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Cisco drops the ball

Cisco has been going great guns in the networking market, but recently the company shelved plans to develop a high-end switching device based on ATM.

It's tough to find strategic holes in a company that just registered a 44 percent increase in sales during what has classically been its toughest quarter.

But for data networking leader Cisco Systems, such growth could be tempered by the firm's disclosure in recent days that it has shelved plans to build high-end technology for the so-called core of the Internet, a hotly contested niche.

The move to halt development on a high-end switching device based on ATM, or asynchronous transfer mode, nearly a year after the company rolled out plans to create such technology, offers evidence of a rare misstep by the high-flying firm.

In a larger context, it also hints at Cisco's continued reliance on its classical strength in routing technology to feed the insatiable appetites of Internet service providers, or ISPs. By contrast, many communications carriers are implementing ATM devices in the core of their networks due to ATM's maturity.

"It's the one wrinkle in their story," said Martin Pyykkonen, financial analyst with CIBC Oppenheimer.

"When you peel the onion, Cisco is a monster sales and marketing machine, but it sometimes comes up short in delivering complex products," Pyykkonen said. "This is one of main areas that will be an interesting battle."

Last week, Cisco beat third-quarter estimates and announced a two-for-one stock split, the eighth split in Cisco's history. But all may not be well.

During last week?s earnings conference call, Cisco executive vice president Don Listwin admitted the company "will lose some business" until it can catch up with existing technology.

At issue is a product called the TGX 8750, announced last June amid fanfare. The TGX 8750 was positioned as Cisco's primary means to marry Internet protocol, or IP, with ATM traffic, so that IP could gain the benefits of the sophisticated services associated with more time-tested ATM technology. Those types of services are thought to be keys for service providers as they move away from simple network access for customers to more sophisticated use and management of their bandwidth.

Cisco, the dominant maker of high-end routing devices, claims it has not conceded the ATM side of the technology equation to competitors. It says it will add high-end functions to an existing device, known as the MGX 8850, to satisfy the demands of its service provider installed base.

"This is just a product that no longer made sense for our customers," said Don Proctor, director of marketing for Cisco's multi-service switching business unit.

Cisco also said its 12000 series routing device and 8540 switching hardware can accomplish many of the same strategic aims. "We don't expect there to be any change in the competitive dynamics because of this," Proctor said. "It's simply a change in how we implement."

News of Cisco's change in strategy was first reported by Network World, an industry trade publication.

"I think it's very unusual," noted Kurt Bauer, vice president of product marketing for access switching at Ascend, of Cisco's change of heart.

"It's obviously a PR disaster for them," said David Passmore, research director with industry consultants NetReference. "I guess we'll just have to see if they deliver on what they say with their existing equipment."

Analysts note the discontinuation is unlikely to harm Cisco from a revenue perspective, but it may offer an opportunity for competitors to gain access to portions of networks that may prefer to use Cisco technology. (They also said it is hard to argue with a company that produced a 70 percent year-over-year gain in sales to communications carriers.)

The market for switching and routing technology intended for the core of service provider networks is expected to grow to $5.5 billion by 2003, according to market researcher Ryan Hankin Kent (RHK). Though Cisco will likely gain a significant chunk of the routing portion of the market, Cisco's ATM-based opportunity seems less certain, unless a rumored high-end switch technology code-named Jupiter appears earlier than expected.

Still, the discontinuation of the product may put the data networking leader in the unusual position of having to inter-operate with competitors who normally might be shut out of Cisco networks. Foes such as Fore Systems, Ascend Communications, and Newbridge Networks could reap sales gains as a result.

In the service provider-oriented ATM equipment market, Ascend captured 33 percent of the market in 1998, compared with 24 percent each for Cisco and Newbridge, according to RHK's research. Fore was fourth at 7 percent, RHK said.

"I don't have any short-term concerns about core switching," said Michael Duran, financial analyst with Lazard Freres. "If we weren't seeing progress on voice switching or they weren't keeping up with the start-ups on data features, we'd be more worried."

Some analysts feel the discontinuation of the switch may be a smart move in the end, since many feel service providers are implementing ATM in the short term, until a new generation of high bandwidth devices based on IP "packets" have proven themselves capable of handling advanced duties. Cisco may be making a simple resource decision, choosing to place its bets in other development areas, analysts said.

"The service provider world is hell-bent on packet-based networking. I consider it a pretty straight-forward business decision," said John Armstrong, an analyst with market researcher Dataquest.

But that migration could also prove daunting for Cisco, since several well-funded start-ups have built technology that surpasses Cisco's current state-of-the-art, the 12000 series. Competitors such as Juniper Networks and Avici Systems, among others, have garnered the attention and investment dollars of Cisco's rivals, a clear indication Cisco will have a fight on its hands going forward.

What also seems clear is that in the short term Cisco may not be able to harvest as much revenue from the ATM side of its business as it could, given the current spending patterns of service providers. But that will not be felt on the bottom line, according to analysts, given Cisco's dominant market position in the data networking business.

In the end, with profits continuing to boom, Cisco can do whatever it wants, according to some. "It's hard to find anything to worry about after a quarter like that," said Lazard Freres' Duran.