Cisco published its earnings report this past week. While the company beat the street on both revenue and profits, Cisco had to execute massive layoffs to get costs in line as it faces ever-increasing pressure from HP.
As you may recall, Cisco was required to discontinue most of its catastrophically failed consumer business as it retools to fight this war of its lifetime - a battle it may not be able to win. Indeed, HP has been discussing its "Manhattan Project" in their war with Cisco, a strategy very similar to the one which caused Sun to fail.
Obviously, this shouldn't come as much of a surprise, because HP was instrumental in killing Sun.
You see, HP plans to nuke Cisco’s profits and the latter corporation, like Sun, isn’t set up to run as lean as HP.
They can’t shift without cratering their stock - but if they don’t shift they will become extinct. Let me explain this more in-depth, as the back story is actually rather fascinating.
The HP Cisco War
Cisco declared war on HP, seemingly without realizing it wasn't at all ready to take on a company like Hewlett Packard. You see, the general computer business is a thin margin business increasingly supplemented with software margins. This means it is trending to zero or even negative margins on hardware - offset by the large margins software and services which will, in a razor and blade like model, support the company.
IBM, HP, Oracle, and Dell are all solidly on this path, though it will likely take a while for their competitive efforts to fully collapse hardware margins.
Remember, Cisco lives off massive hardware margins on switches - generally over 60% - and has no real software business to offset them. Obviously, they do offer certain services, but not to the same massive scale as large enterprise solution vendors. IBM is the largest in services, HP bought EDS and Dell snapped up Perot Systems to expand and stabilize both profits and customer churn.
Until they went into servers, Cisco was a horizontal player, leveraging firms like HP, IBM, and Dell which resold their products. Now, increasingly, these firms are applying what they know about building very thin margin systems to networking. Meanwhile, it is becoming quite clear that Cisco isn’t built, (any more than Sun was when the PC model was taken into servers), to survive, let alone thrive, in this new world.
HP’s Manhattan Project
However, HP’s Manhattan Project, (my name not theirs), is an optical switch slated to cost 1/10th of what Cisco’s comparable product is priced at, and 20% less than Cisco’s older electronic offerings. It is also vastly cheaper to upgrade and easier to integrate with storage and server systems in the same rack - much like HP’s current offering. This just isn’t an attack on price alone, but rather, the switches should be far more energy efficient and integrate seamlessly with the full suite of HP’s other back office offerings.
When it launches, the finished platform is expected to reflect the full power of HP and will directly target Cisco’s massive margins with the primary goal of destroying them.
The transition from electronic to optical switches will be the next truly big thing in the networking space. Unless Cisco can respond in a timely manner, HP will ride the wave with Cisco floundering in the water. Think about it: how many companies can miss a massive wave like this in their own space and survive?
HP's offering is slated to go live in about 3 years - which in this marker is really no time at all.
The Secret Back Story
Cisco does have a significant R&D budget which it appears to be increasing. Still, what it doesn't know is that HP has been secretly working on this technology for over a decade. The efforts were so secret even their executive management was unaware of the unique developments in the optical space because they were intentionally hidden from them.
The back story here is that neither Carly Fiorina nor Mark Hurd wanted to take on Cisco. So, the optical lab largely was funded through the equivalent of a black ops budget and equipped with hardware from the failed .Coms. But don’t think the cloak and dagger atmosphere limited the initiative, as there was a significant amount of highly equipped networking technology and funding available from the .coms days.
Wrapping Up: Armageddon?
I’m not sure Cisco fully realized what it would be like to compete with a thin margin vendor. Certainly Sun didn’t see the risk till it was far too late. Typically, there is only one outcome and that is the higher margin company going to the big corporate graveyard in the sky.
However, Apple - which weighed in this week as the top valued U.S. company - is a high margin firm which does battle with corporations like HP all the time. Ironically, Apple is also a consumer company. Yet, Cisco recently shut down the consumer division of its firm, suggesting the only known defense is no longer available.
Now that’s what I’d call a coming Armageddon.