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

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.'"

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.

Price Isn't Everything

Purchase price is only a small part of overall networking cost, Chambers says. "Most of our competition over the last 15 years has come after us on price," he says. "But a lower-priced product doesn't protect their investment, doesn't help them apply their application, doesn't provide the same service and support." By offering an overall network architecture and constantly adding new capabilities like network access control and wireless LANs, Cisco offers "investment protection" because major network elements won't become obsolete and need to be replaced quickly, he argues.

It's the old total cost of ownership rationale--and who can argue with that? After all, the up-front price of products is estimated to be only 20% of the total cost of a network. However, TCO is difficult to measure and hard to prove, and customers are skeptical of vendor number crunching. "I think it's all overinflated hype," says Keith Cook, network services manager at Indiana Farm Bureau Insurance.

Unbundling hardware and software could affect what it costs to build a network and manage it over time. Today, when customers buy a Cisco box, they get a lot of software, whether they want it or not. Routers, for instance, come with Cisco's IOS operating system, security features, and maybe VoIP and network management capabilities. Customers that have bought systems management suites or security products from other vendors may not want those features from Cisco, but they're paying for them nonetheless. In other cases, customers must buy separate software service contracts to go along with the software-hardware package they've bought. For round-the-clock support, there's one package; for upgrades, another.

There are a few examples in which Cisco already licenses software sans hardware. Customers can buy its VoIP CallManager software under a licensing model. The price depends on the number of users and length of the license. Cisco also sells its Access Control Server security software under a licensing model. Customers can buy it as standalone software and install it on a server or as part of the Cisco NAC appliance. But Cisco's inconsistency in which products are licensed and how they're supported can be confusing. "I'm frustrated that it's not the same across the board," Laidlaw's Turner says. "You would think similar products would have the same type of software licensing and services and support, but that's not the case."

Cisco is now moving in that direction. The company within several years plans to sell much of its software separately from the hardware and related maintenance fees. "We've seen with advanced technologies that a lot of the value comes from the software and not the particular hardware it runs on," says Cliff Meltzer, a senior VP who heads Cisco's Software Business Strategy Council. "Letting customers pay for what they need, when they need it, is clearly the right approach."

Cisco understands the significance of the change. "Our next frontier is to develop sort of a systems approach," says Rob Lloyd, Cisco's senior VP in charge of U.S. and Canadian operations. "We used to price in a classic network way. It's now a systems approach, more like a traditional software approach."

While that approach is commonplace elsewhere in the computer industry, it will be a major change for networking vendors, though one others are likely to copy. HP's ProCurve network arm plans a similar move. Avaya sells per-user licenses for its Communications Manager VoIP software.

Cisco hasn't released many details about which products will be sold under license and what it plans to charge. Chambers broached the licensing issue for the first time last month. Candidates for software licensing include security, network management, and voice services, senior VP Lloyd says.

Some software will be available for a one-time fee; some will be sold as subscriptions on a quarterly or annual basis, not unlike the software-as-a-service strategies from full-time software companies. And Cisco plans to make it easier to buy software, Meltzer says, by letting customers download and try the products using a one-click online program and an automated key specific to each customer.

A new pricing paradigm benefits Cisco as well as its customers. It could help Cisco by aligning revenue more directly to features customers want. "Customers can give us a better sense of what is of value to them in the product," Chambers says. "Here is what security is worth to me, here is what the ability to add new capabilities such as switching or wireless is worth, here is the value that new application software brings to my architecture."

Some Will Pay More

Cisco estimates it will take three to five years to complete the move to software licensing and acknowledges that the potential for customer confusion is high. Cisco must explain the new pricing, make pricing methods consistent across products, determine what becomes a line item and what stays in a bundle, and hash out the financial implications for customers and itself, Lloyd says.

One of Cisco's big selling points is that its architectural approach can make things easier in the increasingly complicated world of networking. If software licensing introduces unnecessary complexity, customers could end up paying more than they do today or it could persuade them to give a competitor a try. Or it could make customers even more dependent on the vendor. Cisco already knows customers will need its help: what releases to run, what's included in particular licenses, the need for buyers to track licensing for compliance purposes.

Some prices are sure to increase. Chambers hinted at as much at the user conference. "Do we charge as much as we should or as much as we could? Probably not," he said. "All the major software companies in the world charge major amounts for upgrades, and customers don't even blink." However, Cisco also could cut prices on hardware as software is decoupled, so a smart shopper may find ways to hold the line on costs.

Cisco is taking a big risk, one that could open the door to competitors. It's also a risk that can't be quickly corrected by acquiring a company with a successful product, a standard Cisco tactic when it makes a bad decision on the direction of technology. In the next few years, customers will get a menu of hardware and software, including operating systems, from which to choose, Forrester Research's Rob Whiteley predicts. In that environment, it's possible that customers will decide to run third-party software and leave Cisco's software out of the equation as much as possible.

That's where all those Cisco software engineers will earn their salaries. If they can keep adding new features and make a Cisco network easier to run, customers will see value in sticking with the vendor. Today, however, Cisco uses many pre-standard and proprietary protocols and often allows partners to run software only on its hardware, limiting customer options. It's not likely to change that without a fight. Another interesting possibility: If networking gear becomes a commodity like PCs, servers, and storage appliances, customers may want to run Cisco software on cheaper gear from other vendors.

But there will be a limit to how much cross-platform swapping goes on. Just like customers can only run limited third-party apps on Cisco's equipment, they can't run Cisco software on most other vendors' hardware today, except for some management and security software that works on standard servers. Networking equipment typically involves unique software running on specialized hardware in support of differentiated services. Some Cisco software can manage and monitor other vendors' hardware, but it can't be directly installed on that hardware.

Industry groups are trying to develop standards for networking hardware and interfaces between products, which could give customers a greater ability to mix and match software, hardware, and features from different vendors. But these efforts haven't made much of dent in Cisco's sales.

Open source could become another option, but the networking market is years away from open source software running on commodity equipment as a mainstream option. There have been some open source IP success stories, such as Sourcefire's Snort IPS/IDS and, to a more limited extent, the Asterisk IP PBX. And there are companies such as Vyatta, which provides open source enterprise routers, and efforts like FreeSwitch, which is developing an open source telephony application that can be used to build open source PBX and VoIP switching systems. However, most open source networking efforts remain flies on Cisco's windshield. Businesses still count on Cisco to innovate for them.

Bravo For Bundles

Some customers don't see the appeal in an unbundled Cisco. Indiana Farm Bureau Insurance has 130 field offices, all of which have older Cisco routers with standard software, making them easy to manage. Network services manager Cook has no interest in buying software licenses, which he says would just complicate matters.

On the other hand, Carl Weddle, director of IT at trailer-parts maker Quality Trailer Products, sees benefits. He would no longer have to buy Cisco security products for parts of his network that already are locked down, and he could leverage an already purchased license to add used Cisco boxes to his network without having to buy hardware-software bundles. "I would love that," he says.

Cisco understands one size doesn't fit all, so it intends to give customers options. For customers that don't want to deal with the details and hassle of software licenses, Meltzer says the company will maintain the current bundled model. For some hardware and software, like its largest routers and IOS operating system for telecom carriers, unbundling might never be an option.

There are potholes in the road to unbundling. Licensing models can become complex and difficult; just ask Microsoft customers. And Cisco can't afford to become complacent or arrogant, something that happens on occasion, some customers say. When Saint Luke's Hospital System, a 10-hospital chain around Kansas City with 5,400 network users, implemented VoIP three years ago, it chose Nortel Networks after a competitive bidding process.

Cisco wasn't happy--and made its feelings known. "The implied comments were, 'I guess we're going to reconsider how much we're going to provide support'" for Saint Luke's remaining Cisco equipment, CIO John Wade says. "Why would you threaten us because we're changing part of our own systems? The answer was, 'Because we're Cisco.' To me, they're leveraging that very dominant position to the exclusion of your own business objectives."

Why Mess With What Works?

Other companies in Cisco's position might avoid change. Cisco commands 70% of the routing and switching markets, is a market leader in VoIP, and leads in network firewalls and intrusion prevention systems. Why mess with a good thing? As Yankee's Kerravala puts it: "The installed base is so big now that in order for someone to come in and take this, they need to execute well and hope Cisco executes poorly."

Cisco has demonstrated an ability to anticipate technology trends and move quickly to stake out a position, whether through internally developed products or by buying companies. Chambers & Co. years ago correctly targeted the intelligent network as the company's future, and they've moved to incorporate security, wireless, VoIP, video, and other technologies into mainstream business networks. "By the time it becomes obvious, it's already too late," Chambers frequently says.

Tech industry veterans know he's right, and pricing decisions can be just as important to a company's success and a customer's happiness as technology decisions. "I don't hear our customers say we want our networks cheaper," Cisco's Lloyd says. "I'm hearing our customers say we want the product to be rock solid, to be told how to deploy it, to be upgradable, and for it to work the minute we turn it on."

Software is the key to making that happen, and Cisco thinks it can no longer give away a major ingredient of its success. If "the network is the platform," as Cisco executives are fond of saying, then software is what makes the platform work and software is what differentiates Cisco's platform from those offered by competitors. Chambers is determined to make sure Cisco gets paid for that software.

Illustration by Doug Chezem

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