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Are networking's salad days over?

1997 was far from a banner year for the networking industry. Not one large player was immune from the general malaise affecting the sector.

No one disputes the long-term potential for the networking equipment market, generally considered the fastest-growing segment of the high-technology industry.

But a series of issues, including short-term worldwide economic concerns, market maturity, and millennium madness, could wreak havoc on an industry sector not used to long stretches of diminished returns.

The last 12 months were far from a banner year for the networking equipment segment. Of the large networking players--Cisco Systems (CSCO), Bay Networks (BAY), 3Com (COMS), Ascend Communications (ASND), and Cabletron Systems (CS)--not one was immune from the general malaise affecting the industry.

Even the dominant and always profitable Cisco felt the pinch of slow international sales, and its stock dipped temporarily as a result.

Some feel that this past year is just the opening round in a prolonged period of retooling for networking equipment companies that could extend for several quarters to come. "It's not going to be the go-go years it was in the past," said Craig Johnson, an analyst with industry researcher Dataquest.

A recent report by market watcher In-Stat found that the networking hardware market grew 16 percent in 1997 to $26.4 billion, a far cry from the 48 percent growth experienced in 1996. The 1997 growth figure is the lowest ever for the networking industry, according to the firm.

As companies announced their financial results through the year, a common thread permeated the discussion: softness in Asia-Pacific markets, especially Japan. That trend could continue well into the new year.

"It's a moving target--you don't know how much worse it's going to get," said Martin Pyykkonen, an analyst with Furman Selz.

But geographic issues will not be isolated to Asia, according to Johnson. A forthcoming report by Dataquest will point to various worldwide economic hot spots that could affect short-term gains by networkers.

Those include the following:

  • The impact of Europe's move to a common currency, a transition that could siphon significant chunks of money away from information technology rollouts.

  • The saturation of infrastructure equipment in North America, where the leading firms are basically battling to unseat an entrenched vendor for large network upgrades, rather than initial network investments. In this market, Cisco remains the eminent force, presenting challenges for others that expect to reap large domestic rewards.

  • Continuing austerity measures being implemented in Brazil, one of the dominant technology purchasers in South America. South and Central America continue to be reasonable areas for growth by networking firms, according to Dataquest, but fragile economies could dampen profit expectations here.

    "It's a coalescing of many factors: maturing markets, commoditization, head-to-head competition, and macroeconomics," Johnson noted.

    Another factor that seems to be having a ripple effect across numerous industries is the Year 2000 issue. The millennium bug stems from decisions by programmers of the 1960s to save memory space by using only the last two digits of a year, instead of all four, when referring to the date, a kind of shorthand that programmers continued to use until very recently. But when "00" comes up for the year 2000, many computers will view it as 1900 instead, causing widespread problems.

    The Gartner Group estimates the costs of dealing with the Year 2000 bug to be between $300 and $600 billion. Another researcher also has noted that companies are generally not far along in IT planning for the new millennium. The result? Dollars normally spent on new infrastructure equipment will likely be used for Year 2000 compliance. (See related story)

    This is not to say that the networking segment will take an abrupt nose dive in the marketplace. Networkers will continue to benefit from an increasingly Net-centric world, as reported earlier by CNET's NEWS.COM. But the financial community may need to rethink its short-term expectations for once high-flying networking stocks, according to some observers.

    In the long run, networking firms could still be a good bet for investors. BancAmerica Robertson Stephens analyst Paul Johnson said in a report published in June 1997 that "the networking industry is in the seventh to eighth year of a 20-year investment cycle."

    While hot markets within networking will continue to abound, success stories may more likely come from smaller firms like Yurie Systems (YURI). Emerging technologies such as hardware that supports gigabit-speed Ethernet--the prominent networking pipe in corporations--could also provide a boost for some.

    As a consequence of market maturity, however, large firms may generate more revenue through acquisitions rather than new markets, analysts say, a sure sign that what was once a "Wild West" atmosphere in networking may be waning.