The first rule of investing: Always keep learning.
If you don't stay ahead of the key trends and themes
developing in various sectors, you'll be investing in yesterday's
technology. And though many industry changes are modest in scope,
impacting investing strategies on the margin, a few are
Lately, I've been researching a monumental change in the
information technology (
) sector that will have a $50 billion effect in annual spending.
That's the size of the networking equipment market, dominated by
Cisco Systems (Nasdaq: CSCO)
Juniper Networks (Nasdaq: JNPR)
F5 Networks (Nasdaq: FFIV)
Brocade (Nasdaq: BRCD)
That major change: a shift to software-defined networking
It's a seemingly simple name for a remarkably complex set of
changes in how information gets routed across networks. Let's try
to boil down the complexities of SDN into a few key
Better, Faster, Stronger
As a consumer, you'll never come into contact with SDN. It will
instead be used as a strategic tool by the chief information
officers (CIOs) who run large corporate networks. These CIOs have
a very tough job, making sure that all of the hardware and
software components interact smoothly, and keeping a focus on the
rapid delivery of network packets (which can carry voice, video
and data) across the country and worldwide.
Those two tasks -- network management and proper data routing
-- have always been seen as one task. But SDN breaks them into
two tasks, enabling CIOs and their IT departments to have much
deeper insight into where data traffic starts, how it moves, and
where it arrives.
Netflix (Nasdaq: NFLX)
as an example. The video-delivery firm spends thousands of
man-hours every month trying to optimize its network by adjusting
the loads on its server, routers and switches that attach to the
Internet backbone. Using SDN, these IT personnel can much more
quickly adapt to changing traffic loads, without making major
Just as important, IT departments can make major changes in a
network's operations, without worrying about unintentional
hiccups in the flow of traffic. In the current hardware/software
hierarchy, any new hardware or software additions can lead to big
headaches if other systems fail to be properly configured. SDN is
a "virtual" controlling mechanism, meaning it can change traffic
delivery patterns without disrupting any existing systems.
The use of SDN will enable IT departments to do
much more, but with fewer workers, yielding solid savings
in terms of overhead.
The Spending Impact
As IT networks are currently run, roughly 80% of tech funds are
spent on personnel that manage these complex systems (with the
other 20% going to hardware and software purchases (that is,
capital expenditures, or capex). The use of SDN will enable IT
departments to do much more, but with fewer workers, yielding
solid savings in terms of overhead.
And speed is another benefit: "SDN implementations (will)
reduce application deployment time from weeks to hours or less,
resulting in significant operational savings," note analysts at
Goldman Sachs. Companies will also save on hardware purchases as
they will no longer need to build a lot of redundant network
capacity to account for inefficient allocation of
2014: The BreakoutYear
Companies are going to proceed slowly, considering the tectonic
shift in network management that SDN entails. So it's unlikely to
have a big effect on the industry for several years. In the year
ahead, look for companies to begin their SDN trials, figuring out
how the process works on a small scale before placing large
orders in 2015 and 2016.
Yet the mere fact that this will become a dominant topic in IT
circles in 2014 makes this a timely investment opportunity. By
the time SDN is all over the financial media, share prices will
have already started to respond to the eventual winners and
UBS held a conference on SDN in the spring, and after hearing
industry comments, concluded that "the value proposition of SDN
around capex/operational expenditure savings and increased
automation and agility is real to customers and we expect this
architectural shift to play out over time."
Considering that Cisco Systems is the overwhelmingly dominant
player in network hardware, many tech strategists figured the
company had the most to lose from the switch to SDN.
Yet in recent months that view has flipped: Thanks to a string
of acquisitions and internal investments, Cisco is now seen as a
clear beneficiary, with a comprehensive set of SDN offerings that
outpaces its smaller rivals. A key part of Cisco's SDN strategy
entails long-term software and service contracts, which is a key
pillar of Cisco's long-term business model shift, as I noted
Analysts at Goldman Sachs, which has Cisco on its "conviction
buy" list, concur: "With Cisco enabling software programmability
to its vast $180 billion installed base, we believe it has an
opportunity to transition from a 'box' company to a platform
Analysts at UBS agree that Cisco is in the driver's seat in
this niche, but caution: "Cisco can't be complacent as the world
evolves from hardware-defined to software-defined, likely
requiring business model changes (software monetization vs.
hardware) and an increasing role for software and services in
Broadcom (Nasdaq: BRCM)
, which is building a set of communications chips that facilitate
, thanks to its $1.3 billion purchase of SDN pioneer Nicira in
Yet for every SDN winner, a rival will lose market share.
Goldman's analysts are concerned that rivals Juniper, F5 and
Brocade lack the scale to show technology leadership, and the SDN
transition may cause them to lose some legacy
Brocade and Juniper Networks have already made acquisitions in
the SDN niche, and if F5 Networks want to quickly become
relevant, it may look to acquire PLUMGrid or Jeda Networks.
BigSwitch or OpenDaylightProject, all of which are privately held
but garnering considerable industry buzz.
Risks to Consider:
By the time the SDN revolution gets underway in a year or
two, many players will have already completed their acquisition
strategies, and incumbent telecom equipment and networking firms
may already have lost the battle before it began.
Action to Take -->
It's hard to overstate how massive this shift will be. SDN
threatens to turn hardware components into commodities, leading
to rapid price declines for traditional networking switch
vendors. In coming months, you'll be hearing a lot more about
SDN, and it behooves you to track the moves of Cisco and others
as they jockey for position in what will become a $50 billion
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