Analysis: Cisco’s most recent earnings report last week shows that the tech giant is accelerating its transformation as well as making more layoffs, says Technology Business Research Analyst Michael Soper.

HAMPTON, N.H. – Cisco is leveraging omnipresence in network hardware to fund investment in software-driven segments that will spur the company’s long-term growth

Cisco’s C1Q17 results demonstrate the company’s ability to strike a balance between relying on traditional strengths in network hardware to drive revenue volume and scaling up in secondary segments to drive sustainable growth in the long term. Currently, Cisco’s secondary segments such as Collaboration and Wireless deliver inconsistent revenue growth, while Security — a consistently growing segment — provides less than 5% of total revenue. These segments are leading the charge to transition more of Cisco’s revenue to a subscription-based model, and this transition results in uneven growth.

Cisco is also weathering weak service provider capex, as the vendor’s operator customers pull back or delay spending due to recently completed major projects, pending consolidation, or software-mediated networking initiatives. Overall, revenue declined 0.5% in 1Q17, but Cisco is outperforming rivals such as Ericsson and Nokia, and continues to deliver leading gross and operating margins of 63% and 26.5%, respectively.

  • Cisco’s acquisition strategy is driving its software- and services-led transformation

The goal of Cisco’s transformation is to derive a higher percentage of revenue from recurring software and services sales as the network hardware market is forecast to contract over the long term due to commoditization and the rise of white boxes and software-mediated networking. To drive its transformation from a product-focused hardware company into a solutions-led player in the networking space, Cisco is leveraging both internal investment and acquisitions, but acquisitions have featured much more prominently in 2017. In just the past three months the company closed its acquisition of cloud application company AppDynamics and agreed to acquire SD-WAN company Viptela, the advanced analytics assets of Saggezza, and artificial intelligence company MindMeld. Cisco is well-positioned to continue making acquisitions due to its $68 billion in cash and short-term investments.

TBR believes Cisco’s acquisition cadence will continue at this rapid pace in 2017 with a laser-like focus on software-based acquisitions to drive Cisco beyond its reliance on switches and routers for revenue volume. Software-mediated networking will gradually, but significantly, erode Cisco’s revenue and margins in network hardware, but the company aims to compensate for this by scaling up and building out its software portfolio to provide the intelligence necessary to run and derive business value from enterprise and service provider networks.

  • Cisco’s transformation requires intensified restructuring, leading to an additional 1,100 layoffs

Cisco (Nasdaq: CSCO) announced in May 2017 that it would eliminate 1,100 positions in addition to the 5,500 it announced in August 2016, which are nearly complete. Cisco’s headcount will decrease a net of fewer than 6,600 employees as TBR believes Cisco is largely retaining the talent brought in by its software acquisition spree and hiring in Internet of Things (IoT), security, cloud and analytics. TBR expects headcount reductions to come primarily from administration and hardware-focused R&D. Cisco will complete the vast majority of layoffs prior to the end of 2017.

In addition to accelerating transformation, reducing headcount will help Cisco maintain leading margins as it encounters headwinds to revenue growth through 2017, including weakening service provider capex and public sector spending. Cisco’s own transition to selling more software and service subscriptions will also drag on revenue in the short term.