What is Happening?   The possible entry by Cisco into server markets with offerings that include networking management and virtualization has prompted Saugatuck to assess the roles and challenges of vendors and users in a changing IT infrastructure environment.

On 16 December, 2008, ChannelWeb cited Bob Moffat, Senior VP and Group Executive of IBM Systems and Technology Group as stating that Cisco has decided to "talk about crossing . . . the demilitarized zone between networking and data centers."

On 19 January, 2009, the New York Times reported plans by Cisco to enter into the server market with offerings combining traditional server functionality with networking and virtualization. Later the same day, Padmasree Warrior, Chief Technical Officer for Cisco, posted a blog article on the company’s site that articulated a vision of a Unified Computing architecture encompassing server, networking, and storage virtualization. Warrior’s blog post almost – but not quite - confirmed the rumors and expectations of Cisco’s imminent server market entry. However, it is important to note that Cisco has as of this date made no formal announcement about entering the server market.

Why is it Happening?   Saugatuck sees at least three reasons why a high-margin, networking-centric firm such as Cisco would approach what is considered to be a commoditized IT box market.

First, while servers themselves have been essentially commoditized, the demand for servers is likely to continue to grow, ironically in part as a result of the spread of virtualization (please see Saugatuck Strategic Research Report, “The Many Faces of Virtualization: Understanding a New IT Reality,” SSR-420, 28Dec07). Though traditional margins are thin, the sheer volume of global opportunity can attract even such high-margin vendors as Cisco.

Second, Cisco sees the handwriting on the wall, foreshadowing continuing decreases in networking hardware margins. Long-term, the market for network switching and management hardware will grow globally, but the margins on individual products will decline due to increased competition.

But most importantly, the “combination platter” concept of IT server, networking and virtualization fits well into Cisco’s “unified communications” positioning and strategy. And this is where Saugatuck sees the server market’s greatest growth for the foreseeable future, as we stated in Saugatuck Strategic Perspective”Virtualization Saugatuck Planning Positions – Part 1”, SPP-426, 18Jan08, and “Virtualization Saugatuck Planning Positions – Part 2”, SPP-429, 29Jan08. The following are key Saugatuck Strategic Planning Positions (SPPs) that help explain why a vendor such as Cisco would find it profitable to enter such a marginalized market (emphasis added in bold, underlined text):

• Through 2010, all facets of IT Virtualization will see substantial enhancements in functionality and performance. However, the most significant enhancements will be in microprocessor, hypervisor, and operating system function for Server Virtualization. Vendors that bring these functionalities to market in simple, easily-deployed and used manners will enjoy and retain significant market share. VMware and XenSource/Citrix are among the vendors that we expect to see in these spaces.
• Through 2010, adoption of IT Virtualization poses risks for substantial revenue impact to vendors of microprocessor chips, servers, Operating Systems, Middleware, and applications. Chip and server vendors will strive to incent sales through new designs to improve virtualization functionality and performance. Software vendors will likely adopt new licensing provisions for use of their products in virtualized images. Virtualization vendors, in sum, are likely to have deleterious effects on vendors of other IT until those vendors can adopt and adapt virtualization (and virtualization management) capabilities into their offerings.

It is the introduction of new, more powerful capabilities that mesh servers, networking and virtualization to optimize price and performance for users, that creates the greatest opportunity for vendors, especially those at the nexus of hardware, networking and virtualization. But this also assumes significant changes in IT buying, channels, and partnerships.

Market Impact:  On the surface, offering a solution that consolidates three or more useful functions into a single package would seem to be very attractive to buyers looking to reduce the overall number of boxes to buy and manage. We expect that Cisco – and its competitors – will enjoy some sales as they bring such products to market.

But the blending of server, network management and virtualization “in a box” is not a guarantee of sales success. If and when Cisco or any competing networking-centric vendor enters the traditional IT infrastructure market, their success will be dependent on management of multiple challenging components, as noted in the following bullets. This includes the acceptance by buyers, channel partners, and technology partners of a converged, IT/networking infrastructure acquisition and management paradigm that has heretofore been rejected.

• Buying centers. Though inextricably intertwined for decades, the markets for communications equipment and for servers and storage have been largely disconnected. Most user organizations still have separate groups responsible for communications versus servers and storage. Selling to communications buyers entails very different expertise and value propositions than those required for selling to server and storage buyers. Very few vendors (e.g., HP, IBM, etc.) have the presence and ability in both servers and communications – and these tend to use separate organizations.
• Pricing. While Cisco is hinting at/promoting potential offerings as new, “unified” solutions that are different and more valuable than traditional servers or network boxes, the fact remains that they must compete in multiple commodity-oriented hardware marketplaces simultaneously. And, they must do so in a market that Saugatuck describes as “spending-free,” versus the “free-spending” IT and networking markets of past decades. Even when customers see value in the solutions, initial pricing will need to be very aggressive to get them to buy. And in IT hardware markets, once pricing is established, it tends to get reduced over time.
• Skill Sets. Adding virtualization to a combined server and networking management offering engenders a new set of required skills, which combine IT virtualization, server virtualization, and network management+virtualization, and which are still emerging. Since they are emergent, they are also expensive. This suggests opportunity for Cisco and others to provide skilled management services along with “unified” offerings. Providing these services would help negate the “commodity” effect of entering the server market. But in the current spending-free environment, will user firms invest in complex offerings that require commitment to new/more expensive skills, services and management?
• Channel Partners. Decent margins and add-on service revenues are key to channel buy-in. But vendors still must face the reality that channels have evolved over the decades to reflect the user paradigm of separated IT and networking management. Vendors must develop, direct, support, and manage channel partners’ evolution from one camp to both.
• Vendor Partners. Partly as a result of the traditional separation of IT and networking , networking vendors have developed strong partnerships with traditional IT vendors. These partnerships enable both sides to attack and profit from whatever middle ground exists within customer (user firms, network providers, telecom providers) organizations. A “unified” strategy and position such as articulated by Cisco draws a new line of competition in that middle ground. Decades-long relationships must be re-evaluated and, probably, renegotiated.
• Cloud Paradigm. The wild card in all the above is the rapid and dramatic emergence and adoption of cloud computing. The shift from a traditional on-premise IT paradigm to a hybrid, on-premise + cloud infrastructure is well under way. We believe that Cisco and its partners are well-positioned to profit from this new paradigm, as networking capabilities will be key to both providing cloud capabilities and using them. Cisco thus stands to profit from looking at clouds from both sides, now and in the future. But it is not clear if users will combine/unify IT and networking practices as a result of cloud adoption.

At the bottom line, Saugatuck sees significant opportunity and challenges for Cisco or any providers trying to bridge the traditionally-separate worlds and paradigms of IT and networking. Virtualization will be a key to adding valuable management capabilities and margins for both. But it will not necessarily be a key to uniting them, or to changing how users buy and manage them.

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