Seems like it was just yesterday that\u00a0Cisco\u00a0CEO John Chambers was touting 20% to 30% annual growth for his company. But the days of such eternal optimism and bravado are long gone - five years, 66 acquisitions and a $400 billion swing in market value gains and losses will change your perspective.Part 2: Challenges dog Cisco as company's role expandsWithout a doubt Cisco has amassed a huge following. However, there are questions about where the company goes from here.With routing and switching markets in its pocket, Cisco will continue using its resources and massive installed base to move into new markets as well as expand its presence in storage, security, wireless and IP telephony.But some observers say Cisco really needs to scramble to reinvent itself as the routing and switching markets decline.In the meantime, the company is keeping its prices relatively high to keep up some semblance of the growth Cisco enjoyed when users were buying network gear at a more rapid pace.Stale bread and butter?Switching and routing make up two-thirds of the company's sales, Cisco reported recently. But these core businesses are on an overall downslide - worldwide router and switch sales shrank 15% and 6%, respectively, the last two years, Dell'Oro Group says - and the technology is becoming increasingly commoditized by new low-end competitors. Because of these factors, there could be much for Cisco to worry about, as some customers might become less willing to spend more on commodity gear, observers say.With the LAN and WAN markets wrapped up - Cisco has an almost 70% market share in both areas - the company is looking for new markets to conquer, with voice over IP (VoIP), wireless, security and storage being on the short list. Chambers says each of these markets will double in size over the next five to six years and will represent a $35 billion opportunity overall in worldwide revenue by 2006.Cisco has seen early success in the VoIP, security and wireless markets. Its Architecture for Voice, Video and Integrated Data (AVVID) products, while criticized early on for lack of features and poor reliability, has won over many customers. Cisco's AVVID products represented more than 50% of the market for IP phones and PBX revenue in the fourth quarter of 2002, according to Synergy Research."I was a little skeptical when Cisco started to market itself as a phone company," says Phil Go, CIO of Barton Malow, a Chicago construction company that recently installed the AVVID products. "I said, why is Cisco doing this, but the more you think about it, the more it makes sense," because the industry is moving to converge data, voice and video to IP.Cisco's security and wireless products also have climbed to the top of their respective markets. The company had 38% share in VPN\/firewall appliances and 41% share in network intrusion-detection gear - tops in both arenas last year, according to IDC. And since entering the wireless LAN (WLAN) arena in 1999 with the acquisition of Aironet, Cisco garnered 34% of the market for enterprise WLAN network interface cards and access points (in the third quarter of 2002, according to Synergy). Cisco's most recent, and most attention-grabbing, push came with a storage-area network (SAN) product debut, with the\u00a0MDS 9000 Fibre Channel platform. While WLAN, VoIP and security all are intertwined in some way with core IP background, the storage market represents uncharted waters for the network giant."Our interactions with Cisco have been around routers, switches and IP phones," says Jon Beyman, CIO of Lehman Brothers, the New York brokerage firm. "[But storage is] a promising market for them. He adds that if Cisco can make the right partnerships with vendors such as EMC, which Lehman uses, he could see the benefits of having Cisco in the SAN.This month, Cisco announced resale deals with EMC, Hitachi, HP and IBM to resell its MDS 9000 storage switch.IP commoditizationDespite having its core markets wrapped up and strong momentum from its growth enterprise areas, Cisco still needs to work hard to secure its future, many industry observers say."Growth markets like voice, storage, security and wireless have long-term potential, but [Cisco] is not seeing huge revenue streams from those areas," says Mark Fabbi, vice president and research director at Gartner."The issue here is commoditization of Cisco's core businesses," says Frank Dzubeck, president and CEO of Communications Network Architects. Cisco has acknowledged new competition in routing and switching, such as\u00a0Dell\u00a0and\u00a0Huawei, which offer low-cost, standards-based gear. Such vendors are "John Chambers' worst nightmare," Dzubeck says, because Dell's distribution channels are of the same scale as Cisco's, and Huawei has lower cost structures."There are a lot of new entrants into this market who would like that" switching and routing are commodity technologies, says Charlie Giancarlo, Cisco's senior vice president for switching, voice and carrier systems. "But what we see is customers who don't look to the cheapest possible product per se. They look to the product that will allow them to get what they need to get done, but also operate at the lowest possible [total cost of ownership]. That doesn't speak to commodity products."Still, Huawei had Cisco worried enough that the firm\u00a0brought two patent infringement lawsuits against Huawei\u00a0earlier this year."[Huawei] has a cost structure in place that no one in the industry has," says Nick Lippis, president of consulting firm Strategic Networks. A U.S. technology vendor such as Cisco might spend $140,000 per year, per engineer, he says, but Huawei can maintain more talent for about half the cost per employee. The recent joint venture with 3Com, which will resell Huawei gear in the U.S., also could prove to be a formidable foe to Cisco."Large enterprises are going to have to look at [Huawei's] products, just because they would be delinquent if they didn't," Lippis says.Talking telecomDespite its declining core markets and low-cost competitors nipping at its heels, some say a looming telecom market rebound could be the magic bullet for Cisco's woes."They're biding their time, trying to find some growth markets and staving off declines in the rest of the enterprise," Gartner's Fabbi says of Cisco, "then preparing for longer term growth spurred by telecom."Cisco's\u00a0service provider business hasn't been a happy one\u00a0as of late. The percentage of revenue from Cisco's service provider line of business has been halved over the past four years, from 40% in 1999-2000 to 20% now. Most of that is attributable to the downturn in the telecom market, where service provider capital spending is now less than half of what it was in 1999-2000.But Cisco also stumbled in marketing to service providers by preaching instead of listening to what they needed. Cisco now is attempting to re-engage them through interaction with operational personnel within the carriers."We count on the service providers to account for a very significant portion of our revenue within four or five years, as high as 40%," says Roland Acra, Cisco senior vice president and service provider CTO. "What we learned is that these guys have a lot of incumbency, a lot of inertia they need to work through. A lot of the improved relations we have with them have to do with us realizing the way forward was to help them through the [circuit-to-packet] transition, and build the tools and the infrastructure, as well as help them with services and [to] go to market."The improved relations have paid off.\u00a0SBC\u00a0is purchasing Cisco's\u00a012000 series Internet Routers\u00a0for a nationwide OC-192 IP backbone network that is intended to transport services such as Dedicated Internet Access and SBC-Yahoo DSL.Cisco is also now the preferred provider for specific SBC managed service products, including IP telephony, IP VPNs, security, storage networking and WLANs.Sprint\u00a0has upgraded its SprintLink IP network to support a Cisco technology called Layer 2 Tunneling Protocol Version 3. The technology lets a carrier encapsulate Layer 2 traffic, such as frame relay, for transport over a Layer 3 network.Despite the recent efforts and progress, Cisco still has a long way to go to buck up that revenue contribution from service providers to 40%, analysts say. Only 3% of carrier capital expenditures come to Cisco, a figure that does not inspire awe considering that there are only a handful of major suppliers to carriers, according to Joe McGarvey, senior analyst for carrier infrastructure at consulting firm Current Analysis."Cisco is far from a giant in the telecommunications space," McGarvey said in a recent report. "Cisco has not been able to capture a larger percentage of service provider spending."And though Cisco has made some progress in gaining the confidence of carriers after its initial missteps, this will be an ongoing challenge for the company rather than a one-time event."They had to basically apologize for their behavior," says Bill Lesieur, director of Technology Business Research. "And they still have an enterprise-oriented organization. How can they build similar relationships with service providers worldwide that Alcatel, Lucent and Nortel have now? That's the biggest challenge outside of the U.S."Cisco's strategy for strengthening relations with carriers worldwide and increasing its share of carrier spending revolves around the deconstruction of barriers to circuit-to-packet infrastructure. They include capital and operational costs, such as the development of operational support systems and provisioning scripts for IP\/packet networks; and identifying profitable applications and services for these nets.Once these barriers are broken down, Cisco's total available market and its share of carrier capital expenditures should increase, Acra says."This is the dominant logic in our strategy," he says.King CiscoFor now, it's good to be king.No other network firm has fought off the bear-market woes better than Cisco, observers say."Cisco's core [enterprise] markets are flat, but profits need to keep going up quarter over quarter" to please Wall Street, Gartner's Fabbi says.Some say this comes at the expense of customers."Cisco's market position helps the company to charge a premium over competition and maintain high margins, which results in robust cash generation," Tal Laini, a Merrill Lynch analyst, wrote in a recent report. "With $21 billion of cash and equivalents on its balance sheet . . . Cisco could buy its 10 closest competitors and still have change left over."Many of Cisco's competitors now lag way behind in terms of product breadth and support, or have suffered financial instability, or both. The result of this has been a relentless flight by customers to Cisco as an all-things-network vendor.The average cost of a LAN port was $75 last year. Cisco's average price was $132, according to Synergy. And when compared with the average price of its competitors, the "Cisco tax" climbs even higher, to 70%."Enterprises at this point look at Cisco as a safe choice [and] don't care how much it costs," Fabbi says. "That just baffles me, considering the tough economic times. Major publicly traded companies are losing money in tough times across the globe. But when you look at network infrastructure, they're willing to just give their money to Cisco."Others see danger in a Cisco-at-all-costs world."This is not a good thing," Dzubeck says. "It's not healthy. Just as it was a bad thing to have an all-IBM environment in the 1980s, the same applies for Cisco today; getting too tied into any one vendor isn't good.""We run into very few situations where customers will just say, 'I'll go with Cisco,' and not worry about it," Cisco's Giancarlo says. He adds that Cisco products are packed with features to help companies reduce maintenance and management costs. And those features cost a little more."The bigger [payoff] for customers is if you put in capabilities that lower overall costs than strictly coming out with the lowest-priced product," Giancarlo says.For many corporations, the value of an end-to-end Cisco network is more important than a perceived loss of pricing leverage or single-vendor dependence."I can understand the concern," Lehman Brothers' Beyman says, "but I have not yet seen a reason to be concerned," with relying on Cisco as the company's sole network provider.In many ways, he adds, "it's great to have a single solutions provider; all the stuff works with each other, and you don't have to spend a lot of time and money stitching together other vendors' solutions.""Cisco's pricing is designed to obviously make a profit," says Eric Mucci, head of IT at Beiersdorf, a Norwalk, Conn., manufacture of skincare products. The higher price for Cisco gear, he says, "is justified by different people in different ways. Often, the 'suits' are happy paying the premium price for Cisco gear because it's a well-recognized brand that they can trust to run their business systems. From an IS point of view, the ROI [for Cisco gear] is easy to calculate after just one call to TAC," he says, referring to Cisco's Technical Assistance Center. Mucci says Cisco's support lets smaller firms deploy complicated technology with less personnel."Most IS departments are understaffed - ours included - so providing that level of support to untrained administrators is worth the premium price," he says.Next week: When you look beyond Cisco's status as Wall Street bellwether, there's the technology that makes the company successful. In our second installment we take a look at where\u00a0Cisco's core technology - IOS - is headed.