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Friday, April 15, 2011

What Happened to Cisco?

By Zeus Kerravala, The Yankee Group

For years, decades even, Cisco has been an icon, the bellweather in tech, a market leader, a prophet and one of the biggest factors in the evolution of technology since the birth of the Internet. There was a time--around the turn of the century--where some were predicting that Cisco would be the first trillion dollar market cap company (its peak was $557 billion in March of 2000). When CEO John Chambers spoke, even after the crash of the dot-coms, everyone listened. Other vendors could say the business outlook was weak but if Chambers said it wasn’t, the market went up. If he said it looked uncertain, the whole market went down. Led by Chambers, Cisco truly led us into the Internet revolution.
 
However, over the past few years, Cisco and its charismatic CEO have come under tremendous fire. What was once viewed as optimism and vision is now viewed as bluster. Five years ago Cisco's stock was $20 per share. Today it's 17 and change. In the same time, archrival Juniper has gone from $17 to $40 and F5 has gone from $30 to $100.
 
All of this has been intensified over the past few weeks with the Chambers memo to employees to embrace change book-ended by the shutting down of WebEx Mail and Flip. When has Cisco ever had to shut down businesses? So, this begs the question, what happened to Cisco along the way to take them from bellweather to a company that has to shut down a business as big as Flip?
There wasn't one thing that happened or any kind of big transition; I think there were a number of things that created the situation that Cisco is in now.
 
* Cisco couldn't keep up with the law of large numbers. Cisco has grown at an incredible rate over the past decade and no matter how big the company got, it was always able to grow in the high teens or more. Its current fiscal year estimate for revenue is $43 billion. Growing a $43 billion company at 15% (which is the mid point of the long term guidance given by Cisco) means growing it by $6.5 billion each year. That's bigger than the combined revenue of Juniper, Aruba, F5, Riverbed and other Cisco competitors. Being a $43 billion growth company is nearly impossible, even for a company as well run as Cisco.
 
* A much tougher competitive environment in its core markets. Despite all of the advanced technologies Cisco has, routing and switching make up over half of the company's revenue. While the router business has remained fairly consistent, the switching business has come under tremendous pressure of late, primarily due to the change in competitive landscape. Five to seven years ago the big competitors to Cisco in switching were 3Com and Nortel, hardly competitors that Cisco needed to worry about. Today though, the switching market includes the likes of HP, Juniper, Brocade through the acquisition of Foundry, Avaya through the acquisition of Nortel and a couple of innovative niche vendors like Force10 and Arista. All of these companies are much better run than 3Com and Nortel were half a decade ago. HP has been the biggest disruptor to Cisco though, as HP is willing to sell products that are sometimes half the price of a comparable Cisco product when maintenance fees are taking into consideration. Even without HP though, the sheer number of stronger, better run companies continually hitting Cisco’s customer base means a tougher environment for Cisco. Cisco hasn't lost any significant share in switching but the continued pressure from HP has caused the margins for the switching business to slide.
 
* The number of adjacent markets Cisco is in. Chambers has continued to indicate a long term growth number of 12%-17% is a realistic number for a company even of Cisco’s size. The router and switching businesses are not growing at that rate, meaning Cisco must continually find new adjacent markets to move into that are growing faster than that. This is why it’s moved into markets such as servers, VDI endpoints, tablets, video, set top boxes, personal video recorders, social media and other markets that could potentially move the needle for Cisco. Critics of Cisco have made the claim that all of these adjacent markets have distracted Cisco and allowed all of these other companies to start pecking away at the network business. I don't fully agree with this thesis but I do believe the pressure of trying to hit such an unrealistic growth number has taken its toll and has caused Cisco to miss some market transitions that it should have seen.
There are other things that one could point to such as the loss of quality people such as Jayshree Ullal, Charlie Giancarlo, Mike Volpi and Tony Bates, as well as the desire to be a consumer vendor, but I believe the three bullets above are the main culprits. So what should Cisco do?
I'd like to see Cisco flex its muscles and use some of the massive cash reserves its has to make some acquisitions to bolster its core businesses. Looking back, Cisco hasn't made a major acquisition in years that directly drive router and switch sales. Tandberg and Starent have some potential but that is yet to be realized. I think a slam dunk acquisition for Cisco is Acme Packet. I know they're expensive relative to revenue but I believe the SBC is as important to multimedia communications as the router was to the Internet. Cisco is one of the few companies that could actually afford to pay the premium to buy such a company and it would get a product that many regard as one of the more important pieces of building next generation networks. I would put F5 into this category as well.
 
Additionally, Cisco needs to deliver on the architectures that have driven Cisco growth in the past. The vision of Borderless Networks and Data Center Business Advantage are sound but need the proof points for Cisco to accelerate the go to market around these architectures.
 
I want to be clear though that although I have painted a somewhat gloomy picture, Cisco is still one of the best run companies in any industry--not just tech. The fact that it can grow at 10% at its revenue size is incredible. Cisco's base of engineers and customer loyalty remain as high as ever. I think the answer to the question of what happened to Cisco is that the company is in the midst of its own transition. The company needs to get through this transition, articulate a vision of what the new Cisco looks like and execute on this plan to get the stock moving north again. Only then will we stop asking what happened to them.

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