Can Cisco Regain Its Margins?

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Source: courtesy of Cisco Systems
While discussion of the quarterly earnings from Cisco Systems Inc. (NASDAQ: CSCO) after markets closed Wednesday has focused on the 6,000 job cuts the company said it would take, that one-time cost pales in comparison to the company’s slipping margins. We noted in our coverage of the earnings press release last night that margins have tumbled from 61.5% to 55.9% over the course of the past two quarters. Cisco cannot afford that kind of erosion, but it may not be able to do more than slow it down.

Cisco faces demands from its customers for lower-cost systems that can be more flexibly integrated with hardware from a variety of suppliers. This issue is not new to the computer hardware business, and it’s certainly not new to Cisco. The way the company — and other hardware makers — try to dodge this bullet is by making claims that their proprietary systems are somehow better. This works for a while, but not forever.

The latest development in network systems is software-defined networking (SDN), a two-part system that separates network control from the networking hardware that does the heavy-lifting. Using open programming interfaces to write the control code makes the machines cheaper both to purchase and to operate.

Cisco calls its SDN approach an “application-centric infrastructure,” which means whatever Cisco says it means. The company’s CEO, John Chambers, said that its version of SDN has been well-received and that anyone who believes that SDN will drive down margins is “just wrong.”

On the company’s conference call last night Chambers also said, “We will lead with this [SDN] implementation and it will let us get higher gross margins.” Cisco must win this battle for better margins, but the odds are against it. In tech hardware, cheaper inevitably wins unless style counts, and then Apple Inc. (NASDAQ: AAPL) invariably wins. But Cisco is not Apple and style points don’t add any value to hardware that’s stuffed into computer rooms and that few people ever see.

Cisco’s shares were trading down about 0.6% Thursday morning at $25.05, about half an hour before trading officially begins. The stock’s 52-week range is $20.22 to $26.08.

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