If you can't beat 'em, supply 'em.
That seems to be Cisco Systems' (CSCO) thinking as it unveils a pretty big strategy change for its massive routing business. Going forward, Cisco doesn't merely plan to sell routers to enterprises and service providers. It will also sell switching/routing processors and optics, as well as license its IOS XR router OS, to third-party hardware makers.
Cisco also unveiled a new router line for service providers -- the 8000 Series -- that it claims has been "optimized" for 400-gig network buildouts (expected to take off next year). The 8000 Series will be powered by a new processor (the Silicon One Q100) that's claimed to deliver "twice the network capacity of all other high-scale routing ASICs," and supports a new, "cloud-enhanced" version of IOS XR (IOS XR 7).
Both the Q100 and IOS XR 7 will be offered to third parties, with Cisco noting that the Q100 can be used for both switches and routers.
Cisco's plans to sell optics aren't particularly surprising. When the company announced its $2.6 billion deal (still awaiting Chinese approval) to buy optical component, module and digital signal processor (DSP) supplier Acacia Communications (ACIA) in July, it promised to continue supplying Acacia's products to other OEMs, while also noting that it already sells some optics to rivals.
On the other hand, the plans to sell switching/routing processors and license IOS XR to third parties are both surprising and represent a big overhaul of a product strategy that has been in place for decades. But it becomes easier to understand when one considers the challenges facing Cisco's service provider sales for much of the last decade.
An Attempt to Boost Cloud Sales
While 5G deployments should provide a boost over the next couple of years, Cisco's sales to traditional telcos and pay-TV providers -- they depend heavily on router sales -- have been pressured by sluggish telecom capex. In addition, Cisco's carrier router business has faced tough competition from Nokia (NOK) , Juniper Networks (JNPR) and Huawei.
And along the way, Cisco has seen relatively limited switch and router sales to Internet/cloud giants that have rapidly dialed up their capex in recent years due to their ever-growing infrastructure needs. The cloud giants tend to rely heavily on internally-designed networking gear that's made by Asian contract manufacturers, and a large portion of their business with networking OEMs has involved Arista Networks (ANET) and Juniper.
Cisco's recent numbers drive home the scope of these pressures. During its last three quarters, the company's service provider product orders -- they cover orders from telcos, pay-TV providers and Internet/cloud firms -- respectively fell 13%, 21% and 13% annually.
Cisco is wagering that its latest moves will provide a major boost to its service providers sales in the coming years, both by putting its carrier router business on better footing as 5G deployments swell and -- more intriguingly -- by helping it become a leading merchant supplier of switching and routing silicon, including for the cloud giants.
The technical strengths of the Q100 could help Cisco's cause. Cisco claims that in addition to providing unmatched processing power, the Q100 is versatile enough to handle four different functions within a networking box, all while relying on a common software development kit (SDK).
Notably, Cisco says that Facebook (FB) and Microsoft (MSFT) are already using the Q100, and the press release announcing its latest moves features positive quotes about its silicon from both Facebook and Alphabet/Google (GOOGL) execs. Also, Cisco has announced that 8000 Series routers will be able to run the open-source, Microsoft-developed, SONiC operating system for networking gear (it already supports some of Cisco's Nexus data center switches).
None of this guarantees that the cloud giants will be using Cisco's ASICs or routers in massive quantities. But considering that Google and Facebook are both known to rely heavily on their networking hardware designs, and that Facebook and Microsoft are both known to be major Arista clients, it's certainly encouraging.
New Competition for Broadcom
As tech analyst Patrick Moorhead pointed out, Cisco's strategy change is a problem not just for Arista and Juniper, but also for Broadcom (AVGO) . Hock Tan's company, which reports earnings on Thursday afternoon, has long been the top merchant supplier of switching silicon, via its Tomahawk and Trident switching chip families (Tomahawk is heavily used by cloud giants, while Trident is more enterprise-focused).
And in recent years, Broadcom has also seen strong traction for its Jericho packet processors, which have often been used in boxes that blur the lines between switches and routers. Cloud giants have been avid buyers of Jericho-powered boxes, thanks to their ability to enable "flatter" data center network architectures that reduce the number of hops a packet of data has to make to get from point A to point B. It looks like Cisco, which it should be noted is one of Broadcom's many networking OEM clients, is now hungrier to get a piece of this business.
Separately, Cisco's plans to sell optics to third parties represents a challenge for companies such as Inphi (IPHI) , Macom (MTSI) and Finisar (recently acquired by II-VI (IIVI) ). This effort comes ahead of 400-gig network deployments that are expected to be a boon for optical component and module sales.
Rivals will undoubtedly try to return fire at Cisco in the coming months. Broadcom, it's worth noting, just began shipping a powerful new Tomahawk switching chip (the Tomahawk 4) that relies on Taiwan Semiconductor's (TSM) advanced, 7-nanometer (7nm), manufacturing process node (the Q100 relies on an older 16nm process node), and began sampling a 7nm Trident chip (the Trident 4) in June. And with the newest Jericho processor (the 16nm Jericho2) having launched in early 2018, it wouldn't be surprising to see a 7nm successor launch next year.
But with that said, Cisco's strategy change does spell a clear opportunity to do more business with cloud giants whose share of IT hardware spending has been growing with each passing year.
And though Cisco does risk cannibalizing some of its existing service provider hardware sales by providing its silicon and software a la carte, this feels like a risk worth taking, given both the current state of its service provider business and how IT spending is likely to keep trending over the long run.