Sunday, May 22, 2011

Why Is Cisco In Trouble?

LAS VEGAS - JANUARY 06:  Cisco Systems chairma...Image by Getty Images via @daylife
I'm going to start with a disclaimer here. I'm just a guy who tries to understand things and one of the things I've been trying to understand recently is what went wrong at Cisco and what they need to do to turn things around.

Financial Background
Cisco was a long time tech darling. The undisputed king of the networking world and a sure money maker throughout the 1990's. From the perspective of their stock that hasn't been true for awhile now...

If you look at the graph to the left of this text you'll see what I mean. Cisco's stock price has been hovering between $15 & $32 for the past decade plus with the general trend being down recently. These aren't the kind of numbers that excite investors.

Of course the stock market isn't purely about numbers or logic. There is an emotional element as well. Until recently Cisco's EPS (Earnings Per Share) have generally shown an upward trend over the past decade.

CSCO Stock Chart by YCharts

I'm not a stock analyst and I won't pretend to play one on the Internet but clearly Cisco's earnings growth haven't been impressing investors. Google is an extreme case but if we compare them to Cisco we'll get a pretty good hint as to why.

CSCO Stock Chart by YCharts

It's not hard to figure out which of these companies most people would prefer to put their money in.

So we know that Cisco's financial performance has been considered poor. The question is, why? Such questions seldom have simple answers. It's probably fair to lay some of the blame at the feet of companies that made radical reductions in their technology investments after the dot com bubble burst. Even so, Cisco has been very slow to recover and recent results have been painting an increasingly grim picture.

The Possible Why(s)
From outside of the company and with zero insider information here is one of the key overlooked contributors to Cisco's current malaise.

Cisco has always been known for their acquisition culture. When they have seen an emerging market or technology they've gone out and bought one or more best of bread companies in that area. They are famous for their ability to quickly incorporate these new purchases into the collective. In the past the advantage to such an approach has been that you could minimize your R&D investment. In addition you got to pick the winners and reward them rather than having to back some of your own failures.

R&D when done right is directed with some goal in mind but it is largely speculative. You might spend millions of dollars on something that turns out to be a complete bust. Cisco was able to avoid taking this risk by simply waiting for new markets to develop and buying their way in. One example from the mid to late 1990's was the emergence of network switches. Cisco was able to acquire several companies and quickly become a dominant player at the network access layer via what became their Catalyst line.

There is a problem with this approach though. No matter how good you are at incorporating new companies into the fold, it takes time. Networking is becoming increasingly complex and tightly integrated in the data center and at the core and edge. These are the areas most large companies care about. The emerging trend towards cloud computing is playing a part as well as small to medium sized companies are increasingly out sourcing much of their most expensive network infrastructure to large service providers who also use highly complex and integrated network topologies. Products acquired from the outside are not going to be plug and play with Cisco's existing product line.

Adhering to industry standards helps in this regard but there has always been a tendency for proprietary technologies to play a part in Cisco and other companies product offerings. The EIGRP routing protocol is an example. Technologies developed in house take into account the larger ecosystem of the company. The  product managers and marketing professionals involved along the way (if they are doing their jobs) build a coherent picture and story about where new products fit into the larger picture.

So, the upside of the acquisition approach is that it allows a company to be nimble and minimize risky investments in research and development. The downside of this approach is that it takes time to "digest" new acquisitions, even if you are as good at it as Cisco. As the pace of innovation has become faster on the high end and the number of players on the low end has increased Cisco has increasingly struggled to keep up with their competition. At the access layer HP offers products with similar or superior features for significantly less money while companies like Aruba, previously known for their wireless products are announcing new products and road maps that offer intriguing capabilities that could greatly increase security and reduce the costs and complexity of managing networks.

One way to be good at incorporating new acquisitions is to create what is essentially a loose federation of smaller entities. Structures such as this become increasingly attractive as companies grow in diversity and complexity. GE would be an example. Cisco has a much narrower focus than GE but you only have to look at their numerous IOS variants (Cisco IOS, IOS XE, IOS XR, and NX-OS for example) to realize that they either chose not to provide a unified architecture in this area or they weren't capable of creating one. Different devices are going to have different needs but until relatively recently Cisco managed to keep their router and switch IOS's reasonably close in terms of syntax and versioning. Now it seems like every new product line has a new and unique operating system that has only a superficial resemblance to IOS.

To be clear, I'm not objecting to the underlying architectural improvements of IOS XR and NX-OS though in terms of intent these two sound similar enough under the covers that I'm not convinced they should be separate product lines. What I'm objecting to is the lack of consistency and tight integration. Networks are  complex and making the lives of people who work in the networking field more difficult is not a good thing.  

A Few More Thoughts/Wrap Up
Acquisitions can also be problematic if you start buying the wrong things. Many people, myself included feel that Cisco went off the rails when they started acquiring companies in the consumer space. Their first mistake was not the purchase of Linksys, but rather putting the Cisco name on Linksys products. This is somewhat akin to Nordstrom buying the Dollar store chain and calling in "Nordstrom's Dollar Stores". From a branding perspective I didn't understand the point of this move.

Other forays into the consumer space were even more perplexing. In business it's generally considered best to stick close to things you know. The further afield you get in terms of acquisitions the more likely you are to make big dollar mistakes. Flip is the most obvious example of this for Cisco. Video certainly drives bandwidth on networks as the recent reports that NetFlix streaming now makes up more than a fifth of Internet traffic in the US show. However, Cisco may have seen video as a growing market and wanted to get a piece of the pie. Pursuing revenue growth is one of the jobs of any company. Doing so outside of your area of expertise is risky because the new area can become a distraction that draws resources and attention away from your crown jewels.

In the interest of keeping this from growing any longer I'm going to wrap up here. From where I'm sitting Cisco is starting to do the right things. They've dropped Flip and they are saying the right things about focusing on their core competencies. I'd like to see them restructure to be more focused on R&D and tight product integration. They should probably keep acquisitions low and focused on technologies that can be quickly integrated into their product line rather than fully or nearly fully realized products. Another reason for laying off the acquisitions is that they may have to find a way to live off of substantially smaller margins for awhile. Having a bunch of money in the bank will help smooth a much needed transformation.

The next two years will be key for Cisco. They are losing to their competition across the board right now. IBM faced a similar crises twenty five years ago and managed to survive. There is no reason to believe that Cisco can't as well but they have a tough road ahead of them.
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