Cisco's Scorched Earth Policy Claims Another Victim

Cisco swallowed another chip company Monday, Greenfield Networks. The notable thing about this acquisition is that Cisco rival Huawei/3Com built their high end system around the Greenfield device. I’m willing to bet that Greenfield was a lot more important to Huawei/3Com than it was to Cisco. And I’m willing to bet that’s why Cisco bought them.

By purchasing Greenfield, Cisco continues their scorched earth strategy of buying key suppliers in order to deny these products to competitors. This move shows the lengths Cisco will go to to preserve its dominance in the L2/L3 switching space. Wikipedia has a comprehensive list of all acquisitions- it would be neat if they had the purchase prices as well.

I profiled their reliance on reselling optical modules as a source of earnings growth, but Bill Koss nails the reason why they can do this, and why they make so much money today - market share:

When Cisco announced their quarterly results yesterday, the fist thought that came to my mind was how nice it must be to own 80% market share for routers and switches. I know the Cisco team talked about ‘firing on all cylinders’ and a ‘validation of their business model’, but the reality is they secured their customer base in the early to mid 1990s and there has been no compelling event to force enterprises to make vast, capital intensive changes to their network using a supplier other then Cisco.

John Chambers handles his job as master of ceremonies exceptionally well during conference calls and while speaking on TV. He even managed to squeeze a reference to Web 2.0 into his CNBC interview, ensuring his dialogue delivers the buzzwords the throbbing masses demand.

What you won’t hear Chambers say is that Cisco is successful because they are 80% of the market and the market for networking equipment is growing at 15-20% a year. This incumbency position provides them with several advantages, including monopsony power over suppliers and the ability to turn commodity items into value added products.

It also gives them the mass to shoulder aside competitors and pull the rug out from under them by acquiring key suppliers. People harbor crazy ideas about oil companies buying and burying 200 MPG engine technology. Cisco does this routinely with silicon suppliers.

Cisco pulled the exact move in 1997, when they acquired Skystone, an Ottawa based chip maker that was the sole source of OC-48 POS/ATM framer silicon. When Cisco assimilated Skystone, several other tier 1 equipment vendors were left without framer silicon and effectively gave the GSR12k a 6-9 month lead in the exploding (at the time) Telco market. They followed it up in 1999 by acquiring StratumOne. These events also catalyzed a gold rush for SONET/SDH silicon suppliers, resulting in an oversupply of products that still exists today.

The game plan for a comm semi supplier looking for liquidity is pretty straightforward:

1. Design compelling silicon that enables a valuable networking equipment feature (sorry, no getting round this one)
2. Get product thoroughly designed into Cisco Competitor to the point where they are 9 months pregnant with your silicon.
3. Get product designed into Cisco (optional)
4. Get acquired by Cisco
5. Write note of apology to Cisco Competitors #1, #2, #3 . . . .

Unfortunately for Netlogic (NETL), they completed step 3 before step 2, and derive 60-70% of their historical revenue from Cisco. Cisco competitors are wary of building systems around their devices. And Netlogic is stuck fighting Cisco purchasing for a few extra points of margin day in, day out.

Meanwhile, Greenfield played the game right. And Huawei/3Com got pwned.