SMARTMONEY ONLINE: Cisco Thinks
Small
By Tiernan Ray
SmartMoney Interactive
NEW YORK (Dow Jones)--Lucent Technologies Inc.'s (LU) parry and
thrust Thursday isn't the only big challenge Cisco Systems Inc. (CSCO)
faces these days. Within its core networking business, the company is trying
to expand its Internet expertise to another uncharted domain: small
businesses.
Cisco has identified small and medium businesses as one of its important
new growth areas - officially, at least.
Some Cisco watchers are openly skeptical. Why would a company with
65% gross margins, whose products often sell at a comfortable premium to
those of Bay Networks Inc. (BAY) or 3Com Corp. (COMS), and that is
gearing up to fight Lucent, wish to battle at the low end of the market?
"I guess I'm a cynic," said Paul
Johnson, with BancAmerica Robertson Stephens & Co. "I think that they're
going to find the carrier space is so infinitely more interesting than the small
business space, that their effort for small business is going to pale by
comparison."
But Cisco may already be headed down that path. The ethernet market,
where its share is highly price-sensitive, and some areas, such as switches,
have recently seen flat to declining sales growth for the industry as a whole.
Amazingly, Cisco has continued to increase its revenue on hubs and
switches per quarter at 25% sequentially from a huge base - up from $589
million at the end of last year to $741 million in the first quarter of this year,
according to market research firm The Dell'Oro Group. But much of that
revenue growth has been at the expense of 3Com, Bay Networks and
Cabletron Systems Inc. (CS), and it has clearly been driven in part by
lowering prices.
Although Cisco products still enjoy a premium overall, average selling
prices have declined by as much as 25% since the beginning of 1997. And
a good portion of Cisco's market share growth comes in areas like modular
switches, where the company has aggressively and consistently undercut the
competition in price. The question is, how much further will Cisco go down
the path of price cuts?
Cisco has assigned a visionary to the task of winning small businesses, an
affable, shoot-from-the-hip type named Howard Charney who was with
3Com once upon a time and who came to the company in 1994 when
Cisco bought his startup, Kalpana.
"Are we serious? We are very serious," said Charney, who argues that
small businesses will be the lynchpin of the emerging digital economy.
"Cisco has 83 of the Fortune 100," he said. "It's difficult to make that go to
85 or 94. We look out into the future, and we see that we have this
technology that was used to build the Internet. Now, we realize the great
growth area is going to be connecting up small businesses [to the Net]. You
look at this and you say, 'We have to change our focus as a company."'
To change that focus, Cisco is making an aggressive effort to sell through
two-tier distribution channels, an area where Cisco has never been strong.
That is hard, because 3Com has dominated the reseller market, and its
brand is much stronger in indirect sales. Charney, assigned to the task of
winning small businesses, is proud to point out that Cisco will earn more
than $1 billion dollars in the channel this fiscal year, up from zero three
years ago.
But selling indirect is one thing, and selling to small businesses is another.
Charney's goals on that point are vague, partly because market share
numbers are vague. He would like to close the gap, he said, between
3Com's roughly 25% share of the small business market and Cisco's share
in the teens. "You'll see us do a lot of branding in the coming months," in
addition to rolling out price-competitive products, said Charney.
Amid the throng of small business shoppers at PC Expo, Cisco announced
a deal with International Business Machines Corp. (IBM) to sell a line of
inexpensive small business hubs, with financing provided by Cisco's capital
unit. Meanwhile, Cisco has weathered the price compression in the
networking business well. True, its sales in the latest quarter were up only
33% from those of a year earlier; back in 1996, when we originally picked
the stock, the company's sales growth was running 50% to 100%.
And earnings per share are less likely to grow annually at the 1996 rate of
50% to 60% per quarter. First Call Corp.'s average estimate shows the
company's earnings growing a more modest 27% this year, to $1.75 this
year from $1.37 last year. But Cisco routers and switches still perform
enormously well, and some still fetch premium prices despite the fact that
average selling prices for competitors' wares continue to slide.
In the end, no one on the Street seems disappointed with a little less Cisco
growth. "The bottom line's going to be slowed a bit, because they're hiring
anywhere from 1,200 to 1,500 hundred people a quarter," to bulk up on
voice and video expertise, said A.G. Edwards & Sons Inc.'s Peter
Andrew. "But I don't look at growth as slowing. Maybe it's around 30%. I
can live with that."
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