Cisco’s Next Big Bet Is Years in the Making

 fortune.com  6/20/2017 6:00:52 PM   Jonathan Vanian
Fortune Brainstorm TECH 2016

Cisco’s quest to overhaul its huge business of selling data center equipment for managing corporate networks involves a big bet on something the company is not well-known for—software.

The tech giant debuted software on Tuesday designed to make it easier for corporate customers to manage and monitor their networks. In addition to the new software, the company also introduced new data center switches with custom-made chips that are intended to make operating the software more efficient.

Customers that buy the new equipment must pay a subscription to access many of the new software features, marking a big departure for Cisco from its longtime business strategy. In the past, Cisco sold hardware that came with most services pre-installed and that customers had to pay for whether they wanted that software or not.

The new software by subscription underscores Cisco’s efforts to deal with declines in its legacy business of selling equipment for managing Internet and telecommunications networks. Businesses are increasingly buying computing resources on-demand from companies like Amazon (amzn) and Microsoft (msft) instead of buying traditional data center hardware, which has hurt Cisco because of its dependence on selling data center gear.

Cisco's overall sales have dropped for six straight quarters, raising concerns that its business is facing difficulties competing in a radically changing IT market. In May, the company said it would lay off 1,110 employees after releasing weaker forth-quarter financial guidance than investors had expected.

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Like Juniper Networks (jnpr) and other networking companies, Cisco has been shifting to a pay-as-you-go model for some time. Subscriptions make it easier for Cisco to predict future revenue and also lets it sell new software more quickly because they can be delivered via the Internet instead of having to be delivered in boxes.

Ultimately, the new software “is just the first phase of a much longer term strategy,” said Cisco CEO Chuck Robbins. Cisco plans to use the new software as a beachhead for selling customers additional services that are aimed at powering Internet-connected devices like elevators and factory equipment.

Although Cisco already sells some of its software products by subscription, the latest combines those existing products into a more easy-to-buy package. Additionally, the software bundle includes new features like the ability to spot security threats in encrypted corporate networks, a difficult task, and a service that lets IT staff manage Cisco gear without having to tweak the underlying code. Another service was designed to anticipate when a certain corporate app needs excess bandwidth so it doesn't crash under heavy use.

Cisco started developing its new software six months before Robbins replaced longtime Cisco chief John Chambers in July 2015, Robbins said. The company's business was not growing as fast as it once was, facing competition from both cloud computing providers and newer businesses selling more flexible networking software.

“We looked at what we saw happening in the industry and where we saw things going and what I felt was we had a need to shift investments into our core technologies more aggressively than we had,” Robbins said.

Under Chambers, Cisco was more hesitant to create software services because of the risk of cannibalizing its hardware sales. Customers could have merely bought the software without buying as much high-priced equipment, Cisco's primary revenue source.

Robbins, however, has taken a gamble and made software a big priority including several big software acquisitions like a $3.7 billion deal for software monitoring firm AppDynamics.

Cisco chose to debut the new software this year because it believes that companies have “hit an inflection point” in managing their IT operations, which are now spread across both internal data centers and with cloud computing providers, Robbins said. The increase in Internet-connected devices linked to corporate networks makes those networks more complicated to manage, he explained.

“If we tried to define this architecture three years ago, it would be tough to get your head around,” Robbins said.

Cisco is hoping that its customers will use the new software and hardware to build and manage their separate corporate software and apps. It’s a big challenge considering businesses are increasingly using the services of cloud computing providers like Amazon Web Services to create and run new software.

“It will be interesting to watch if this [new software] offsets any of the momentum towards the cloud,” said Jim Duffy, a 451 Research analyst.

In March, technology news publication The Information reported that Cisco was looking to completely break apart its networking software from its hardware and was developing a new networking operating system to help with the task. Cisco declined to comment if it's new software services were built using the operating system mentioned in the report.

Big Internet and cloud computing companies, the biggest customers of data center gear, are buying less hardware from big-name brands, according to several analyst reports. Instead, companies like Facebook and Microsoft are increasingly doing business with Taiwanese contract manufactures like Quanta and Winstron, which build generic data center equipment that their customers can fill with their own custom networking software.

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Robbins declined to comment about big cloud computing companies are buying more or less data center gear, citing an upcoming financial analyst day on June 28. But he would say that new software represents Cisco's future and that it is designed to keep the company relevant.

"When you’ve sold your technology the way you had for 30 years, it’s very difficult to go to your customer and say, 'Guess what, I’m going to change the way you are going to buy it.'” Robbins said.

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