entry into growing market for storage-networking switches would sink established players
have proven unfounded, so far.
After three quarters of shipping product, Cisco is well behind its target of doubling storage revenue every quarter. The best Wall Street estimates -- Cisco refuses to break out detailed storage revenue -- show Cisco's storage bookings grew from $10 million in the third quarter of fiscal 2003 to $17 million in its fiscal 2004 first quarter. That performance earned the company a market share of 3%, compared with 50% for Brocade and 36% for McData, according to the Dell'Oro Group, a research firm.
"We were a little bit disappointed with our progress in the storage area networking markets, where we experienced some manufacturing issues, longer-than-anticipated sales cycles and a few other challenges," CEO John Chambers conceded during Cisco's earnings call in November.
What's more, if investors were nervous about McData and Brocade last year when Cisco entered the storage-networking-switches arena, they got over it in 2003. The two companies have each appreciated by about 45% this year, just a hair less than the
as a whole. Cisco, meanwhile, is up over 70% year to date.
But McData and Brocade are hardly out of the woods. Cisco hasn't made any big mistakes in storage, analysts note. It has good products, a sales force that is too smart to alienate the established distribution channels, and most importantly, lots of time and deep roots in business networking. "In two years they will be taking major market share," predicted Nancy Marrone-Hurley, senior analyst with the Enterprise Storage Group.
Even the competition admits to being concerned: "With Cisco in the race, it doesn't matter how their horse is running. They're still in the race," said Jay Kidd, vice president of technology for Brocade.
Clearly, it's a race worth running. Worldwide revenue for fibre channel switches in 2002 was $847 million, and that number is expected to increase to $2.69 billion in 2007, according to Gartner analyst James Opfer.
Barriers to Entry
With the benefit of hindsight, Cisco's slow start is easy to understand. Unlike servers or PCs, storage-network switches are still far from becoming plug-and-play commodities. A high-end switch, also called a director, is an extremely complex piece of hardware selling for well over $100,000.
Put simply, the switches direct traffic on storage area networks, or SANs, themselves a relatively new technology that allows massive amounts of data to be stored -- and accessed -- on dedicated networks, thus unburdening the data network.
As a SAN grows, new switches must be added. But because SANs are so complex, mixing switches from different vendors on the same network gives IT administrators the creeps, according to Marrone-Hurley. "You don't just come in and say 'add my switch' to an established network. Customers don't go for it," she said. McData and Broacade, on the other hand, already have large installed bases.
Fair or not, many customers don't believe that Cisco products always work well with competitors' products. Also, some customers avoid early versions of any new product as a matter of principle.
Cisco's admittedly aggressive expectations in the storage market were fed by overly optimistic forecasts. Last year, Gartner predicted that the storage-switch market would grow to $4.2 billion in 2006, well above the revised forecast for 2007, Opfer noted. Why the shrinkage? IT spending didn't pick up as quickly as many expected.
It's also possible that SAN technology actually fooled the market and did what it was supposed to do -- increase efficiencies. If so, SANs may be cheaper to implement than first thought, Opfer said.
Elephant in the Room
Even if Cisco had met its targets for storage revenue, the additional $70 million or so would still be the equivalent of a rounding error for the tech behemoth. After all, Cisco's revenue has been averaging about $4.7 billion a quarter. But no one in the industry doubts that the company is serious about storage.
Although its acquisition of privately held Andiamo Systems, whose technology is the key to Cisco's storage strategy, is not complete, the eventual price -- based on a complex sliding scale -- could reach $2.5 billion. That's serious money, even for a giant like Cisco.
Cisco and Andiamo are already engaged in joint product development, and Cisco is selling Andiamo products under an existing partnership. The acquisition is expected to be completed by July.
"There are two races, technology and price," says Jamie Gruener, senior analyst with The Yankee Group. "Cisco will gain share by constantly revving its product set. They'll out innovate the competition," he predicted.
Gruener also expects Cisco to exert considerable pressure on pricing, but so far, that has not happened, at least at the higher end. In fact, Cisco was apparently charging a premium of about 30% over Brocade and McData during the first half of the year, which led
to cut prices sharply on the Cisco storage products it resells.
Brocade's Kidd says his company won't engage in a price war, and McData will likely
miss its October quarter because it refused to knuckle under to
demand that it cut prices. But the threat is there. Some industry watchers believe that customers, including the major OEMs, may push hard for more standardization of switches, a trend that would force prices lower.
For its part, Cisco says it's on track, despite the slow start up. "Cisco has met every product developmental and distribution and partnership goals that we laid out as far back as August 2002, and we are very committed to and optimistic about our prospects in the storage market," said spokesman Jim Brady. Brady notes that Cisco products are resold by
Hitachi Data Systems
and EMC, and that the number of its storage customers increased from 43 in the third quarter to 140 in the fourth.
Everyone knows that Cisco is not a company any competitor can afford to ignore. But McData and Brocade have time to strengthen their offerings or change their game plan. Both made a number of well-received acquisitions recently and are pushing R&D to stay ahead technologically.
Tech insiders generally rate McData, which is very strong at the high end, as the more viable competition for Cisco. But it's too early to write off either company.
For now, issues such as valuation and earnings merit more attention from investors than the threat from Cisco.