Cisco, Rivals Confront the Commodity Crunch

Networking-industry leaders are about to pay a steep price for their success.

A decade of innovation has created a thriving communications-gear business centered on the Net. Leaders such as Cisco (CSCO) have amassed mighty fortunes charging premium prices for the equipment that kept the Internet rolling smoothly, even as usage boiled higher.

But investors know technological achievement comes with a cost. The more robust and widely accepted a given standard, the faster prices will fall as competitors flood the market. Tech watchers call the process commoditization.

And that's the prospect facing Cisco and its peers in 2004: As tightfisted big companies and telcos opt for cheaper, simpler gear, networking outfits will have to decide whether to fight the onrush of low-cost competition or flee to other niches.

"We are at the beginning of the second major wave of change in the industry in the past 40 years," says Blaylock & Partners analyst Gabe Lowy.

Aptly enough, the first wave was driven by the PC -- another business radically remade by commoditization -- and the need to connect computer systems. The second phase, says Lowy, will shift emphasis away from underlying infrastructure and toward the delivery of services.

Now efficiency-minded outfits like Dell (DELL), NetGear (NTGR) and 3Com (COMS), the last in partnership with China's Huawei, are driving hardware commoditization directly into Cisco's once-untouchable market. And analysts, including Lowy, say other parts of the telecom market are likely to see similar challengers coming up through the lower end of their markets.

"I wouldn't be shocked if Huawei partnered with someone like Ciena (CIEN) or Tellabs (TLAB)," says Lowy, who has a sell on Ciena and no rating on Tellabs.

You can blame the Internet for dishing up a simple new protocol to displace the competing and incompatible standards that formerly dominated telecom networks. Yesterday the Internet brought us the breakthrough innovation of connecting computer systems; today it has largely become our plain-vanilla communications network.