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  the Software View: The Cisco kids. (Part I)

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Ten years ago, Cisco Systems hadn't even gone public. Today it's far and away the leader in Internet networking, holding on to the number one or number two market share in every market in which it participates. And in the past two years, Cisco Systems has posted close to forty percent or better in revenue growth; earnings have increased by nearly thirty percent or more. That's how fast Internet networking is growing. That's how strong Cisco Systems is within the sector. And that's why during November of 1999, its stock market share price was $71, and the company fetched an astounding price-to-earnings multiple of 135 to 1.

Jeffrey Young wrote, "Look at the numbers. If a thousand customers are dialing in to the Internet, and all are online at an average speed of, say, 33.6 kilobits per second, their Internet Service Provider (ISP) requires less than forty megabits of bandwidth per second. That's easily supplied by today's routers and switches, but even so, Internet brownouts frequently occur during peak afternoon work hours. If the same thousand people upgrade to higher-speed Digital Subscriber Line (DSL) lines, each of which can carry data at about two megabits per second, the bandwidth needs increase fifty-fold, to two gigabits per second - barely within the range of the latest gigabit routers. Move up to multiple channels of high-definition video, at six megabits per second each, and the bandwidth requirements rise accordingly, necessitating more and more routers with much higher capacities - gigabit, even terabit routers.

Now, do the math. Twenty years ago there were 100 million e-mails sent each year, versus 135 billion pieces of first-class mail. In 1997, the two reached parity at about 190 billion each. Ten years ago, data was barely five percent of all telecommunications traffic. Today, with Internet traffic doubling every 100 days, it's nearing fifty percent. The cost of moving data has fallen by an order of magnitude, from ten cents per kilopacket per second in the late '80's to less than one cent today.

Realize that this is only the beginning. Home networks are emerging. Wireless broadband is looming. Voice and data networks are converging. Within five years, the Yankee Group estimates, data will account for about seventy percent of all telecom traffic.

The implications are both breathtaking and banal: Office buildings bathed in an ether of high-speed wireless data. Plummeting long distance rates. Musical instruments played across the Internet. Voice, data, video, audio - all coming down the same pipe. Each accounted for and billed separately. Change without precedent. Business opportunity galore.

The next Net: Call it "Internet 2.0" or, as Cisco Systems President and Chief Executive Officer John Chambers prefers, the New World Network. It's a $500 billion opportunity. And it's Cisco's to lose. In short order, the trend toward sending voice over data networks will quintuple Cisco in size. By whatever name, offering high-speed access to everyone at any time will necessitate beefing up the existing public data infrastructure - the "infranet". All along every line. Everywhere.

This technological imperative explains why Cisco, which controls about thirty percent of the market for data networking equipment and around eighty percent of the key router segment, is poised to explode. Never mind the fact that Cisco is already the fastest-growing company ever listed on the NASDAQ. That was only the first act.

In the next five years, more money will be spent on new telephone equipment than the sum total undepreciated value of all the gear already in place today. This is a tidal wave of at least $500 billion in new spending that's about to hit. The scary thing for every other equipment vendor is that most of it is Cisco's to lose.

Says Chambers: "It is our goal to be the largest computer player ever in terms of changing the way people work, live, play, and learn." Unprecedented opportunity. Chambers has been the company's President and Chief Executive Officer since early 1995. A West Virginia native, avid tennis player, and a son of a doctor, Chambers has a reputation for being a charming and courtly speaker. Since taking the helm of the world's largest maker of data networking equipment, he has quadrupled revenues and profits. In 1998, despite Asian economic turmoil, he put even more distance between Cisco and competitors such as Cabletron Systems and 3Com.

Cisco propelled itself, during the first Internet explosion, from a niche company with $69 million in 1990 revenues to a multi-national company with $9.6 billion in 1999 revenues and a stock-market valuation of $76.7 billion. With its suite of network solutions and strategic partners in place, Cisco is setting the pace in the new world of telecommunications - defined by the convergence of voice, video, and data in a packet-based network.

More and more often, Cisco is becoming synonymous with the Internet. They are being recognized as the experts in many areas of the Internet, ranging from product solutions, design, and applications, to using the Internet to create a competitive advantage. As a result, they have experienced more than a twenty percent increase in productivity per employee and $500 million-plus in savings. They reinvest those savings into research and development. They are also very focused on identifying innovative technologies to enhance their product portfolio and service offerings. They fully expect to continue forming alliances and partnerships that will provide their customers with powerful solutions for the new world infrastructure.

The company intends to keep resellers happy and maintain strong sales growth. Cisco is currently sailing upstream to battle Lucent and Nortel Networks. Its "Cisco Seminar Series" road shows will help resellers bolster their marketing, public relations, and sales efforts. The Seminar Series workshops have reached 3,700 resellers to date. Current topics focus upon designing virtual private networks (VPN's) and voice-over-IP (VOIP) networks, bolstering quality of service, and zeroing in upon higher-margin support opportunities. To extend its dominance beyond the enterprise market, Cisco is planning to blanket service providers, small and mid-size businesses (SMB), and home networking. The efforts will include a sweeping security program, unveiled in June of 1999; a major VPN initiative; a massive small-business branding campaign; and new partnerships in the consumer-networking sector.

ROTO ROUTER

Routers are designed for the fat pipes and bandwidth-hogging applications of tomorrow. They are the engines underlying Chambers' New World Network.

Routers, of course, hum away in the air-conditioned operation centers of ISP's and corporate Information Technology (IT) departments, determining the most efficient path for the rising tide of data traffic. The underlying TCP/IP protocols divide everything - from e-mail and Web pages to the inevitable streaming video - into manageable data packets, which are independently sent from router to router and reassembled at their final destination.

Of course, speed doesn't come cheap. Cisco routers start at $37,000 and can exceed $500,000 depending upon configuration.

DATA: RAISING ITS VOICE

The worldwide data networking equipment business is worth upwards of $30 billion per year. It is dominated by Cisco; the also-rans include 3Com, Nortel's Bay Networks, Cabletron, and Lucent's Ascend. Excluding network cards and hubs (which Cisco doesn't make), the sector is exploding, growing at better than forty percent per annum.

The much larger business of circuit-switched voice equipment is worth upwards of $110 billion. This sector is growing at less than seven percent per year.

The two networks are converging. Data networks, which gain robustness by simply routing around trouble spots, are much cheaper to install and maintain than voice networks, with their multiple and redundant million-dollar telecommunications switches. And broadband Internet Protocol (IP) networks - designed to hurl around big network applications, digital video, compact disc-quality music, et cetera - can carry huge quantities of voice traffic at almost no extra cost.

The consolidation of the data and voice traffic industries will be a $200 billion market by the year of 2003. All of the leading-edge service providers recognize that circuit switches will be replaced with IP (Internet protocol) and asynchronous transfer mode (ATM) switching technologies.

In enterprise businesses, we are seeing traditional voice private branch exchange (PBX) technology beginning to be replaced by a data infrastructure. This combination of data, voice, and video over a single network is the basis for future networks, and Cisco is committed to providing the best of class solutions in this new world.

Gaining just ten percent of the market for voice equipment would double Cisco's revenues. Chambers, however, mandates the company must have at least a twenty-five percent share. Preferably forty to seventy percent share. In short order, the trend toward sending voice over data networks will quintuple Cisco's size.

"The old equipment makers are mathematically unlikely to catch us," says Chambers. "Everyone is assuming that Lucent and Nortel are going to be able to effortlessly go from a circuit-switched infrastructure to a data-based one, where productivity is three times as great per employee and where acquisitions will be critical. It's a world moving so fast that we are having trouble keeping up with our customers. And we know data networking inside and out."

This is a defensible advantage. Listen to Marty Kaplan, chief technology officer at Sprint, one of the incumbents in the telecommunications game: "Five years ago, we started to design an entirely new network, one that would be last-mile independent and protocol insensitive. We wanted to carry voice, but also any kind of data that came along. No more separate platforms for voice, frame relay, asynchronous transfer mode (ATM), and IP the way it is today. It had to integrate, integrate, integrate."

The result was Sprint ION (for "integrated on-demand network"), which is aimed at delivering dynamically to the end user virtually any amount of bandwidth as needed. ION relies upon Cisco as its primary supplier.

Why? "We needed a partner who knew how to move fast, who was willing to throw out the old rules," explains Kaplan, "and, most of all, someone who knew how to be a partner."

In what might be one of its more important acquisitions of the last couple of years, Cisco spent $194 million to acquire a small company called LightSpeed, International in December of 1997. LightSpeed's specialty is a vital protocol called Signaling System Number 7. Every time you use a phone connected to a traditional circuit-switched network, you use SS7. Push "1" on your telephone and SS7 indicates a long distance call is being initiated. Follow that "1" with, say "212", and SS7 directs the call toward Manhattan's circuits. In essence, SS7 sets up, then tears down, individual connections.

Before being bought by Cisco, LightSpeed was working on a Unix-based system for manipulating SS7 protocols - and other bits of esoteric telephonica - that wasn't tied to any particular gearmaker's proprietary technology. This system offered a programming environment that was designed to let a smart set of software engineers craft some very sophisticated telephony-related applications. With Cisco as its new parent, the LightSpeed team blended in IP. The resulting device, which handles both IP and circuit-based connections, costs about a hundred thousand dollars, but effectively functions as a high-end telecommunications switch - the kind Lucent sells for millions of dollars.

Cisco plans to migrate its entire telephone system to its IP network by the end of the year 2000. Along the way, the company will phase out its leased private branch exchanges (PBXes) and Lucent phones and replace them with Ethernet-based voice technology. Cisco says this ambitious project will reduce telecommunications costs by several million dollars per year, because managing a single IP network is cheaper than maintaining separate voice and data systems. What's more, Cisco will use the network as a role model for how value-added resellers (VAR's) can transition corporate telecommunications networks over to IP systems.

Fred Baker, a Fellow at Cisco systems, says, "Telecommunications is, frankly, some pretty non-visionary stuff. One of the biggest problems that I have dealing with telecommunications folks is the line, 'But we have always done it this way.' They should try thinking outside the Bell-shaped box."

Cisco is banking upon the transition of infrastructure over the next several years to swing from the legacy old world ways of networking to the high-speed, packet-switched new world. And, with Chambers at the helm, Cisco has quickly left its competitors behind to become the forerunner, directing how this transition will occur. According to Chambers, the prevailing company in telecommunication's brave new world won't necessarily be the largest (but will probably be the fastest), but the one that can keep up with the changing times.

Most service providers now recognize that voice is converting to a packet infrastructure. By utilizing one network to deploy data, voice, and video, service providers can leverage significant cost savings, as well as introduce additional bandwidth and other new features. They can also add value on top of an open IP infrastructure, as opposed to the old world proprietary environment.

@ YOUR SERVICE

Cisco's service model is based upon a program that Tom Stevenson, the then vice president of world-wide channels, and a consultant friend developed while under contract for IBM in the 1980's. These days, Stevenson is updating Cisco's services workshops to include at least three specialized training modules: Business Planning, Accounting, and Marketing/Communications. The Business Planning Module, for instance, allows a reseller to examine its profits and losses against successful Cisco reseller models. Cisco also offers these modules on compact disc and via the Internet.

Aside from services, Cisco offers other options to further boost reseller margins. Resellers that earn high grades on Cisco customer satisfaction surveys are given product discounts and credits.

Cisco will be number one or number two in each product arena they choose to compete in and in end-to-end networks. And their entire strategy is based upon partnering and open standards. This company was borne of the Internet, a venue with open competition, open standards, and without patent issues. Their channel revenue is approaching over eighty percent.

Backed by service-savvy resellers, Cisco is extending its networking franchise beyond corporate enterprises to increasingly include service providers, SMB's, and even home networks.

Several initiatives, including a massive security undertaking, will blanket all of these business markets. Cisco's theory is, if it can convince businesses that the Internet can be secured, then its sales will continue to climb across all market sectors.

Cisco's security effort, championed by over 200 engineers and marketing gurus, will include a multi-vendor security program, along with enhanced VPN products, new firewalls, and a reseller-oriented certification program.

There are VPN products for mobile users, and firewall cards that slide into Cisco's modular routers and switches, which will leave firewall leader, Check Point Software, all wet.

Analysts estimate that Cisco's SMB sales are growing nearly 100 percent annually, with sales ranging somewhere around the $2 billion mark.

To continue driving sales, Cisco partners with Internet service providers that deliver bundled Cisco solutions. One example is AT&T's Small Office Solution, which features a Cisco 1600 Series Router, ten network mail boxes, packet filtering, and other Web services for $650 per month.

And for SMB's that prefer to outsource Web applications, Cisco is partnering with application service providers (ASP's). Still an emerging market, ASP's (which include resellers, ISP's, and software developers) host Internet applications that businesses can access over the Web for a monthly fee. "For small and mid-size businesses, the ASP model is a strong option," says Susan Bostrom, Vice President of Internet Business Solutions at Cisco.

Bostrom will play a critical role in Cisco's ASP strategy. An energetic consultant-type who previously worked for McKinsey & Company, Bostrom's 55-person unit cuts across all of Cisco. The unit helps SMB's, service providers, and large businesses to embrace emerging Internet opportunities.

To be continued ...

Sincerely,
Mark Kuharich

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