As Embattled Cisco Shutters Flip, More Cuts Are Certain

Cisco Systems Inc. (Nasdaq: CSCO) is hurriedly ripping up its playbook in the wake of poor performance and an inability to respond adeptly to market trends. Only a few weeks after signaling his intention through an internal email to address problems at the Internet equipment giant, chairman and CEO John Chambers has ordered the closure of its Flip camera business and will be laying off 550 staff in the near future.

However, the biggest question in assessing whether Cisco will rapidly get back on track is whether Chambers is correct in his assessment that the company's strategy is basically sound but needs to be better executed. My belief is yes, but...

Here's how Chambers characterized his company's crisis in an internal email sent to Cisco employees on April 4: "To be clear, I am confident that our vision and fundamental strategy is right -- we are aggressively capturing the opportunity to take the network where our customers need it to be... It is aspects of our operational execution that are not."

The market would agree with the latter. According to The New York Times, Cisco stock has earned a negative return of approximately 55 percent since 2001. The stock's 52-week range is $16.97 to $27.74. In early trading today, Tuesday, April 12, Cisco's stock was at $17.50, up approximately 3 percent from the 52-week low. The technology-heavy Nasdaq Composite Index, meanwhile, was at 2,740.97, up nearly 33 percent from its 52-week low of 2061.14.

Chambers's prescriptive solution is to focus the company on five areas: "Leadership in core routing, switching and services; collaboration; data center virtualization and cloud; architectures; and video," he wrote in the internal email.

Focus is important because Cisco has been on a decade-long acquisition binge, during which it spent $34 billion gobbling up companies like Flip video camera maker Pure Digital. Now, Cisco is ditching Flip, and if you're wondering why, when video is one of Chambers's core priorities, it's because Flip is a consumer play. Cisco also said it's going to restructure its Linksys division, which makes consumer networking products.

Those are the first steps in, as Chambers noted in the email "address[ing] with surgical precision" what needs to be fixed. Expect to see more moves which pare down Cisco's high-cost structure. That was telegraphed in February, when Chambers named Gary Moore his first chief operating officer. I've heard that, internally, the word is that one of Moore's first orders of business will be to trim company headcount, perhaps significantly.

OK, now that I've given you some background, let's assess the strengths, weaknesses, and missing back story surrounding Chambers's email. Chambers is a likable and benign autocratic who has created a powerhouse of a company that mirrors his presumably best -- and not-so-best -- qualities.

He's ambitious, smart (maybe too smart), certain of the way forward, and slow to re-trim his sails in the face of short-term setbacks. However, now that he's decided that change needs to happen, true to his style, Chambers is likely to go all out, particularly in paring the company's cost structure.

That's important because while Cisco, with its efficient supply chain, may not be the highest-cost producer, it has traditionally commanded the highest product margins. So, in addition to cutting costs, Cisco will have to seriously look at getting more competitive on pricing, because there are a lot of lower-cost, quality alternatives in switches and routers.

On the compute front, UCS, Cisco's new Unified Computing System, combines server, storage, and networking fabric in a well-designed, one-stop package. It's a smart, competitive thrust against best-of-breed offerings fielded by the likes of Hewlett-Packard Co. (NYSE: HPQ) and IBM Corp. (NYSE: IBM). However, at some point, UCS becomes a difficult sell, especially in today's challenging economy -- unless Cisco gets more aggressive.

As for responding quickly to new markets, Cisco hasn't done badly there. (UCS is a case in point.) However, to continue to succeed, I believe Chambers must jettison the "councils" he put in place in 2009. The move put decision-making in the hands of dozens of committees. As The Wall Street Journal noted at the time: "Critics of the new structure say that it adds bureaucracy and strips away accountability."

I've heard talk, from people close to Cisco, of workers being pulled off of their real jobs to help research presentations for these board meetings.

I call what Chambers put in place here the "bandwidth bureaucracy." That is, it has sucked up all the bandwidth that might have been used to respond more rapidly to markets and customers, instead making everything inward-facing. However, there's hope that the councils may go -- Chambers wrote in his email that "we will simplify the way we work."

Eliminating the burdensome committees would better position Cisco to succeed in emerging arenas like cloud computing, which I'll look at in my next post.