"Disaggregated Business Model": Cisco (CSCO)

For years, Cisco (CSCO) dominated the internet routing business, earning the moniker "the plumber of the internet." At the height of the "tech bubble," CSCO's stock hit a price of $77 - a price it has not come close to since - and was one of the most valuable businesses in the world. Since then, CSCO has continued to thrive, but its market cap has never recovered. Why?

For years, CSCO has sold its networking solutions as an integrated system. Such systems set themselves up for what Clayton Christiansen defined as the "innovator's dilemma." What does that mean? That means that some businesses set up their business profitability based on a margin driven by the "value-added" of integrating components. The nature of capitalism is to disaggregate these components and commoditize them. Often this occurs by a lower-cost modular innovation, such as connected microcomputers replacing mainframes.

Based on Christiansen's framework, CSCO was a prime candidate for commoditization. By 2014, the largest companies in networking, such as telecommunications and Big Tech companies, had moved forward into software-defined networking (SDN). SDN allowed companies to use lower cost hardware and then design software to meet their specific requirements. The result was a lower cost, higher quality outcome. CSCO protested that their security was better. But the large purchasers increasingly pursued SDN.

Last week's WSJ reported the inevitable modularization as it announced that CSCO would now allow customers to purchase the chips alone. Given that this was going to occur, it may be that CSCO has finally accepted the inevitable because either 1) it is better to stop losing market share and accept lower margins or 2) it is now in a prepared position with vastly superior chips that allow for a reorganization of value into one of the components - the chip. It will be fascinating to see which way this develops.