Cisco (CSCO -0.64%), one of the largest networking companies in the world, generates nearly $50 billion in annual revenue by connecting devices to one another. This makes Cisco a natural investment in the Internet of Things, or IoT, the digital framework that will connect smart objects such as appliances, watches, and cars to the cloud.
Cisco already has an established footprint in IoT infrastructure with its Unified Computing Systems converged data solutions and network security software. However, the company has generally lagged IBM (IBM 0.06%) and Oracle (ORCL 0.92%) when it comes to analyzing that data for organizations. That's why Cisco recently launched its new "Connected Analytics for the Internet of Everything" initiative, which integrates data analytics capabilities into its existing network hardware.
Why Cisco's competitors should worry
Cisco controls over 40% of the global enterprise networking and communication market by revenue, according to Infonetics Research. Infonetics also reported that Cisco was the only major networking company to offer products across every major project category (networking, communication, and security) in the enterprise networking market.
This expansive reach lets Cisco aggressively bundle its products and services. An organization will likely save money by buying a bundle of routers, switches, and security software from Cisco rather than buying the technology separately from multiple companies. Many of Cisco's smaller competitors, such as Aruba Networks, have been bruised by these bundling tactics.
Adding IoT analytics -- which target a wide range of retail, telecommunications, and smart cities -- could help Cisco compete against IBM and Oracle, which lack Cisco's 70% plus market share in routers and switches. Cisco's approach is also potentially disruptive to IBM and Oracle's analytics businesses, as their current services are focused on analyzing past events rather than real-time developments.
Why Cisco investors shouldn't celebrate yet
Cisco estimates the IoT market will grow from 25 billion connected devices in 2015 to 50 billion devices by 2020. Over the next 10 years, Cisco expects the value of the IoT industry to hit $19 trillion, with $7.3 trillion coming from analytics solutions alone.
For Cisco, expanding its IoT business is less about market growth potential than dominating a major market transition. The company previously leveraged its dominant market share in routers and switches to increase its security solutions business. It is using that same strategy to connect those customers with its IoT and Big Data markets.
But all that bundling weighs down Cisco's bottom line. In fiscal 2014, Cisco's total revenue from products and services declined 3% year-over-year to $47.1 billion, and net income plunged 21%. Last quarter, Cisco's revenue rose 1.3% year-over-year, but net income fell 8.4% due to weak sales in emerging markets, with a notable 33% decline in China.
It's hard for Cisco to improve its bottom line, since it constantly lowers price expectations for its products with bundles. Competitive pressure from its biggest adversary in China, Huawei, also prevents it from raising prices on its routers and switches.
The true future of the IoT
Cisco's IoT predictions might be bold, but much could change over the next decade. A surge in hacks, data breaches, and accusations of cyberspying could prevent organizations from flooding the market with constantly connected devices.
Alarming reports have also emerged regarding the hackability of smart cars and homes. Nissan recently investigated claims that its Infiniti Q50 could be theoretically hacked and controlled via Bluetooth. In August, a team of security researchers reportedly hacked Google's Nest -- the central hub of its smart home system -- within 15 seconds.
However, stories like this could fuel stronger demand for more securely connected IoT devices with real-time data analytics, which would be a boon to Cisco.
What does this mean for Cisco investors?
Long-term Cisco investors should look at the big picture. Although the company's bottom line will remain under pressure as it bundles and integrates various products and services, this strategy keeps its challengers at bay. As Cisco's market share in IoT security and analytics grows, so could its pricing power.
That change will take time, but Cisco knows how to reward patient investors. The company has raised its dividend annually since the payout was introduced in 2011, and it currently pays a forward annual dividend yield of 2.8% to those willing to look beyond its bottom-line and emerging-market issues.