As we head through earnings season, we get the opportunity to learn a bit about the state of the networking industry. Each data point gives us a bit more information about how the competitive landscape is unfolding, and ultimately how this will shape the market. So what do we know so far?
Start with Arista
Perhaps the most important data point for anyone in the networking industry not called Cisco is Arista’s post-IPO performance. Since their much-anticipated IPO earlier in the year, Arista’s stock is up more than 25%. Part of the price certainly reflects pent up demand, but performance also tracks with their impressive earnings growth.
So what does this mean for the rest of the industry?
Arista proves that there is demand in the networking market and that there are large enough volumes of customers who favor value more than pure incumbency and entrenched relationships. It also suggests that the market needs a strong second supplier for networking solutions.
While customer demand does not ensure vendor execution, it does mean that if vendors can demonstrate value, there is enough interest in the marketplace to build very lucrative businesses. It is true that there will always be buyers who subscribe to the mantra No one ever got fired for buying Cisco, but there is reason to believe that the cadre of those who put building something better above merely avoiding risk is growing.
What about Cisco?
Cisco’s earnings coverage has been dominated by the announced layoff of 6,000 employees. We should be somewhat fair when looking at these numbers. Cisco employs more than 70,000 people worldwide. While 6,000 is no small number, Cisco’s employee purges are really an annual event. At a company with as diverse a portfolio as Cisco, we should expect that they will constantly evaluate the bets they have placed, and then back off investments that aren’t performing and double down where it makes sense. To put it candidly, I think that people are taking their eye off the ball a bit by focusing on the cuts.
So where should we be focusing if not on the cuts?
Cisco’s numbers were actually not bad across the board. They beat estimates by by 2 cents per share and consensus revenue estimates by $300 million. To put those numbers into perspective, they beat estimates for the quarter by about as much as Arista earned in all of 2013. That’s not a bad haul. Another interesting point of view – for Cisco to grow 10% year-over-year, they basically have to build a Juniper Networks every year (not easy considering Juniper took 16 years to get to $5B in revenue).
That said, the stock has been hammered a bit. So why? Basically, Cisco’s strong numbers are underpinned by a couple of scary trends. Weakness in emerging markets (especially China) is worrisome. But beyond that, they reported year-over-year losses in both routing and switching (7% and 4% respectively).
The emerging markets trends are not terribly surprising given the global fallout in the post-Snowden era. But those trends are more damaging when you consider the losses in both routing and switching. It would appear that Cisco is losing share across both areas. So long as new markets are growing fast enough to offset share movement in more stable geographies, maybe things are not so bad. But if those new markets stall out, then share losses mean there is significant headwind.
When you take competitive growth and Cisco losses side-by-side, you get a little bit of nervousness in the investor community.
Why margins matter
If competition is heating up, Cisco will have to pay closer attention to pricing. This is partly why there is a strong focus on Cisco’s gross margins across the board. The fear for some is that a changing network landscape that features more competitors and new technology trends like bare metal switching will ultimately force Cisco to drop those healthy margins down into the 50s (they reported 61.8% for the year).
Interestingly, if Cisco is forced to drop price, it will actually create shockwaves through the industry. Players who have counted on being cheaper as part of mitigating the risk of switching to a new vendor will find that one of their competitive edges has been blunted. In markets that tend to buy on features and performance (carrier routing, for instance), this might not matter so much. But in more price-sensitive spaces (switching, for example), this starts to matter.
It will be interesting to watch both Arista and bare metal advocate counterpunch. They have to be preparing for Cisco to drop prices aggressively at some point. This could be why we are seeing a lot more attention paid to DevOps and automation, both of which allow vendors to continue the Total Cost of Ownership discussion with OpEx replacing CapEx in the models. The challenge is that OpEx is notoriously hard to model well.
Beyond the big numbers
The other number Cisco talked about is around ACI adoption. Chambers indicates that Cisco has over 580 ACI customers. Strictly speaking, I believe this number refers to Nexus 9000 customers, which is arguably not full ACI without the APIC controller (recently shipping). But regardless, for a nascent product (announced last year but fairly recently available), this demonstrates strong demand. More importantly, this indicates a healthy appetite for a different way of networking. Cisco’s ACI represents a new architecture built around the application and leveraging an SDN architecture. That customers are willing to migrate from legacy deployments to a new architecture is telling. It signals a change in buying behavior that favors solutions that are more application-oriented.
An interesting juxtaposition
Arista’s strength and Cisco’s ACI progress create an interesting juxtaposition. On the one hand, you have a market that is hungry for a second supplier. On the other, you have a set of buyers interested in a new way of networking. At some point, these trends will have to reconcile. The result has to be that a second supplier to the newer networking paradigms emerges. This creates intense opportunity, which will nurture a renewed focus on innovation in an industry that spent most of the new millennium making only incremental improvements.
The bottom line
So who wins? Ultimately, the winner has to be customers. Competition breeds improvement, both in terms of pricing and innovation. Those companies most capable of innovating should find hope in both Cisco’s and Arista’s earnings. And anyone banking on a legacy networking approach should eye these results with a concerned eye. We will see new players continue to rise at the expense of the laggards. And no amount of product re-labeling (But I SWEAR it’s SDN!) is going to make a ton of difference.- See more at: http://www.plexxi.com/2014/08/can-learn-ciscos-latest-results/?utm_source=feedly&utm_reader=feedly&utm_medium=rss&utm_campaign=can-learn-ciscos-latest-results#sthash.tRy4uilS.dpuf