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3Com Corp., like many of its networking industry competitors, has been fighting to regain profitability and stability in a market that has been suffering from slow customer demand. 3Com lost $79 million in the most recent quarter. Deciding to focus on the enterprise networking market, the company sold the assets of its CommWorks telecom equipment unit to UTStarcom for $100 million. Bruce Claflin, 3Coms CEO, discussed the companys progress with eWEEK Editor in Chief Eric Lundquist and Executive Editor Stan Gibson.
eWEEK: What steps are you taking to bring 3Com back?
Claflin: We decided there were three or four things we would have to do to gain market share in an otherwise ugly industry. First, we had to get a full line of infrastructure products to sell to the enterprise.
The second gap was in voice over IP. We believe that voice over IP is real and compelling and its going to happen now. While we had a good product line it was, again, low end.
Third gap: While the industry overall is fairly depressed, there are pockets that are doing very well and China struck us as enormously attractive. We wanted to have a strong position in that market, which I believe it is the most attractive IT market in the world.
The last gap has to do with cost. I believe the networking industry is going to have price pressures and cost pressures. You have to demonstrate value for the dollar. In the early days of networking that wasnt on customers minds. Today, the payback has to be real and hard.
eWEEK: That brings us to your Chinese partner, HuaWei. Can you elaborate on your relationship?
Claflin: We concluded the most attractive company to help us would be HuaWei, with a dominant position in the Chinese market and excellent engineering skills. They had just gotten into the enterprise market with a complementary product line to ours. They thought they couldnt expand internationally without a partner.
The joint venture enables us to have a complete line of products, because HuaWeis product line includes a full line of modular switches and a full line of routers. Were going to build an integrated road map for the combined product line.
HuaWei and 3Com products will be sold under the joint ventures logo in China and Japan. Everywhere else our products and HuaWeis products will be sold under the 3Com name. I believe we can become No. 1 in the China market. (Cisco Systems Inc. is No. 1 now.)
The venture will give use help on our cost structure. Weve been moving a lot of our manufacturing to China, and about 60 of our volume is made in China.
Voice over IP
eWEEK: Does the agreement encompass voice over IP?
Claflin: One gap the HuaWei venture didnt fill is for high-end voice over IP. We found inside the company we had a fantastic voice solution, jointly developed with AT&T. It is carrier class, software based running on Sun servers. We developed it, and it was reasonably successful in the carrier marketplace. Were going to sell that to the enterprise. It will be generally available in the U.S. in August.
eWEEK: Are you using VoIP internally?
Claflin: 3Com is a trial customer and our CIO is committed to 70 percent cost takedown. Were getting rid of PBXes and Centrex services. IP conferencing is a big payback.
eWEEK: Do you feel confident that the technology is ready?
Claflin: Yes, its proven. Youve been using it through AT&T and dont know it.
Customers told us the thing they didnt like about VoIP was that it required a forklift upgrade. They said, If I have voicemail I want it to run across my entire network. Because we developed it for AT&T we support every protocol known to man. It will support Cisco phones, 3Com phones and PSTN phones. You can put it in and start getting the savings. All the applications run on the soft switch, and you can use the handset you want.
Also, most states require that handsets have to have e911 capabilities. Carrier networks and enterprises have to have phones identify their location to within 50 feet. We sell a four-port switch that you can use to get e911 support to the cube. Theres no one in the world that has that today.
Making an Investment
eWEEK: Having filled those gaps, what else is left to be done?
Claflin: Were going to invest in our service, marketing, sales and support—the customer-facing activities. We will also invest in higher value-add channels than we have typically been in.
Global systems integrators told us about their relationship with Cisco. They said it was love-hate. They said Cisco wants to have account control and so do they. They said they hate that they [Cisco] have 20 percent of their revenues coming from services and they try to displace our service offering. They said they hate the margin pressure; they dont like their [Ciscos] arrogance.
But they said that selling Cisco equipment, they dont have to fight a battle with the customer. They also said Cisco had a complete product line and you guys [3Com] dont.
So were now going back to them saying, Voila, we have a full line of products, and voila, we have no intent to have account control. We tell people were going to become a tier one network provider.
Some companies have a good price structure and some companies are tier one, but we dont know of any other company that is trying to do both.
eWEEK: Most everyone assumes that Cisco will survive, and yet, theyve had very hard times as well.
Claflin: Im not going to say that Cisco is in imminent peril. Having said that, theyre a dripping roast. Just imagine a big, fat dripping roast that you just cant wait to sink your knife in.
Its like when IBM came out with the 360 and the 370 architecture. Who took a big chunk out of IBM? Gene Amdahl. He leveraged 360 and 370 software, using technology to give a better price and function point at every level. It ran standard code, and his gross margins were 20 percent less than IBM.
This is where Cisco is exposed.
eWEEK: This is Dells argument.
Claflin: Well get back to Dell in a minute. Regarding Cisco, heres a company that had their stock at 80 a share and now its trading at about 12, so its taken a big whack. It still has a P/E ratio of 25 to 30, which means it has to have extraordinary returns to justify $12 per share. What happens if someone puts pressure on and they cant sustain those gross margins? Theyd have to gut the company: massive reductions, real estate sales. The price goes from $12 to $2. Is it likely in the near term? No, but is that a real risk for them? You bet.
If a company can come along and demonstrate products as capable as if not more so than theirs, supported by world-class partners, and can price it far lower—thats where I see the dripping roast. It happened in mainframes, it happened in PCs, and its happening in storage.
Dells Strategy
eWEEK: And Dell?
Claflin: I think that Dell is really smart. Dell decided it could go in and suck out a nice piece of business at the very low end. Now everyone immediately said Dell wants to be an enterprise company. Kevin Rollins told Smith Barney that Dell had changed its strategy and wasnt going after being a tier one company, but has moved to tier two.
Dell went out and hired a bunch of people from the networking industry, and they developed a business plan for Layer 3 switches sourced in Asia. Michael [Dell] put the kibosh on it and said, Were going to do plug and play, standardized, low end.
I think Dell is a real competitor. Do I believe theyre going to be a tier one networking company with a broad enterprise product line? Absolutely not.
eWEEK: How do you read the industry and the economy?
Claflin: Ive come to the reluctant conclusion that I was wrong. When I became the CEO two years and four months ago—that was right when the industry was going into the downturn—I publicly said it was going to be a deep, long downturn, but that it was a traditional cycle and that it would emerge at the other end.
I said it wasnt going to emerge like it was at the end of the 90s but like it was at the beginning of the 90s, when networking was growing at 10 to 12 percent, that was three to four times GNP growth.
Im rethinking, and recently Im of the belief that for at least the next five to six years, the networking industry will be fundamentally altered. The main characteristics of the last decade or so are gone.
Its more likely that industry growth will mirror GNP growth, maybe with an additional point or two on top. If the industry does better, thats great. But were planning for an environment where it grows a couple of points above the economy, period. That implies that the networking industry might only grow 4 to 6 percent.
Any idea that we might be a high-growth company on the back of a good industry is gone. We have only one choice, and thats take market share. We learned we would not take market share going at the current course and speed.