Cisco Systems, Inc. (NASDAQ:CSCO) market share in switching business as well as its profit margins will come under intense pressure, say Citi Research analysts Ehud Gelblum and Kimberly Watkins. Yesterday, Dell Inc. signed a deal with Cumulus Networks, which develops Linux OS for “bare metal” networking equipment like white box switches. The Round Rock, Texas-based company would start offering buyers the option to use the OS that comes with Dell’s S6000 and S4810 devices or choose Cumulus Linux OS.

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Customers fed up with Cisco’s model?

Citi Research said in a research note to investors that the deal between Dell and Cumulus is a big threat to Cisco Systems, Inc. (NASDAQ:CSCO)’s dominant position in datacenter switching market. The research firm expects Cisco’s market share to decline from 66% in 2013 to 58% in 2016, mainly due to late availability and proprietary nature of its Insieme solution. Switching business generates about 30% of the San Jose-based company’s total revenue.

Cisco Systems, Inc. (NASDAQ:CSCO) has been offering hardware and software together for a long time. But Cumulus chief JR Rivers argues that a large number of customers are fed up of that model, thanks to unnecessarily high hardware prices. Many customers want to purchase the “bare metal” boxes and pick the variant of Linux OS they like. Dell Inc. estimates that Cumulus Linux-based switching would cost at least 20%-25% less than Dell’s Force 10 switches.

Cisco margins may decline faster than expected

Gelblum said that as more customers adopt white box switching, Cisco Systems, Inc. (NASDAQ:CSCO)’s profit margins will also come under pressure. In December 2013, the analyst expected its gross margin to decline from 63% in Q1 2014 to 61% in 2016. But Dell’s latest deal may take a bigger toll. Though switching accounts for 30% of Cisco’s revenue, it generates more than 35% of the company’s gross profit. Moreover, Citi research estimates public cloud business to rise to 39% of the total market by 2016, up from just 21% in 2013. That would require 25% annual growth from the current $1.9 billion to $4.5 billion in 2016. Meanwhile, the private cloud market is expected to remain flat at $7 billion.

Citi Research has a Sell rating on the stock with an $18 price target. Cisco Systems, Inc. (NASDAQ:CSCO) shares skidded 0.41% in pre-market trading Wednesday to $21.66.