Cisco Systems Inc. (CSCO)’s shutdown of the Flip video division lets Chief Executive Officer John Chambers get started on a bigger challenge: shoring up the main business of routers and switches.
The largest maker of networking gear faces a threat from lower-priced rivals, such as Juniper Networks Inc. (JNPR) and Hewlett- Packard Co. Routers and switches, which help businesses and carriers handle Internet traffic, account for about half of the company’s revenue.
Cisco, which said yesterday it will cut 550 jobs as part of the Flip closure, faces a trade-off between profit and market share. Its traditional networking gear has been its highest- margin source of revenue, propelling its dominance in the industry. As new competitors introduce cheaper alternatives, Cisco is struggling to maintain its lead without matching rivals’ price cuts, said Sean Conner, an analyst with Nuveen Asset Management in Minneapolis.
“If a customer only needed a Chevrolet, Cisco would sell them a Porsche even if they didn’t need the extra speed,” said Conner, whose firm sold its Cisco stake in January after holding the shares for more than five years. “Now they can’t because HP and Juniper came in and said to consumers, ‘Why are you paying for all that extra stuff?’”
Hewlett-Packard, the world’s largest computer maker, is selling more networking gear to capitalize on the growth of data centers -- the vast server facilities that power the Internet. Juniper, meanwhile, entered the switching market in 2008, building on its routing business.
Karen Tillman, a spokeswoman for San Jose, California-based Cisco, declined to comment.
‘Tough Market’
Chambers said last week that Cisco is taking a hard look at the switching business, where it has more than 80 percent global market share. Cisco is seeking ways to bring new products to profitability more quickly, he said.
“Switching is our challenge,” Chambers said last week at an investor conference in San Francisco, singling out International Business Machines Corp. (IBM), Oracle Corp. (ORCL) and Hewlett- Packard as rivals. “It’s going to be a tough market for us.”
Sales of switches rose 12 percent to $13.6 billion in the fiscal year ended in July, accounting for about a third of total revenue. In the subsequent six months, year-over-year growth has slowed to 7.2 percent.
Some networking rivals are willing to accept 40 percent gross margins on switches, while Cisco has typically seen 70 percent to 80 percent margins, Chambers said at the investor conference. Gross margin measures the percentage of sales remaining after deducting product costs.
Time to Choose?
“Cisco needs to choose between protecting share or preserving margins,” John Slack, an analyst at Citigroup Inc. in San Francisco, said yesterday in a note to clients. “It simply can’t do both.”
Chambers said in an April 4 memo to staff that he would make several “targeted moves” to restore lost credibility and sharpen the company’s focus. Shutting Flip, which Cisco bought for $590 million in 2009, isn’t enough to compensate for the declining profitability of its broader consumer business, said Alex Henderson, an analyst at New York-based Miller Tabak & Co. The company should exit that area entirely, he said.
“They’ve got a lot of work to do, and this is just a drop in the bucket,” Henderson said of the Flip decision.
The job cuts yesterday represent less than 1 percent of total employees and will take place by the end of the fiscal year, the company said. Cisco’s consumer division also includes Linksys home networking, and audio and media-storage products.
Home Video
Cisco bought Flip to expand its expertise in home-video networking, a bid that never paid off. Flip posted about $325 million in revenue last year, less than 1 percent of total sales, Citigroup’s Slack said.
Cisco’s gross margin narrowed to 64 percent last fiscal year from 70 percent in 2003, in part a reflection of the push into consumer products and pressure from rivals on prices of its corporate products.
The slump has taken its toll on Cisco’s shares, which have declined 34 percent in the past year. That’s wiped out about $50 billion in market value. The stock fell 3 cents to $17.44 yesterday in Nasdaq Stock Market trading.
Competition continues to mount. As Cisco was pushing into new areas, smaller companies such as Riverbed Technology Inc., F5 Networks Inc. and Aruba Networks Inc. have been able to gain an edge, according to Mizuho Securities USA Inc.
While these competitive pressures may have caught Cisco by surprise, they’re unlikely to keep the company down for long, said Rohit Mehra, an analyst at IDC in Framingham, Massachusetts.
“I don’t see a lot of these challenges as Herculean,” Mehra said. “We can call these small missteps. You will lose some market share when you’re the 800-pound gorilla.”
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