Crisis? What crisis? This is Cisco, kids

By Ian Fraser

Sunday Herald

June 24th, 2001

THERE’S a line on the new Proclaimers album that goes: “We don’t know a crisis until it kicks us up the arse.” This is true of John Chambers, the 51-year-old chief executive of Cisco Systems.

Last year, Chambers was one of the most revered men in California’s Silicon Valley. Fortune magazine put him on its cover and asked: “Is this the best CEO in the world?” As Cisco’s chief executive since 1995, he had steered the company to a market capitalisation of $550 billion by March 2000 – which briefly made it the world’s largest company ahead of the likes of General Electric and Motorola.

An evangelist of the transformational power of the internet at both national and corporate levels, Chambers was feted by world leaders including China’s Jiang Zemin, Tony Blair and Bill Clinton.

The politicians wanted some of the magic to rub off and to ensure their countries did not get left behind by a technological revolution that Chambers argued will be a panacea for global economic ills.

But earlier this year the halo slipped.

Belatedly, Cisco woke up to the fact its model of 70% annual growth could not continue ad infinitum. The massive correction in the value of technology and dot.com companies that has plagued global stock markets since late March 2000 meant demand for Cisco’s core products – the servers, routers and switches used to direct traffic across the web – was drying up. Many of its customers were either struggling or going bust. Unsurprisingly in such circumstances, IT budgets were being slashed.

Yet despite its much-vaunted abilities to close its books in a single day and to make impeccable forecasts, Cisco failed to spot the downturn. The company had convinced itself its customers would continue ordering equipment at the same pace as if nothing had changed.

Even as the internet revolution ground to a halt, Chambers believed demand for Cisco’s hardware would grow even faster, so he ordered output to be stepped up. Even now, he is reluctant to acknowledge Cisco screwed up big time. Instead he uses biblical language to blame the sudden collapse in sales on a “100-year flood” and the fact that a flat-calm lake was suddenly transformed into a series of raging rapids, “almost waterfalls”.

“I sure wouldn’t have built up inventories in those areas,” Chambers now says, “but every single one of my peers missed their targets. We were the first to admit things were much more serious than we realised and stand up to the problem aggressively.”

To European ears the over-arching self-confidence of this West Virginian can smack of smugness.

So how come the web’s infrastructure giant failed to spot that demand for its internet “plumbing” would fall? Probably because the company’s revered sales machine was tuned to please Wall Street by pushing goods – mostly made by third party manufacturers in the Far East – into the marketplace.

Desperate to meet their targets, Cisco salesmen did not shirk from granting generous terms, even to shakier new economy customers and heavily indebted upstart telcos.

Chambers had become so obsessed with making deliveries on time that Cisco ended up with billions of dollars of hardware languishing in warehouses.

Bill Hambrecht, founder of investment bank Hambrecht & Quist and a long-time observer of the US technology sector, believes Cisco was a victim of its own success.

He told the Sunday Herald: “You get into the situation where you’re predicting certain numbers, which sort of filter through your system, and the salesmen start making deals with customers, saying ‘let me ship you the equipment, I know you can’t pay for it, but don’t worry, we can work it out.'” Hambrecht added: “That covers up a slowing in demand for a while. When it finally becomes apparent that their distribution channels are filled and that customers really don’t need the equipment – you go right off a cliff.”

“It’s not a question of spotting [the fall in demand]. It’s more a question of not really wanting to spot it.”

Cisco finally bit the bullet in early January 2001. Several senior executives were summoned by Chambers to an emergency 4.30am breakfast meeting at Carmel. As they gingerly toyed with their hash brownies, they drew up a damage limitation plan that would, hopefully, position the company to survive the rapids.

A key element was an immediate hiring freeze. Cisco had hired 15,000 people in the previous 18 months. Many who were due to start at Cisco’s bland campus-style office buildings near San Jose found themselves axed before they had even arrived.

Next came a redundancy programme that saw 8,500 people – around 18% of the global workforce lose their jobs. In a symbolic gesture Chambers cut his annual salary to $1 to appease shareholders and departing employees.

Chambers said: “In December our growth was up by over 70% year-on-year. We had to put the pedal to the metal – and then switch to the brakes very rapidly. We focused on six key elements.”

The company also called a halt to growth in discretionary spending. Chambers added: “You will see us move our resources to where the growth opportunities are.” Part of this will involve a more measured approach towards acquisitions. Cisco used its own highly rated paper to acquire more than 70 companies between 1993 and 2000, but has not bought a single company for six months (see box below).

Cisco’s most recent financial results in early May reported a spectacular loss of $2.69bn for the three months to April 28, after restructuring expenses and the write off $2.2bn of unsold hardware.

Chambers said: “We did this all within a two month time frame. Opting for a Big Bang approach meant we got the bad news out at one time, which I believe is better for your customers, your employees and for financial markets.” Chambers adds that the measures would not have been made if he thought the downturn in demand would be a “one quarter phenomenon”.

By taking all its medicine at once, Cisco has certainly won bouquets in Wall Street. “They have cut a lot of costs and acted quickly to reduce the payroll,” said Paul Sagawa, analyst at New York-based Sanford C Bernstein. “But conditions will remain harsh for some time.”

This harshness will doubtless be exacerbated by the fact that Cisco backed the wrong horse in the telecoms market. Sagawa said: “The part that is selling to telecoms carriers is going to have a very difficult time until at least 2003. There’s been that much over-investment.” The analyst added that, positioning itself as the “arms supplier” to new challengers in the telecoms market – many of which are now cash strapped or bust – was a strategic error as Cisco may well have alienated more traditional carriers. Furthermore Chambers’ 1998 remark that “voice would be free” won him few friends among telecoms executives.

Yet Cisco remain undaunted and expects to be able to raise productivity per employee by 50% per year. Chambers said he is aiming to increase productivity per employee from around $450,000 to $850,000 and then onto a “stretch goal” of $1m. “The use of e-learning will make this possible,” he said.

In recent months Cisco salesmen have been able to tap into online briefings that keep them abreast with new products and services and how they should be marketed. Chambers now believes e-learning will have as big an impact on the business as e-commerce.

There is something almost uncanny about Chambers’ bullishness in the face of adversity. Many of the firm’s customers believe the company will recover its poise, largely thanks to the superiority of its products. But for Chambers to insist Cisco can return to the heady days of 30% to 50% annual growth and reach sales of $50bn and leadership in terms of profitability by 2004 – even though relative minnow Juniper Networks has taken a 38% share of its core router market – suggests the triumph of hope over experience.

Cisco Systems is still worth around $120bn and has $12bn in the bank. But there are sceptics within the US financial community. Sagawa said: “It is difficult for a company that size to achieve even 15% growth. To promise it is either a sign of madness or incredible guts. Setting expectations at that level certainly erodes Chambers’ credibility.”

But Chambers does not see it that way. Instead he is absolutely focused on downplaying the significance of the dot.com crash and on highlighting how companies can learn from Cisco by adopting online internal management systems and e-learning.

As he clings to his raft and negotiates the rapids, Chambers has become an evangelist for the internet, believing the dot.com crash was a minor speedbump on the open road towards a fully wired economy. And he is desperate to persuade other multinational companies that they too should become early adopters to boost their own bottom lines – and Cisco’s order book.

“I’m an optimist. I believe a decade from now every major company in the world will be an e-company. The Wal-Marts will re-invent themselves. Two to three years ago they viewed technology as an expense, but now they understand its effect on productivity.

“I would encourage you to look not at a quarter or two quarter phenomenon, but as with any revolution or any major change in how business or major social change occurred over one or two decades. I am more optimistic than ever about the productivity advantages that can be made through the right applications at the right times. It is the network effect, the internet effect, whatever you want to call it, that’s changing business.”

Hambrecht brings things back to reality but remains cautiously optimistic about Cisco’s future: “Now Cisco has to deal with the realities of demand. They have to clean out the distribution channels and wait for demand to catch up. But demand will catch up. I mean hell, we’ve just bought another server. When I would start to worry about Cisco is when my IT team tell me someone else is offering a better server, cheaper.”

Copyright SMG Sunday Newspapers 2001

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Posted by Ian Fraser on Jun 24 2001. Filed under Article Library. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry