New Market Realities For Cisco

Cisco watchers have been wondering whether the company’s realignment is to take advantage of much-talked about market transitions or to hunker down for battle with the current generation of formidable competitors (like HP, Huawei, Juniper).  Some might see this week’s appointment of Gary Moore as COO as an indication that the business has lacked operational excellence, but that’s easy to reject.  I remember sitting down with Randy Pond nearly 10 years ago (he was EVP operations -- the de facto COO for Cisco at the time) and talking about operational priorities required to profitably take advantage of market transformations and build world class capabilities across Cisco’s complex environment.  At the time, Cisco was a complex combination of acquisitions (like Crescendo where Randy had been VP Operations) and contract manufacturing around the globe. Operational excellence has always a hallmark at Cisco; that’s not the central issue facing the company. Instead, it is facing a fundamental transition to “incumbent” status.  Cisco is now the object of every competitor’s attention, and high-growth markets that are large enough to make a substantive impact are increasingly hard to find.

When Cisco announced earnings on February 9, they beat market expectations for revenue but disappointed Wall Street with their current and projected future profit margins.  With revenue from new products and services bolstering the top-line, higher expenses associated with product refresh and redesign costs in traditional products and lower overall margins in new product segments drove margins lower than expected.  CEO John Chambers has been very open that product line refreshes hurt margins and said that he expects to see margins return to historical levels in 2-3 years. But isn’t that about the time the next portfolio update comes around?  Lower margins (albeit still at stellar levels), coupled with the announcement last September that Cisco will initiate dividend payments, signals to me that Cisco is settling into its role as a traditional technology-market 800 lb gorilla. Profitable? You bet! Dominant in its core business? For sure. Continuing its historic growth performance? Not so much . . .

Recent news stories show some troubling developments -- like Huawei winning mobile network upgrades with Vodaphone Australia, or Juniper building out the IP/MPLS backbone for China Mobile to serve the growing demands of smartphone users, or HP winning more business from CERN (the European Organization for Nuclear Research) supporting their introduction of IPv6 networks.  Cisco should have been in the hunt and could have won any of these deals.  They were all large-scale opportunities to deploy new technologies or replace incumbent solutions to help networking customers seize the advantages presented by technology and market transformations.  If Cisco’s win rate in large deals falls, and I’m not convinced that is true, then Cisco would be in for some very rough years indeed.

More likely, Cisco is finally feeling the pressure that all market leaders feel -- namely that because they are in every deal and every market segment, they are in the sights of every challenger, putting pricing pressure on every deal.  And while the profitability of their core business is under pressure, the costs to fuel global innovation as they enter more adjacent technology markets are rising.  As the market leader, the largest opportunities are available to Cisco -- opportunities to both succeed and to fail.  My bet is that Cisco is in some ways a victim of their own success. They will not be able to replicate the growth rates and margins of their traditional core router/switching franchise as they enter new, adjacent markets like video, consumer networking, and the corporate data center. Instead, Cisco will be able to achieve exceptional results by being an exceptional portfolio manager -- delivering above average results by selecting the right time to invest in transformative technologies.  That blend of big, profitable, and new businesses will not, I believe cannot, deliver the same eye-popping growth and profitability that many have come to view as normal Cisco performance.  That’s not bad; it’s just a new reality.