Editor’s note: Cisco’s traditional core business of network hardware declines as its latest earnings report on Wednesday shows, but growth in a diversified portfolio of offerings such as security and collaboration are enabling growth, says Technology Business Research analyst Patrick Filkins.

HAMPTON, N.H. – Organically, Cisco’s (Nasdaq: CSCO) revenue declined 1.1% year-to-year, primarily driven by lower demand for its core networking solutions. But excluding Cisco’s divested CPE {customer premisis equipment) business, revenue grew 3% year-to-year.

Cisco recognizes demand for network hardware will fall over the next several years as its customers shift investment to software-mediated solutions. Combined, NGN Routing and Switching as a percentage of revenue declined 130 basis-points year-to-year to 44.5% as sales increased in Cisco’s growth segments (Security, Collaboration, Wireless, Service Provider Video and Data Center), in 1Q16.

Within its growth segments, Cisco is committed to driving recurring revenue from sales of software and services. Software sales are structured according to the Cisco ONE delivery model where it provides its customers with a range of licensing options to ensure hardware investment is complemented by automatic software updates.

TBR believes Cisco’s strategy will enable it to drive higher software sales, which deliver strong margins, partially offsetting the negative effects of hardware commoditization on its core businesses.

Cisco builds on its networking heritage by realigning its engineering teams to drive cloud innovation

Cisco’s latest round of restructuring demonstrates its ICT transformation while maintaining its core networking roots. In March CEO Chuck Robbins announced substantial changes to the company’s engineering organization, which will align under four segments consisting of: Networking, Market Segments and Solutions (NMS); Security; IoT and Applications; and a new Cloud Services and Platforms group.

Under the NMS group, Yvette Kanouff will lead Cisco’s Service Provider business, supplanting Kelly Ahuja, an 18-year Cisco veteran. Kanouff was previously SVP and GM of Cisco’s Cloud Solutions group, indicating Cisco’s desire to rapidly shift to a cloud-first focus in the telecom market.

TBR believes this restructuring is necessary as Cisco’s customers transform and adopt cloud, SDN and IoT infrastructure. However, like many of its peers, Cisco will be challenged by the business and financial model shifts associated with cloud services. The most glaring threat will be to Cisco’s existing customer base which is migrating to hybrid cloud, exposing them to a wider range of solutions outside the Cisco ecosystem which may be less expensive or easier to procure.

Cisco enters the hyperconverged market to spur Data Center segment sales

Following a yearly decline in its Data Center segment in 4Q15 and single-digit growth in 1Q16, Cisco is expanding its portfolio to find new growth. Cisco views technological disruption in the data center, driven by a shift to software-centric converged and hyperconverged solutions, as a growth opportunity. In March Cisco commercially launched HyperFlex, its hyperconverged solution. Cisco’s solution is engineered to converge a customers’ networking fabric (Nexus), compute (UCS), storage and hypervisor software into one stack.

Cisco partnered with Springpath, in which it is an investor, to deliver network storage through software. Springpath’s software eliminates the need for traditional network storage by tying together compute and storage functions across the data center.

Storage is an area in which Cisco has struggled to monetize on its own as evidenced by the discontinuation of its Invicta flash storage products in 3Q15 and its reliance on partners such as EMC to supply converged solutions through the VCE business group.

While Cisco is a late entrant in the hyperconverged market, TBR believes it will leverage its networking heritage to differentiate by offering swift integration with its customers’ existing network infrastructure, which is typically a technical hurdle during hyperconverged implementations.

(C) TBR