Brocade: Product Provider Perils

Today, the Wall Street Journal announced storage and networking company Brocade Communications has quietly put itself up for sale

A quick analysis of Brocade’s financial results verify three key trends impacting hard core product providers such as Brocade. The image below compares Brocade’s most recent quarterly results to the same period one year ago:

Brocade Financials

Brocade Financials

 The three trends relevant to these numbers that have been telegraphed in this blog over the past year are:

  1. Product Margins are under incredible duress. This reality has been presenting itself in our Service 50 Analysis since Q1 of this year. For Brocade, they lost $36M in product margins dollars compared to one year ago.
  2. The cost of selling maturing products is increasing. It is becoming more expensive to sell and market products in maturing enterprise product markets. I discussed this trend back in January of this year in IBM Earnings and the Axe on Cost of Services
  3. Companies with no services buffer are performing worse in this downturn. Back in February, I posted on the financial benefits of having a buffer of services revenues  when product revenues and margins are under pressure. Product companies like Brocade with no significant services buffer feel the pain almost instantaneously in a downturn. As my analysis has shown, the services buffer provided by EDS to HP provided 40% of HP’s margin dollars and kept top line revenues from shrinking 20%.   

To pause on just the first two trends: If Brocade had maintained the same product margins it had one year ago and kept sales expenses at the same percentage of total revenues, the company would have made an additional $48.9M and posted a 10% profit instead of a 4% loss! Now, we layer in the fact that Brocade has no services buffer to offset lower product margins, and the downward trends all become amplified.

Change Market, Change Mix?

Brocade is facing the classic challenge outlined in Bridging the Services Chasm. Can the company find new, high margin product markets to fuel future growth or should the company pursue new services to augment its current market position in storage and networking? The historical guidance has always been to “change market” and bet on the new technology that allows the company to stay geared as a hard core product provider.   However, EMC, a direct competitor for Brocade, has long since opted to change mix .  Dell, a product provider cousin, has dramatically decided to change mix with its acquisition of systems integrator Perot. So the historical guidance to always change market (the Apple model in the world of consumer electronics) is no longer the obvious choice.

What Now?

So, what does the Brocade data point reveal? Two insights:

  1. If a classic product provider like Brocade is paralyzed in the services chasm between choosing change market and change mix, they may seek a third option called “acquisition.”
  2. How many other hard core product providers are left that can sustain themselves in a change market strategy?

Can storage provider Netapp stay an independent product provider? Or will they need to pursue the “change mix” or “acquisition” options? What about hard core software product providers like Autodesk or Akamai? Here is my prediction. Five years from now, there will be very few independent product providers left in the technology industry (companies that receive a vast majority of revenues from product sales). These current product providers will have “changed mix” or been acquired. Why? Look at the data—the trends are not in the favor of product providers to drive top line growth and bottom line profitability solely on the back of products. Just ask Brocade.

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2 Responses to “Brocade: Product Provider Perils”

  1. The Readers’ Vote: Top Three Trends « Service Visions Says:

    [...] Commoditization: Hardware companies are facing continued erosion of product margins. This erosion is putting more intense pressure on service organizations to deliver both revenues and margins. This trend was discussed in Product Provider Perils.  [...]

  2. Key Trends: 2011 « Service Visions Says:

    [...] Commoditization: Hardware companies are facing continued erosion of product margins. This erosion is putting more intense pressure on service organizations to deliver both revenues and margins. This trend was discussed in Product Provider Perils. [...]

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