Cisco’s Investor Day was all about their growing position in the software space. Software grew from 20% of revenues in 2017 to 30% in 2021, which is certainly a validation of their claim of software growth. What’s far less clear is whether Cisco’s avowed shift to software is offensive or defensive, and whether it can sustain bottom-line revenue growth for Cisco in the longer term.
Cisco’s product revenues, which include software, were $36.014 billion for the year ending July 31st, and were $39.005 billion for the year ending July 31, 2019, a decline of just short of three billion. If software revenues are indeed growing, then hardware sales declined more than that between 2019 and 2021. The key point, I think, is that Cisco is expecting to have its hardware “persist” longer in accounts, and will rely on software subscriptions for the devices for annual revenues.
This theme is attractive to Wall Street, who believe that hardware is under pressure both from budgets and competition, and who apparently think that the sky’s the limit with respect to software. If that were true, then Cisco is rushing down the Yellow Brick Road, but is it? There are three challenges.
Challenge One is feature exhaustion. Most of Cisco’s “software” is really what some (including me) have cynically called “underware”, the software designed to create functionality for a hardware platform like a switch or router, or to manage networks of those platforms. In a real sense, it’s like a form of operating system. Even before Cisco separated its hardware and software, there were plenty of users of its IOS network operating system family who didn’t upgrade. The thing that keeps users upgrading and paying for subscriptions is new capabilities. It’s not easy to add those new things year after year, and maintain a sense of user value.
Many of my readers may not remember Novell, who stepped out in the 1980s as the darling of workgroup networking. NetWare was the network operating system of choice for enterprises, the source of print sharing and file sharing, the start of the notion of resource catalogs, and a lot more. The problem was that Novell made money by selling and upgrading software, and over time they used up more and more of the stuff users valued. Eventually, there wasn’t much left to add.
That leads us to the second challenge, which is exploding competition. Novell was hit hard when Microsoft added basic resource sharing to Windows, which is one example of exploding competition. Cisco can expect other network equipment vendors to counter its own “disaggregation” of software and hardware, but there’s a more serious competitive risk. In order to create value-add to justify continued subscription revenue, Cisco will have to expand beyond basic routing/switching. That leads it upward into hosting, which of course they’ve offered via their UCS servers.
Well, maybe. At Cisco’s recent investor conference, many were surprised to see that Cisco made almost no mention of UCS servers. It’s hard to see how Cisco could really be aiming to be a serious software player if the only “software” they offer is that “underware”. Competition and the need to create update pressure for customers would drive Cisco upward, into areas where the software is more generally linked to computing tasks. How could that be done without servers to run it on? Why, if you had servers in your inventory already, wouldn’t you prepare a place for yourself in the general or at least edge-focused hosting market, by pushing the fact that you’re a server vendor already?
The edge-focused piece is of particular importance because Cisco, like all network vendors, would probably find the easiest path out of pure packet-pushing to be edge computing, which is evolving from 5G hosting missions that are (as I’ve noted) already budgeted. Not only that, server and software vendors like Dell, HPE, IBM/Red Hat, and VMware are all going after the 5G hosting and telecom opportunities, and their efforts threaten network equipment.
That threat is multiplied by the possibility that the same software would be hosted in both servers and white boxes. If major software players offer that sort of dualistic software, then a Cisco retreat from hosting might well result in software players creating a growing customer interest in white-box switches and routers. That could cut into Cisco’s device sales and make them even more dependent on a strong, expanding, software strategy.
The final challenge is facing internal push-back. Cisco has tried the software game for ages, and it’s never measured up to their hopes. I think that a part of that is due to resistance from the traditional hardware types that have dominated Cisco engineering for decades. Today, as I’ve already noted, Cisco is really not a software company at all, but a hardware company who separated out their previously bundled software. That move didn’t create the same back-pressure that earlier and broader software initiatives created, but Cisco can’t stay on that limited software track and keep revenue flowing.
The further Cisco’s software aspirations diverge from “underware”, the harder it will be for Cisco to rely on the skills it has in house, and the more new people will be needed. As that influx shifts the balance of power, it only magnifies the resistance of the employees who have been with Cisco the longest, and who have likely worked up to senior positions. Will those people embrace the new software dominance? Doubtful.
The net of all of this, for Cisco, is that making software claims is easier than making software the center of a future revenue universe. The most problematic thing about their investor-meeting story, in fact, is the lack of emphasis on UCS. That’s Cisco’s biggest, and most unique, asset among the network-equipment-non-mobile vendors, and it would logically seem it should have been a focus of the discussions, which it decidedly was not. There are three possible reasons why it wasn’t.
First, Cisco might have no intention of broadening its software position beyond “underware”. If that’s the case, then their only justification for their story to investors would be to buy time while they try to figure out where they go next. That’s not a good thing, obviously.
Second, Cisco might actually believe that they only need “underware” to succeed in software. If that’s true, then I think that instead of looking at a rebirth, as Cisco and the Street have suggested, we might be looking at the start of a major slip from Cisco dominance. Think Novell, and that’s a very bad thing.
Third, Cisco might be preparing a true software blitz that will indeed involve UCS, and are just not ready to expose their plans. That would avoid having competitors in the server/software space jump in to build barriers to Cisco before Cisco really has anything to compete with the competitive offerings. That’s semi-OK as a reason for their seemingly ignoring UCS, providing that they actually have that “true software blitz” in the wings, and quickly.
A software strategy for Cisco obviously has to meet Cisco’s own revenue/profit goals, but to do that it has to meet the goals of the buyers, deliver the ROI they’ll demand. Right now, Cisco has a software transitioning strategy that’s not transitioning to a state that will clearly deliver on that, and they need to fix that quickly or they’ll not only fail to deliver on their promises in 2022, they’ll risk putting their whole software-centric vision at long-term risk.
