Enterprise-Switching Dilemma Behind Cisco’s Strategic Shift

If Goldman Sachs is right, Cisco will be faced with a dilemma in 2010. Under mounting pricing pressure from emboldened competitors in enterprise switching, Cisco will have to choose between defending is margins or defending its market share.

If it chooses to defend its market share — which slipped from 75 percent in Ethernet switching as of the fourth quarter of 2008 to 69 percent in the third quarter of 2009 — it must tolerate reduced margins, never an easy option for a public company.

On the other hand, if Cisco decides to hold the line on margins, it will be condemned to lose market share, along with the ongoing revenue flows attached to defecting customer accounts.

In developing markets, Huawei is putting price pressure on Cisco. In the USA, Cisco is facing a renewed pricing assault from a slew of vendors. That situation is likely to intensify now that HP has acquired an army of low-cost Chinese engineers and competitively priced products and technologies as a result of its 3Com purchase.

Goldman’s research found that performance and price were the foremost considerations of 100 Ethernet-switch-buying IT executives at Fortune 1000 firms. As Goldman notes, those priorities suggest “best-of-breed vendors with superior price/performance can gain market share despite Cisco’s significant incumbency advantages.”

Cisco isn’t going to be transformed overnight from a bruising champion to a battered has-been in enterprise networking. Nonetheless, the networking giant is gradually losing the aura of invincibility that shielded it like an impregnable bubble in Fortune-listed accounts. It is vulnerable to losses, and its rivals know it.

The question is, does Cisco know it? I would argue that it certainly does.

That’s why it is pursuing the strategy of “market adjacencies” that is taking it into new, unfamiliar territory. Cisco saw the writing on the wiring-closet wall, and it didn’t like what it said. The company saw a mature, slow-growth market susceptible to increasing commoditization, with all the pricing pressure that such a situation entails. It was facing a double whammy of slow growth and reduced margins.

Cisco will fight, of course. It will pull out all stops, use every sales trick in the book, and leverage every last ounce of goodwill and loyalty from its enterprise customer base. But some of the factors arrayed against Cisco are beyond its control. There’s only so much it can do, and there are limits to how much territory it can protect if it plays the old game by the old rules.

Give Cisco credit. It’s sales force has been accused of arrogance, but the company’s executive team isn’t so hubristic as to overlook or to underestimate looming dangers. It knows what’s coming, whats’ been building on the horizon for a while now. That’s why it devised the all-or-nothing Unified Computing System (UCS) for the converged data center — and that’s also why it’s barreling into so many new markets.

Cisco is trying to change the rules of one game while getting involved in several new ones. Adhering to the old rules, just playing out its hand in enterprise switching, wasn’t an option.

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