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7/28/2006
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In Depth: Chambers Is Changing Cisco's Pricing. How Far Will He Go?

You're already paying more for Cisco gear. Will unbundling hardware and software increase your bill?

Cisco Systems is a networking vendor first and foremost, but it has a software company's aspirations. CEO John Chambers has signaled plans to unbundle much of the sophisticated software that powers the company's routers, switches, voice-over-IP systems, and other products and offer the code independently of its metal sheath and electronic guts. The change is intended to give customers à la carte flexibility in the way they build and buy systems, Chambers asserts. For Cisco, whose premium prices and fat profit margins already are the envy of rivals, it also represents a potentially lucrative new source of revenue.

Cisco dominates the networking market almost as much as Microsoft does the desktop, and it continues to charge top dollar for its products, sometimes more than double the industry average. Customers have complained for years about its prices, but they keep coming back, buying more routers, switches, firewalls, VPNs, and wireless LANs. Cisco products typically are sold as a package, with hardware and software sold for a single price. It's an industry practice that dates back to the days of analog PBXs, when the likes of AT&T and Nortel sold voice switching systems containing proprietary software.

The unbundling would let customers buy only what they need, possibly reducing the amount they spend with Cisco and making it easier to mix third-party products into their networks. Some customers could end up spending more on software and hardware that has to be purchased separately. Unbundling could lead to the commoditization of network-ing hardware, one of the few tech sectors that has proved resistant to the trend. And it could give Cisco greater insight into the features and technologies customers want, letting the vendor place a more accurate value--and a premium--on in-demand products.

While customers may resist throwing more money Cisco's way, it's a necessary move, as software has become one of the company's main value propositions. Already, 60% of the work done by Cisco's 16,000 engineers is on software, and most new features are delivered as software, not hardware. Cisco, however, doesn't get the annual software license fees that generate a steady flow of revenue for companies such as Microsoft, Oracle, and SAP, and Chambers wants to change that. "One thing we haven't done well [is] we haven't charged for software in ongoing fees," he said at Cisco's annual user conference last month. "So often people get the difference between maintenance and software upgrades [confused], when in fact they are in the same category."

A Position Of Strength

Most vendors make major pricing changes when they're in trouble, when they're losing sales to competitors that have better technology or lower prices. Cisco, in contrast, is still the leader in most of the markets in which it competes. And despite grumbling, customers are loyal. "Sure, you pay a bit of a premium," says Ruth Harenchar, former CIO at legal staffing firm Hobart West. "What you get is confidence in the product. I've put them into the pot of 'I don't have to worry about that.'"

No network worries for Harenchar

No network worries for Harenchar
But you do pay for it. In an InformationWeek Research survey conducted in November, Cisco was last behind Hewlett-Packard, Nortel, and 3Com when customers ranked their networking vendors on pricing. Other data bears that out. In low-end switches, for instance, Cisco's Fast Ethernet ports fetch more than double the industry average, at $225 per port compared with the average $100, according to the Yankee Group. The difference at the high end is narrower: $315 to the industry's $290. In routers, Cisco's price per low-end access box averages about $1,000, while competitors sell for hundreds less, Dell'Oro analyst Shin Umeda says.

For voice over IP, Yankee analyst Zeus Kerravala pegs Cisco and Avaya at just under $600 per user to get VoIP up and running, while Nortel and Siemens cost a little less, and low-end vendors such as 3Com and ShoreTel cost around $400 per user. In the wireless LAN market, Cisco charges 20% to 40% more than Aruba Networks and Trapeze Networks, its two biggest competitors.

There are a few places where Cisco actually is less expensive. Several Cisco VPN concentrators cost less than one-third of comparable Juniper models. But it's rare that Cisco is such a bargain.

Our survey in November found the biggest challenge organizations face in executing a network strategy is high cost, so customers care. Yet Cisco came out on top in overall customer satisfaction. "It's still the best product on the planet, even if you have to pay a bit more," says Stan Turner, director of infrastructure at transportation company Laidlaw International.

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