Cisco Margins Fat Like Crisco

Back in the 90s the knock on Cisco was that it was bad at in-house development and R&D.  So it got good at something else: selecting and integrating acquisitions.  That was fine; a competitive advantage is a competitive advantage.  And when the bubble ultimately imploded, it was basically the only company left standing.

A few months ago, I looked into Cisco's P&L when doing some research, and was surprised at how high the company's gross margins were.  I assumed it was because its business model was more software-like than I had previously thought, as I didn't think any hardware maker could carry such margins.  But the company is in the rare position of being both a monopoly and a monopsony.  It can force price concessions on its suppliers, and high prices onto its buyers.  As Andrew Schmitt points out, this can make for some pretty sweet margins:

It’s common knowledge in the close circles of the optical module business that Cisco (CSCO) has built an extremely profitable business on the backs of optical module companies. What is not appreciated is the magnitude of the business and the corrosive impact it has on the profitability of the optical module business.

It’s important that people get a sense of exactly how upside down the optical module business is.

Finisar and Avago sell short reach modules in large volumes to Cisco for $25, netting out around $5 in gross profit on each module sold. Cisco then resells this module (which has been pre-packaged and labeled for Cisco by Finisar/Avago) for $150 to $300, depending on the customer. Cisco has added no value to the product yet extracts a gross profit 25-50x greater. This is the power of the Cisco monopsony.

Is there anything wrong with this? No. It’s a brilliant business for Cisco, and makes paying $2.00 for a cup of coffee seem like a great deal. However, it does not represent a return on invested R&D, and high margin businesses with low barriers to entry like this cannot last indefinitely.

Some interesting thoughts to consider, as Cisco is again near multi-year highs.

 

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Whats a monopsony? If its a monopoly, shouldn't the government have stepped in and resolved that issue by now? Are they still doing now what with the recession and all?

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