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Corporate networking in troubled times

Networking firms that once made their living off corporate sales are now targeting the red-hot Internet service provider and telecommunications market.

Is the corporate networking market dead?

For most of the past decade, firms such as Cisco Systems, 3Com, Bay Networks and others saw their profits soar from selling networking equipment to businesses.

Revenue grew 25 percent to 30 percent each year as these companies regularly tore out their old networking gear and replaced it with faster, more powerful products that gave employees high-speed connections that allowed them to communicate and exchange information over a corporate network.

But times have changed.

With most businesses already using the networking equipment they need, sales have slowed. Networking firms that once made their living off corporate sales are now targeting the red-hot Internet service provider (ISP) and telecommunications market. Here, profits are higher and demand for high-speed equipment stronger, as carriers and ISPs feverishly try to handle the explosion of Net traffic on their networks.

When the networking industry gathers in Las Vegas next week at Networld+Interop, one of the largest such trade summits of the year, much of the discussion will revolve around the ISP and carrier markets--a huge change from the show's roots as a haven for corporate information technology (IT) types.

"There's definitely a slowdown in corporate sales," said analyst Esmeralda Silva of International Data Corp. "All of the firms are heading in the same direction: They're trying to get more revenue from service providers."

Nortel Networks, which bought Bay Networks in 1998, is a prime example. Despite reporting stellar first-quarter revenue growth last week, corporate sales only increased 5 percent, while service provider sales jumped 64 percent.

"If we could get our enterprise business going," Nortel chief executive John Roth said last week, "we would truly be firing on all cylinders."

Some established networking firms are even trying to ditch the business. 3Com recently bowed out of the high-end corporate business to concentrate on service providers and small and mid-sized businesses, while Lucent Technologies and Cabletron Systems, for example, recently announced plans spin off its slower-growing corporate business into separate companies.

Analysts say the move away from the corporate market and toward the service providers makes sense for several reasons: Cisco has dominated the maturing corporate market; stiff competition has driven prices down; and the service provider market is exploding. Furthermore, new service providers are renting services and software such as email and management of networks to corporations--offerings that businesses used to build and provide for themselves.

According to a new study by Synergy Research Group, Cisco captured 44 percent of corporate networking sales in 1999, a 4 percent increase from the previous year, and stole market share from 3Com and Cabletron.

3Com ranked second in sales with 18 percent of the market. Nortel was third with 9 percent, followed by Lucent with 5 percent and Cabletron with 4 percent.

With the service provider market booming, analysts say networking firms have a better chance of success competing in the new market, rather than fighting for scraps in a niche some view as mature.

"Everyone wants to get in early and dominate it," said Current Analysis analyst Tere' Bracco.

Young high-flyers Foundry Networks and Extreme Networks, which made their names by selling high-speed corporate gear, are still making good profits in corporate sales. But executives from the two firms say the service provider market is too lucrative to ignore.

For example, Foundry's corporate business sales tripled in its most recent quarter, from $8 million last year to $25 million this year. But during that same time, revenue from service providers jumped sixfold, from $7 million to $45 million.

"The service providers need to build out these huge infrastructures at horrendous speeds, and they definitely have a big appetite for big equipment," said Foundry chief financial officer Tim Heffner. The (corporate) market does not appear to be growing as fast."

Despite the disparity in revenue growth between corporate and service provider sales, analysts say the corporate networking market is still viable and profitable.

"The growth rates are different because the service provider market is starting from a smaller base," IDC's Silva said. "What people fail to realize is that from a sheer number perspective, there's more revenue from (corporate) sales out there."

The corporate market grew 15 percent last year as revenue reached $21.5 billion, while the service provider market grew 81 percent as sales reached $10.3 billion, according to the recent Synergy Research Group study.

Next year, the corporate sales growth will dip to 12 percent as the service provider market continues its torrid pace with 70 percent growth. By 2001, revenue from service providers will surpass revenue from corporate sales. Service provider sales in 2001 will grow 65 percent and reach $28.9 billion, while corporate sales will grow a tepid 12 percent and reach $26.9 billion, the study found.

When compared to service provider sales growth, the corporate market appears to be slowing down. But in reality, it's still healthy, analysts say.

"The margins will be lower and growth will be lower, but there's still money to be made there," Bracco said. "Just because something is not bringing you 25 percent market growth, doesn't mean it's not profitable."

For example, 45 percent of Cisco's revenue is from corporate sales. Bracco estimates that the company currently sees about a 10 percent growth rate in corporate sales.

"Ten percent is a huge mondo number added to an even bigger mondo number," she said.

Analysts expect the corporate market will continue to grow in specific niches, such as new Internet-based phone systems that are cheaper than traditional voice systems and Web switches, equipment that helps e-commerce Web sites run faster and more reliably.

Silva added that while many businesses in North America have enough networking equipment, the market in Europe, Asia and elsewhere remains largely untapped.

"There are lucrative segments within the corporate market that are still growing," she said.

Bracco said the companies that are spinning off or dropping out of the corporate networking market may be making a mistake and are doing so to show stronger growth to Wall Street analysts and investors.

The companies could lose potential sales, she said. For example, an Internet service provider that buys Cisco gear to build out its service provider network could choose to buy Cisco's corporate equipment for its own internal network.

"Perhaps they've set their revenue, growth and return-on-investment goals way too high for a mature business," she said. "It's kind of dismaying to see the (corporate) segments being spun off not because they're completely different businesses, but because they're not growing fast and don't make us feel as exciting."