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Optical/IP

Cisco's Cloudy Forecasts

Cisco Systems Inc. (Nasdaq: CSCO) has supply-chain issues.

Cisco has been late on deliveries of its ONS 15454 optical transport platform (See Cisco's Optical Customers Face Delays). The company acknowledges there have been product delays, but, according to Light Reading sources, those delays were caused by a combination of unexpectedly strong demand from customers and inaccurate forecasting by Cisco.

Carl Russo, Cisco's group vice president of optical networking, maintains that the industry-wide shortage of optical components is not the problem.

Indeed, the shortage of optical components is not the whole problem. Cisco's product delays and some of its $3.83 billion backlog (orders that have been confirmed, but haven't yet shipped) comes from a combination of several factors, including "fuzzy math" salespeople, subcontractors who are growing too fast, and (surprise!) a shortage of optical components.

Since Cisco doesn't make any of its own components, the company is careful not to say anything that suggests it is having a tough time identifying reliable sources of supplies. In its filings with the SEC, however, Cisco admits that certain components are only available from one or limited sources (see Cisco's Components Feast).

As Cisco's latest quarterly report put it, "We believe gross margin may additionally be impacted due to constraints relating to certain component shortages that currently exist in the supply chain."

To help take the edge off this industry-wide problem, Cisco vows to beef up its inventory levels. This is going to be difficult to do while its sales are skyrocketing -- and that's where all the other factors listed above come into play.

Cisco's subcontractors are also having growing pains. This indirectly results in longer product lead times for Cisco. One subcontractor, Flextronics International (Nasdaq: FLEX), has seen its workforce triple in size over the past year. That's a tough thing to manage, especially as waves of Cisco orders come crashing in.

More importantly, though, Cisco's salespeople, always eager to beat their sales goals, probably undercut their forecasts too much in recent months. They probably thought no one would notice the difference between monster growth and large growth.

Unfortunately, setting low goals doesn't work in a supply-constrained market. Manufacturers typically work off two sets of forecasts -- a base plan, used to predict the company's revenues, and a stretch plan, used to guide the company in case things go better than expected.

Perhaps Russo, a salesman by nature, didn't realize how much Cerent's lack of sobriety would be exacerbated by Cisco's sales-driven culture. When Cisco bought Cerent, it acquired a great product but also got a method of forecasting which doesn't jibe with the reality of a market where there are many heavyweights competing for the same parts.

Now Russo and Cisco are in a period of adjustment -- they must be realistic with their sales targets (see Carl Russo, Cisco ). This won't be easy for a firm where salesmen have dominated the chief executive post.

So the industry-wide components shortage isn't the direct cause of Cisco's backlog or its late shipments to customers. But when a company as large as Cisco is rejiggering how it predicts growth in a fast-moving market, it certainly won't help them sleep at night knowing that components are in tight supply.

Cisco needs to worry less about beating expectations and more about getting its products out on time. Now that so much pressure is on carriers to recover revenues from their networks quickly, they can't afford to hear: "The parts are in the mail."

-- Phil Harvey, senior editor, Light Reading http://www.lightreading.com

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