ENTERPRISE GIVES CISCO SAFE HAVEN

May 13, 2002 12:00 PM, Tim McElligott

Cisco Systems surprised Wall Street last week by beating expectations for its fiscal third-quarter earnings by 2¢ per share. But while Cisco hit what President and CEO John Chambers called an operational home run by beating its cost-control goals, the outlook for new revenue was left stranded, leaving vendors and service providers to contemplate their own enterprise network strategies.

Gross profit margins improved almost 6% from last quarter despite a flatline in enterprise orders.

"Given normal seasonality, this could be interpreted as an early positive signal," Chambers told analysts. "However, there is not enough data, and it is too early to call a possible turnaround."

The company expects a 5% revenue increase next quarter, mostly from vertical enterprise markets like education, health care, retail and banking. The service provider market, which now accounts for only 15% of Cisco's revenue and was down more than 10% in the U.S., is not expected to grow.

Still, Cisco has high hopes for an eventual return to the service provider space. "Our service provider strategy and our expanding relationships with the ILECs and IXCs in the U.S. will position Cisco well, assuming we execute properly when this market recovers," Chambers said during the earnings call.

Admitting that his company needs to do a better job addressing ILEC needs than it has the past couple of years, Chambers said Cisco must let carriers drive its product direction. For the short term, he said, "We have such a small percentage of the total service provider market that we might be able to experience growth rates dramatically above what the capital expenditure rate may be."

Bolstered, perhaps, by his company's turnaround, Chambers' long-term plans for the service provider market are more ambitious. "We are working very aggressively to be positioned in many large incumbent service providers to become the No. 1 or No. 2 strategic vendor and business partner," he said. It could have been the earnings talking, however.

"That would be too ambitious of a goal," said Nikos

Theodosopoulos, managing director in the technology group of UBS Warburg. "Maybe in a specific product category they could [win], but across all products they try to sell, that would be unlikely."

While Cisco patiently positions itself for a return to the telecom space, traditional telcos and their vendors-which have succeeded in cutting costs on a scale equal to or surpassing Cisco's-are trying to tap the enterprise revenue stream that helps keep Cisco healthy. Recent product introductions from Alcatel, Lucent Technologies and Nortel Networks delve further into the enterprise, either directly or indirectly.

"Now more than ever before, we are committed to delivering outstanding value to our enterprise customers," said Serge Tchuruk, chairman and CEO of Alcatel, in a keynote speech last week at the Networld+Interop show in Las Vegas.

Tchuruk said that while Alcatel is not well known among North American enterprise customers, it is the leading supplier of telecom solutions for the enterprise market in Europe. "We have to win the game here, and we are prepared," he said.

Last week, Alcatel introduced the OmniSwitch 7000 series of data infrastructure switches for the enterprise network edge. The switch currently is being beta tested by Texas A&M University.

Nortel, by contrast, has one of the more sophisticated enterprise plays for a traditional telecom vendor, said Hilary Mine, executive vice president with Probe Research. "They had voice over ATM before Cisco even knew what ATM was," she said. But the company has a long way to go to compete with Cisco in the enterprise.

To that end, Nortel introduced several enterprise products last week designed to lower the total cost of ownership for secure IP services by merging dynamic routing capabilities and virtual private networking into one device. Using what Nortel calls Secure Routing Technology and a new series of Contivity Secure IP Services Gateways, the company is trying to move enterprises away from the concept of router-based networks to one that is founded foremost on security.

Nortel also introduced a new family of BayStack Ethernet switches-a development that analysts say has been slow in coming since Nortel acquired Bay Networks in 1998-and a Succession Communications Server for Enterprise Multimedia Xchange, for which it won an Interop award.

"I don't know if it's an increased importance [on the enterprise market], but I think it's an increased recognition of the importance, since that is where there is continued spending and expected growth," said Greg Merritt, vice president of marketing, enterprise networks at Nortel.

Lucent also recognizes the importance of the enterprise space, despite many analysts' assertions that the company's enterprise play was lost with the spinoff of Avaya. Lucent launched a channel program last October that sells to enterprises primarily through its service provider customers, but also increasingly through the 200 value-added resellers Lucent has contracted with over the last six months.

"It's not that we are trying to change Lucent's position to go after the enterprise space," said Mark Wilson, vice president of business partner relationships at Lucent. "But our products also have an addressable place in the enterprise space, and we want to go after some of that revenue."

Lucent has four products for the enterprise: a high-end firewall; its Vital Suite network assurance and management software; Access Point, a premise-based VPN product; and OptiStar, a high-end optical router for storage area networks. Lucent hopes the enterprise market will contribute up to 20% of its revenue.

Traditional telecom vendors may not expect to chip away at Cisco's enterprise business anymore than they expect Cisco to chip away at their core markets. But having gone through restructuring and cost-cutting, they are hoping some diversification of their revenue base will help ease the pain.

"For some of these companies, there might be real opportunity to pursue in the enterprise, but you can't look at next quarter's results to see the impact," said Mike Smith, managing director of competitive operator strategies with Stratecast Partners. "Even if they started pursuing the initiative aggressively today, it wouldn't pay dividends for maybe a year."

Cisco, on the other hand, can't be counted out of the telecom carrier market, Probe's Mine said. "Cisco is very interested in figuring out how to win in the telecom space, and they are going up against some very battered companies," she said.

Chambers, in fact, telegraphed his intentions: "We are using the slowdown in the service provider market to build stronger relationships with the operational side of incumbents." n

With additional reporting by Glenn Bischoff from Networld+Interop in Las Vegas.