Part I Cisco: How they lost their way…

At bottom of this post, I included a copy of a blog post I wrote on 08.09.06.  After their earnings report on 08.08.06, CSCO’s share price went on a run increasing 67.24% over the next five months.  I remember back in 2004-2006 timeframe, CSCO sales reps had a presentation for customers buying Ethernet switches entitled “Cisco and the 8 Dwarfs.”   It was all about how they dominated Ethernet switching and all the other players were niche players or insignificant players.  Four and half years on my 08.08.06 blog post, the world is dramatically different for CSCO.

Recently John Chambers, CEO of Cisco, wrote an all hands memo that foreshadowed a number of organizational changes.  This is all searchable on web.  I going to walk through the challenges CSCO faces and outline the area in which I think Cisco lost focus.  We will start with the challenges:

1. Ankle Biters Hurt: Across a number of market segments, CSCO has a number of strong, well focused competitors.  A partial list is RVBD, FFIV, APKT and ARUN.  These companies are attacking portions of Cisco’s business and I think it is plausible to assume that on an individual basis it does not matter to Cisco because any one business segment is not big enough to matter.  I worked at company that Cisco destroyed in the 1990s and maybe the Cisco of today that turns out $10B quarters is just a bigger, less mean and more cuddly version of their former self.  When I talk to Cisco competitors, none of them are in fear of Cisco and that is a real change from four years ago.

2. Dwarfs got Bigger: When I wrote the 2006 post the Ethernet switching market really was Cisco and everyone else.  FDRY was the Porsche of the industry.  They were six months ahead of Cisco on features and focused on performance.  They had their niche, their loyal group of fanatical buyers who needed to have the fastest switch with the most advanced features.  Everyone else was also-ran in the market.  What happened was that 3Com refreshed their product line with the help of Huawei, HPQ bought them which effectively fixed their North American channel which had been left for dead years ago in strange, almost fatal decision by the prior management team and Juniper (JNPR) decided to get into the switching business.  Brocade buys FDRY and now the dwarfs are bigger, well capitalized and with refreshed product lines.

3. Internal Decision Makers Became Confused: I think the new management structure that CSCO rolled out in early 2009 confused the company.  I know it is easy to say that management by committee does not work, that is why I am not saying it.  I give the company credit for trying something new at the height of the recession.  There was no better time to take the gamble.  That was the time to try something new, unfortunately I think the new management concept confused the leadership of the company from the middle levels on up.  The company became too internally focused and missed the world around them.  Below are four quotes from John Chambers during the four earnings calls in 2009 regarding the new management structure.

11.04.2009: “In Q1 we conducted 77,000 Cisco internal meetings, had another record quarter in terms of units sold, selling over 570 systems and adding approximately 85 new customers. We just recently celebrated our three-year anniversary since launching TelePresence, and since that time we have conducted more than 500,000 internal hours of meetings and 427,000 meetings, to be exact.”

08.05.2009: “…today we are investing in 30-plus new market opportunities that are adjacent to our core business, and in each of these cases the technology architectures drive innovation in our core products, which we believe translates into growth. Assuming we’re successful in many of these opportunities, you will see us expand well beyond the 30 that we have today. Our innovative organization structure of councils and boards brings together leaders from across the functions, all of our corporate functions, to define, plan, execute and monitor our progress in these market adjacencies. This disciplined approach allows our teams to scale and work across opportunities with both speed, flexibility and then to be able to replicate these models quickly. You can expect these market adjacencies to become a growing part of our business over time, just as the advanced technologies did, looking back several years ago. While some of these may be able to be discussed in ways similar to our earlier advanced technologies, others may not easily be discussed as standalone segments.”

05.06.2009: “Our new organization structure of council’s, Boards and working groups as discussed on the last call is operating very effectively. These structures allow speed, scale, flexibility, and rapid replication. An example of this speed, scale, and replication is since our last conference call we have added three more market adjacencies to our list which is the last conference call was the 26th, these three new ones include virtual healthcare, second, safety and security, and, three, smart communities bringing the total of these cross functional priorities or market adjacencies to 29. And of perhaps equal importance our largest customers understand how this highly innovative management structure and these business models we have been talking about can launch this many major products into market adjacencies with quality. That’s something probably is the key tipping point we’ll talk about more later in terms of our customers grasping what this means in terms of speed but also the ability to move into so many markets at one time.”

02.04.2009: “Our organization structure leverages the power of communities of interest, which we call councils, which we believe are (inaudible) opportunities, Board that we see as [1 billion] opportunities and working groups. These organization structures allow us to more effectively prioritize resources across over two dozen cross functional opportunities as well as within each of our corporate functions.”

4. CSCO lost their Competitive Edge: It is easy to ask questions like why did CSCO pay $600M for a handheld video recorder in March of 2009 when the iPhone was in the market?  Android phones were on the way and handheld digital devices were getting cheaper and more sophisticated.  Although the Pure Digital decision was a disaster, I would blame #3 for this decision, but in my view the real issue was that focusing on the Flip device took focus away from the core business.  It is all about the network – not the devices.  It is the network, stupid, to coin a phrase.  I think Cisco needs to get back to focusing on the network, which I outline in the second post.  Cisco needs to return to the foundation of the company and stop trying to be too many things.

5. How the Stock Price is Likely to Act for 2011: As per the CEO’s internal memo, the company is organizationally challenged and they are trying to fix the execution issues.  That is a start and likely to take some time.  We are in the month of April (almost May) and it hard for me to see the stock rebounding until 2012.  The NASDAQ is up 8.12% YTD and CSCO is down -14.38% YTD.  I find it hard to believe that any long only money manager is going to be buying CSCO at this price level.  It is not cheap enough for value investors and the business turn around will take time.  If numbers are trimmed again the stock cannot work for 2011.  Long only money managers will use it as a source of funds and buy other stocks lifting in their benchmark.  The FOMC has a floor under the market for the near term and bond market outflows into equities are likely to continue, hence I find it hard to believe that CSCO is going to a lot of love in 2011.  Cisco’s management team gets a pass for 2011.  Forget about the stock price, focus on the business.  Worry about the stock price in 2012.  CSCO stock chart below.

{Part II: A Strategy to Move Forward: tomorrow}

/wrk

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Wednesday, August 09, 2006

 Cisco Results: Understanding the Hidden Message

The quarterly results posted by Cisco yesterday afternoon were spectacular. Revenues were up, solid earnings, cash is just short of $18B, DSOs were up, but who really cares when you are $28B company and growing. If you take the time to read through the press release there is a section called “Business Highlights” towards the end. This is usually the pompom waving portion of an earnings press release, wherein leadership teams try to include existential data points to frame the progress of the corporation. The first bullet that the Cisco team chose to highlight was: “Cisco’s core enterprise networking platform, the Cisco Catalyst 6500, surpassed $20 billion in sales.”

The Catalyst 6500 platform started as the first acquisition by Cisco in 1993. The company Cisco acquired was named Crescendo Communications and the price was $94.5M. Twenty billion in sales later, the Catalyst 6500 product family does not look anything like the first Crescendo products from thirteen years ago – but the impact of that acquisition is affecting the market today for several public companies as well as several private companies, a number of venture capital firms and the investment banks on Wall Street. The significance of the market share dominance that Cisco enjoys in the switching market can be seen in three areas of the overall market:

1. Extreme Networks and Foundry Networks: Both of these companies are public companies. Over their seven years of existence, they have achieved around $5.2B in combined total sales. Two companies with a broad set of products focused almost exclusively on the switching market have total sales that are a quarter of Cisco’s total sales in the same networking technology vertical market.

2. Brocade and McData: There is a reason why Brocade and McData are merging. That reason is Cisco. The reality is the FICON and Fibre Channel switch business is being attacked by Cisco. Brocade and McData simply decided that it was better to combine their market share and development efforts with the hope that by concentrating their forces, they can prolong their existence and hold off Cisco.

3. Force10 IPO: Force10 Networks competes in the same technology vertical market as the Cisco Catalyst 6500 and the products from Foundry and Extreme Networks. F10 has reportedly raised more then $300M in venture capital. $300M for a company to build a business in a market dominated by Cisco with market share probably greater then 75% and handful of other companies (some public) fighting for the remaining market share. I would think the investors of F10 as well as the investment bankers on Wall Street would love to take F10 public. It would mean a nice payday for everyone involved in the seven years it has taken to build the company. Alas, we are still waiting on the F10 IPO.

I think Cisco let everyone know why there is market consolidation (e.g. Brocade/McData) in the switching business. Why new entrants (i.e. F10 Networks) cannot build a business that can support an IPO. Why smaller players in the market segment cannot grow revenues (i.e. Foundry and Extreme). It is because Cisco has a $20B installed base and plans to protect their market share aggressively.

/wrk