Cisco facing up to challenges

Company attempts to tap new sources of growth as others mature

Cisco is both envied and vilified for its success in the network industry.

The company is the market leader of both routers and switches to both enterprises and service providers, is usually the No. 1 or No. 2 vendor in every market in which it competes, has little problem attaining the 10% to 15% annual growth targets it sets, and has a distribution channel second to none.

Slideshow: Who will Cisco buy next?

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Cisco is both envied and vilified for its success in the network industry.

The company is the market leader of both routers and switches to both enterprises and service providers, is usually the No. 1 or No. 2 vendor in every market in which it competes, has little problem attaining the 10% to 15% annual growth targets it sets, and has a distribution channel second to none.

Slideshow: Who will Cisco buy next?

Yet as Cisco prepares to meet with thousands of customers at next week's Networkers conference in Anaheim, Calif., it is facing several challenges: Sales to U.S. enterprises are slowing, forcing the company to look for growth overseas; margins are eroding in some markets; the company faces new low-cost competitors; and its core technologies are becoming increasingly commoditized.

Not that any of that is reflected in current financials. The company’s fiscal 2007 ends in July and sales are expected to climb 22% to $35 billion, while earnings are expected to jump 21%.

The trick will be sustaining that growth.

Global outreach

While the U.S. enterprise market accounts for about 13% of Cisco’s total sales, demand is softening, with U.S. enterprise spending rates stabilizing in the mid-single digit range, according to UBS Warburg.

Cisco is feeling it: US enterprise orders grew in the mid single digits in the third quarter, down from 20% in the third quarter of last year. So Cisco is looking overseas for growth.

“We have been investing in sales coverage around the world, with a specific emphasis on investing in emerging markets,” says Rob Lloyd, Cisco senior vice president for U.S. and Canada field operations.

Cisco’s emerging markets include more than 130 countries in Central and Eastern Europe, Russia and the Commonwealth states, the Middle East, Latin America and Africa. It represents about 2.3 billion people and has a gross domestic product that exceeds the GDP of developed countries such as the United States, Japan, and Germany.

Emerging markets could add up to a $10 billion opportunity by the end of the decade, according to Cisco, and Lloyd says growth has been fluctuating in the high 30% to low 40% range. Analysts agree, noting that emerging markets has a sustainable growth rate of 30+% for the next three to four years, while domestic sales grow at around 10% and Europe/Asia at 15%.

Lloyd acknowledges, though, that U.S. enterprise sales and sales to the federal government have slowed, attributing it to the “war effort.” He says, however, that U.S. enterprises have been shifting spending to global operations – many in the emerging markets Cisco is tapping – and that overall, the enterprise business on a global scale has been “solid.”

Margins, commoditization, saturation

Yet Cisco must always confront the specter of declining prices in the enterprise market, analysts note.

“The big challenge is commoditization and competition from lower-cost providers,” says Dave Passmore, research director for network and telecom strategies at Burton Group.

This is particularly true at the lower end of the market.