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As Embattled Cisco Shutters Flip, More Cuts Are Certain

{complink 1131|Cisco Systems Inc.} 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 {complink 2376|Hewlett-Packard Co.} and {complink 2470|IBM Corp.}. 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.

12 comments on “As Embattled Cisco Shutters Flip, More Cuts Are Certain

  1. AnalyzeThis
    April 12, 2011

    First of all, lots of good stuff in here, Alexander. I’m looking forward to your next post on this.

    I have mixed feelings about the decision to close the Flip business, for a couple of reasons: first of all, I actually own a Flip camera and think it's an excellent product for the price.

    Secondly, I'm a bit confused as to if there was an attempt to sell that business off at a fire sale price. One would think maybe Sony — which has the similar Bloggie product — might be interested in snapping up the scraps of Flip for bargain price. At least they'd get SOMETHING back for all the money they poured into the Flip, but perhaps it didn't make sense from an accounting standpoint to even bother with such an idea.

    Thirdly, while I do understand that the consumer-oriented nature of the Flip didn't exactly fit in with most of what Cisco was doing, I am kind of scratching my head over how anyone could objectively look at Cisco and say, “This! This stupid little camera! This thing is poison which is destroying your company!” because I don't believe that to be the case. And if anyone thinks that just because Cisco ditched Flip that somehow magically this fixes everything, well, I think they're probably delusional.

    Regardless, it is not exactly encouraging that Cisco pumped more than half a billion into this company just two years ago and now… they're just shutting it down? What a waste.

  2. Anand
    April 12, 2011

    “Chambers is correct in his assessment that the company's strategy is basically sound but needs to be better executed”

    I am not sure if everything is alright with strategy, If strategy is sound then why did Cisco choose to buy Flip ? Because of Cisco's decision to buy Flip it lost half a billion dollors within two years.

  3. Alexander Wolfe
    April 12, 2011

    Cisco bought Pure Digital, the makers of the Flip video camera, as part of its expansion into consumer during the company's acquistion binge. I believe Cisco was hoping for a couple of things. One was to enhance their consumer branding and presence. We see that in action with the ever-present Cisco telepresence commercials with Ellen Page.

    The other thing they were hoping for is a kind of second-order effect, where consumers would buy lots of Flip cameras, upload lots of video, and thus the bandwidth requirements of consumers in aggregate would increase, leading to sales of more routers. I'm obviously talking on a long time line and on macro scale here.

    True, as both DennisQ and anandvy point out, a half billion is a lot of money to waste, but OTOH I take it as an encouraging sign that Cisco is intent on lightening up on the consumer and refocusing on its core businesses.

  4. DataCrunch
    April 12, 2011

    Hi Alexander, thanks for the very interesting article.  Cisco has a lot at stake and getting aggressive for the UCS (Unified Communications Systems) market is a good move.  This is an area that can provide positive growth and can easily scale.  Just recently Cisco and Verizon jointly announced that they will be offering UCS as a service together.  This should help both companies gain market share quickly in this space.

  5. sureddy
    April 12, 2011

    Good analysis Alex. I would like to cite a blog i wrote a blog way back in 2009 on Cisco's M&A strategy and challenges of integration.. Check it out at http://skreddy.wordpress.com/2009/10/25/views-and-experiences-growth-by-innovation-or-ma/

    Like to share some of my thoughts …

    … Cisco has worked to make acquisitions a routine process, as route as the product development. Kind of open their eyes and ears to look for new innovations part of their strategy. This strategy worked well for Cisco for reasonable amount of time.  Does this strategy work for long run? Is it sustainable? In my view, I think they also reached the point of inflection. For every strategy there is a decay unless it is constantly refined and reinforced. And I am sure Cisco started to experience this too. It is rather very difficult to scale this strategy for ever. The complexity of trying to manage these different business units soon will overwhelm the advantage of integration. Though M&A helps eliminating the competition vs making their competition irrelevant. Companies that focus on this strategy, soon end up with an unsustainable or strategy decay. What do they do next? Then they go and spin-off or de-mergers or break them into small companies. Or get rid of the bad apples. All these would lead to the circus of financial engineering to unlock the shareholder wealth. Never forget that good companies gone bad are simply companies that for too long denied the strategy decay or trying to over reach their growth without any strategic differentiation.

     


     

  6. Alexander Wolfe
    April 12, 2011

    Excellent points, sureddy. You nailed it. Initially, acquisitions were a good way for Cisco to grow, but as the company became, er, humungous, eventually they became a drag on the business and detracted from a core focus on networking.

    As you aptly put it: “The complexity of trying to manage these different business units will overwhelm the advantage of integration.”

    Of course the big question now is, if Cisco successfully pares back costs and also cuts business units, and then if they cut margins, too, to be more competitive, how do they increase sales volumes to make up the difference (i.e., to grow revenues)?

  7. Jay_Bond
    April 13, 2011

    This was a very informative article. It will be interesting to see how many drastic changes Cisco is going to make to remain competitive and gain more ground in the market. I am curious as to what Cisco plans on doing with Flip. Are they just going to shut it down and eat the total costs, or sell that part of the business to a competitor? I've heard great things about the camera from people who own them.

  8. eemom
    April 13, 2011

    I find it very interesting that Cisco's first move is to shut down a part of its business.  It seems that they need to look inward and streamline their operations as well as take a long hard look at their strategic goals.  I agree with the previous comments about the Flip.  When I was researching video cameras for my daughter for Christmas, the Flip was the best quality camera for the price.  It's a shame they didn't try to spin it off or sell it rather than just shutting it down and laying off hundreds of people.  I really fail to see how this addresses their core problems, it barely scratches the surface.

  9. t.alex
    April 14, 2011

    Perhaps the Flip may not break even any time soon? I always see Cisco as the market leader in routers and networking. Probably Cisco is seeing more and more competition, epsecially in the household markets where there are many alternatives from China.

  10. elctrnx_lyf
    April 16, 2011

    Cisco has been a leader for a long time, but now there is lot of other companies which are on head to head competetion in different product segments. Particularly Juniper is moving ahead in few areas like mobile back haul networks and cisco doesn't want to take it easy anymore. They will invest their money, time and people only for the networking products.

  11. Alexander Wolfe
    April 16, 2011

    That's a great point about Cisco's competition heating up, elctrnx_lyf. You mention Juniper, which is certainly the number one competitor Cisco needs to be concerned about in terms of a company which is also fielding a comprehensive vision (and product line) as far as being a complete provider of all aspects of networking technology.

    However, Cisco also needs to battle the likes of HP (the Procurve stuff), F5, Brocade, Dell (Powerconnect), and others. That's why I believe it's particularly important for Cisco to reduce its costs, so it can live with tighter margins as it strives to compete.

    Or course, tighter margins means Cisco will have to increase its sales volumes just to remain steady, earnings-wise, so there are a lot of moving parts to the competitive equation to contend with.

  12. hwong
    April 18, 2011

    I hope they won't be another “Sun Microsystem'. That's all…

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