In this blog I look beyond the obvious and try to find out why people and companies do what they do - and what it means for the rest of us. 
It’s not what you say, it’s who you are standing next to when you say it. EMC and Cisco are dance partners – and everyone is talking about it. HP decided they were tired of Cisco being the homecoming king and went out and bought 3Com – just to take on the king. It’s sort of like Karate Kid when the bad ass got taken down by the weak kid. No offense to HP with a Ralph Macchio reference, of course, and no, I’m not going to succumb to the obvious “wax on, wax off” reference either.
Eventually the prom king and queen end up old and lame, don’t they? Isn’t that what happened in “Back to the Future”?
HP just picked a fight with the big jock Cisco, and now everyone is going to the parking lot to see what’s going to happen. There is no romance involved, as HP doesn’t want Cisco’s girl (sorry EMC/VMware), it’s more about money, pride – and maybe a degree of monarchy toppling.
As in the movies, a lot of people who are used to the king being the king assume the challenger will get their butt kicked and that tomorrow the king will be back giving wedgies in the hallway. Meanwhile, there are a ton of supporters for the challenger that have heretofore been too afraid to show that support – lest they become a wedgie recipient.
After HP gets their hands on the 3Com/H3C stuff in earnest, it will be fantastic to see if the silent lower castes step up to be heard.
Cisco is in a pickle, me thinks. As magnificent a company as they are, they find themselves a bit boxed in by their own success. They have the unfortunate disadvantage of being so wonderfully predictable, that Wall St. has built value models that aren’t very flexible. Cisco makes 65% gross margins – which is both awe inspiring and terrifying. It has been possible because Cisco is one of the greatest run companies in history. It has been sustainable because as a brilliantly run company, they have effectively controlled the market. You can charge what you want if you are the only game in town. When the house is on fire, you don’t quibble on price with the guy who owns the water supply. You might not like it, but what are you going to do? There is only so much beer one can drink.
Up until now, Cisco has been able to effectively control their market, and thus been able to sustain 65% margins. The margin knob is a violence inducing knob. People kill to turn it up, and jump off buildings when it turns down. Enter Wall St.
HP, through H3C, now has a set of core switching products equal to, or better than, Cisco’s stuff. While I don’t expect people to start tossing perfectly good Cisco gear out their windows, a company like HP is going to get the ear of the Cisco buyer. Once they have that ear, HP is going to tell those buyers the following:
“Cisco is great (they won’t mean it). We have these products that are better – and they are 40% less money. We are HP – you might have heard of us. All we want is to be your second supplier – just give us a taste, because if nothing else, it will help you keep Cisco honest.”
Customers will say, “OK”. They will give HP a taste. They will spend 5%, then 10%, then more on the HP stuff. Then the fun will begin.
If the stuff works as I believe it does, the next deal will get ugly for Cisco. Once HP proves its stuff is up to snuff, Cisco will have to justify why they have a 40% price premium – which they won’t be able to do. Cisco doesn’t have the product portfolio breadth that HP has, so it’s not like they can bury margin in one place and make up for it elsewhere – like in servers! That will leave Cisco with a bad decision – either drop price which means cut margin, or lose share. If Cisco loses 10% margin, it will turn into BILLIONS of dollars in cap value losses. If they lose 10% share, it will be a bloodbath.
HP, on the other hand, can pull this off because of the following:
- They already have incurred the cost of sale – they are already there. They have to add true core data center networking expertise, but they don’t have to build a “company.” They have a trust brand to die for – they will get the benefit of the doubt.
- HP makes 12-22% margins – so even selling at 40%+ less than Cisco, the HP margins realized on this kind of stuff will be 35-50% – 2-4X their average. I’m no math wiz, but I see a distinct advantage here.
So will everyone drop their Cisco dance partner? No, of course not, but there is a new kid in town and he doesn’t appear intimidated by the king.
See you after school.
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Fantastic point – I had to sell the Cisco stuff a few years ago as part of an IBM deal (I was an IBM reseller and IBM were putting Cisco through the channel) – I thought the 3Com stuff would have been an easier sale (it was plug an play) but we got stuck with the Cisco which had the engineers tied up in knots for 3 days trying to get it all set up. At the time, we won the deal against HP, which made little client difference as they were also selling Cisco gear.
To hell with the co-opetition and meaningless alliances of convenience, now, what about the HP high end storage proposition?
—-Good question. Hitachi (not HDS – direct deal with Hitachi) and HP have a fine relationship, so I don’t see a gun to HP’s head to find a replacement necessarily. Second, it’s clear to me that while it would be nice if HP could dominate the very high end storage market, having their own product won’t be the reason. I don’t think having the Hitachi array hurts them at all – maybe the opposite. It’s hard to imagine HP would end up with a better product no matter what, so as long as the financials work, why screw with it?
What I can see is more/different/better midrange offerings. I still like the idea of HP buying NTAP – which would double their storage business overnight. I can also see them picking up a Compellent type that has newer architectures and technologies. — Steve
Great post! But what I’m slightly puzzled about: wasn’t Cisco the first to break rank in the “layer cake” and go from their layer (switches et al) into HP’s (& others) with servers?
So isn’t this more of a “you try to eat my cake, so I’ll just get right back atcha and eat yours!” kind of deal?
Or did I miss something entirely?
In any case, interesting developments as the players in the various layers (sounds stupid…) start eating away at other layers.
Good stuff, go competition!
You are confused that cisco margins translate to higher prices. Cisco designs own ASICs, has very low costs, high productivity. HP is going to be on the defense in the server market not cisco in the network market. Cisco already beat hapless 3com and HP is a non player in networking. Cisco is coming after hp’s market and ciscos UCS product is an amazin. Market changer while HP tries to compete with their traditional servers.
Cisco has proven time and time again that they can move into new markets and take a 1 or 2 position quickly (think telephony, security, video…).
—–Au contraire my friend. Cisco’s margins at CURRENT market pricing are 65%. My argument is that they will be forced to cut pricing to maintain share and ANY cut in pricing will directly negatively impact margins. There is no way around it – unless they are able to maintain their current pricing, which seems almost impossible. I can’t agree with your assessment that HP is a non player in networking – they are a clear #2 from any angle you look at it from (but mainly $$$).
Both companies are well entrenched in their primary IT markets – Cisco in networking and HP in servers. My point is simply that Cisco is going to be hard pressed to take any meaningful share from HP in servers (if they do, they lower their margins accordingly) as HP owns that market – but I agree UCS and VCE have absolute promise (just not at the mass market level). HP is already a force in small/mid-market networking and with their relationships globally, will have an opportunity to bring the H3C gear to net new markets (they don’t play in North America nor Europe really) at a significant discount to Cisco – and HUGE margin improvements to HP. —- Steve
As a customer the Vmware – Cisco – EMC relationship is a big turn off. Why would I want to now get over charged for Cisco Servers when I am already being over changed for Cisco networking gear, EMC storage, and vShpere Enterprise “Plus” licensing?
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