Tuesday, May 10, 2011

Contrite Cisco Regroups Before Skeptical Wall Street


Published: May 8, 2011

SAN FRANCISCO — John T. Chambers, one of the best salesmen in Silicon Valley, has been having trouble selling anyone on his company’s future.

Cisco Systems, where he is chief executive, is in a slump. The management system he put in place slowed decision-making and innovation. The company’s growth has slowed and its profits are falling.

His latest sales pitch is that he can revive Cisco — a technology colossus that makes computer networking equipment — by pruning its sprawling business and refocusing on its strengths.

But investors, Wall Street analysts and customers are a little bit skeptical of Mr. Chambers’s promises. No major improvement in Cisco’s finances is expected when it reports third quarter earnings on Wednesday. Given Cisco’s size, the scope of the overhaul and the increasing competition that is eroding the company’s market share, a turnaround could take time.

Last week, Cisco said it would reduce bureaucracy by eliminating a crazy-quilt management structure that had executives responsible for geographic regions as well as serving on “councils” that were supposed to encourage cooperation between the different groups. Instead, it slowed decision-making.

Last month, Mr. Chambers, who declined to be interviewed for this article, took his first step to fix Cisco by suddenly shutting down its Flip video camera business. Only two years earlier, Cisco had acquired Flip’s parent company for $590 million to expand its nascent consumer products division. The camera was popular and, indeed, the company was days away from release of the latest version of the video camera.

“This isn’t simply a midcourse correction,” said Jeffrey Kvaal, an analyst with Barclays Capital. “They’re facing challenges that are multi-year.”

The doubt in Mr. Chambers’s sales pitch began last year when Cisco’s sales started to show weakness that Mr. Chambers initially attributed to the sour economy. When profits continued to wither quarter after quarter, Mr. Chambers alternately blamed a decline in government spending and a “transition” after the introduction of new switches for computer networks.

In the last 12 months, its shares have fallen 31 percent as the Nasdaq index gained 22 percent. While Cisco’s shares fell, those of its rivals like Juniper Networks rose 35 percent. Alcatel-Lucent’s shares doubled.

In April, in a memo to employees, Mr. Chambers acknowledged systematic problems at Cisco. He blamed slow decision-making and a lack of accountability. “We have disappointed our investors and we have confused our employees,” Mr. Chambers wrote. “Bottom line, we have lost some of the credibility that is foundational to Cisco’s success — and we must earn it back.”

The contrition is unusual for Mr. Chambers, who is known for his unwavering optimism during his 16 years leading Cisco. He has paused his cheerleading only once before — during the dot-com crash more than a decade ago, when Cisco was unprepared for customers sharply cutting back orders. Cisco had been one of the hottest companies of the Internet boom of the 1990s with a high-flying stock to match. Much of the blame for its shortcomings fell on Mr. Chambers, much as it does today.

The last few years should have been golden for Cisco. Telecommunications companies worldwide were rapidly expanding their infrastructure to accommodate growing traffic from online streaming and mobile phones.

But Cisco failed to keep pace with changes in the network switching and routing equipment, which accounts for nearly half its revenue. The industry has shifted from more standardized technology — a landscape in which Cisco thrived — to specialized equipment for various niche markets.

For example, Cisco’s market share in edge routers, used by Internet providers to route traffic near the edges of their networks, dropped 11 percentage points over three years to 42.2 percent in 2010, according to the Dell’Oro Group, a market research firm.

“They’ve been lagging,” said Shin Umeda, an analyst with the Dell’Oro Group. “As a result, the competitors have been able to move in.”

Rivals like Alcatel-Lucent and Juniper Networks grabbed market share from Cisco in edge routers. Meanwhile upstarts like F5, based in Seattle, have chipped away at Cisco in other specialized markets like the equipment for controlling the load on Web servers in data centers.

Analysts said Cisco stumbled because Mr. Chambers distracted the company by trying to push into new businesses like videoconferencing, smart meters for monitoring electricity use, television set-top boxes, video screens for stadiums and even a tablet computer for businesses. These initiatives, called “adjacencies” within the company, were supposed to be the foundation of future growth.

Some of them have gained momentum, like Cisco’s corporate voice-over-Internet telephone systems and WebEx, the business videoconferencing service it acquired four years ago. But others, like the consumer products and digital signs, failed to catch on or are so far afield from the company’s main focus that analysts say Cisco is better off without them.

In addition to cutting Flip, Cisco folded its Umi home videoconferencing into its business-oriented unit. Eos, a service for media and entertainment companies to manage online content, will most likely be discontinued as a stand-alone product or sold. So far, Cisco has cut 550 jobs, but it has also offered voluntary buyouts to some of its employees in the United States and Canada.

Despite Cisco’s troubles, the company remains a powerful force with $40 billion in annual revenue and nearly 73,000 employees.

Still, more reorganization at Cisco is expected. The Linksys unit, which sells routers for home networking, is among the most likely targets because of its lower profit margins, analysts said. Cisco is expected to pay closer attention to its main router and switching businesses.

In his memo, Mr. Chambers largely signaled as much by saying that Cisco will “compete to win in the core.”

He added that the company’s breadth of products gave it a big advantage.

However, achieving the long-term goals of up to 17 percent annual revenue growth is no easy feat for a company so big. Indeed, Mr. Kvaal, the Barclays analyst, said that he would be happy if Cisco simply shored up its business and kept up with the networking industry’s growth.

Sales of switches are expected to be flat this year, but grow 6 percent the following three years, according to the Dell’Oro Group. Router sales are supposed to grow 9 percent annually over that period.

“Cisco doesn’t have to be a market-share gainer, they just have to hold onto the share they have,” Mr. Kvaal said. “They have taken the first step, but it’s not the only step.”

(Reference - http://www.nytimes.com)

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