Why Cisco’s Software and Services Business Is Growing in Value

Developing new offers in the services space

Cisco (CSCO) is one of the largest service providers in the security segment. To drive growth in this business, Cisco is migrating its model from a hardware business to a software and services business.

In Cisco’s earnings call, CEO Chuck Robbins stated, “Overall, Q2 was a solid quarter in a volatile macro environment. We saw good top line growth, strong profitability, and operating leverage. We continue to shift our business model to more software and subscription recurring revenue.”

Why Cisco’s Software and Services Business Is Growing in Value

Cisco is looking to develop new offers and ways to monetize its services business. It has focused on acquisitions including Jasper and OpenDNS to complement this business model. Both the acquired companies are software-as-a-service models.

Focus more toward recurring revenues

In fiscal 2Q16, Cisco’s services revenues rose 3% YoY (year-over-year), and its product revenues fell by 1%. Cisco continued to show progress toward its goal of driving more recurring revenues. Deferred revenues rose 8% in total, with product up 11% and services up 7%.

Cisco’s recurring revenue accounted for 28% of its total revenue in fiscal 2Q16, a rise of 26% over fiscal 1Q16. Many companies are shifting their business models to recurring revenue models. Having businesses based on recurring revenues gives companies and analysts better visibility on future revenues.

Microsoft (MSFT), SAP (SAP), and Oracle (ORCL) have all taken initiatives in the past to grow their recurring businesses.

Cisco accounts for 3.2% of the Technology Select Sector SPDR ETF (XLK).