Analysis

Why Cisco chooses acquisition over R&D

Jennifer Scott

There is nothing unusual about an industry heavyweight looking around the world of start-ups for a smart buy to boost their technology portfolio. Nor is it strange for billions to be spent in a relatively short space of time to incorporate the product line and talent into an organisation.

What is remarkable is when a company decides to do this nine times in as many months, as Cisco has during 2012.

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In February the networking giant picked up the relatively unknown Lightwire for $271m to take advantage of its optical interconnect technology. Since then a further eight companies have joined the ranks, with the cash that Cisco paid out remaining undisclosed in most cases.

Cisco's latest buy was cloud networking company Meraki, for an impressive $1.2bn, but the biggest purchase prize went to UK video software company NDS, for which Cisco paid $5bn in March.

The threat from software-defined networking (SDN)

Cisco has paid out around $6.5bn for four companies and who knows how high this figure would be with the additional five. But why does Cisco think it better to chase down acquisition targets?

“I believe they are going through a transition phase, as SDN threatens their current market,” claimed Roy Illsely, principal analyst at Ovum. 

“They have recognised this, even if they are not publicly admitting the potential disruption, and the move to do more acquisitions I think is an attempt to broaden their presence and enter new adjacent markets.”

It is true that SDN poses a threat to Cisco. The company has traditionally made substantial revenues from selling proprietary routers and switches. With SDN, the software solutions make the hardware underneath irrelevant, meaning customers can in theory buy any supplier equipment and get the same performance out of it.  

With the expense associated with Cisco and the inevitable tie-in due to its proprietary nature, SDN could steal away significant market share if the momentum behind it continues to grow at the same pace and more companies, like Big Switch Networks, get their products on the shelves with industry backing.

Cisco diversifies portfolio

Cisco has already shown it is attempting to widen its appeal. Its investment into its Unified Computing Systems (UCS) has been paying off as, despite not taking over the market, it is the fastest growing area of the company, with revenues for the datacentre division at Cisco growing 61% in the last quarter to $417m.

"How successful this will be it is too early to say but it certainly is needed so that Cisco remains relevant to enterprises in the future"

Roy Illsley, principal analyst, Ovum

This figure doesn’t compare to the $3.6bn brought in from its switching division, but broadening its remit will be necessary if it is to make up any falls in this revenue pot – which already fell 2% in the last three months.  

“How successful this will be it is too early to say,” added Illsley, “but it certainly is needed so that Cisco remains relevant to enterprises in the future.”

“I also expect to see many more strategic partnerships, like the one with Citrix – working on cloud and mobility solutions – where they are deciding a market is mature and not financially viable and they need to focus resources on more upcoming technologies.”

Acquisitions more cost-effective than R&D

It is clear Cisco has the cash to invest. In its most recent results, profits rose 18% to $2.1bn and sales were up 5.5% to $11.9bn. But why is it spending this money on external talent and technology, rather than investing into more research and development by its own engineers?

"With acquisitions it is more like ‘here is one we prepared earlier’" 

Clive Longbottom, founder, Quocirca

“In truth, acquisition is more cost-effective,” said Clive Longbottom, founder of Quocirca. “With internal R&D, you have to work out whether you have the right skills in house first. If you have, you have to take them off whatever they are working on and lock them in a darkened room to work on something new.”

“Even if you can do this, there are no guarantees and the end product may be good or may be bad. With acquisitions it is more like ‘here is one we prepared earlier’ where you are getting the technology, the talent and even perhaps a ready-made market.”

Extending customer base and innovation

The choices of acquisitions may be a little more confusing. As Longbottom pointed out, Cisco had already covered the midmarket area that Meraki sells to with the purchase of Linksys in 2003 and had the wireless area wrapped up with the 2005 purchase of Airespace.  

But it seems like acquisition is a strong path for Cisco to follow. It is one IBM is renowned for – Big Blue picked up 20,000 patents alone last year – and one that looks likely to help broaden Cisco’s customer base, ensuring it can innovate in new areas, even if the innovation doesn’t come from Cisco itself.

We will watch closely to see who is next on the shopping list.


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