CISCO walked into HP’s bread and butter by hopping into the server space. I’m not sure they really thought this through all the way. HP countered by buying 3Com–wanting to become #2 (for now anyway) in the enterprise networking space.

HP is going to win this battle.
Here’s why:
It’s all about the margin structure. Cisco has enjoyed roughly 70% margins in core networking forever, because they have had no real competition for the last 15 years. They have not pushed the commodity envelope and passed on savings to the market – because they didn’t have to. Now, they are addicted to that contribution margin – it funds everything else they do.

IF (note the big IF) Cisco become successful in servers, they will only do so by changing their margin profile. They will not ultimately be able to sustain margins in excess of HP or IBM or Dell because they simply can’t buy at anywhere near the levels of the big server guys. Nifty packaging is just that–packaging. It’s not a sustainable value proposition that justifies a huge margin profile. Cisco has sold about 1,000 UCS systems over the last year, I think. HP ships 8,500 servers a DAY.

To get to scale, Cisco is going to have to buy someone. Dell? That would be awesome and give them scale–but awfully expensively. Who else? They can’t buy IBM or HP, or Intel, so who else is there? That means they have to do it organically–which will cost a fortune and drag down earnings in my estimation–let alone the distraction it will cause.

Now for HP and networking, the opposite is true. Networking margins for HP will be GREAT! They will be closer to 50%–twice that of serverseven if they price at 50% of Cisco. HP already has 5,000 people trained on the products and is aggressively hiring salespeople. HP will find no real trouble convincing shops to let them start as a legitimate number two. Once they are in, who knows? No matter what, Cisco will be forced to either lower their pricing and eat margin or cede market share. I suspect they will be forced to cede share, as once they drop pricing their whole model breaks. Final thoughts here:

1. HP only has to show minor, consistent share gains to win.
2. HP has a much deeper overall portfolio versus Cisco. Cisco has networking and telepresence. HP has everything and the kitchen sink.
3. Cisco can be outsold. Their dominance has allowed them to move from hunters to farmers over the years.
4. If Cisco is committed to the server space, they almost are forced to pick up the last big piece–storage.
5. HP has always pushed the commodity envelope. It will be bad enough that HP gets a foothold in core networking and forces a one time price correction–but they won’t stop there. They will keep on forcing it year over year. At least that is what history tells me. (In my next column I will forecast the course that IBM and Oracle will take.)  

ABOUT THE AUTHOR:
Steve Duplessie is the founder of and Senior Analyst at the Enterprise Strategy Group. Recognised worldwide as the leading independent authority on enterprise storage, Steve has also consistently been ranked as one of the most influential IT analysts. You can track Steve’s blog at http://www.thebiggertruth.com