Cisco's Slump Kills Off Some High-Tech Myths
latimes.com
Technology: Unfinished buildings and a sagging stock price are symbols of the
hardware giant's stumble. Observers predict the firm will regain its footing, but few
expect it to return to the glory days.
Sunday, May 6, 2001
By CHARLES PILLER, Times Staff Writer
SAN JOSE--George W. Bush came calling. So did British Prime Minister Tony Blair and
China's President, Jiang Zemin. All sought the counsel of John Chambers, chief executive of Cisco
Systems, which a year ago reigned as the most valuable corporation on Earth.
Chambers' lofty goal was to wire the world for the Internet. And for a decade Cisco surged to
prominence by selling arcane hardware that directs the Internet's trillions of messages and images
each week like an army of electronic traffic cops. The company became the crowning achievement
of the "new economy."
Cisco's sales shot up from $69 million in 1990 to nearly $19 billion in 2000--a phenomenal
average annual rise of 75%. Unlike many Internet firms, Cisco sold real products and made real
money--nearly $5 billion in profit last year.
But to understand the breadth of the technology industry's meltdown, just look at the problems
Cisco faces today.
A recent series of miscalculations has sent Cisco into a catastrophic tailspin. The company's
sales have nose dived 30%. It is laying off 8,500 workers, or 18% of total employment, and is
paying college students "severance" to walk away from recent job offers. Cisco's stock also has
melted down by 76%, some $400 billion in total market value--or the current value of General
Motors, Bank of America, Wal-Mart and Boeing combined.
As orders plummeted, Cisco wrote off a staggering $2.5 billion in unsold inventory. The
company also halted a building binge and plans to install windows on empty shells to prevent the
incomplete structures in San Jose from becoming eyesores.
Cisco's unraveling has raised questions about the theory that technology-driven growth is
inherently more efficient and manageable than in past eras.
This slowdown also debunks Chambers' faith--shared by other tech executives--in the power of
sophisticated software systems to closely monitor orders, manufacturing, accounting and inventory
to precisely track sales growth and anticipate demand.
"The belief in the new era--that we have much higher levels of productivity because of
information flow, and that we won't make mistakes that past generations have [caused Cisco's
predicament]," said Fred Hickey, editor of the High-Tech Strategist newsletter.
"Chambers was going around telling world leaders that they don't get it," Hickey added. "He was
lecturing Alan Greenspan . . . because his stock was the top stock in the bubble."
Chambers described Cisco's unforeseen drop in orders as greater than a 100-year flood. "We
never built models to anticipate something of this magnitude," he told financial analysts last month.
Yet for nearly a year, danger signs had piled up. The dot-com universe--including key customers
for many of Cisco's biggest customers--had imploded.
Chambers remained convinced that demand for Internet hardware would keep climbing. He
spent heavily last year to buy almost two dozen computer networking firms and stockpiled
inventory to satisfy frantic demand. But large corporate customers, including telephone giants Sprint
Corp. and WorldCom Inc., cut spending in December and some smaller carriers went bust. Today,
failed dot-coms are unloading barely used Cisco gear and thousands of its products are being sold
on EBay at fire-sale prices.
Cisco declined to make top officials available for comment.
Despite its problems, though, Cisco clearly is no dot-com teetering on the edge of bankruptcy.
The company had nearly $4 billion in cash at the end of the last quarter, and it still dominates key
markets.
Still, the magnitude of Cisco's sudden slowdown stands at odds with a decade of relentless
growth.
The company's founders invented the router--one of most important technologies of the Internet
Age. Routers look at nearly every piece of data that crosses the Internet and direct information to
the correct recipient.
Some of these bland boxes--ranging in size from laptop computers to 6-foot-tall consoles--are
literally worth their weight in gold. Internet companies, telecom providers and enterprises that
operate large computer networks pay a few thousand dollars to as much as $1.5 million per
product.
Cisco dominates the market it invented--selling about 80% of all routers and half of all computer
network switches. The company also provides software and other hardware tools that manage
high-speed connections to the Internet. And Cisco has recently mounted a challenge in the new
market for optical switches--devices that direct data over light beams traveling through fiber-optic
cables.
During Cisco's boom, the company's stock became a license to print money, soaring from less
than $1 a share in 1993 to $82 last year. In that period, Cisco gobbled up 71 competitors and
promising start-ups.
For years the model worked. Technology originated by the company's first
acquisition--Crescendo Communications, purchased for only $89 million--has earned Cisco billions
of dollars in switch sales. A few other purchases have proved nearly as prescient.
But critics say the strategy--buying untested companies and overpaying for their potential--was
unsustainable. By issuing so many new shares to make those acquisitions, Cisco diluted the value of
its stock dramatically.
The tech-stock crash derailed Cisco's growth strategy. After acquiring 23 companies in 2000,
Cisco has bought none this year.
And Cisco may now be choking on some of the costly purchases. In August 1999, Cisco paid
$6.9 billion for Cerent Corp.--a 2-year-old money-losing start-up with 287 employees--at a
jaw-dropping $24 million per employee. Cerent was supposed to jump-start Cisco in the optical
network components market, but it has yet to gain a foothold.
Also in 1999, Cisco paid $500 million for another optical company, Monterey Networks. But
Monterey's $1-million-plus optical router flopped and Cisco was forced to kill the product last
month.
Such episodes are familiar to Ian Bell, a middle manager who left Cisco in 1999 after a year
with the company. Bell worked in a Cisco division that developed products to bring voice
communications onto the Internet.
Cisco bought several voice companies, he said, but many of the new--and newly
wealthy--employees knew that their products would be late to market or noncompetitive.
"From a customer's perspective, Cisco was really good at making people pregnant, but not so
good at [delivering] babies," Bell said.
Viranjit Madan, a Cisco engineer for three years who left the company in November, said
jealousy often erupted between established Cisco engineers and newcomers.
"People . . . came in far wealthier than you, just because they happened to be from a company
with a product [Cisco wanted]," he said. In some cases, Cisco engineers resigned en masse when
newcomers took over their operations, according to Madan.
Critics suggest that Cisco may have been blinded by crushing pressure to keep growing fast
enough to justify its stock price.
A shareholder lawsuit filed by Milberg Weiss Bershad Hynes & Lerach against Cisco in April in
federal court in San Francisco alleges that Cisco's purchases were ill-advised and contributed to
securities fraud.
According to the lawsuit, Cisco financed its own customers' purchases in "loan amounts [that]
frequently exceeded the cost of the equipment . . . by more than 100%." Cisco "knew [that many
customers] were not credit-worthy and would likely never repay the loan . . . in full," the suit says.
And it alleges that Cisco falsely inflated revenue figures because the company knew some
customers probably would fail before they could repay the loans.
A Cisco spokesman called the suit "groundless."
David Rogan, head of Cisco's financing unit, said Cisco now has $800 million in outstanding
loans to customers, and that loans for more than the purchase price of equipment are typical in the
industry.
"The risk is rising, and we are doing the prudent thing . . . by increasing the reserves," Rogan
said. Cisco has set aside $700 million to cover the possibility of customer default, he said.
"Cisco always had supply problems," said Bell. "You build a product that's really exciting, then
you can't build enough of it and drive up demand. Some customers were double- and
triple-ordering products just so they could get them on time. When those orders stopped, they
stopped hard."
Another reason for Cisco's inventory troubles--and for those of other technology
companies--dates from the Y2K fiasco, said Mike Moone, former vice president for Cisco's
consumer products. Like many companies, Cisco expected a drop-off in orders for network gear in
late 1999 as customers prepared for disruptions from the 2000 software bug. But the Y2K bug
proved a dud. Instead, demand grew and some customers had to wait months for certain products,
so Cisco overcompensated.
"They started ignoring [the] just-in-time supply model and stocked up on inventory," Madan
said. "They deluded themselves into building [for an] . . . unsatisfiable demand."
During the boom times, thousands of Cisco employees became paper millionaires via stock
options and top executives received Hollywood-scale compensation packages. Chambers, 51,
exercised more than $150 million in stock last year, and a trio of other Cisco executives exercised
$138 million in options in the same period.
Now with many Cisco employees' stock options worthless, the company may face an exodus of
talent.
"It's always been difficult for people to leave because of the golden handcuffs [of valuable stock
options]," said Richard Lowenthal, a former Cisco vice president and general manager. "Loyalty
was based on [stock] options. That's a real problem for Cisco now. How do they keep people
motivated?"
But to rebuild, Cisco may need to return to a philosophy credited to Chambers, an earnest,
soft-spoken West Virginian: Avoid Silicon Valley's swagger, listen carefully to customers and
deliver what they need.
Despite his own staggering wealth, Chambers has enforced unusual frugality at his company.
A Cisco management meeting last summer was held at Chambers' vacation home in Pebble
Beach, Calif. Top executives carpooled from San Jose in their own cars--Cisco has no corporate
fleet--and stayed at Chambers' house.
"Here we are bunking in sleeping bags at John's house," and Chambers paid for dinner out of his
own pocket, Moone said. "This is how a company should be run."
Madan also praised the skill and integrity of Cisco's management. He said Chambers held
monthly breakfasts with employees who had birthdays that month. The events were
no-holds-barred question-and-answer sessions.
Such modesty and receptiveness could prove pivotal to Cisco's future.
Experts say that with economic recovery, the company will gradually regain its footing. But few
now predict Cisco will recapture its past momentum. At its current stock price, Cisco's shares
would have to grow 20% a year for nearly eight years just to match the peak of a year ago.
"Remember Smith Corona? They owned the typewriters. Wang? Pan Am--worldwide icon?
Gone," Moone said. But he predicts Chambers will never allow Cisco to die--partly because
Chambers was one of the Wang executives who presided over that once-towering tech company's
free fall in the late 1980s. He still feels the pain of the experience, Moone said.
But the glory days will be hard to recover. Said Moone: "It'll be years and years before there's
another rush to the stars."
* * *
Cisco's Stock Price Has Plunged...
Monthly closes and latest on Nasdaq
Friday close: $19.64, up $0.98
...And Acquisitions Have Stopped.
Number of companies acquired by Cisco
As of May 3: 0
Source: Cisco, Times research, Bloomberg News
Cisco's Slump Kills Off Some High-Tech Myths
Technology: Unfinished buildings and a sagging stock price are symbols of the
hardware giant's stumble. Observers predict the firm will regain its footing, but few
expect it to return to the glory days.
By CHARLES PILLER, Times Staff Writer
SAN JOSE--George W. Bush came calling. So did British Prime Minister Tony Blair and
China's President, Jiang Zemin. All sought the counsel of John Chambers, chief executive of Cisco
Systems, which a year ago reigned as the most valuable corporation on Earth.
Chambers' lofty goal was to wire the world for the Internet. And for a decade Cisco surged to
prominence by selling arcane hardware that directs the Internet's trillions of messages and images
each week like an army of electronic traffic cops. The company became the crowning achievement
of the "new economy."
Cisco's sales shot up from $69 million in 1990 to nearly $19 billion in 2000--a phenomenal
average annual rise of 75%. Unlike many Internet firms, Cisco sold real products and made real
money--nearly $5 billion in profit last year.
But to understand the breadth of the technology industry's meltdown, just look at the problems
Cisco faces today.
A recent series of miscalculations has sent Cisco into a catastrophic tailspin. The company's
sales have nose dived 30%. It is laying off 8,500 workers, or 18% of total employment, and is
paying college students "severance" to walk away from recent job offers. Cisco's stock also has
melted down by 76%, some $400 billion in total market value--or the current value of General
Motors, Bank of America, Wal-Mart and Boeing combined.
As orders plummeted, Cisco wrote off a staggering $2.5 billion in unsold inventory. The
company also halted a building binge and plans to install windows on empty shells to prevent the
incomplete structures in San Jose from becoming eyesores.
Cisco's unraveling has raised questions about the theory that technology-driven growth is
inherently more efficient and manageable than in past eras.
This slowdown also debunks Chambers' faith--shared by other tech executives--in the power of
sophisticated software systems to closely monitor orders, manufacturing, accounting and inventory
to precisely track sales growth and anticipate demand.
"The belief in the new era--that we have much higher levels of productivity because of
information flow, and that we won't make mistakes that past generations have [caused Cisco's
predicament]," said Fred Hickey, editor of the High-Tech Strategist newsletter.
"Chambers was going around telling world leaders that they don't get it," Hickey added. "He was
lecturing Alan Greenspan . . . because his stock was the top stock in the bubble."
Chambers described Cisco's unforeseen drop in orders as greater than a 100-year flood. "We
never built models to anticipate something of this magnitude," he told financial analysts last month.
Yet for nearly a year, danger signs had piled up. The dot-com universe--including key customers
for many of Cisco's biggest customers--had imploded.
Chambers remained convinced that demand for Internet hardware would keep climbing. He
spent heavily last year to buy almost two dozen computer networking firms and stockpiled
inventory to satisfy frantic demand. But large corporate customers, including telephone giants Sprint
Corp. and WorldCom Inc., cut spending in December and some smaller carriers went bust. Today,
failed dot-coms are unloading barely used Cisco gear and thousands of its products are being sold
on EBay at fire-sale prices.
Cisco declined to make top officials available for comment.
Despite its problems, though, Cisco clearly is no dot-com teetering on the edge of bankruptcy.
The company had nearly $4 billion in cash at the end of the last quarter, and it still dominates key
markets.
Still, the magnitude of Cisco's sudden slowdown stands at odds with a decade of relentless
growth.
The company's founders invented the router--one of most important technologies of the Internet
Age. Routers look at nearly every piece of data that crosses the Internet and direct information to
the correct recipient.
Some of these bland boxes--ranging in size from laptop computers to 6-foot-tall consoles--are
literally worth their weight in gold. Internet companies, telecom providers and enterprises that
operate large computer networks pay a few thousand dollars to as much as $1.5 million per
product.
Cisco dominates the market it invented--selling about 80% of all routers and half of all computer
network switches. The company also provides software and other hardware tools that manage
high-speed connections to the Internet. And Cisco has recently mounted a challenge in the new
market for optical switches--devices that direct data over light beams traveling through fiber-optic
cables.
During Cisco's boom, the company's stock became a license to print money, soaring from less
than $1 a share in 1993 to $82 last year. In that period, Cisco gobbled up 71 competitors and
promising start-ups.
For years the model worked. Technology originated by the company's first
acquisition--Crescendo Communications, purchased for only $89 million--has earned Cisco billions
of dollars in switch sales. A few other purchases have proved nearly as prescient.
But critics say the strategy--buying untested companies and overpaying for their potential--was
unsustainable. By issuing so many new shares to make those acquisitions, Cisco diluted the value of
its stock dramatically.
The tech-stock crash derailed Cisco's growth strategy. After acquiring 23 companies in 2000,
Cisco has bought none this year.
And Cisco may now be choking on some of the costly purchases. In August 1999, Cisco paid
$6.9 billion for Cerent Corp.--a 2-year-old money-losing start-up with 287 employees--at a
jaw-dropping $24 million per employee. Cerent was supposed to jump-start Cisco in the optical
network components market, but it has yet to gain a foothold.
Also in 1999, Cisco paid $500 million for another optical company, Monterey Networks. But
Monterey's $1-million-plus optical router flopped and Cisco was forced to kill the product last
month.
Such episodes are familiar to Ian Bell, a middle manager who left Cisco in 1999 after a year
with the company. Bell worked in a Cisco division that developed products to bring voice
communications onto the Internet.
Cisco bought several voice companies, he said, but many of the new--and newly
wealthy--employees knew that their products would be late to market or noncompetitive.
"From a customer's perspective, Cisco was really good at making people pregnant, but not so
good at [delivering] babies," Bell said.
Viranjit Madan, a Cisco engineer for three years who left the company in November, said
jealousy often erupted between established Cisco engineers and newcomers.
"People . . . came in far wealthier than you, just because they happened to be from a company
with a product [Cisco wanted]," he said. In some cases, Cisco engineers resigned en masse when
newcomers took over their operations, according to Madan.
Critics suggest that Cisco may have been blinded by crushing pressure to keep growing fast
enough to justify its stock price.
A shareholder lawsuit filed by Milberg Weiss Bershad Hynes & Lerach against Cisco in April in
federal court in San Francisco alleges that Cisco's purchases were ill-advised and contributed to
securities fraud.
According to the lawsuit, Cisco financed its own customers' purchases in "loan amounts [that]
frequently exceeded the cost of the equipment . . . by more than 100%." Cisco "knew [that many
customers] were not credit-worthy and would likely never repay the loan . . . in full," the suit says.
And it alleges that Cisco falsely inflated revenue figures because the company knew some
customers probably would fail before they could repay the loans.
A Cisco spokesman called the suit "groundless."
David Rogan, head of Cisco's financing unit, said Cisco now has $800 million in outstanding
loans to customers, and that loans for more than the purchase price of equipment are typical in the
industry.
"The risk is rising, and we are doing the prudent thing . . . by increasing the reserves," Rogan
said. Cisco has set aside $700 million to cover the possibility of customer default, he said.
"Cisco always had supply problems," said Bell. "You build a product that's really exciting, then
you can't build enough of it and drive up demand. Some customers were double- and
triple-ordering products just so they could get them on time. When those orders stopped, they
stopped hard."
Another reason for Cisco's inventory troubles--and for those of other technology
companies--dates from the Y2K fiasco, said Mike Moone, former vice president for Cisco's
consumer products. Like many companies, Cisco expected a drop-off in orders for network gear in
late 1999 as customers prepared for disruptions from the 2000 software bug. But the Y2K bug
proved a dud. Instead, demand grew and some customers had to wait months for certain products,
so Cisco overcompensated.
"They started ignoring [the] just-in-time supply model and stocked up on inventory," Madan
said. "They deluded themselves into building [for an] . . . unsatisfiable demand."
During the boom times, thousands of Cisco employees became paper millionaires via stock
options and top executives received Hollywood-scale compensation packages. Chambers, 51,
exercised more than $150 million in stock last year, and a trio of other Cisco executives exercised
$138 million in options in the same period.
Now with many Cisco employees' stock options worthless, the company may face an exodus of
talent.
"It's always been difficult for people to leave because of the golden handcuffs [of valuable stock
options]," said Richard Lowenthal, a former Cisco vice president and general manager. "Loyalty
was based on [stock] options. That's a real problem for Cisco now. How do they keep people
motivated?"
But to rebuild, Cisco may need to return to a philosophy credited to Chambers, an earnest,
soft-spoken West Virginian: Avoid Silicon Valley's swagger, listen carefully to customers and
deliver what they need.
Despite his own staggering wealth, Chambers has enforced unusual frugality at his company.
A Cisco management meeting last summer was held at Chambers' vacation home in Pebble
Beach, Calif. Top executives carpooled from San Jose in their own cars--Cisco has no corporate
fleet--and stayed at Chambers' house.
"Here we are bunking in sleeping bags at John's house," and Chambers paid for dinner out of his
own pocket, Moone said. "This is how a company should be run."
Madan also praised the skill and integrity of Cisco's management. He said Chambers held
monthly breakfasts with employees who had birthdays that month. The events were
no-holds-barred question-and-answer sessions.
Such modesty and receptiveness could prove pivotal to Cisco's future.
Experts say that with economic recovery, the company will gradually regain its footing. But few
now predict Cisco will recapture its past momentum. At its current stock price, Cisco's shares
would have to grow 20% a year for nearly eight years just to match the peak of a year ago.
"Remember Smith Corona? They owned the typewriters. Wang? Pan Am--worldwide icon?
Gone," Moone said. But he predicts Chambers will never allow Cisco to die--partly because
Chambers was one of the Wang executives who presided over that once-towering tech company's
free fall in the late 1980s. He still feels the pain of the experience, Moone said.
But the glory days will be hard to recover. Said Moone: "It'll be years and years before there's
another rush to the stars."
* * *
Cisco's Stock Price Has Plunged...
Monthly closes and latest on Nasdaq
Friday close: $19.64, up $0.98
...And Acquisitions Have Stopped.
Number of companies acquired by Cisco
As of May 3: 0
Source: Cisco, Times research, Bloomberg News |
