As I’ve argued in the past, there are still other moves that HP could make to fend off Cisco in enterprise IT. But those would be rendered moot if Cisco decided to pull the ultimate offensive move — that of buying Dell.

The Math

Even in the face of the current economic downturn, Cisco could afford to buy Dell. It had some $41 billion in cash and assets as of the end of its latest fiscal quarter, though it would likely look to buy Dell using a combination of cash, debt and stock. The combined market capitalization of Cisco/Dell of around $150 billion would easily trump rival HP’s $96 billion.

The margins on Dell’s products are much thinner than Cisco’s have traditionally been (17 percent vs. Cisco’s 64 percent in their two most recent quarters, respectively), but combine the two and you have a very profitable business. My rough calculations — without taking any potential merger synergies into account — put a combined Cisco/Dell at $20.4 billion in top-line revenues per quarter with $7.3 billion in gross profits (36 percent). I am willing to bet that with synergies the combined company would have gross profits of over 40 percent — compared to HP’s most recent quarterly gross profits of just 24 percent.

The Products

In a move to further penetrate the consumer market, Cisco recently purchased Pure Digital Technologies, maker of the Flip Video camcorders. In the meantime, it’s seen good growth in its Linksys consumer networking products -– at least in areas where they compete with HP. However, while those products are a step in the right direction for Cisco, they won’t help the company win out against HP. But if Cisco bought Dell, it would get a wealth of consumer products that are directly competitive with HP’s, among them laptops, desktops, printers, digital cameras, monitors and more. Increasingly, all of these devices need to be networked together in the home, and Cisco has the technology to do that in spades.

Beyond the strategic fit on the consumer side that would result for Cisco, such an acquisition would make good strategic sense for Dell, too. Dell has always wanted to be a major player in enterprise IT, a traditional market for rival HP. To that end, the company has its PowerConnect enterprise networking products, and at the start of the year announced a partnership with Cisco focused on the next generation of data center switching — a partnership focused on battling the common enemy of HP.

In the meantime, Cisco unveiled its first enterprise servers with its UCS product line. Dell’s PowerEdge enterprise servers and blade servers would complement UCS and enable the combined company to sell a complete enterprise computing solution that could rival HP’s ProLiant and Integrity products.

The Result?

If Cisco wants to triumph over HP, the value proposition of a combined Cisco/Dell is compelling. Cisco/Dell would continue to dominate over HP in enterprise data and voice networking, would be a very formidable competitor against HP in enterprise servers and be well positioned against HP in the consumer markets.

The question is, what would HP do in response? Would it move to trump Cisco in the enterprise storage market by buying EMC and its crown jewel, VMware? Perhaps it would move up the enterprise IT stack and acquire Citrix for that company’s enterprise application suite? One way or another, if Cisco were to acquire Dell, HP would see it as a declaration of all-out war.

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Azure charges 10 cents for the bandwidth to upload and 15 cents to download a gigabyte of data. The disparity in pricing, I believe, is meant to encourage Microsoft developers to move lots of applications and associated data into Azure and then have lots of users access the applications from the same platform.

Let’s assume that a customer of Azure develops an application that downloads 10 gigabytes of traffic per day, 20 business days a month. That means the application downloads a total of 200 gigabytes of traffic in a month (and to make the point, let’s assume that the upload traffic is minimal). Azure charges the customer $30 per month for this bandwidth use (200 gigabytes times 15 cents per gigabyte), which seems like a small amount to pay.

If the customer’s application is only sending data and consuming bandwidth 12 hours a day –- all of its users are in North America — during 20 business days, that means that the customer is effectively using 1.85 megabits per second of bandwidth during the month (200 gigabytes per month divided by the sum of 20 days times 12 hours in a day times 60 minutes an hour times 60 seconds per minute). Put another way, the customer’s $30 per month equates to a bandwidth charge of $16.20 per megabit ($30 divided by 1.85 megabits per second).

Cloud service providers buy a lot of bandwidth to provide access to the Internet. My market research (albeit not exhaustive) puts the current price per megabit of bandwidth for a large cloud provider at around $8. That means that for the 1.85 megabits per second that the customer uses, Azure effectively pays $14.81 to its bandwidth provider and keeps $15.91, or 51 percent gross profit — not a bad profit margin on a commodity business like bandwidth. To be fair, other cloud service providers, like Amazon and Rackspace, charge similar or higher bandwidth fees and likely make similar gross profits.

While this example is for a fairly limited charge to the customer of Azure, if a customer were to build an application on Azure that generates a lot of bandwidth, then the costs and profits to Microsoft get substantial. For an application that downloads 200 gigabytes per month, the costs are $600 for bandwidth for about 37 megabits per second of usage (again assuming the application only consumes bandwidth half of the day for 20 business days a month). Of that $600, Microsoft pays its service provider $296.30 and keeps $303.70 of gross profit.

And the model scales linearly –- if Microsoft can build up Azure to cumulatively charge for all customers’ applications sending 100,000 gigabytes of data a day, it will reap approximately $151,000 in daily gross profit off bandwidth. That would equate to a lot of copies of Microsoft Windows sold daily without any packaged software developers on staff required. With these gross profit margins, one can easily understand why Microsoft is building thousands of megabits of bandwidth to serve data from Azure applications.

So if you’re using a cloud customer and your application will send a lot of data from the cloud, our analysis indicates that once you’re sending over 50 gigabytes of data daily (or a terabyte a month costing you $150 on Azure, for example), it may make sense to leave the cloud and buy your own bandwidth to the Internet –- you’ll probably save 50 percent of your monthly bandwidth charges. The trick will be moving your application from the cloud to your own infrastructure and dedicated bandwidth and then finding the expertise to manage this environment. Cloud service providers are counting on that being a difficult trick to perform.

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HP needs to first realize that the focus of this war is the enterprise IT market. As far as the other markets Cisco serves, service providers are already being flank attacked by Huawei, Juniper, Alcatel-Lucent and Ericsson, to name just a few, while DLink, Netgear and dozens of others are busy in the Linksys consumer markets.

HP needs to think about the markets their enemy is headed toward, not where it has been or is today. They need to think about what the IT marketplace will look like in 2-3 years, when CIOs could actually have budgets again. Startups are where the innovating ideas of tomorrow are already being developed, and for many of these companies, their price tags may never be this low again.

So, which startups should HP acquire? If it’s looking to make gains at the expense of Cisco, the list is as follows:

Cavium Networks: This Mountain View, Calif.-based startup builds intelligent processors for networking functions such as compression, encryption and data acceleration. Notably, however, Cisco is a major customer of Cavium’s, so I imagine they’re contractually obligated to provide Cisco processors for many years to come.

Arista Networks, Blade Network Technologies or Force10/Turin Networks: While HP’s ProCurve line of switches has become a significant player in the enterprise data networking market, it needs to have a winning 10/100 gigabit Ethernet switching product line. Each of these startups have Ethernet switching technologies that could help HP aggressively attack Cisco at the core of the data center network.

DataDomain, StorWize or Ocarina Networks: Storage optimization is the emerging technology that CIOs need in order to cost-effectively deal with the mountains of data that enterprises store over long periods of time. With an $800 million market capitalization, DataDomain may be too large of an acquisition right now, but both StorWize and Ocarina Networks are just the right size.

BlueCoat, Zeus Technology and Strangeloop Networks: The application delivery market, focused on making applications run faster and optimally, is a battlefield strewn with many players. While HP recently inked a partnership with Riverbed, this is merely a shot across the bow. HP needs to acquire in this area, and although market leaders F5 (market capitalization of $2 billion) and Riverbed (market capitalization of $800 million) may be too expensive, BlueCoat, which has a $400 million market cap, may give them the firepower they need. Likewise, startups focused on the next generation of application delivery such as Zeus Technology and Strangeloop Networks would provide the necessary weaponry.

Nirvanix or Parascale; Rightscale or Elastra; SkyTap: Most of the companies in the enterprise cloud computing space are still privately held, so this may be the ideal time to make decisive acquisitions. HP should acquire companies focused on helping enterprises reach storage and compute power in the cloud in a scalable manner, those enabling what I call the Cloud Two-Step. In the storage battleground, HP should move to provide outsourced storage clouds, perhaps by acquiring Nirvanix, or allow enterprises to build internal storage clouds by buying Parascale. In the compute cloud market, HP needs to acquire a company such as Rightscale or Elastra. To help enterprises build and scale applications, SkyTap, which provides testing resources in the cloud, would make a compelling acquisition.

To win the upcoming war, HP needs to pick its battles carefully and strike quickly. For the past decade, Cisco and HP have had a cold war alliance –- Cisco claimed enterprise IT networking while HP focused on enterprise servers and compute. Both companies have been rewarded with exceptional market capitalizations. Now that Cisco has broken that alliance and declared war with their enterprise servers, HP must respond. I suspect bloodshed will soon ensue, so HP should move quickly — or risk losing the war before the first shot is fired.

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Nortel has long been considered the technical jewel of the Great White North. The company’s origins date all the way back to 1895; it was responsible for inventing and deploying many fundamental telecom technologies, perhaps the most prominent example being the digitizing of phone calls. Its most successful product, the DMS-100, was a digital central office switch that provided telephone service for some 100,000 phone lines. The name Nortel has evolved as well: The firm began life as Northern Electric, then went on to be known variously as Bell-Northern Research, Northern Telecom Limited and finally, after its merger with Bay Networks, Nortel Networks.

But is preserving the country’s technological heritage reason enough to spend millions in taxpayers dollars? I am not an economist, but rather a venture capitalist, and from that standpoint I could argue that the telecommunications market needs strong global competition to be successful and that the absence of Nortel would leave a notable hole in the marketplace. On the other hand, Nortel has clearly suffered from poor leadership and operational execution, so perhaps the market has spoken — and we should just listen.

All of which, of course, sounds eerily similar to the arguments here in the U.S. over the government-led bailouts of certain financial and auto companies. On that note, one small piece of advice for Nortel executives as they work with the Canadian government on their bailout: Don’t fly the corporate jet from Toronto to Ottawa.

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Some of the key features of the Generation 4 Modular Data Center design are the use of an innovative spine infrastructure for cooling, power and connectivity; the use of pre-fabricated and completely modular server containers and buildings; and ambitious goals for energy efficiency (an average power usage effectiveness (PUE) of 1.125 for all data centers by 2012).

By putting forth its plans for the Generation 4 Modular Data Center, Microsoft is simultaneously throwing down the gauntlet in the data center arena and showing its cards. By openly sharing its data center plans it is taking the technology and thought leadership away from Google in the critical area of Internet and services infrastructure. At the same time, in somewhat typical Microsoft fashion, it is asking (or perhaps requiring) the industry to standardize on its data center design approach. Given its influence and buying power with vendors it may get its wish.

Viewing this information in conjunction with announcements of the Azure Services Platform and Office Live, there is no doubt that the giant in Redmond is aggressively focused on delivering enterprise cloud computing. To top it off, market timing could not be better for Microsoft, as its hordes of cash and diversity of enterprise products should prove one version of the Golden Rule: “He who has the gold makes the rule.”

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Server huggers like being near their servers -– they feel that the emotional well-being and efficient operation of their servers requires them to be physically close at all times. And while it may be easy to scoff at server huggers and their technical idiosyncrasies, it is this same breed of folks that keep the applications running on the Internet — we would all be grasping to master our social graph, unable to micro-blog to our abundant followers and forced to live in our real life without them.

But server huggers face an impending crisis — the data centers that host their servers in many large metropolitan areas such as Chicago, Los Angeles, New York and San Francisco are increasingly filled. It is unfulfilling to hug a server that sits in a cardboard box because there is no rack space left in a data center, so server huggers have been scrambling to put their servers in geographically desirable locations that do not require new construction or an exorbitant budget.

And that got me thinking: Does the data center of the future look like a mobile home park? A mobile home park provides a place for you to park a single-wide or double-wide home and some basic utilities — power, roads, mail, etc. Yet, unlike seemingly every person on the Jerry Springer Show, servers do not operate well in mobile homes. However, as Microsoft, HP, Verari and others have shown, high density blade servers can be packed with hundreds of terabytes of storage, cooled and operated efficiently inside standard shipping containers. Maybe instead of more metropolitan data centers for the server huggers, we need container parks.

A container park would be on a plot of land within a metropolitan area (or on the immediate outskirts) and provide basic services to host containers filled with servers. Container parks could be located in spare lots close to power generation facilities, or be set up along a high-bandwidth fiber routes or even adjacent to a telecommunications facilities.

Compared to building, a top-tier data center that can cost $1,000 per square foot, setting up a container park could be done relatively cheaply — all is needed is a plot of land with the appropriate physical security, a power distribution plant, backup generators and abundant Internet connectivity. These items are available in metropolitan locations where server huggers and their employers congregate. While the containers themselves are self-contained, there should be no reason that multiple organizations and their server huggers could not share servers in a single container. After all, server huggers already share cabinets and cage space in data centers today.

So, will container parks soon emerge as the next bastion of the server hugger? Given the choice of moving their beloved servers to the cloud or hugging them in a nearby cool container down the street, the choice seems somewhat obvious.

Image courtesy of Verari.

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Before we talk about specific two-step moves, it’s important to realize that the economic crisis has forced enterprise IT departments to stop or severely limit their spending. While this may help the enterprise stay afloat, it also requires that those departments find imaginative and cost-effective ways to serve technology needs. Put another way, they need to find the cheapest way to provide two commodity resources: storage and processor power. And providing flexible, cost-effective and outsourced storage and processor power is the value proposition of cloud computing that makes the CIOs of Fortune 1000 companies stand up and take notice.

Enterprises are looking to leverage the buying power and infrastructure management expertise of cloud vendors such as Amazon, Microsoft, Google, GoGrid, Mosso, Joyent and others. These clouds allow the enterprise to lease rather than own processors and storage. The lure of leasing these resources allows for the flexibility to turn up and down resources as needed instead of owning and provisioning for a high watermark of requirements. Perhaps one of my favorite illustration of the power and economics of cloud computing is the Washington Post example available on Amazon.com.

So why are enterprise IT departments not running toward cloud computing to help scale resources and control costs? One oft-cited reason is that this technology is still in its infancy, but I think the real reason is that they are struggling to transform their traditional practices to ones that extend into the cloud. For example, if an IT department decides to outsource some of its processing power to Amazon like the Washington Post did, then how are those resources provisioned, monitored for faults and performance issues, secured against break-ins and accessed by both internal resources and third-party partners? There are some cloud solutions for these issues, but enterprise IT has spent decades building integrated internal systems and needs a way to bridge the gap from what they are using today to the cloud.

That’s where the cloud two-step comes in. The cloud two-step is a technology strategy that bridges the gap between traditional IT practices, ones that occur within the four walls of the enterprise, and the desire for IT practices that work under a new economic environment. It is a way to step into the cloud in two easy steps: the first to deploy technology within the enterprise that IT can fully control, the second to then use this technology to leverage clouds. Some examples include:

• a technology solution that configures enterprise network management systems (step one) to monitor faults and performance of cloud vendors (step two)
• software that configures virtual machines in an enterprise data center (step one) with an overflow option to offload processing to a cloud (step two)
• a new enterprise backup system (step one) that automatically provisions cloud storage when disk capacity reaches a certain threshold (step two)

It seems likely that there will be many dancers auditioning to perform the cloud two-step for enterprise IT in the upcoming year, and I look forward to seeing these solutions help further establish clouds as the next generation for IT. So while enterprises will always need their IT departments, those that find solutions that allow them to dance the cloud two-step gracefully will live to dance another day. Those that don’t may find that their next dance is their last one.

Allan Leinwand is a venture partner with Panorama Capital and founder of Vyatta. He was also the CTO of Digital Island.

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If Cisco were to acquire EMC, it would have an enormous impact on the technology landscape and etch in granite the combined company’s role as the hub around which the rest of the enterprise data center industry revolves. It would also place the firm at the forefront of the ongoing synergy between storage and data networking, a trend observed back in July, when Brocade Communications Systems agreed to buy Foundry Networks for $3 billion dollars.

And it would give Cisco control over VMware, the leader in enterprise virtualization software, and help move it further up the technology stack from being a data networking vendor and into enterprise software. Last month at VMworld, Cisco announced the Nexus 1000V switch, an integration of their switching software with VMware ESX (this was not what I predicted, but it was a step  toward my prediction).

Such a deal could also help Cisco satisfy Wall Street by growing revenues, something that the company has done very successfully through other acquisitions, although not on this scale, in the past. This is where the economic crisis comes into play. Cisco had $26.2 billion in cash and cash equivalents as of its most recent financial quarter. EMC has a market capitalization of around $24 billion. Taking into account its current cash balances and outstanding debt, EMC’s enterprise value is around $22.4 billion. If Cisco wanted to pay a premium to EMC shareholders to purchase the company it would more than likely need to pay at least $25 billion or slightly less than its current total cash on hand. While Cisco is generating billions of free cash every quarter, spending all of its cash to acquire EMC would not be a prudent fiscal move.

If this rumored acquisition was considered strategic enough to the Cisco board of directors, one way to fiscally accomplish it without draining the cash reserves would be to raise debt. But given the current economic crisis, the debt vehicles that are available on the market are either non-existent or on very unattractive terms. So for now, it seems likely that Cisco will need to put its rumored acquisition on hold until the economic crisis gets resolved.

Allan Leinwand is a venture partner with Panorama Capital and founder of Vyatta. He was also the CTO of Digital Island.

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Entrepreneurs seeking funding usually turn to one of two sources: angels and venture capitalists. And given that I fall into the latter category, let me go on record as saying that both sources can provide exceptional outcomes. In fact, in many cases, some of the best deals that we see in venture capital come from angel investors. So angels and venture capitalists are not mutually exclusive sources of funding, as one can lead to the other. However, with the economy as it stands today, entrepreneurs need to think clearly about how to solve their funding needs from now all the way until better economic times.

I have known many entrepreneurs that have worked with angel investors and had great outcomes. Generally, angels are exceptionally smart entrepreneurial individuals who make fast investment decisions, take a smaller ownership percentage than venture capitalists in startups they fund and opt to have minimal involvement in the operational aspects of the business. On the other hand, some entrepreneurs note that angels are not focused enough on their business (anecdotally I have heard of some angels spreading their investments over 30 or more startups) and some have a fairly short expectation on the investment horizon for returning their capital.

For an entrepreneur, working with a venture capitalist is a different experience. Investing our limited partner’s money generally requires us to have a more diligent and lengthy investment process than angels, to work with a very limited set of companies (at Panorama Capital we limit our full-time involvement to 5-7 companies for each partner) and thoroughly study a market before investment. As venture capitalists, we would argue that this focus and investment commitment should equate to more ownership in a startup than is typically taken by an angel investor.

After the initial investment, we also give access to syndicates for additional financing, study the market landscape for partners and competitors and help with team building. In other words, while we are more focused on our investments, we are also working on behalf of our limited partners to provide a return on their investment and that, in some instances, can admittedly result in a conflict of interests between us and the entrepreneur. In my experience, this conflict happens less often than one might think, typically when there isn’t a strong and productive relationship between the investor (angel or venture capitalist) and the entrepreneur.

While there are objective reasons to take capital from both an angel or venture capitalist, in my mind the current economic downturn means that an entrepreneur needs an investor who will commit to a startup over a much longer time period than a typical angel investor. For example, before we commit, we ask ourselves if this is an investment that we would be excited about being involved with for 10 years.

The technology IPO market is dead and many predict it will stay that way for at least another 18 months. Debt financing for larger firms to use for mergers and acquisitions is practically non-existent. So unless you’re an entrepreneur working at a startup that is narrowly focused on getting bought by a company that is flush with cash (and there are a few of these, such as Google, Microsoft and Cisco), you’re going to need an investor with a long-term commitment to your business.

While I do know some truly remarkable angels who can help on all of these fronts, overall it seems clear to me that now, more than ever, is the time for venture capital.

Allan Leinwand is a venture partner with Panorama Capital and founder of Vyatta. He was also the CTO of Digital Island.

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If my prediction comes true, it would help Cisco remain relevant in the data center, allowing it to do more than move IP packets between servers. It would also entrench the company into the enterprise, distancing themselves even further from the likes of Juniper Networks and 3Com, both of whom have struggled against Cisco to gain some toehold in the enterprise infrastructure marketplace.

And this move would allow Cisco to participate in the server and virtualization ecosystem itself. Organizations that have invested heavily in Cisco infrastructure would be able to expand the lifetime of their equipment by running on their networking equipment any software application that runs in the VMware virtual machine — a set of applications that’s growing every day. Enterprises that want a single vendor to supply both their networking infrastructure and their virtual machine environments, meanwhile, could reap benefits from integrated support. As a benefit to Cisco’s internal operations, this integration would allow them to move into higher margin application support, possibly allowing for easier acquisition integration.

The downside for enterprises that use VMware virtual machines on Cisco hardware is that they’d be unable to leverage the Intel x86 server hardware ecosystem to their advantage. Today, without the VMware and Cisco integration, enterprises buy hardware to run their software applications that have benefited from the large economies of scale in the Intel supply chain. Combined with the effect of Moore’s Law, this has resulted in an excellent price-to-performance ratio for enterprise compute platforms. These performance increases in the server hardware rise in tandem with market demand and volume and are not bound to the high-margin expectations of products like Cisco’s.

So when tied to Cisco hardware, which would have lower volumes than the Intel x86 ecosystem, this solution would inevitably result in higher price and less performance. Cisco has always been a hardware company and this move could tie enterprises into their higher-margin products. Indeed, in some instances, Cisco hardware that performs commodity functionality has been sold at over 40 times the price of commodity hardware that performs the exact same function.

While this is not the Cisco Blade Server that I forecast earlier this year, if this prediction does come true, it will undoubtedly cause additional friction between Cisco and the giants of the server industry, namely IBM, HP and Dell. If enterprises can run applications in VMware on Cisco hardware, it could obviate the need for some servers to exist.

Finally, with this step networking would evolve from being the technology that moves bits between servers to participating in the central role at the heart of the enterprise data center. Competitors in both markets — server hardware and networking — should take note and prepare for further waves of change in the enterprise data center.

Allan Leinwand is a venture partner with Panorama Capital and founder of Vyatta. He was also the CTO of Digital Island.

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