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.