Cisco’s Comeback

For the first few weeks of 2001, John T Chambers, the irrepressibly

optimistic CEO of Cisco Systems Inc. thought the networking giant might neatly

sidestep the tech wreck. Twice he had canvassed his top lieutenants, only to

rebuff their advice that he lay off workers for the first time in the company’s

history. But on the evening of March 8, 2001, Chambers landed in Silicon Valley

shaken by what he had learned during a two-week business trip around the world.

Customer after customer had told him they were slashing spending. Finally, he

succumbed: It was time for a massive overhaul. He stayed up all night, hitting

the treadmill for hours in his Los Altos Hills home. "I just ran and ran

and ran, and thought through the alternatives," he says. At 4 a.m., he

decided to call a meeting of his top managers for 6:30 that morning.

It would be a gut-wrenching session. An unusually downbeat Chambers huddled

with his top execs and then okayed 8,500 layoffs–18% of the payroll.

"This is the toughest decision I’ve ever had to make," he said,

according to one person who was in the room. At 9:30, he left to break the news

to employees at his monthly breakfast with workers celebrating birthdays that

month. "He had serious feelings of remorse, of ‘what could I have done

differently?"’ says Peter Solvik, the company’s former chief

information officer. "For a year after that, he was somber."

How times have changed. On November 5, when Cisco announced its quarterly

results, Chambers was back to his ebullient self–at one point jokingly asking

a vice-president if he was sure he didn’t want to raise his forecast in

response to an analyst’s question. His giddy mood spoke volumes, as did Cisco’s

results: The company’s profits zoomed 76%, to $1.1 billion for the quarter,

while sales hit $5.1 billion, the highest level since January, 2001. With orders

on the upswing, Cisco said it expected to post 9—11% growth in the current

quarter.

The Challenges Ahead Cisco still faces some knotty problems:

Seizing New Markets Growth in its core business–supplying networking gear to corporations–is slowing. To boost revenues by 12% annually, as Wall Street expects, Cisco must dominate new, fast-growth markets, such as security and Internet-based phones. Ring Up Sales to Phone Companies Cisco aims to boost its share of the $64 billion telecom-equipment market to at least 15% from its current 3%. Trouble is, phone companies fear Cisco’s gear isn’t reliable enough. Reverse Bad Karma with Partners During the downturn, Cisco used all of its muscle to win discounts from sales-starved suppliers and resellers–then left many in a lurch by reducing the number of its business partners. The result: Widespread resentment of Cisco’s 68% gross margins. If they see the chance, spurned partners may switch to Cisco’s rivals. Beware of Bureaucracy The company has saved billions by imposing more controls and processes on its entrepreneurial troops. As the tech recovery gains steam, it must prove it can still move quickly and aggressively to hold off challengers.

Cisco isn’t just back in fighting trim–it’s stronger than ever. The

company’s share of the total $92 billion communications-equipment business has

jumped to 16% from 10% in 2001, according to Synergy Research Group Inc.–the

biggest land grab in Cisco’s history. While battered rivals Lucent

Technologies and Nortel Networks are only now glimpsing black ink, Cisco is

racking up record profits. It earned $3.6 billion in the most recent fiscal

year, nearly a billion dollars more than its previous best in 2000. And with no

long-term debt and $19.7 billion in cash and investments, Cisco’s balance

sheet is among the strongest in the tech industry. Says Chambers: "We’ve

executed to the point that we have 100% of the industry’s profits, 100% of the

cash, and about 70% of the market cap."

Rebuilt Foundation



Indeed, Cisco could be a case study of how a sullied highflier can use a

slump not only to clean house but also to build a better foundation. While

Chambers was late to recognize the worst tech downturn in history, once he

realized it was no mere dip, he seized the moment to rethink every aspect of the

company, upending its operations, its priorities, even its culture.

Chambers replaced the chaos that went with growth at any cost with the order

of a company managed for profits. Under a six-point plan, he imposed operating

discipline on entrepreneurial staffers who had been too busy taking orders and

cashing stock options to bother with efficiency, cost-cutting, or teamwork.

Engineers who had been able to chase any idea willy-nilly suddenly had to work

only on technologies approved by a newly appointed engineering czar. Mid-level

managers with the authority to invest $10 million in a promising startup saw the

open checkbook snapped shut. Execs encouraged to compete with one another found

that teamwork would count for as much as 30% of their annual bonuses. And

staffers who fueled Cisco’s 73-company buying binge from 1993 to 2000 by

scooping up any networking outfit with a shot at success were told they would be

held personally accountable for a deal’s financial results. "Process was

a dirty word at Cisco, including for the CEO," admits Chambers.

In all, it’s the rare tale of an Internet star that turned out to be more,

rather than less, than it seemed to be. It would be hard to overstate the

battering Chambers’ reputation took in the first few months of 2001. He was

relentlessly upbeat even as evidence of trouble mounted. Lucent, Gateway, and

others announced layoffs, and still Chambers waxed optimistic. He didn’t back

off projections of 50% revenue growth until Feb 6–and then only to 30%. He

assured investors that Cisco’s hyper-efficient e-business systems enabled it

to forecast demand with near-scientific precision. Then he was proven wildly

wrong. After Cisco announced layoffs and a staggering $2.2 billion inventory

write-down, Chambers looked like a corporate Goodtime Charlie, incapable of

managing in turbulent times. But once his eyes were open, he threw himself into

the reality of a new, harsher environment with the same near-religious zeal he

had the Internet boom.

Cisco’s conversion has been agonizing for many involved. More than 3,000

resellers and 800 suppliers were squeezed out as Cisco reduced its partnerships

to cut costs. Some employees felt the mass layoffs were a draconian

overreaction. Even Chambers has paid a price. The 54-year-old West Virginian

looks like he has aged 10 years in the past three, with the lines around his

eyes and mouth visibly deeper. "It was obviously the most challenging time

in my business career," he says.

With the trying times behind him, Chambers now wants to put more distance

between Cisco and its rivals. While he won’t commit publicly to a specific

growth target after being burned so badly, two high-ranking executives say the

internal goal is a scorching 20% a year. Is it possible? Cisco sees three

engines of growth. For starters, the company already gets 14% of sales from six

fast-growing markets it targeted during the downturn, including Wi-Fi and

security software. It’s also banking on an upgrade cycle in its primary

business of selling routers and switches, the large computers that direct the

flow of data on the Net and corporate networks. The third leg of Chambers’

growth plan: grabbing a large share of the telecom-gear market as the world’s

phone companies go from running separate networks for voice, data, and video to

a single, more cost-effective network to handle all three. Chambers thinks Cisco

can boost its share of the $64 billion telecom market from 3% now to at least

15%, though he won’t specify a time frame. Investors are optimistic: Cisco’s

shares have surged 80% over the past year, to 23.

Still, Chambers will struggle to live up to such sky-high goals. Investors

and top execs may think of Cisco as a turbocharged growth company, but it simply

isn’t anymore. Even in the much-celebrated first fiscal quarter, Cisco’s

revenues rose only 5%. And that’s not going to improve much in the years

ahead. Why? It’s the law of large numbers: The networking-equipment biz that

accounts for 80% of Cisco’s revenues is expected to grow a piddling 6% in

coming years, according to JMP Securities. Cisco will get a lift from expanding

into new markets, particularly telecom, but it’s unlikely that top-line growth

will pass the low double digits for the foreseeable future. "I think they

can get to 10%," says analyst Brantley Thompson of Goldman, Sachs & Co.

"I don’t think they can get to 15%. At some point, all the tech giants

slow down."

Payback?



Ironically, the going may get tougher as the economy rebounds. At the

downturn’s nadir, most corporations grudgingly paid Cisco’s premium prices

rather than incur the cost of switching to weaker rivals that might not survive

for long. Now customers are starting to shop around–and there are bargains to

be had. Dell and China’s Huawei Technologies, in particular, are aggressively

undercutting Cisco’s prices. "Cisco is in denial," says Dell Inc.

president Kevin B Rollins. "In every tech market we’ve seen, prices and

margins come down. It’s a law of gravity." Also worrisome are the

resellers and suppliers Cisco squeezed during the slump. With the economy

bouncing back, many bruised ex-partners, such as networking specialist Xtelesis

Corp. in Burlingame, Calif., are eager to help rivals take Cisco down a notch.

"They’re not hurting now," says president Scott Strochak. "But

once customers are investing again and Cisco has lost half of its smaller

distributors, I’d like to think it will hurt them."

Cisco also must prove that its newfound discipline hasn’t dampened its

hard-charging zeal. Some recent departees say there have been frustrations with

all the new procedures, and they worry that bureaucracy may slow Cisco down as

it battles nimble rivals. One sign of potential trouble is Cisco’s inability

to hold off upstart Juniper Networks in the market for high-end routers that

telephone companies use to handle massive data flows. While Juniper has been

gaining share, insiders say Cisco’s years-long effort to field a competing

product has been stymied by engineering delays. "Cisco has been too

conservative," says Tom Nolle, president of consulting firm CIMI Corp.

Still, there’s no doubt that Cisco’s rebound positions it as a powerhouse

for years. The company is more disciplined and cohesive, and Chambers’ plans

for new markets may change the very nature of Cisco. Besides security software

and wireless gear, it’s moving into storage-networking products, optical gear,

even consumer gadgets. Selling Wi-Fi gear is worth nearly $1 billion, and Cisco

has begun rolling out consumer offerings, such as a $149 wireless security

camera. All told, analysts expect the new businesses to count for 30% of Cisco’s

revenues in 2006.

The company’s remarkable journey began as many difficult transitions do–reluctantly.

In late 2000, contract manufacturers began warning that parts were piling up in

their warehouses and asked for permission to cut back on orders. Cisco execs

told them to keep ordering. Even after Cisco narrowly missed Wall Street’s

earnings expectations in the quarter that ended January 30, 2001–its first

miss in 11 years–Chambers couldn’t break from his growth-oriented mind-set.

"John had always boldly gone where no one else would go," says Gary

Daichendt, his former No. 2, who retired in December, 2000.

All that changed during Chambers’ around-the-world business trip in late

February and early March. He realized the world had changed, and Cisco would

have to adjust. "At times like those, you have to analyze what you did to

yourself, versus what the market did to you," says Chambers. "You

almost always get surprised , but you determine how deep and long

you think it will be, take appropriate actions, and start getting ready for the

next upturn."

One of Chambers’ first moves after the $2.2 billion write-down was to visit

Mario Mazzola, a well-respected engineer who had joined Cisco in 1993. The

Italian native, now 57, had long planned to retire–an internal memo about his

departure had already circulated. But over several meetings at Cisco’s

sprawling collection of squat, three-story office buildings, Chambers told

Mazzola that Cisco needed him. The company’s engineering efforts were a jumble

of overlapping development projects. At one point, Cisco had five separate

efforts aimed at data-storage switches, according to JMP analyst Sam Wilson.

Chambers told Mazzola that only he could corral the company’s 12,000 engineers

and make Cisco a stronger innovator, less reliant on acquisitions. In August,

Mazzola agreed.

Strict Diet



He quickly got to work. Many iffy projects were axed, including a broadband

wireless technology when the two biggest potential customers decided not to

pursue it. In all, Cisco cut the number of models it sells from 33,000 to

24,000. Still, insiders say there’s far more fat to cut. Says a former exec:

"If you’re 50 pounds overweight, you can lose 20 pounds just by walking–but

to lose that last 10 pounds."

There’s no question Cisco has trimmed its once-freewheeling investment

practices. In the past, acquisitions and investments in other companies were

haphazard. That ended when senior vice-president Daniel A Scheinman took over

corporate development in August. An attorney who had been Cisco’s general

counsel, Scheinman set up an investment review board that analyzes investment

proposals before they can move forward. Roughly 50% are okayed, he says.

The acquisition free-for-all ended, too. Scheinman set up monthly meetings

with the heads of operations, sales, and finance to vet potential deals. Besides

making sure an acquisition makes sense for the company as a whole, the group

works up detailed operational plans to make sure the business can be

successfully integrated into Cisco–and a deal’s sponsor must commit to sales

and earnings targets. That put a screeching stop to the buying binge: Cisco

bought two companies in fiscal 2001, down from 24 the year before. The company

is doing deals again, but more carefully. When Cisco bought home-networking

leader Linksys Corp. in March for $500 million, Scheinman and his group talked

for six months before proceeding.

Some of the most painful progress began during the fall of 2001 on the

operations front. With Cisco’s sales plunging, Pond’s staffers began playing

hardball with suppliers to keep profits up. The CEO of one supplier said Cisco

wanted to take 90 days to pay for his products instead of the normal 30. It also

wanted the supplier to extend the warranty on its goods to three years from one.

When he balked, the CEO got a call from a midlevel manager. "If you don’t

, we’ll instruct our people not to use your

products," he recalls the manager saying. The supplier, like many others in

such tough times, couldn’t afford to lose Cisco’s business and buckled

under.

Many others lost out entirely. Cisco’s list of key suppliers has fallen

from 1,300 to 420. That lowered administrative costs and led to volume discounts

worth hundreds of millions of dollars each year. Pond also outsourced more

production to lower costs, from 45% in 2000 to over 90% today. At the same time,

he spent millions to shift production work from nine contract manufacturers to

just four. And smaller resellers complain that Cisco began giving discounts to

strategic distribution partners such as IBM and SBC Communications, leaving

hundreds of smaller players unable to compete against these behemoths.

"Cisco went from being our best partner in good times to our worst enemy in

bad times," says the former CEO of one reseller. SBC says the closer

relationship is helping it sell more to its business customers.

In early 2002, with Cisco making progress in adopting Chambers’ new

marching orders, the CEO considered an even more ambitious goal: He approached

CIO Solvik and asked him if it was possible to double productivity, to $1

million per employee, by 2007. That way, Chambers figured, Cisco could

capitalize on the next spending upturn without having to add many workers,

sending profits through the roof. After a few months of studying industry

leaders such as Wal-Mart Stores and Dell, Solvik said it was doable–but only

if Cisco stopped behaving like a confederation of startups and more like a

mature, cohesive corporation.

In Cisco’s cowboy culture, this was explosive stuff. When Solvik explained

his findings at Chambers’ vacation home in Carmel, Calif., in April, 2002, the

response was chilly. Execs listened uneasily while gazing at the 180-degree view

of Monterey Bay. When Solvik asked for volunteers to investigate how Cisco could

emulate the best company in a certain area–say, Dell in operating efficiency–not

a single exec followed through. "It didn’t resonate well with the group

at all," recalls Pond. "But Pete wouldn’t let go of it."

Chambers backed Solvik. Just after the Carmel gathering, he instituted an

Internet Capabilities Review. Three times a year, top managers share how they

use the Web to boost productivity. At the same time, they’re measured on how

well they implemented the best ideas from previous sessions. He also created a

series of committees to get all parts of the company working together. Now, most

decisions–what parts to buy, what products to design, what distributors to use–must

be cleared by business councils that focus on Cisco’s overall performance.

All the new procedures created some controversy. Product managers were

stunned at the extra steps required to get anything done. Under the new

structure, Ish Limkakeng, a product-development manager for switches, must get

clearance from a committee of executives from various parts of the company

rather than just chat up a few associates. He says the change was difficult,

though he came to understand the benefits for the company.

Some salespeople still feel hamstrung. One of Chambers’ initiatives is an

e-customer project that will consolidate 19 different databases into a single

repository. It’s designed to boost efficiency and prevent mishaps such as the

double ordering by customers that contributed to the inventory write-down. But a

salesperson can no longer log in an order for a new customer without first

clearing it with a support team that makes sure the customer isn’t already in

Cisco’s records. One insider says sales people in Europe have been

"thumbing their noses" at the e-customer rules and not following the

new guidelines. Sales chief Richard J Justice acknowledges some griping and says

Cisco may refine the process to address the complaints.

Calling Telecom



Chambers took other steps to rein in Cisco’s Wild West culture during

2002. Most pointedly, he made teamwork a critical part of top execs’ bonus

plans. He told them 30% of their bonuses for the 2003 fiscal year would depend

on how well they collaborated with others. "It tends to formalize the

discussion around how can I help you and how can you help me," says Sue

Bostrom, head of Cisco’s Internet consulting group.

When it came time to divvy up those bonuses, it was clear that Chambers’

overhaul had resulted in a leaner, more efficient Cisco. On August 5, the

company announced that it had earned $3.6 billion for the year–almost double

net income for the year before, even though sales were flat, at $18.9 billion.

And employees were getting more comfortable with the new Cisco. "There’s

been huge progress," says Justice. "There’s a sense of redemption

and vindication."

Today, revenue growth remains the biggest challenge. The company is off to a

fast start in a number of promising markets. In security software, Cisco already

has taken the lead from Check Point Software Technologies, with a 27.3% share in

the second quarter, up from 20.1% in 2001, says Synergy Research. And Cisco is

building quickly on its Linksys acquisition. Charles H Giancarlo, a senior

vice-president responsible for Linksys, says Cisco plans to introduce a dozen

more home gizmos over the next year. "Who knows?" he says. "Linksys

might become a household name, while Cisco may only be for portfolio

planners."

Still, to get revenue growth back to double digits, Cisco will finally have

to make headway with the big phone companies. And they’re wary shoppers.

Established carriers such as BellSouth Corp. had serious reliability problems

with Cisco gear in the ’90s. To make matters worse, Chambers served as the

arms merchant for scores of their upstart rivals–only to see most of them

disappear in the telecom bust.

Now, Cisco has been on a crusade to get into the telecom industry’s good

graces. Chambers himself called top telecom execs to apologize for his past

arrogance. "He said maybe they’d forgotten one of their fundamental

rules: Listen to your customer," recalls BellSouth chief technology officer

Bill Smith. Cisco also began pouring over 50% of its research and development

budget into new gear that could be used more easily with the phone companies’

existing switches. Cisco’s most recent quarter suggests the plan is going

well: Orders from carriers were up 20% over the previous year–far more than at

rivals such as Lucent or Nortel. And phone company execs say Cisco has made

progress. "I think they are capable of becoming a top one or two

provider," says SBC chief technology officer Ross Ireland. BellSouth plans

to deploy a Cisco switch next year to handle voice and data traffic.

After a difficult three years, much has changed at Cisco. At one point during

the annual sales powwow at a San Francisco convention center in August, a

wizened Chambers came out from behind the podium to be closer to the 10,000

salespeople. Dressed in casual clothes, Chambers squatted on the steps of the

stage and struck an intimate tone. Recalls sales manager Gregory H Lynch:

"Chambers said, ‘I think we’re ready to grow again. I’m asking you to

help me."’ The words are toned down from the wild years, but Cisco looks

poised to continue its dominance.

By Peter Burrows in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc

Cisco’s Savvy Overhaul>>>>>>>

Engineering



In the boom, engineers followed their geek muses wherever they led. In 2001,

Cisco centralized engineering, and top execs started setting the tech road map.



Result: Since then, Cisco has cut its product line 27%, to 24,000 models, to
focus on the most successful. That has helped win volume discounts worth

hundreds of millions of dollars.

Operations



The company used to operate like a band of independent tech tribes. Each

unit could choose its own suppliers and manufacturers. Now a committee oversees

all such decisions.



Result: Since 2001, Cisco has cut its suppliers and manufacturers, and
productivity is surging. Sales per worker has risen 24%, to $548,000, this year.

Acquisitions



Cisco had long been a binge buyer–of even unproven startups with no

profits. Now it focuses on established companies that can contribute to

earnings.



Result: Acquisitions tumbled from 23 deals in 2000 to two in 2001. And
Cisco says home-networking leader Linksys, which Cisco bought in March,

contributed to earnings from Day One.

Culture



The old Cisco was known for its carpe diem culture–with little coordinated

planning. Now teamwork is emphasized.



Result: Some 92% of workers expect to be with Cisco in five years,
according to an internal survey of 30,000 staffers, vs. 50% at most companies.

And top execs are collaborating–partly because new compensation policies tie

30% of their annual bonuses to their ability to work with peers.

Information Systems



Cisco, an e-business pioneer, is upping the ante with thrice-yearly reviews

where execs must map out new ways to use the Web. A goal: Improving Cisco’s

sales forecasts to prevent a repeat of the $2.2 billion inventory write-off in

April, 2001.



Result: Cisco says it realized $2.1 billion in savings from using the Net
in 2002. It’s now spending $100 million on three big projects, including a

database consolidation to improve forecasts.

Growth Strategy



In the past, Cisco focused almost exclusively on networking gear. Now it’s

pursuing six new markets, including security and Net phones. Over 50% of its

$3.3 billion R&D budget in 2002 is for emerging markets, up from the past.



Result: Cisco is making headway in most new markets and gets 14% of its
revenues from them. Now Cisco is introducing new products, including wireless

gear, such as security cameras, for consumers.