This syndicated post originally appeared at No Jitter - Recent posts by Zeus Kerravala.

Having Dell in networking creates another significant competitor to Cisco and HP; this will further innovation, which is good for everyone.

On Wednesday July 20, Dell ended months, even years of speculation surrounding its entry into the networking market by announcing its intention to buy Force10. Over the past year or so, Dell has steadily been hiring network talent from all of the major networking vendors to bolster its expertise in this area. Clearly, Dell didn’t hire a bunch of high-level network engineers, marketing people, and other folks just to sell PowerConnect and OEM a number of other switching vendors.

The rumors of Dell’s acquisition of Force10 seemed to peak around Interop (I guess that’s what happens when you put thousands of network people in the same place for that many days) but the names Extreme and Brocade were also thrown around. Anyway, Force10 it is, so here are my thoughts on the deal.

First, the purchase price: Although no official price was given in the Dell press release, the rumored amount seems to be $700 million. Not bad for a company with a trailing 12 month revenue of $200 million. If that price is indeed true, it makes HP’s $2.7 billion acquisition of 3Com a steal. The same multiple on revenue would make Extreme worth about $1.2 billion. Quite a premium considering Extreme’s market cap is a shade under $350 million.

So why did Dell pay the hefty premium? Hard to say but this could have been driven by customer demand. Both Zynga and Facebook are notable Force10 customers and they are also Dell customers. In fact, a reliable source at Force10 says Zynga and Facebook are a significant amount of Force10’s revenue. Speculation is that Facebook and/or Zynga have been concerned about the long-term viability of Force10 and twisted Dell’s arm into buying Force10. If this is true and Dell can strengthen its relationship with both of these Web monsters, then it’s probably worth it. I’ve always felt if an acquisition is a good acquisition, then you can’t really pay too much.

Next question: Will dropping Force10 into Dell’s channel accelerate the Force10 business? Dell certainly has a huge channel compared to Force10 and has the potential to be big in networking, but selling networking is hard, particularly at the high end. Brocade bought Foundry, who has a similar target audience as Force10, and tried to push it through their channel and distribution. After struggling with that for a while Brocade went back to the tried and true model of quality sales people with outstanding support from sales engineers. For Dell to be successful, at least in the short term, they’ll need to do so by staffing up sales and then trying to find a channel model that works. Also, the traditional Dell buyers of servers and storage are not buyers of network equipment, so cross pollination in the high end and high performance computing (HPC) market isn’t likely.

Dell could be price disruptive though. With Dell’s overall company margin being in the 20s, Dell could drop the price of Force10, move the margin structure way down from traditional networking and still have it be margin-accretive to Dell. That’s a luxury that none of the mainstream data center networking vendors have. Ultimately though, the market Force10 plays in isn’t a price driven market like edge switching. Features, performance, functions and roadmap determine market leadership–not price. So, while I think that Dell has potential to be disruptive, I do believe that Dell will struggle initially while they find the best way to leverage the acquisition.

Whether they are successful now or later, Dell did need to make this acquisition. Intel recently bought Fulcrum, Cisco launched its own server, Brocade bought Foundry, etc. There are enough proof points in the industry now that it’s clear that network and computing are converging and Dell needed to bolster its network portfolio somehow.

What’s the impact to the competition? This is an interesting question since the market punished Brocade on this news. Brocade highly publicized its OEM relationship between Brocade networking and Dell networking so at first glance, Brocade would be the most impacted vendor. However, truth be told, that relationship hasn’t gone anywhere. Although Brocade doesn’t report how much OEM business it is doing with Dell, my estimate is that it’s less than 1% of overall Brocade and less than 3% of the IP business. So I think the impact to Brocade is minimal.

The vendors most likely to be disrupted in the short term are HP and Cisco. Dell has become mortal enemies of both companies and will likely take the Force10 products right at their customer bases.

However this works out though, having Dell in networking creates another significant competitor to join the ranks of Cisco and HP and the increased competition will further innovation, which is good for everyone.

One last point: I don’t believe this will be Dell’s only acquisition in networking. I can see them grabbing Extreme for the campus portfolio or perhaps a wireless LAN vendor.

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Zeus Kerravala

Zeus Kerravala is the founder and principal analyst with ZK Research. Kerravala provides a mix of tactical advice to help his clients in the current business climate and long term strategic advice.
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