For the first time in nearly a decade, network superstar Cisco Systems Inc. failed to meet Wall Street expectations. Cisco stock in the 30s seemed impossible just three months ago, and now Cisco stock in the 20s seems very possible – even likely. What’s wrong? How far can Cisco fall? More significantly, what does its fall say about the future of our industry?

Why is Cisco not meeting expectations? Because connectionless routing isn’t growing as fast as it has been, and because its slower growth can no longer sustain Cisco’s growth expectations. Why is connectionless routing not growing as fast as expected? Because the Internet isn’t a very profitable carrier service business, and ISPs can’t continue to expand their networks without any clear indications they’ll be profitable selling Internet services.

How far Cisco might fall is a little harder to say. Based on the company’s next three years’ potential, I think its stock should be about US$28 per share. Wall Street tends to punish firms that disappoint it, though, and we could see Cisco fall much further – maybe as low as the US$25 level. The problems Cisco has had with sales and earnings won’t be solved in the next quarter, and probably not this year because Internet and IP spending on the enterprise and carrier levels won’t grow much in 2001. Cisco has the majority of the router market, so getting market share from somebody else isn’t much of an option – only growth of the market can increase Cisco’s numbers.

That brings up the real issues the Cisco announcement poses for the market. First, can the network market overall do well if the poster child of networking is doing less than well? Second, have we expected too much from IP and convergence? The answers, respectively, are “no” and “yes.”

Cisco’s problems are IP and the Internet’s problems. Don’t look for good news anywhere in that area if it doesn’t come from Cisco. As IP goes, so goes optical. There can be no more of a baseless and naive position in all of networking than the view that optical networking is exploding while Cisco earnings fall short. We really need to assume that a Cisco shortfall translates to an industry shortfall. Later this spring or early summer, we can expect to see a major shakeout in the optical market, and a lesser one in networking overall.

So what really brings in the network bucks? During the next three years, carrier spending on capital equipment must focus on two areas: creation of broadband access facilities (particularly to residential users) and creation of profitable data service extensions to existing data services.

In the first area, the key products are next-generation fibre remotes capable of voice/DSL service support. Cisco has no strength there and needs some. In the second area, the key product is the so-called “service switch.” Cisco has no strength there, either. Because service switches are a kind of router successor product, Cisco may resist even admitting to their value.

Broadband Internet won’t make money. Wireless Internet won’t make money. Non-Internet IP services already make money, as do frame relay, transparent LAN and other corporate data services. We need to expand the range of the proven data services, introduce “business IP” to replace “business Internet” and figure out how to make a profitable data service for residential users. The first step in accomplishing these goals is to admit that the Internet and connectionless routing alone is not the answer to our market prayers. That’s the hardest pill for Cisco to swallow, but one it must swallow if it’s ever to return to its former lustre.

The market at large will have to swallow this same bitter pill to prevent the Cisco slip from becoming a market-wide collapse. We’ve somehow made the Internet into a constitutional right and not a business. As a result, we’ve forgotten the problems with Internet profitability and ignored the question of how a market segment that isn’t making money can continue to spend it on new equipment. Cisco, and the industry, needs to back not a technology but a revenue paradigm – one that’s real and not just hoped for. The Internet isn’t it.

One of Cisco’s commercials claims that voice – more than 80 per cent of today’s service provider revenue – will be free in the future. Show service providers the profit source that will replace it, and Cisco and the rest of our industry can stop the stock price and confidence slide in its tracks.

Nolle is president of CIMI Corp., a technology assessment firm in Voorhees, N.J. He can be reached at [email protected]

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