The New Cisco Is All About Software, Software, Software

January 26, 2017, 12:15 AM UTC
Fortune Brainstorm TECH 2016
Fortune Brainstorm TECH 2016 WEDNESDAY, JULY 13TH, 2016: ASPEN, CO 9:00 AM A NEW MODEL FOR CONNECTIVITY Chuck Robbins, CEO, Cisco Interviewer: Andrew Nusca, Senior Editor, Fortune PHOTOGRAPH BY STUART ISETT/Fortune Brainstorm TECH
Stuart Isett—Fortune Brainstorm TECH

The new Cisco is starting to look like the old IBM and Hewlett Packard, at least when it comes to the software business.

Cisco made waves Tuesday when it jumped in at the last minute to buy enterprise software company AppDynamics for $3.7 billion before the startup was slated to go public this week. Fortune’s Erin Griffith wrote a gripping account on Wednesday of how the deal went down.

So why would Cisco, one of Silicon Valley’s old guard data center and networking hardware companies, buy a software maker used by businesses to monitor the performance of their apps? Software apps like the one for ride hailing service Uber don’t seem like they have anything in common to the switches and routers that Cisco sells.

But the reality is that software is now very different from just a decade ago when companies like IBM (IBM) and Hewlett Packard (before splitting into two separate businesses) were betting big on tools for coders to create and manage software. In 2006, for example, Hewlett Packard bought IT software company Mercury Interactive for $4.5 billion, followed a week later by IBM buying infrastructure software company MRO Software, Inc. for $740 million.

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Flash forward a decade later and Hewlett Packard’s business-focused unit, now Hewlett Packard Enterprise (HPE), has chosen to spin off Mercury and related IT software services to U.K. company Micro Focus in a $8.8 billion deal. IBM, on the other hand, is moving away from its traditional IT software business and is investing heavily in its Watson data crunching and cloud computing business.

AppDynamics CEO David Wadhwani said Wednesday in a call with analysts that when AppDynamics was founded eight years ago, companies like Hewlett Packard and IBM were still pushing their own software monitoring tools. However, these companies failed to see how Amazon’s nascent cloud computing business would fundamentally change how coders create software, he explained.

Amazon Web Services’ growth over the last decade was a double-edged sword for hardware companies like Hewlett Packard Enterprise and IBM. IBM and HPE have seen their hardware and server businesses decline as companies have increasingly bought their computing services on demand. At the same time, IBM and HPE’s old-school software tools have become more irrelevant in today’s world of AWS-powered apps like home-renting service Airbnb and ride-sharing app Lyft.

The digital blood-and-guts of these apps aren’t in one server tucked away in a lone corporate data center like they may have been in the past. Instead, the software infrastructure for these powerful apps is often distributed across in thousands of computers in multiple data centers, many owned by Amazon, Microsoft, and Google.

The trend of companies moving their software to Amazon, for instance, has been the single biggest source of growth for AppDynamics, whose technology tracks the performance of modern software and spots problems in it. AppDynamics grew its revenue 84% year-over-year to $150.6 million in its fiscal 2016 while losing $134.1 million, according to a regulatory filing.

Now Cisco wants AppDynamics to help to augment its nascent software subscription business, which the company said is growing, but without revealing exact numbers. Cisco, like HPE and IBM, has also been hurt by the growth of cloud computing because it has meant a slowdown in sales of its core switch and router businesses. However, Cisco hopes that it can sell software services like data and security analytics to customers to pick up the slack from its weakening hardware business.

If Cisco can capitalize on an area of technology that HPE and IBM have downplayed over the years, perhaps it can use its size and relationships with re-sellers to supercharge the now Cisco-owned AppDynamics business unit. But, that’s easier said than done.

For one thing, Cisco’s radical transition under CEO Chuck Robbins has caused several high-profile executives and engineers to leave the company over the past year. Executive discontent in a time of rapid changes in the industry could make it more difficult for Cisco to successfully integrate the new technology and talent.

For more about Cisco and AppDynamics, watch:

Additionally, IBM, Micro Focus, and CA Technologies are likely to try to win customers while rival Cisco and AppDynamics are busy merging, explained Forrester analyst Milan Hanson. By buying AppDynamics, Cisco is now stepping into the turf of these other legacy companies, which have been rewiring their existing software monitoring tools to better fit today’s era of cloud computing, Hanson said.

Wall Street is optimistic that other big business technology companies will respond by also gobbling up upstarts. Shares of software monitoring and analytics company New Relic rose nearly 11% to $36.85 on Wednesday while shares of Splunk, which tangentially competes with AppDynamics, were up almost 8% to $58.59.

And then there’s Amazon and its AWS cloud computing business, the source of so much upheaval in information technology. AWS has been steadily introducing various IT management services for businesses, and there’s nothing preventing it from creating an AppDynamics-killer of its own; bits and pieces of its various services already do similar software monitoring for its customers.

If Amazon, or other big cloud companies like Microsoft or Google decide to get into the same space as AppDynamics, Cisco will have another tough competitor to worry about.

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