need to know is that then entire global base of networks are up for replacement. CSCO will win their share, but it is possible and probable they will lose share in this cycle. The last cycle was the evolution of shared LANs to switched LANs driven by GbE and CSCO used M&A and product cycles (Cat 5k/6k) to win the vast amount of market share in that era. If you want to be long CSCO, forget about macro conditions, telepresence, transformational connected communities, cloud, big data, mobility and all the other crap. All you need to be comfortable with is the knowledge that CSCO will win and upgrade the core of networks in the next five years.
OpenFlow/SDN: I have written a lot about SDN and OpenFlow and what it all means or might mean or does not mean in the past month. The real question you have to ask about CSCO is why do they fail at internal innovation? CSCO confirmed the Insieme investment ($100M with right to buy for $750M) last month. They have used this proven method in past to great success. No arguments from me on the validity or success of the strategy. The question I would ask is why does CSCO have to use this method? I accept that it works, I accept that it is proven – but AAPL does not use this strategy. A person who thinks about companies might ask: why does a company with an annual R&D budget of $5B need to use the spin in strategy? Is $5B too little to fund innovation with so many legacy product lines to support? The other odd data point is the Insieme team is building a product for the heart, I repeat the heart of the Cisco franchise. Switching is not some adjunct part of the company. Switching is the business in which the company made the very first acquisition. I know that great innovation has been done by companies taking teams and separating them from the core business such as IBM with the PC. I get it.
On the other hand if you add up all the venture capital in the next-generation of networking companies in the US it has to be around $200M give or take $50M. CSCO invested $100M in Insieme, provided space and have a call option on Insieme for $750M. Was it not possible to do the same internally for $250M over two years, which is 5% of the annual R&D budget? Did anyone on the BOD even ask the question why the company has to go outside the company to build something innovative for company’s core franchise? This leads back to the 10Y chart. If the company has to do something special to accelerate a product solution in the core franchise of their business, two unspoken facts must be true. (1) There is a bigger threat to their core switching franchise than they are willing to identify and (2) they cannot drive their internal teams in the their core franchise to innovate.
I have read speculation that the whole OpenFlow/SDN movement will die in a few years. As I posted earlier, changes in how networks will be designed will have little to do with OpenFlow in my view and SDN is just a poor term. Networks have always been about software. We have all been through various software debates in networking. How many people remember APPN versus APPI? Back in the early 1990s, CSCO was all about APPI when they were going against the monster incumbent IBM who was willing to license APPN for $400k. Interesting comments from CSCO this past week complaining about Huawei using on site support people to lock out competition. I felt the same way in the late 1980s and early 1990s, but I used to complain about the teams of IBM employees at every F500 company selling SNA. Where is IBM today in terms of networking? Market share can shift from the company with 80% share. Perhaps more of you remember tag switching and Ipsilon Networks; today we have MPLS. Side note on IBM. It may be unnoticed by many people, but IBM acquired a company called BNT in October 2010. I continue to read speculation that IBM is going to rebuild their networking division. The same division that CSCO destroyed in 1990s and then purchased in 1999. More than a decade after IBM exited the networking business, why would IBM want to get back in the networking business? You can come up with your own answer, but I do not think the answer is: more of the same.
Cash: CSCO has not filed their 10Q for the Q3 FY12 yet, but if we look at the 10Q filed on 2.21.12 CSCO had $41.7B of cash off shore and $5B of cash in the US. I do support CSCO’s position that US companies domiciled in the US should be offered a cash repatriation holiday perhaps with some sort of on-shore investment requirement. I would call it bring home cash for US jobs. How is that a bad? I think it is terrible that US companies are using off-shore cash for foreign investments when that cash could be used in the US.
As always this is just a bunch of speculation by me. I am sure I not in possession of all the relevant facts and it quite likely much of my speculation is incorrect. For new readers to my blog, Notebook posts are a collection of data points and theses that I am thinking about. I was inspired to write Notebook posts after reading Alchemy of Finance.
/wrk
The Tech Field Day team posted videos from most of their meetings last week. I was an avid viewer during the week, but I was sure I missed some points so I went back and watched a few selected videos. One of the videos I watched was from Andy Bechtolsheim, co-founder of Arista Networks. I heard Andy speak at the Flagg 2012 High Performance Computing Linux for Wall Street conference on Monday and it was a good opportunity to compare notes. Here are three paraphrased points and three quotes from the video. The quotes are at the 7:40 mark of the video:
“Networks have evolved pretty slowly from a protocol perspective.” I agree and have written the same here.
“Reality is people spend a lot of money on networking gear. Once it is installed it works. Don’t touch it, you may break it.” I have been writing about this for more than a year and I called it out in my Tubthumping post.
“Once people have adopted a certain network topology they are highly unlikely to change it unless there is really something better comes along.” I agree with Andy and have written much the same, but this is the point at which we diverge and I choose The Road Not Taken.
Insieme Follow-up: My two posts on Insieme here and here are by far the most popular posts I have written. As expected they generated a lot of reader reaction. In my first post I offered up a couple of possible product strategies. I tend to think that the Path 1 strategy is the most likely direction. Use custom ASICs in a new Leaf/Spine product set (note if you watch the AB video I linked to in the first paragraph, Andy talks about this network architecture being the state of the art and locked in for years as networks are slow to change). The new Leaf/Spine product set will have the ability to hook back into the legacy Nexus (~10k installed customers), but have very high bisectional bandwidth for storage.
For years it has been speculated that CSCO would buy a storage company like NTAP, but with the rise of flash, SSDs (note there are ~14 storage startups targeted at the home-enterprise-cloud provider markets), CSCO could add storage to the Nexus platform with the new Insieme product line. Let us assume the company has product plan hashed out and they are aggressively recruiting the product development team. If we assume January 2012 start, we could expect this product in 18-24 months and the 18 month assumption is if everything goes perfectly. Most likely is we would see the product in 1H 2014. What we would see is a new Nexus compatible set of switches, 100G ready, but using ASICs that allow for very high cross-sectional bandwidth and some sort of CSCO storage product. Yes, I think this team puts CSCO squarely into the storage game against incumbents and startups alike. UCS now gives you networking, blades (Romley) and storage.
I think the days of getting a significant (e.g. Cerent) integration and cost advantage through an ASIC are over, but using an ASIC does provide deterministic supply advantages. Back to the Andy video, he says that Arista prefers to use merchant silicon from all suppliers and in his talk at the HPC he had several slides onMoore’s Law and riding the merchant silicon wave and predicated 16/32/64 core silicon in years to come. As the Leaf/Spine architecture holds (remember (i) slow rate of network architecture change and (ii) once the network is installed do not touch it) some competitors will ride the merchant silicon cycle and a few will do ASICs. Using ASICs does remove one from the pack and having to be tied to the product development cycles of chip suppliers (BRCM, MRVL and INTC), but at the same time there are suppliers like Pica8 and Cumulus Networks who are thinking ODM hardware from Asia-Pac and bring your own OS. It looks like the battle will be joined with CSCO/Insieme thinking closed architecture, ASICs, one stop shop for network-compute-storage and at the other end of the spectrum are the white box/DIY/Open Flow abstraction layer companies with several companies in the middle focused on specific application use cases and even putting FPGAs with APIs in the switch data path. As always this is all speculation and probability is in favor of me being in error.
Market Thoughts: We have ha a bit of sell off. As I wrote a few days ago I had been trimming exposure into rally. I let the APKT position go on Monday and I hope to buy it back. I have some shorts on and would like to go back to being long oil and gas, but I took profits in those positions a few weeks ago and now I am just waiting for entry points. We have earnings starting soon and I really do not like having any large positions into earnings events. I am content to read the news and react.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. **
The following are my thoughts on the NYT report that Cisco was creating or supporting a new startup called Insieme. I have decided to use a framing format for this posting, because I really do not know what Cisco or the Insieme team is thinking. It is not as if they asked me to review their plan. All I have done in this posting is look at a number of data points and draw two conclusions. The conclusions are at the bottom of the posting if you have spent too much time using Twitter and have a diminished ability to focus on reading.
Frame 1: What is a Spin In? Back to the 90s and Ardent
Ardent Communications was founded in 1996 as a planned spin-in startup focused on building a specific product designed for Cisco Systems. The spin-in model was a method to create a startup that could attract top talent that, in turn, would build a product defined by Cisco in short period of time. To capitalize the new company, Cisco invited Sequoia Capital to participate in the funding of the new venture. To foster the entrepreneurial atmosphere, the employee and management pool was sized at 55% [see Cisco Systems: A Novel Approach to Structuring Entrepreneurial Ventures, Stanford University Graduate School of Business, Case Number EC-15, February 2000]. The trigger mechanism on the deal was a put/call feature that gave Cisco the option to purchase the company at a specific time or upon a product deliverable at a specified price of $232.5 million in cash or stock. The first round of funding for Ardent closed on August 11, 1996. Less than a year later, on June 11 1997 Cisco announced the acquisition of Ardent Communications for $156 million, which does not includes the 32% of the company already owned by Cisco bringing the total transaction value to $232.5 million. Ardent was a made to order M&A transaction. It combined venture capital and a publicly traded stock to build a product outside of the corporate structure and process of Cisco Systems. The real beauty of transaction was the minimal risk incurred by Cisco and Sequoia Capital. Unless the team failed to develop the product, it was a guaranteed exit strategy using M&A.
Frame 2: Nuova Systems and Post from October 23, 2011
I wrote a post about Arista, Cisco and Nuova back in October 2011. Here is the relevant portion of that post. “To understand what I am thinking about, we need to go back to Nuova Systems. Cisco acquired the company in April 2008. From this company emerged the Nexus 5000 class set of products. What was unique about the company was the funding and the impact it has had on others in the Cisco ecosystem. Think about where Cisco stood in 2008. For the FY2008, Cisco sold $13.46B in switching products. (Note that Cisco’s fiscal year is August-July). FY2008 was the peak year in Cisco switching revenue before the onset of the global credit crisis in September 2008. I have detailed the 2009 catch-up spend event here and here, but consider the world before the credit crisis induced spending collapse and subsequent catch-up phase. Cisco was the dominate market share owner in switching. There was no one close and they had spent their acquisition capital from the start on this market segment. This is a just a partial list of Cisco’s switching centric deals starting the most important being Crescendo in 1992. This list alone totals $6.4B:
| 24-Sep-93 | Crescendo Communications | LAN switching | $94,500,000 |
| 24-Oct-94 | Kalpana | LAN switching | $204,000,000 |
| 8-Dec-94 | LightStream | LAN switching | $120,000,000 |
| 6-Nov-95 | Grand Junction Networks | LAN switching | $220,000,000 |
| 6-Aug-96 | Nashoba Networks | LAN switching | $100,000,000 |
| 3-Sep-96 | Granite Systems | LAN switching | $220,000,000 |
| 28-Jul-98 | Summa Four | LAN switching | $116,000,000 |
| 31-Aug-99 | IBM Networking HW Division | Computer networking | $2,000,000,000 |
| 11-Apr-00 | PentaCom | LAN switching | $118,000,000 |
| 20-Aug-02 | Andiamo Systems | Datacenter Switching | $2,500,000,000 |
| 29-Jun-04 | Actona Technologies | Data storage | $82,000,000 |
| 8-Apr-08 | Nuova Systems, Inc. | Datacenter Switching | $678,000,000 |
| $6,452,500,000.00 |
Nuova was started in mid-2005. It was self-funded by the Cisco executives who left to form the company. This list included: Mario Mazzola, Luca Cafiero, Prem Jain, Soni Jiandani as well as outsiders Ed Bugnion and Tom Lyon. In August 2006, Cisco increased their ownership to 80%. In April 2007, Nuova had ~200 employees and Cisco agreed to a cap of the potential buyout of remaining 20% at $678M. A year later, April 2008 Cisco closed the deal to acquire the remaining 20% for $678M. No venture capital firms were involved to my knowledge. Jayshree Ullal left Cisco in May 2008 and joined Arista in 2009.”
Frame 3: Google Search Terms
After I wrote the Arista post in October 2011 and mentioned the Nuova team, my blog started getting hits from people searching for the team. Here is a the summary of those search terms and views:
| Search Term |
Views |
| mario mazzola luca cafiero |
22 |
| luca cafiero |
21 |
| luca cafiero new startup |
15 |
| mario mazzola new startup |
9 |
| prem jain startup |
7 |
| mario luca prem |
7 |
| mario mazzola |
5 |
| luca cafiero cisco |
4 |
| mario mazzola startup |
4 |
| luca cafiero startup |
3 |
| mario mazzola 2012 |
3 |
| prem jain OpenFlow |
3 |
| mario prem luca |
3 |
|
106 |
Frame 4: Twilight in the Valley of the Nerds
I am a firm believer in providing credit where credit is due and citing sources. The blog Twilight in the Valley of the Nerds was one of the first sites, if not the first site to post about a new start-up brewing. You can find the posts here on July 28 2011 and the most recent posting here.
Frame 5: Why a Spin In?
Before I present what I think Insieme is building, a few short thoughts on the idea of a spin-in. My first reaction to the NYT article was: why is this not being done inside the traditional constructs of the corporation? In the post-Madoff age of private capital ventures, the accounting and valuation process is much more scrutinized. I know auditors of PE-VC funds are increasingly demanding support and documentation for valuations. It has been reported just last month that the SEC is looking into how valuations are marked and the conflicts within investment pools. If we assume that the Insieme product can be built for $50M and that it would take 24 months, what is the value of the corporate entity and why is it better for Cisco to build a product outside of the company? I think I can answer my own question. JNPR started QFabric in mid 2008 and it took a lot longer to bring the solution to market than planned, sometimes doing an engineering project outside the company is a better plan. When I worked at CrossComm in the late 80s early 90s, we took a core team out of the company to build the company’s next-generation product. We put them in a building a few exits up the highway where they would not be distracted by the day-to-day events in the legacy product lines. I can understand how internal resources can be distracted by present day activities; that is something I have blogged about over the past several months. The question that John Chambers has to ask himself is what is the appropriate price to pay for the asset. I am going to assume that there will be pressure on the valuation of Insiemi compared to the valuations used for Andiamo and Nuova and therefore I think 10X on an assumed $50M investment means a $500M exit for the team if successful. These numbers are assumptions on my part; feel free to insert any number for the capital to build a product. Maybe it is $35M or maybe it is $100M.
Conclusion: What I Really Think they are Building
I received a good comment over the weekend (much of which I agree with) on what CSCO has accomplished in the switching space. I think there are two paths that the Insiemi team could be going down.
Path 1: Assume there is unfinished business in the storage space, which is why I linked above to the comments over the weekend. I think it is possible that the MLP team would go build what would become a new Nexus family member with storage network hooks. This would be Cisco’s strategy to abandon FCoE as a convergence strategy. DG at Arista already opened this discussion last year. The new Insiemi box would use a similar approach to Xsigo’s product strategy, but instead of using Infiniband, the Insiemi box would be all Ethernet, but have two separate Ethernet channels (i.e. forwarding planes). One Ethernet channel would logically allocate bandwidth vertically and be intended for traditional IP traffic deployed in hierarchical switched data networks. Basically what the world has been building for the last fifteen years. Nothing new in the first Ethernet channel, it would be the second Ethernet channel that would be disruptive. This second channel would be for SAN networks and instead of being hierarchical in nature – they would scale horizontally across the compute element. This second channel would run Ethernet down to the host (N2K?) and split out storage traffic from data traffic. Maybe this Insiemi box acts like a storage bypass in front of the N7K. Add in some fibre channel ports and you have a Director killer. Coincidently you would also have a product designed to force Arista to live in their low latency and cloud market applications and force Big Switch and Nicira to address a scaling challenge that in turn becomes a capital spending challenge. Path 1 is a strategy to box the competition into a small addressable market space. Attacking the storage space provides a number of benefits for Cisco. Once data is placed on a drive (does not matter what kind of drive) it becomes physical in nature. Facilitating the connections between storage and the compute element would accelerate the demise of FC. FC will be around for sometime, unless someone helps speed the decline. Building a transition switch and using SDN like features to facilitate SAN networks (i.e. NAS) while keeping the traditional Ethernet flows separate is a strategy to address some part of the big data market. Path 1 is really an extension of the current Nexus strategy, which was switching, then added compute, and therefore the next step is to add storage integration.
Path 2: This is the SDN/OpenFlow strategy path. From this Network World article, we know that the Insieme team has licensed or has access to NOS (Nexus OS). Here are several links to various postings about Insieme and Cisco’s OpenFlow direction:
- Twilight in the Valley of the Nerds 10.22.11
- Twilight in the Valley of the Nerds 03.16.12 (read comments)
- David Meyer presentation at ONF October 2011 (Is slide #14 a tell?)
- Video of David Meyer presentation at ONF October 2011
- Read “no where fast” comment about Insieme on Cisco blog
Taken in totality, I can envision a new platform that acts as a NOS to OpenFlow arbitration box. The platform would connect to the Nexus OS (hence the license) and it would have a set of interfaces for connections to the OpenFlow network. Cisco would use SDN like concepts to control the translation to and from the NOS network from the OpenFlow interface. Think of it as a session border control (SBC) for your network between the NOS network and the OpenFlow network. Cisco keeps their installed base closed to direct OpenFlow control, yet provides an OpenFlow portal in which they control the translation and arbitration function between the two networks. The plan in Path 2 is to keep Cisco market share locked in, but tell customers that Cisco has provided an OpenFlow access point and will plan to build SDN products using NOS and OpenFlow. I suspect that this would be a complex, software intensive platform, but would be valuable to Cisco as it would provide them a story, a migration strategy to convince customers to keep the status quo, upgrade their N7Ks and wait till the next upgrade cycle for OpenFlow as Cisco will have a SDN/OpenFlow like platform built to Cisco standards. Does anyone remember Ipsilon Networks?
I really have little idea of what I am writhing about and it quite likely that the Insiemi team is building a completely different product than the two possibilities I have describe in this post. I just thought it was interesting exercise to consider some development strategies if I was in their position.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. **
Another nice weekend on the east coast of the US and there is so much to think about that happened over the past week. CSCO spent five billon of their off shore pile of cash on a video company. ADTN announced a terrible quarter to start the year. These two events are part of the conundrum of the past 10-11 years that when I hear people telling me how the internet is going to break, the upcoming exaflood and video is a huge problem it makes little sense to me. At first I was going to write a big post with all sorts of charts, but the weather is too nice and I am not going to bother with the details. It might be better to just state my opinion and if you feel differently go ahead and put money to work. Just remember:
Innovative, Alternative Technology Solutions = Velocity
Developed Technology = Spent Capital, Doctrine, Incrementalism and Creativity Fail
All of these drivers of bandwidth are ongoing in the ecosystem and yet service provider CAPEX is lumpy! CSCO has to buy a software based STB/codec company and ADTN who is in the heart of the local loop upgrade market has a huge miss because service providers CAPEX is lumpy, spotty, insert word of your choice. Go look at any 10-year weekly chart of a service provider communication equipment company and you will see that the trend is down. If the traffic trend is up, why is the equity value chart trend down? Enough said on my part on the subject.
The NYT reported that CSCO was supporting a spin-in startup called Insieme. I have a lot of thoughts on this subject, but I am going to take a few days to collect and organize my thoughts on the subject. It will be the topic of my next post. I posted some additional thoughts over on the Plexxi blog as to what I am seeing in the DC market.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. **
Back in May 2011 I was thinking that set top boxes (STBs) were going away. Several months later it sure does look like that is the known trend.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. **
Cisco just put up a $3,675M print in switching. I have that as the single best Q in the company history. I think some competitors must be feeling some pain.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. Just hover over the Gravatar image and click for email. **
This post is an amalgamation of many of my prior Cisco posts, trends in networking and Clayton Christensen’s book. I started a thought process in my Notebook 11.02.11 post and this is extension of that thinking. I wrote on 11.02.11:
“Datacenter Switches and Mobile Devices: I was sitting through a presentation from a merchant silicon team last week. They were going over their designs in detail as well as roadmaps and application examples. They put up a slide matching chips to switch reference designs. A customer could choose chip A and build 48x10G switch or chip B with 48x10G and 4x40G design, etc. I was looking at the slide and thinking where have I seen this before and then it occurred to me: the mobile device market. One of the reasons I have been negative on the mobile device market is it really down to four operating systems: IOS, Android, Windows and RIMM. Apple is a fully integrated (vertical) and closed system. That is the most valuable franchise in mobile devices. RIMM has the oldest OS that was designed to solve problems from ten years ago. If you want to design a smartphone today, the process is to pick an OS: Android or Windows. Then you get a reference design from QCOM or Mediatek, etc. The real value is in the user interface (UI). I know marketing, manufacturing, distribution all matter too, but the mobile device market is bifurcated into Apple (the closed OS with ASICs) versus the Windows or Android OS phones with developer built UIs and merchant silicon (reference design) mobile device companies. I am crossing analogies to explore a thought path. Will the switching market go the way of the mobile device market? Will CSCO someday have to make a choice like Nokia or will they go the way of RIMM? Will a new company or legacy company quickly rise to take share because they built a vertically integrated switching solution like the iPhone? Will the rise of merchant silicon and reference designs create a vast market of white boxes driving down price points in which the differentiation and value is in the software, i.e. the customer UI? Just a thought path I am exploring.”
Here are six network diagrams. Take a look at the graphic and see if you can guess the year of each diagram. If you guessed reading top left across to bottom right: 1991-1995-1999-2003-2008-2011 you are correct. I consolidated these diagrams from current websites as well as the Internet Archive. No real mystery in the diagrams. It does not require an engineer to realize that we have been replicating the same network design for twenty years. When I first posted a theory about Moore’s Law Exhaustion, which now seems dated as I wrote it in July, I was specifically referring to the replication of this network architecture in product cycles based on the next iteration of silicon, form factor and densities.
Cisco reports a large installed base for the Nexus platform. At their recent technology field day the company presented the Nexus customer base as “19,000 NX-OS customers, 50K Nexus 5000 chassis, 
18,000 Nexus 7000 chassis and 3 million 10 gigabit Ethernet ports shipped!” The chart to the left shows Cisco’s quarterly switching revenue going back to 1999. Long time readers are familiar with my theory on the catch-up spend coming off the 2008 credit crisis. What is interesting to ponder about this chart is the direction over the next two years after the catch up spend was completed. It does show a topping out pattern and this might be reflective of product cycles, macro weakness or a changing market. When CSCO reports this week it will be interesting to see the direction of line. I drew in three dotted line variants.
In the world of switching it is relevant to understand where profit margins are located in the network diagrams show above. The exact profit margin varies vendor to vendor, but in the Leaf/Spine or ToR/Switch or ToR/Fabric designs (different terms for the same design), the calculations I have done show that profits can be broken down into two groups. Approximately 28-45% of the profits are in the Leaf/Spine or ToR/Switch or ToR/Fabric portion of the solution. The remaining 55-72% of the profits is in the pluggable optics – which the system vendors are reselling. Another way to look at would be to say that ~60% of the solution cost is the pluggable optics, which is marked up from the manufacture. I think this is a sustainable model – until someone decides to do something different.
That leads to the questions of what would be something different in networking/switching and who would do it? I have heard a number of people tell me that their strategy is to use multi-sourced commodity silicon (i.e. merchant silicon) and write their own code (i.e. in house switching code or some variation of Openflow). The quasi-vertically integrated vendors like CSCO, JNPR, BRCD, DELL, HPQ, do have a similar approach. Almost all the incumbent suppliers in this space are using chips from Fulcrum or Broadcom. Some suppliers use ASICs on the large switch platforms like the Nexus 7K. Merchant silicon has the potential to disrupt price in the market, because value can be pushed to the edges of the model. Using the handset market as an analogy, AAPL has a tightly integrated model (i.e. closed ecosystem) around IOS, iTunes and A4-A5 processor and their devices. A lot of value (i.e. profit) is created in this integration because the user experience is powerful.
The competitors to AAPL who use Android or Windows (i.e. merchant operating system (OS)) do not have as powerful a user experience and brand profile, but they can sure produce a powerful hand held device a lower cost point than Apple. That has an affect on the market especially when large legacy companies with dominant market share (e.g. Nokia had 40% mobile device share in 2008) are faced with lower cost devices coming from merchant OS/merchant silicon sources and a superior high end solution coming from Apple. This type of market structure could develop in the world of switching in which there are suppliers willing to live on much lower margins such as DELL, who use commodity silicon and a commodity OS. One or two other vendors might emerge who build a tightly integrated solution or maybe take a different architecture approach and they can demand a premium because they are solving problems that the legacy network design cannot solve such as scale, bi-sectional bandwidth and simplicity. All of the above brings us to the inventor’s dilemma. I think CSCO has three options to play or some combination of the three.
Plan A: Do nothing, keep the status quo, assume that 75% market share will forestall changes in the market structure and what has worked over the last twenty years will work for another twenty years. CSCO sells ~$3B a quarter in switching gear, has 10s of thousands of customers as cited above, armies of loyal and highly trained people around the world and plan A would be to continue to extend the twenty year run for another decade. Assume the worse case is someone does disrupt the profit model and in that case Cisco just rides it out without matching pricing over the decade and maybe Cisco has to buy a company if the pain gets to be too much. Cisco chooses this plan because disrupting the ecosystem model with armies of VARs and distributors and customer relationships is not worth the effort.
Plan B: Keep the twenty year model, but fight competition and change with price. Over time profit margins erode, but this will be a long process and we can always do something different when we are forced to act differently.
Plan C: Self Cannibalization. This is the most disruptive plan. This requires the CEO taking a team of people and putting them in a separate facility and telling them to come up with a new solution that obsoletes our existing installed base. Think IBM and Don Estridge inventing the IBM PC inBoca Raton, 1300 miles from the mainframe developers. Why wait for a competitor to cannibalize our installed base when we can do it ourselves. Plan C is the control our own destiny plan. We ride out the twenty year run and when it looks like the switching franchise might be threatened, we unveil a new solution to the market and change the playing field. Plan C comes with all sorts of risks and most of them are related to internal politics and inequality not to mention business and financial planning. Those are mainly the reasons why companies choose not to obsolete their own installed base and thus when faced with the inventor’s dilemma choose the least disruptive option to the business.
CSCO reports on Wednesday and I have no idea what to expect. Since the stock peaked in 2010, earnings events have been a disappointment with the exception of the August 2011 report. I heard one of the CNBC investment experts around noon recommending CSCO as a long and he might be correct, but I also think he has zero knowledge about CSCO’s business and the shifting sources of influence in networking. As usual this is just a blog and I could be entirely wrong about the various suppositions contained in the post.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. Just hover over the Gravatar image and click for email. **
A few reactions to reports from yesterday, this morning and other news:
RIMM: I got an email last night asking me if I was following the activists who are posturing for changes at RIMM and one of their proposals was to break up the company into three companies: devices, networks and patents? I have no idea how or why you would want to separate networks from devices, this is not NOK or ERIC with large independent business units. RIMM’s devices are directly tied to their NOC operations. I do not think that separation is even possible. It is beyond me why people with a poor understanding of the company’s technical operations are promoted by various media outlets when all they are doing is talking their book.
RVBD: The numbers look fine. I was thinking about a theory on RVBD that if there is a slowing trend of spending in enterprises, that RVBD should do better in that environment as they provide a lower cost solution that extends the life of the current network and enables enterprises to put off upgrades which is what is really needed to solve network performance issues. In time, I think RVBD’s WAN acceleration will go the way of the distributed CDN, but this is probably a few years out.
ERIC: Wow…those margins suck, but I would say that mid-30s is going to be the new normal over the LT and some companies will need to adjust to that trend.
ATT: The CAPEX number is out and it is $5,220B for Q3. Waves of relief emails are pouring into my inbox. I have been bearish on ATT CAPEX, as noted in prior posts, and I still think something is 
amiss based on APKT, PWAV and JNPR commentary. I would say that I modeled ATT CAPEX to be a little ahead of this number and if ATT still plans to spend to $20B in CAPEX, then the Q4 number should come in around $5,300-5,340B. In all, that still tells me that multiples are going to be finishing their correction, contraction process. The CFO will probably make a statement on CAPEX later this morning on their call. I have updated the charts I posted in July and added a simple chart of ATT CAPEX back to 2002. The wireless revenue miss is going to cause all sorts of questions to be asked. Does this mean they have made enough investment in wireless or not enough? I will wait to make a final call on ATT CAPEX until I hear from CSCO in November and CIEN in December.
CSCO: Acquired private company in which they had previously made an investment. This is just further evidence of a content deep networking trend and that CDNs can easily be built by service providers. I covered all this is prior posts.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. Just hover over the Gravatar image and click for email. **
I spent part of yesterday parsing Cisco’s data center announcements here and here including Fabric Path. I was trying to rationalize facts from media coverage. In trying to sort out the facts, I did the following:
1. I read a few sell side reports on the Cisco’s announcements, but there was not as many as I had expected.
2. I read numerous blogs including Cisco’s blogs.
3. I read most of the software release notes and data sheets.
4. I also configured and priced out models using the Nexus 7009 / 7018 / 5548 and Fabric Path.
My conclusion is there are some hardware improvements in terms of port densities, which help with cost per port, but this is just a lot of marketing. I should support this statement with some facts because the majority of the reports I read seem to be written by people who have very little, if any knowledge about the company and technology they are covering. I think the best way to understand technology solutions is to build and price the solution. Never believe what the marketing people tell you because they are like a car dealer who gives you a nice price, but forgets to tell that air conditioning, power package, entertainment systems and heated seats are extra. Marketing people tend to do their job, which is to find all sorts of ways to promote their products that are generally meaningless to the core function and value of the product.
I built several pricing models for the Nexus line using reseller pricing in the market yesterday. I built a set of complex models in which I make margin assumptions for Cisco and their VARs, but I think these models are too complex for a blog. I condensed the models to show list and street pricing for three components in four configurations (I did more configurations with the complex models, but for the blog I am going with simplicity).
There are two important numbers in the following chart. The first is the cost of the 10GbE spine ports and the second is the cost of the 10GbE client ports (ToRs) which include the spine cost. I chose a 
3:1 subscription model, which means there are three (3) client 10GbE ports for each 10GbE uplink port to the spine which is either a Nexus 7009 or Nexus 7018. I show the spine and client port costs at list and street and with and without optics (SFPs). For simplicity I used short reach 850NM SFPs priced as new, not refurbished.
In Cisco’s announcement there was a new fabric model (Fab-2) for the Nexus 7k series and a new 48 port 10GbE module. This helps with cost per port calculations. They also announced Fabric Path, which is a software enhancement that needs to be purchased per N7K. The release notes for the N5K say that Fabric Path will be supported in a future software release and I do not know if this will be included in the base software so I left it blank. CSCO also announced a stackable 16x40G switch for the 3000 series.
What this chart shows you is the port costs in a N7009 (spine) and N5548 (ToR) arrangement using 3:1 subscription using the old hardware. The second column is the same configuration, but using the new Fabric-2 module, 48x10GbE card and Fabric Path. The third column is a N7018 (spine) and N5548 (ToR) configuration. The <$1,200 per port list price called out by the Cisco marketing slide is calculated here at $1,146. The final column uses the N7018 (spine) and N5548 (ToR), but I priced in the LISP software which is required for inter-data center scale. According to the Cisco release notes for NX-OS 5.2 “The Locator/ID Separation Protocol (LISP) is a new routing architecture designed for Internet scale and global reach across organizations. Cisco NX-OS Release 5.2(1) introduces LISP VM mobility which is designed to enable global IP endpoint mobility across private networks and the Internet. LISP functionality requires the use of the 32-port 10-Gigabit 
Ethernet SFP+ I/O module (N7K-M132XP-12) or the 32-port 10-Gigabit Ethernet SFP+ I/O module XL (N7K-M132XP-12L). These modules can be used independently or combined with F1 series modules in proxy mode to deliver LISP functionality in a Cisco Nexus 7000 Series switch. Traffic received on other M-series modules will not be processed by LISP because they cannot operate in proxy mode. LISP does not require a new license. It can be enabled with the Transport Services Package license (N7K-TRS1K9).”
If you are a shareholder of CSCO, you are very happy with the Fabric Path announcement and the new Nexus hardware. CSCO is attacking Juniper’s QFabric scale with all sorts of numbers, but rest assured there is very little reduction in price and profit margin. This is good news is, customers staying on the CSCO path will continue to purchase vast amounts of hardware to scale the network vertically. The other action by CSCO was to fend off the ankle biters like Arista and that is exactly who the new 3016 switch is targeted against. Pricing is not available in the channel for this product as of yesterday.
When I wrote a post on how Cisco lost their way here and part 2 here, one aspect that did not occur to me at the time was how many isolated platforms are inside the company. When I read this post by a Google engineer who accidently posted his rant on what is wrong with Google on his Google+ account, it reminded me of how things must look inside Cisco which is why we got the announcements yesterday.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. Just hover over the Gravatar image and click for email. **
In eight days we are going to here Cisco’s full year FY11 and Q4 FY11 report. Prior to their Q3 FY11 results I wrote about how important Cisco’s report is for the technology industry. All the signs that CSCO had lost their way came true in the Q3 report. What should we expect next week? In the August report, CSCO is going to be the first technology company to tell us about July and they should guide FY12. If they do not guide for the full year FY12, that is a red flag. If they talk about visibility being limited, hard to define macro, and at this time only guide Q1 FY12, then red flags all around. Public sector is a big piece of Cisco’s business so we want to see this number and hear about trends.
A few other data points to look at (1) margins, is the company discounting to protect/gain share (2) commentary from John Chambers on spending dispositions from CEOs. I am looking for additional data points around slowing CAPEX which I posted here and here before JNPR confirmed with their results.
Here are two charts over the same period for JNPR and CSCO, which spans the market bottom in March 2009 till today. CSCO benefitted first from post credit crisis catch up spend, but JNPR had a longer duration uplift driven from positive product cycles against CSCO. As JNPR enters the market slowdown in 2011, do they enter into negative product cycles as CSCO refreshes product lines? CSCO issued five consecutive disappointing reports starting in May 2010. JNPR’s July 2011 report is really their second disappointing report. How many are left?
I still think the bigger problem for CSCO and JNPR is they are clinging to the past, while others are focused on what is appearing in the network. Network deployment strategies are changing. I described the past practices as “if you are selling networking equipment for CSCO, JNPR, BRCD, ALU, CIEN, etc, you go to work every day trying to perpetuate the belief that Moore’s Law rules. You go to work everyday and try to convince customers to extend the base of their networks horizontally to encompass more resources, vertically build the network up through the core and buy the most core capacity you can and hope the over subscription model works. When the core becomes congested or the access points slow down, come back to your vendor to buy more.”
Another description would be if you think network deployment strategies are changing and the inflection point of another long and sustained network build out occurs in the 1H of 2012, then you need to be pretty far down the product/solution development effort path. It is August 2011, which means it is really September because everyone is on vacation. If you want to start selling solutions and deploying solutions in the 1H of 2012, you need be aggressively moving on the plan of record (POR). You have about five months to get product development efforts complete enough to sell and position in your key accounts. What I am going to be looking for at industry conferences over the next few months is evidence that the legacy Moore’s Law companies have realized there is a change and they are now trying to skate to where the puck will be, but I suspect I will find no evidence of this and they will be focused on skating to where they want the puck to be. Game is on.
/wrk
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. Just hover over the Gravatar image and click for email. **
The numbers that matter:
Q3 Revenue: $10.866B
Q3 Product Revenue: $8.669B
Q3 Services Revenue: $2.197 B
Gross Product Margin: 63.9%
Bookings commentary: “about one” from the CFO. This tells me that bookings were around $8.600B. I think backlog going into Q4 is around $4.025B, which is actually slightly less that the start of Q3 hence, the lowered guidance for Q4. For Q4 management guided revenues to be in the range of $10.84B-$11.05B versus the previous guide of $11.7B-$12B. In short, management pulled a billion off the table and they did this in traditionally their best quarter. If you look at the fiscal years between 1994 and 2010, the fiscal fourth quarter was the highest revenue quarter 14 out of 17 years. For people who like statistics, I would state that the stock has never worked when their best quarter was not in Q4. Worrisome was commentary about the switching business, margin pressure and the GM guide of 62%. Through in public sector spending comments and the upcoming deficit ceiling debate and muni market mess I would not be expecting much out of this sector for awhile.
FY12 Guidance: None
If you look at the updated stock chart below, the stock has rallied into the last five prints only to sell off sharply the following day. Will tomorrow make 5 out of 5? I put a little red line in the chart as I think the stock goes to around $15. Anytime management is talking about layoffs, core business segments under assault and closing of product groups, competition, etc, it is hard to see anyone paying a premium to own the equity. It is not a disaster. They make a lot of money and have a lot of cash. It is just really hard to move the top line when you are putting up $10B quarters and there are a lot of people attacking your success.
Side note…John said the word “compute” four times. That is four times more than he did in the last four quarterly calls combined. Was he reading my blog? Hi John if you are reading and do not forget to read that copy of my book I sent you.
/wrk
** It is all about the network stupid, because it is all about compute. **
Welcome to Cisco week. CSCO reports earnings after the close on Wednesday. When I was on the buy side this would mean a mind numbing night of numbers after a conference call that was too long and too repetitive. Cisco is an amazing company that provides a far better set of financial data than the vast majority of technology companies. It is the broad data set provided within CSCO’s results that are relevant for tech. Here is a partial list of companies that have revenue exposure to CSCO:
|
NETL |
OPXT |
FNSR |
JDSU |
AVGO |
AVT |
JBL |
FLEX |
CLS |
SANM |
|
BKHM |
IDTI |
CAVM |
MERX |
PMCS |
BRCM |
MSP |
AMCC |
APH |
MRVL |
|
MSP |
ALTR |
XLNX |
SIGM |
FTNT |
EZCH |
ATHR |
Then there are the competitors:
|
JNPR |
FFIV |
BRCD |
EXTR |
HPQ |
QLGC |
APKT |
NTGR |
ARUN |
RVBD |
As mentioned in a previous post, the stock has been a loser for the past year. Of late there has been more positive sentiment on the stock by sell side analysts. This comes from three sources: (1) management changes (CEO’s letter to the employees), (2) strategy/product changes and (3) positive channel checks. The stock has bounced a little and management has set a high bar for this quarter (Q3) and next quarter (Q4). This is the area that I want to explore because I would contend that the financial data set provided by the company really does help an investor understand the velocity of business within the technology industry. The company provides backlog data on an annual basis, they provide product bookings trend on a quarterly basis and in early 2009 the CEO went as far to provide monthly product bookings data. When I state bookings and backlog I am only referring to product bookings and backlog which does not include services. Look at the information that the CEO provided on the last three calls:
- Q4 2010 “From a global perspective, Q4 product orders grew 23% from a year-over-year perspective.”
- Q1 2011 “From a book-to-bill perspective, while product revenues were very good at 21% year-over-year growth, total product order growth was only approximately 10% year-over-year; therefore, book-to-bill was below 1.”
- Q2 2011 “Moving on to a more general picture of our products, total product book to bill was greater than 1, and backlog increased. Product orders grew approximately 8% year-over-year, while total product revenue growth was 3% year-over-year in Q2.”
If you go through the financial numbers when filed with the SEC (note the results on Wednesday will be preliminary) and take what the company tells you on the quarterly call, it possible to build a model to predict the linearity and velocity of CSCO’s business. I have such a model and I will not share it on this blog. It culls a decade worth of performance data, management commentary, sell side notes, etc into viewpoint designed to predict how management will guide the business versus market expectations. This can be reproduced, especially if you have no life and like to spend many hours reading and calculating numbers on a spreadsheet. If I look at the model here is what it is telling me for Q3 which they report on Wednesday and Q4.
The model calculates backlog, bookings and other ratios and average expected values based on the data set Cisco provides. I am sure the model’s backlog calculation is not accurate to the actual company’s backlog, but the model is providing an output that is close enough to be of value in predictive terms as to how the management team will guide the business. If I look only at the data set for last 14 quarters a few statistics are apparent:
On their Q2 FY11 call, CSCO guided revenues to $10.9B for Q3 and $11.85B for Q4. I am using the mid-point of the guide for Q4. This revenue level is a tad aggressive. Assuming that the services business continues to grow by ~$100M a quarter, Cisco is expecting two big back to back bookings quarters or they have deferred revenues coming off the books they expect to recognize. In the past 14 quarters, CSCO has missed the revenue line once (Q4 FY10) by 28bps. That tells me they have an excellent near term ability to predict the follow-on quarter revenue. If the management team says they are going to print $10.9B for Q3 FY11 I believe them.
What is surprising about the $10.9B number is it implies a big bookings number in Q3. I estimate to get to this number the company needs $9.1B in product bookings followed by $9.75B in Q4, which is typically their best business quarter. I think it can be done, but we are assuming that in a quarter of organizational changes, mea culpa letters, soul searching that the company was able to be focused on the business. I am going to take them at the word on the Q3 revenue number; I just wonder what they had to do to get the numbers done? Will product margins suffer? The two most important forward looking numbers that management will provide for Q4 and Q1 FY12 will be (1) revenue and (2) margin trajectory. The stock will work or fail off these two metrics. If you are long CSCO, then you are making the assumption that management can run the business to achieve a high rate of customer wins, margins are stable and this implies that the economy is getting better. If you are bearish CSCO, you think they have negative product cycles in switching and routing, margins will suffer and the company is unlikely to grow a pace to move the stock. See the product revenue by quarter chart, the downtick in switching has been a big concern for investors.
Here are some charts that make you cautious on the forward expectations:
The Broader Meaning of Cisco’s Results
As soon as the CEO provides some bookings commentary the model I have can calculate the expected guidance for the forward quarters. Beyond this exercise in buy side / sell side / management alignment, I think that CSCO’s report is going to provide some clarity to three questions:
- Can the market specific competitors (e.g. APKT, RVBD, JNPR, ARUN, FFIV) continue the momentum against CSCO?
- Will technology spending in general see a positive or negative inflection going forward?
- Has CSCO stopped the negative product cycles (e.g. switching) and momentum?
If the forward guidance is soft and the product segment data looks poor, I would say this further proves in the theory that focused competitors are hurting CSCO and this is good for FFIV, APKT, RVBD, JNPR and ARUN.
Reaffirming or increasing revenue projections would imply that the US and maybe the global economies are getting stronger and that caution should be considered on being long the CSCO competitors. The argument can be made that a rising tide lifts all boats, but some consideration of competitors eating CSCO’s lunch in specific markets must be considered and whether CSCO has decided to defend and take market share. Margins will be an indicator. Net/net…I wait to hear what management has to say before I make my choices.
Any lower guidance on revenues or poor margin guidance would be bad for the stock. That would mean that you want to be long the CSCO competitors and that the management team needs to go back into the Telepresence chamber and figure it out.
/wrk
** It is all about the network stupid, because it is all about compute. **
This section is a modified email of an exchange I had with a CTO of networking startup. I have removed any specific references to the company and focused on what I think are the emerging trends in networking and this is where Cisco needs to be focusing. I am going to start with how value has been created in the networking segment post 2000.
When I look at a handful of IPOs in recent years (RVBD, INFN, DDUP, BBND, STAR, MITL, BSFT, APKT, etc) the parallels to the 1990s are clear. I looked at all of these companies while on the buy side. I became very familiar with the management teams, operating characteristics of the companies, what really worked and what did not work.
- RVBD: What did they do? Put a drive in a network element to cache content and improve the compute function at the edge of the network because the CIFS protocol was too chatty and the network did not have an enough bandwidth/capacity to overcome the software coding limitations. So the content was moved deeper into the network. In the case of RVBD, this was not really innovative. I was on a engineering team that coded various run length compression algos into bridges and routers in the late 1980s and put PBX functions in an ATM based CPE box in the 1990s. What was innovative about RVBD was the mechanism used to identify the content frequently called by remote users and move that content locally to improve the local compute cycles and then sync the data between the storage points. The key point to focus on is compute.
- FFIV: In my view, the game change for FFIV came after the 2001 crash. They opened their platform (Big IP) up to 3rd party apps with a developer’s kit, API, simulators, tools etc. They then let the community of users share these apps. When you talk to big banks (I spent a lot of time with CIOs and developers of the top ~10 banks over the past few years) you find out they have 10s of thousands of apps. FFIV organically created a community of users who became very loyal because of this community. This community also became compelling to new users. Lesson learned was opening Big IP platform to market to create a community of application users. BTW…applications are about compute. Note…JNPR is trying to do this with JUNOS, but it is not quite the same. JNPR is more partner OS related than end-user related.
- INFN: I am going to say very little about INFN. I will just summarize by saying that the commoditization of the optical component supply chain happened far faster than they estimated and when they brought a system level product to market the price disruption was far less than expected. Hence…a lesson…processor, memory, capacities tend to be commoditized on a horrible curve of buy more for less. When processing, capacity, memory are sliding on the curve of more for less, this means software will just consume the compute cycles. If you doubt me, there is a reason Apple developed their own processors.
- DDUP: I think these guys wrote the book on how to build an innovative, disruptive business in a market structure with large dominant companies. Lesson here is that operational software that removes the need to spend huge amounts of CAPEX on storage arrays and increases the effective utilization of sunk cost is a winner. Why would a customer what to effective move data from tier 1 storage to other tiers? Answer is to allow compute cycles and new apps to use the top tier.
- STAR: They made a really smart bet that EVDO would have much longer theta than the incumbents where willing to assume. Hence, they were the only real innovator of software on a HW platform. If you have ever seen an ST-40 up close it takes up a whole rack of power in a CO. This thing has more silicon in than a beach and runs hot, hot, hot – yet it has software margins. How? When you looked at what STAR sold it was a software MCP with all the management tools built on a custom hardware platform.
- APKT: I wrote a blog post on APKT the other day so that will stand as my place holder.
Network Trends I Believe:
Processors, memory, storage and bandwidth are elements that you can buy more for less over time. The companies that create extraordinary value find ways to arbitrage the gap when one or more of these elements become dislocated. Look at RVBD; when drives became cheap enough and large enough it made economic sense to fix the transaction cost of CIFS for SQL servers by caching the content. The ultimate need is compute, but the problem was an inefficient, poorly designed protocol and not enough network capacity that was cheap enough to fix the protocol problem with the network. DDUP is another example.
Akamai, what did they do? Built a better way to call for and process content. They cached content which means they moved the compute function deeper in the network to overcome network bandwidth/capacity limitations with their routing algorithms. What problem did AKAM really address? The answer is compute. They made compute (consumption of web content) easier because the network could not handle the traffic load so they distributed the compute function by moving the content deeper into the network, replicating it and finding more efficient routing paths to call for the content.
Virtualization and all the commodity cloud networking trends are forcing applications and data to be partitioned and replicated across multiple data centers. Data sizes will continue to grow as we move from click streams, to scientific data, to user audio, photo, and video collections. Processing or the compute function of these trends will really run in parallel on thousands of machines. All of this is leading to the enablement of scale out networking (to use the Google term) which is…
If you believe in this compute trend and that optics/bandwidth will follow the curves of processing, memory then the network is out of sync with the other elements. The need becomes TB and PB metro and access networks that evolve to EB networks in ~10 years (a guess on my part). Virtualization should really be a positive driver for network equipment suppliers because of replication and accessibility of data for compute. CSCO had the correct thesis, it is all about the network – the problem is they got to big and lost focus on the network. That created opportunities for companies like RVBD, FFIV, APKT, DDUP, to really hurt them in market silos that CSCO cannot seem to get the A team to focus on.
What Do Networking Products Look like in the Future?
If we assume the network trends discussed above are true, then networking companies need to be focused on applications and compute to be a strong value creator – instead of a hardware box supplier. As part of this thesis here are five key elements:
It is all about the network stupid, because it is all about compute.
/wrk
At bottom of this post, I included a copy of a blog post I wrote on 08.09.06. After their earnings report on 08.08.06, CSCO’s share price went on a run increasing 67.24% over the next five months. I remember back in 2004-2006 timeframe, CSCO sales reps had a presentation for customers buying Ethernet switches entitled “Cisco and the 8 Dwarfs.” It was all about how they dominated Ethernet switching and all the other players were niche players or insignificant players. Four and half years on my 08.08.06 blog post, the world is dramatically different for CSCO.
Recently John Chambers, CEO of Cisco, wrote an all hands memo that foreshadowed a number of organizational changes. This is all searchable on web. I going to walk through the challenges CSCO faces and outline the area in which I think Cisco lost focus. We will start with the challenges:
1. Ankle Biters Hurt: Across a number of market segments, CSCO has a number of strong, well focused competitors. A partial list is RVBD, FFIV, APKT and ARUN. These companies are attacking portions of Cisco’s business and I think it is plausible to assume that on an individual basis it does not matter to Cisco because any one business segment is not big enough to matter. I worked at company that Cisco destroyed in the 1990s and maybe the Cisco of today that turns out $10B quarters is just a bigger, less mean and more cuddly version of their former self. When I talk to Cisco competitors, none of them are in fear of Cisco and that is a real change from four years ago.
2. Dwarfs got Bigger: When I wrote the 2006 post the Ethernet switching market really was Cisco and everyone else. FDRY was the Porsche of the industry. They were six months ahead of Cisco on features and focused on performance. They had their niche, their loyal group of fanatical buyers who needed to have the fastest switch with the most advanced features. Everyone else was also-ran in the market. What happened was that 3Com refreshed their product line with the help of Huawei, HPQ bought them which effectively fixed their North American channel which had been left for dead years ago in strange, almost fatal decision by the prior management team and Juniper (JNPR) decided to get into the switching business. Brocade buys FDRY and now the dwarfs are bigger, well capitalized and with refreshed product lines.
3. Internal Decision Makers Became Confused: I think the new management structure that CSCO rolled out in early 2009 confused the company. I know it is easy to say that management by committee does not work, that is why I am not saying it. I give the company credit for trying something new at the height of the recession. There was no better time to take the gamble. That was the time to try something new, unfortunately I think the new management concept confused the leadership of the company from the middle levels on up. The company became too internally focused and missed the world around them. Below are four quotes from John Chambers during the four earnings calls in 2009 regarding the new management structure.
11.04.2009: “In Q1 we conducted 77,000 Cisco internal meetings, had another record quarter in terms of units sold, selling over 570 systems and adding approximately 85 new customers. We just recently celebrated our three-year anniversary since launching TelePresence, and since that time we have conducted more than 500,000 internal hours of meetings and 427,000 meetings, to be exact.”
08.05.2009: “…today we are investing in 30-plus new market opportunities that are adjacent to our core business, and in each of these cases the technology architectures drive innovation in our core products, which we believe translates into growth. Assuming we’re successful in many of these opportunities, you will see us expand well beyond the 30 that we have today. Our innovative organization structure of councils and boards brings together leaders from across the functions, all of our corporate functions, to define, plan, execute and monitor our progress in these market adjacencies. This disciplined approach allows our teams to scale and work across opportunities with both speed, flexibility and then to be able to replicate these models quickly. You can expect these market adjacencies to become a growing part of our business over time, just as the advanced technologies did, looking back several years ago. While some of these may be able to be discussed in ways similar to our earlier advanced technologies, others may not easily be discussed as standalone segments.”
05.06.2009: “Our new organization structure of council’s, Boards and working groups as discussed on the last call is operating very effectively. These structures allow speed, scale, flexibility, and rapid replication. An example of this speed, scale, and replication is since our last conference call we have added three more market adjacencies to our list which is the last conference call was the 26th, these three new ones include virtual healthcare, second, safety and security, and, three, smart communities bringing the total of these cross functional priorities or market adjacencies to 29. And of perhaps equal importance our largest customers understand how this highly innovative management structure and these business models we have been talking about can launch this many major products into market adjacencies with quality. That’s something probably is the key tipping point we’ll talk about more later in terms of our customers grasping what this means in terms of speed but also the ability to move into so many markets at one time.”
02.04.2009: “Our organization structure leverages the power of communities of interest, which we call councils, which we believe are (inaudible) opportunities, Board that we see as [1 billion] opportunities and working groups. These organization structures allow us to more effectively prioritize resources across over two dozen cross functional opportunities as well as within each of our corporate functions.”
4. CSCO lost their Competitive Edge: It is easy to ask questions like why did CSCO pay $600M for a handheld video recorder in March of 2009 when the iPhone was in the market? Android phones were on the way and handheld digital devices were getting cheaper and more sophisticated. Although the Pure Digital decision was a disaster, I would blame #3 for this decision, but in my view the real issue was that focusing on the Flip device took focus away from the core business. It is all about the network – not the devices. It is the network, stupid, to coin a phrase. I think Cisco needs to get back to focusing on the network, which I outline in the second post. Cisco needs to return to the foundation of the company and stop trying to be too many things.
5. How the Stock Price is Likely to Act for 2011: As per the CEO’s internal memo, the company is organizationally challenged and they are trying to fix the execution issues. That is a start and likely to take some time. We are in the month of April (almost May) and it hard for me to see the stock rebounding until 2012. The NASDAQ is up 8.12% YTD and CSCO is down -14.38% YTD. I find it hard to believe that any long only money manager is going to be buying CSCO at this price level. It is not cheap enough for value investors and the business turn around will take time. If numbers are trimmed again the stock cannot work for 2011. Long only money managers will use it as a source of funds and buy other stocks lifting in their benchmark. The FOMC has a floor under the market for the near term and bond market outflows into equities are likely to continue, hence I find it hard to believe that CSCO is going to a lot of love in 2011. Cisco’s management team gets a pass for 2011. Forget about the stock price, focus on the business. Worry about the stock price in 2012. CSCO stock chart below.
{Part II: A Strategy to Move Forward: tomorrow}
/wrk
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Wednesday, August 09, 2006
Cisco Results: Understanding the Hidden Message
The quarterly results posted by Cisco yesterday afternoon were spectacular. Revenues were up, solid earnings, cash is just short of $18B, DSOs were up, but who really cares when you are $28B company and growing. If you take the time to read through the press release there is a section called “Business Highlights” towards the end. This is usually the pompom waving portion of an earnings press release, wherein leadership teams try to include existential data points to frame the progress of the corporation. The first bullet that the Cisco team chose to highlight was: “Cisco’s core enterprise networking platform, the Cisco Catalyst 6500, surpassed $20 billion in sales.”
The Catalyst 6500 platform started as the first acquisition by Cisco in 1993. The company Cisco acquired was named Crescendo Communications and the price was $94.5M. Twenty billion in sales later, the Catalyst 6500 product family does not look anything like the first Crescendo products from thirteen years ago – but the impact of that acquisition is affecting the market today for several public companies as well as several private companies, a number of venture capital firms and the investment banks on Wall Street. The significance of the market share dominance that Cisco enjoys in the switching market can be seen in three areas of the overall market:
1. Extreme Networks and Foundry Networks: Both of these companies are public companies. Over their seven years of existence, they have achieved around $5.2B in combined total sales. Two companies with a broad set of products focused almost exclusively on the switching market have total sales that are a quarter of Cisco’s total sales in the same networking technology vertical market.
2. Brocade and McData: There is a reason why Brocade and McData are merging. That reason is Cisco. The reality is the FICON and Fibre Channel switch business is being attacked by Cisco. Brocade and McData simply decided that it was better to combine their market share and development efforts with the hope that by concentrating their forces, they can prolong their existence and hold off Cisco.
3. Force10 IPO: Force10 Networks competes in the same technology vertical market as the Cisco Catalyst 6500 and the products from Foundry and Extreme Networks. F10 has reportedly raised more then $300M in venture capital. $300M for a company to build a business in a market dominated by Cisco with market share probably greater then 75% and handful of other companies (some public) fighting for the remaining market share. I would think the investors of F10 as well as the investment bankers on Wall Street would love to take F10 public. It would mean a nice payday for everyone involved in the seven years it has taken to build the company. Alas, we are still waiting on the F10 IPO.
I think Cisco let everyone know why there is market consolidation (e.g. Brocade/McData) in the switching business. Why new entrants (i.e. F10 Networks) cannot build a business that can support an IPO. Why smaller players in the market segment cannot grow revenues (i.e. Foundry and Extreme). It is because Cisco has a $20B installed base and plans to protect their market share aggressively.
/wrk
