The world according to Chambers Cisco

Cisco’s chairman and chief executive is stretching his company in all directions. Can it hold together?
JOHN CHAMBERS no longer travels much. That is not for want of energy, of which the boss of Cisco Systems has plenty. It is because he is a proud and enthusiastic user of his own company’s technology. Since 2006 Cisco has been selling a system called TelePresence (pictured above, with Mr Chambers holding forth), which turns awkward videoconferences into pretty lifelike encounters. He pulls all-nighters to talk to customers and colleagues in Europe and Asia.

Meet Mr Chambers in the flesh, and the small talk lasts for about five seconds, until he asks: “What do you expect from this conversation?” If he seems to have no time to waste, no wonder. He does not only have a huge company to run, but he is also reshaping it.

During the dotcom boom Cisco was hailed as the leading light of the “new economy”, being the supplier of most of the gear guiding data through the internet. In early 2000, when its market capitalisation peaked at nearly $550 billion, it was briefly the world’s most valuable company. But a year later, like other technology giants, it was hit by what Mr Chambers calls the “hundred-year flood”. Cisco did not drown, but much of its stockmarket value was swept away (see chart 1). Since then it has been regarded for the most part as a lowly network plumber: necessary, but dull.

The company has not been immune from the world’s latest bout of economic troubles. In the quarter that ended in July its profit, $1.1 billion, was 45% lower than a year before. But Cisco, which had revenues of $36 billion in its latest financial year and employs more than 66,000 people, has been making headlines again for different reasons as well. “Cisco plans big push into server market,” read one in January. Another, in March, declared: “Cisco pushes further into consumer territory.” More recently a third said: “Cisco: smart grid will eclipse the size of internet.”

In other words, the plumber is branching out. As well as making these unexpected forays away from selling network gear, Cisco is exploring other sidelines. From “virtual health care” to “cloud computing” and “safety and security” to “routers in space”, the company is tackling more than 30 “market adjacencies”, as new areas of growth are called in the corporate argot. Mr Chambers expects to keep adding more. He hopes that at least half will be successful and generate 25% of Cisco’s revenues within five to ten years.

Some on Wall Street worry that Mr Chambers, who has been Cisco’s boss for 14 years, is stretching his company so thinly that it could be ripped apart. Mr Chambers, not surprisingly, sees the expansion, seemingly in all directions at once, differently: as a bold attempt to achieve two things. He wants Cisco to become the main supplier of the essential elements of an increasingly connected economy, and to be a shining corporate example of how to use them. It should provide not only the tools of the company of the future, but also its organisational model.

Even at the height of the dotcom boom, people had only the vaguest grasp of Cisco’s business. Its physical incarnation was easy to picture: hardware such as routers and switches, which direct traffic through a network. But Cisco also made a lot of money from services, for instance by helping customers to maintain those networks. It was always a software firm as well, providing the dominating operating system for internet-type corporate networks. This mixture goes a long way towards Cisco’s dominance in the networking market and its high gross margins (64% in the most recent quarter): firms have continued buying Cisco gear not least because it works best with IOS (originally Internetwork Operating System), as the software is called.

Cisco also has a record of being willing to reorganise itself. It was an early outsourcer of manufacturing, for instance. Many of its products are never touched by a Cisco employee, but built by a contract manufacturer, tested remotely and then shipped directly to the customer. Cisco was also one of the first big IT companies to let others do much of its R&D. To plug holes in its product portfolio or react to market demand, it bought dozens of other networking firms and perfected the difficult process of integrating them.

The once-a-century flood, however, did not just wash away nearly a third of Cisco’s revenues in a single quarter. It also laid bare the limits of the firm’s business model. Its core markets, routing and switching, had matured: they would never again boast the annual average growth rates of more than 50% that drove Cisco’s revenues from $1.2 billion in 1994 to $18.9 billion in 2002. The firm was also running up against the law of large numbers, which makes it more difficult for big companies to grow rapidly. And however efficient the supply chain, networking gear is bound to become a commodity eventually.

The obvious remedy was to move quickly into new businesses promising more value. Some companies would have begun gently, with one or two; Cisco went for half a dozen, including optical networks, wireless equipment and internet telephony. Today these “advanced technologies”, as they are called internally, bring in 25% of Cisco’s revenues (see chart 2). This branching out has been institutionalised and expanded. Hence the 30 market adjacencies.

Corporate giants were on the defensive for decades. Now they have the advantage again

IN 1996, in one of his most celebrated phrases, Bill Clinton declared that “the era of big government is over”. He might have added that the era of big companies was over, too. The organisation that defined capitalism for much of the 20th century was then in retreat, attacked by corporate raiders, harassed by shareholders and outfoxed by entrepreneurs.

Great names such as Pan Am had disappeared. Others had survived only by dint of huge bloodletting: IBM sacked 122,000 people, a quarter of its workforce, between 1990 and 1995. Everyone agreed that the future lay with entrepreneurial start-ups such as Yahoo!—which in late 1998 had the same market capitalisation with 637 employees as Boeing with 230,000. The share of GDP produced by big industrial companies fell by half between 1974 and 1998, from 36% to 17%.

Today the balance of advantage may be shifting again. To a degree, the financial crisis is responsible. It has devastated the venture-capital market, the lifeblood of many young firms. Governments have been rescuing companies they consider too big to fail, such as Citigroup and General Motors. Recession is squeezing out smaller and less well-connected firms. But there are other reasons too, which are giving big companies a self-confidence they have not displayed for decades.

Big can be beautiful…

Of course, big companies never went away. There were still plenty of first-rate ones: Unilever and Toyota continued to innovate through thick and thin. And not all start-ups were models of success: Netscape and Enron promised to revolutionise their industries only to crash and burn. Nevertheless, the balance had shifted in favour of small organisations.

But deregulation had already begun to go out of fashion before the financial crisis. The Sarbanes-Oxley act, introduced after Enron collapsed in disgrace, increased the regulatory burden on companies of all sizes, but what could be borne by the big could cripple the small. Many of today’s most dynamic industries are much more friendly to big companies than the IT industry. Research in biotechnology is costly and often does not bear fruit for years. Natural-resource companies, whose importance grows as competition for resources intensifies, need to be big—hence the mining industry’s consolidation.

Two further developments are shifting the balance of advantage in favour of size. One is a heightened awareness of the risks of subcontracting. Toy companies and pet-food firms alike have found that their brands can be tainted if their suppliers (notably, from China) turn out shoddy goods. Big industrial companies have learned that their production cycles can be disrupted if contractors are not up to the mark. Boeing, once a champion of outsourcing, has been forced to take over faltering suppliers.

A second is the emergence of companies that have discovered how to be entrepreneurial as well as big. These giants are getting better at minimising the costs of size (such as longer, more complex chains of managerial command) while exploiting its advantages (such as presence in several markets and access to a large talent pool). Cisco Systems is pioneering the use of its own video technology to improve communications between its employees (see article). IBM has carried out several company-wide brainstorming exercises, recently involving more than 150,000 people, that have encouraged it to put more emphasis, for example, on green computing. Disney has successfully ingested Pixar’s creative magic.

You might suppose that the return of the mighty, now better equipped to crush the competition, is something to worry about. Not necessarily. Big is not always ugly just as small is not always beautiful. Most entrepreneurs dream of turning their start-ups into giants (or at least of selling them to giants for a fortune). There is a symbiosis between large and small. “Cloud computing” would not provide young firms with access to huge amounts of computer power if big companies had not created giant servers. Biotech start-ups would go bust were they not given work by giants with deep pockets.

The most successful economic ecosystems contain a variety of big and small companies: Silicon Valley boasts long-established names as well as an ever-changing array of start-ups. America’s economy has been more dynamic than Europe’s in recent decades not just because it is better at giving birth to companies but also because it is better at letting them grow. Only 5% of European Union companies born since 1980 have made it into the list of the 1,000 biggest in the EU by market capitalisation. In America, the figure is 22%.

…but size isn’t really what matters

The return of the giants could well be a boon for the world economy—but only if business people and policymakers avoid certain pitfalls. Businesses should not make a fetish of size, particularly if this means diversifying into a lot of unrelated areas. The conglomerate model may be tempting when cash is hard to find. But the moment will not last. By and large, the most successful big firms focus on their core businesses.

Policymakers should both resist an instinctive suspicion of big companies (see article) and avoid the old error of embracing national champions. It is bad enough that governments have diverted resources into propping up failing companies such as General Motors. It would be even more regrettable if they were to return to picking winners. The best use of their energies is to remove the burdens and barriers which prevent entrepreneurs from starting businesses and turning small companies into big ones.

Aug 27th 2009 | SAN JOSE, CALIFORNIA
From The Economist print edition

source : The Economist