May 16, 2002 2:25 PM PDT

Dell switches may threaten competitors

Dell Computer is about to introduce three data switches to compete with networking gear makers like 3Com and Cisco Systems. Analysts are saying the move will eat away at the computer maker's already downtrodden competitors.

Dell has been diversifying into the storage and server markets, along with a recent move into the apparel market, offering T-shirts and other products to complement its popular TV commercials featuring "dude" Steven. Dell has also been inching its way into the market for data switches, competing with networking gear makers like Cisco, 3Com and Nortel Networks.

Three new switches, called the PowerConnect 5224, 3248 and 3048, are slated to be released by the end of July, upping the ante with competitors in the market for low-end data switches aimed at small and medium-sized businesses.

Analysts say the company can succeed in a tight market thanks to two factors: incredibly low prices and a relationship with customers that will allow it to bypass resellers. Though Dell's strategy in switches echoes its cost cutting in the computer market, a price war isn't likely to ensue, analysts say.

Dell first entered the market in October with four switches; it expanded with two more switches in February. The networking equipment market wasn't a hospitable place then, and it isn't improving. Cisco, a bellwether in the sector, recently reported better-than-expected quarterly results, spurring a brief rally in some networking equipment stocks, but most analysts said the enthusiasm was unwarranted.

"Cisco said things are looking up, and everyone agreed--at least for one day. If only WorldCom and its colleagues would stop depressing us, maybe we could join the Cisco crew in their overall optimism," wrote Merrill Lynch analyst Tom Astle in a recent report.

But Dell is determined to take a bite out of the market with three switches aimed at what's known as the Ethernet Layer 2 market. It's the largest market for networking switches, which control the forwarding and filtering of data. Principal players are Cisco, with approximately 70 percent market share; 3Com, with 6 percent market share; and Nortel, with 5 percent market share, according to statistics from equity research firm Credit Lyonnais Securities.

Analysts say other networking equipment makers will suffer as Dell intensifies its push into the market.

"Dell's expanding product offering will likely begin to eat away at the low-end switch market competitors," Credit Lyonnais Securities analyst Gabriel Lowy said in a recent research note.

"The competition is pretty tight. It's about just a few dollars here and there," said analyst Zeus Kerravala at research firm The Yankee Group.

Dell's strategy is to squeeze out its competitors by offering low prices, analysts say. For example, one of the switches to be released in July, the PowerConnect 5224, will include 24 Gigabit Ethernet ports at approximately $100 a port. The average cost overall in the market is about $300 to $500 per port, according to Lowy.

"With Dell and switches it's about commoditizing the market, just like they did with PCs," Kerravala said. "The game is about being cheaper than the other guy, and Dell is the cheapest brand on the street." Dell took the PC market by storm by undercutting competitors and implementing a price war.

Kerravala said Dell can offer cheaper switches by manufacturing them overseas in Taiwan. Dell spokeswoman Michelle Mosmeyer confirmed that overseas manufacturing helps, but said the main way Dell can compete with the incumbents is by bypassing the sales channel and selling directly to customers.

"Our leading position in servers and desktops helps us," Mosmeyer said.

At least one analyst believes Dell's success will be limited to the low-end market. Kerravala said he believes Dell won't ever be a "serious enterprise player" competing with higher-end switching products.

But Dell argues that the features on some of its forthcoming "managed" switches, which allow remote management, will attract larger companies. These switches are due in July. Several large businesses also use Dell's products in their branch offices, Mosmeyer said.

The price wars that Dell inflamed in the PC market led to margins so low that computer makers suffered across the board, but that isn't likely to happen in the switch market, analysts say.

"Traditional vendors have no interest in trying to match Dell's prices," said Kerravala, who believes customers will end up paying more if they want switches tailored to specific uses, or if they want more support and services with their gear.

"Cisco is really good at selling a vision," Kerravala said. "The lower prices are going to force other companies to offer total product packages...instead of individual products to differentiate themselves," he predicted.

Even if competitors manage to keep Dell out of certain niches, they are still likely to suffer. "Dell currently resells switches made by 3Com and Extreme Networks, as well as networking products including interface cards and routers from vendors such as Nortel and Lucent (Technologies)," Lowy said. Those companies are likely to suffer as Dell starts making more switching products, and as more complex switches replace routers, the more traditional networking devices, Lowy added.

3Com said it has already expanded into selling more services and support with its products. The company also said it considers its use of sales channels a competitive strength. "We sell through a local reseller, so customers have a local contact to call up for support," said a company representative.

Cisco declined to comment, saying it does not discuss competition.

 

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