By Kevin Kelleher, contributor
FORTUNE -- As a purveyor of switches and routers that form the Web's backbone, Cisco Systems is responsible for building the Internet. Perhaps more so than any other company. But as the Internet evolves, Cisco has entered a kind of middle age, struggling to find new areas of growth as it fends off competitors in a market where its signature products have become commoditized.
The Internet's networking structure has largely become much more sophisticated. The core networking gear of switches and routers that was Cisco's (CSCO) bread and butter for years has largely become a commodity, while some of the more complex tasks of controlling the dynamic flow of data is managed by software running on top of the hardware. As a result, Cisco has lost some of its share of the networking-gear market as companies like Juniper have offered more competition. In an April 2011 memo to Cisco staff, Chambers acknowledged the lack of focus. Chambers said candidly, "Many say that in the face of this expansion, Cisco needs more discipline. I agree."
Cisco has pushed into higher-end networking equipment, but its overall business in these areas is declining: Both switches and routers, which make up 62% of the company's total revenue, declined 2% in the most recent quarter from the year-ago period. Other areas Cisco has moved into, in contrast, are doing much better: Service video is up 30%, wireless revenue is up 38% and data center revenue is up 61%. Together, these three segments account for only 22% of Cisco's total revenue.
Cisco's initial response was to make a detour into more consumer-oriented networking technologies. Several years ago, began selling set-top boxes, Linksys home WiFi routers and the Flip video camera. That detour proved largely ill-advised, and Cisco sold off its set-top boxes and folded up its Flip business as smartphone cameras proved increasingly popular.
More recently, Cisco has embarked on an even more aggressive goal -- transitioning from the top Internet communications company in the world to becoming the top IT company in the world. "Bottomline, we're starting to become an IT player," CEO John Chambers said in Cisco's earnings conference call this month. "It's an important aspirational goal for us to become the number one IT player. Time will tell if we can do that or not, but we like what we're seeing in the market overall."
Cisco's expansion into areas like Internet security, wireless technology and data centers are a part of this strategy from communications equipment to a broader portfolio of IT hardware and services. The announcement last week of Cisco's $1.2 billion purchase of Meraki is another big step toward the vision Chambers outlined. Meraki's cloud-networking platform offers Cisco a stronger presence in WiFi and mobile management. Most of Meraki's customers -- including Nordstrom (JWN), Applebee's, Starbucks (SBUX), local governments and universities like Stanford and MIT –-- are mid-sized institutions, an area of the market Cisco has not focused on so far.
Rob Soderbery, Cisco's senior vice president of enterprise networking said in a call to investors, "I believe that Cisco and Meraki will transform how midmarket organizations...build and consume network technology. So this is not just a product technology or talent acquisition, we're bringing Meraki in as the new platform within Cisco for cloud advantage networks."
Cisco's stock is up 5% since announcing the Meraki deal. Analysts noted that the deal could strengthen Cisco's 50% share of the WiFi market: Most of Cisco's WiFi customers are larger customers, and Meraki could bring smaller customers into its fold. What's more, Meraki's cloud-based platform can handle IT maintenance without taking on more IT staff. Jason Ader, an analyst at William Blair, said in a note last week that "Meraki's cloud based management software is the crown jewel of the deal from Cisco's perspective, and could be used to 'cloudify' multiple products within Cisco's enterprise portfolio in the future."
Cisco ended October with a $45 billion cash stockpile, enough to allow it to make more targeted acquisitions like Meraki. The business of building the Internet's backbone may not be as lucrative as it was a decade ago, but Cisco seems to have learned to expand prudently into new areas of growth related to that core business.
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"We have disappointed our investors and we have confused our employees."
-- Cisco CEO John Chambers in a company-wide email. (Wall Street Journal)
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