Friday, June 5, 2009

UCS – Brilliant Move or Blunder?

I spent last week in the San Jose area. Outside of the discussion of whether Avaya or Siemens would acquire Nortel, the next hottest topic was Cisco’s UCS. Some of the conversations were around the technology, but more of the conversations were about how the announcement of UCS will dramatically alter the marketplace. In particular, there was a lot of discussion about what Cisco’s movement into servers means for Cisco’s relationship with HP and IBM.

To put all of this into context, roughly two years ago I was among a small group of analysts who were having lunch with John Chambers. As ever, Chambers was peppering the room with questions. One of the questions he asked us two years ago was if we thought that three years into the future that Cisco would still be a close partner with HP, IBM and EMC. His question clearly portended Cisco’s movement into servers. Based on what I now know, I feel quite confident that a year from now Cisco will not be a close partner with HP and IBM.

There is a line of thought that says that they only way that the elastic provisioning of IT resources (a.k.a., cloud computing) will ever work is if the environment is homogeneous. This line of thought argues that even minor differences in the IT infrastructure greatly increase the difficulty of achieving the goals of cloud computing. If Cisco truly buys into this line of thought, then they could argue that they had to move into the server market just as some of the major players in the server market will have to move into the networking market.

However, there is another line of thought that says that Cisco is a big company and the only way that a big company can grow substantially is to enter other big markets. That is a reasonable business strategy, but like all business strategies it comes with risk. In this case, part of the risk is how will the major players in the server market respond? The story that I heard is that when Cisco told HP of their plans to enter the server market, they were walked to the door. I don’t know if that story is true, but I doubt if HP’s reaction was to embrace Cisco, give them the secret handshake and welcome them to the club. I also doubt if IBM was terribly amused. So what is Cisco’s upside as it enters the server market? The good news is that the server market is indeed sizable. The bad news is that it is characterized by a number of large, established players and relatively small margins.  

Cisco’s switch and router business brings in over twenty-five billion dollars a year in revenue and is characterized by extremely high margins. Cisco does have some competitors in the enterprise router market, but none of them have found a way to gain double-digit market share. There is a line of thought that says that Cisco is putting this cash cow at significant risk in order to enter a low margin market.  

Probably nothing dramatic will happen in the market in the near term. The rumors that IBM was going to buy Juniper Networks have calmed down, at least for now. HP already has a networking business, but I doubt if Cisco takes it very seriously. That could certainly change if HP started to gain market share. One of the key issues that will get played out over the next year or two is “Is it easier for a network company to do servers than it is for a server company to do networking?” Part of that issue is technical. A bigger part, however, is account centric. For example, who has more control over the customer – Cisco or IBM?