Ethernet equipment

Cisco's Old Math

2:55 PM -- Recently, readers were disappointed that I didn't flag CEO John Chambers as a Cisco Systems Inc. (Nasdaq: CSCO) executive likely to get ousted. (See Who Else Is Exiting Cisco?)

That doesn't mean I think he's been perfect. In fact, there's one major mistake I think he made repeatedly in recent years, and it might have helped turn shareholders against the company.

It's the "12-to-17 percent" growth forecast. This occurred to me recently, during Cisco's fourth-quarter earnings call, the one where all the bravado came back. (See Cisco Says It's Ready to Fight.)

Analysts always seemed skeptical about that forecast. Every now and again, someone would do the math and ask, "If you're sticking to 12-to-17-percent, doesn't that imply you have to make $[Unlikely Number] next quarter?" I seem to remember Simon Leopold at Morgan Keegan & Company Inc. doing this more than once.

Chambers's answer was always that "12-to-17 percent" was the long-term trend and that Cisco might cruise above or below it in any given set of four quarters.

The October 2008 crash messed up the math; Cisco's revenues went downward, then climbed madly, percentage-wise, as business reverted to normal. It was hard to glean a long-term trend. The more pressing concern was that Cisco's size made "12-to-17 percent" seem overly ambitious.

Analyst Brian Marshall of Gleacher & Company Inc. writes that Cisco has grown 11 percent per year, on average, during the past five calendar years, which falls short of the goal by $400 million or so per year. It takes a lot of Flip cameras to make that up.

It was a mistake for Chambers to stick to the image of Cisco as a growth company. Cisco lost its startup status a long time ago, and it never seemed likely that the company could find some new purchase or adjacency, every year, to reach the 12 percent line.

Now that Cisco has apparently abandoned the 12-to-17 target, Marshall thinks it should declare a new target of 10 percent. That seems reasonable, and in fact, it's the range of natural growth -- not counting acquisitions or adjacencies -- that Cisco was projecting for itself in 2009.

Like any smart company, Cisco wants to stay "innovative" and "nimble" and all those other Silicon Valley words that everybody likes. But it has to grapple with its status as a big incumbent vendor. Keeping the innovative spirit is going to require some shocks to the system.

This time around, the shock came from the outside. Chambers told us in July that he's set a self-administered wake-up call four years from now, when he expects Cisco to require its next major changes. He seems to have learned from this latest cycle -- but we'll find out in four years, or maybe sooner.

— Craig Matsumoto, West Coast Editor, Light Reading

shygye75 12/5/2012 | 4:55:46 PM
re: Cisco's Old Math

Lots of executives -- and the investors who love them -- are firm believers in the myth of infinite scale. Without that blind faith, there would be too much stability and predictability in the business world. We'd all be bored and complacent.

Rush21120 12/5/2012 | 4:55:45 PM
re: Cisco's Old Math

Heck if Jeffery Immelt can stay on I see no reason why Chambers should step down.  It would be welcomed if he (Chambers) changed his strategy and reinvested all that foreign capital here in the US (but that will take an act of Congress).

CapitalC 12/5/2012 | 4:55:44 PM
re: Cisco's Old Math


Old math indeed.

"12-to-17 percent" revenue growth is ambitious. It's also the wrong metric. It creates the wrong incentives. It's okay to forecast, but it's stupid to make it the top priority. I guess when your CEO is just a sales guy...

But this isn't 1998. Company value isn't about eyeballs, mind share, or buzz. And it's not about revenue either. Large-cap investors want net income. They want return on equity. They want the profitability that comes from competitive advantage, based on intelligent strategy and sound management.

Cisco seems obsessed with growing the top line, the number of lines of business, and the diversity of the portfolio. They will jump into any "adjacency" that has the promise of being a "billion dollar business". Never mind that the business is unprofitable, the industry is unattractive, and there are no synergies with the existing business.

Sure, desktop IP phones are a "billion dollar business". In revenue terms. But you have to give them away, pay partners to install them, waste engineering resources, and distract the executive team to produce the revenue. And at the end of the day, you don't make any profit.

Same thing with Flip cameras, telepresence, StadiumVision, social video, wonky data center server hardware and the rest. They produce revenue! Billions! But they suck the life out of the rest of the company.

Meanwhile, one of the most profitable competitive advantages in the business universe - a dominant position in switching and routing equipment - has been squandered. Now, the competition makes better stuff, and customers are switching. And all the smart engineers now work elsewhere. Oops.

Craig is absolutely right that Cisco's biggest mistake was focusing on crazy revenue growth long after the company had become big and established. It's not a hot growth stock - it's in the DJIA, for goodness sake. The focus should have been on sustaining a strong position in a huge and profitable networking equipment market. Oops.

That's all water under the bridge now. The game today is to run a lot of commercials to pump the stock. Cloud! The Human Network! And pay some dividends to attract yield-hungry investors who won't notice that their principal is evaporating. And fire people to juice the next quarter. 

Well, it could be worse - it could be HPQ.



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