We have the capability: it's the 12-point billion-dollar plan for Cisco's comeback

Back in the dark days of 2001, the systems specialist had to take a $2.2bn writedown. Now, in a world of new gadgetry and lower margins, it has an ambitious vision for the future, as its chief executive explains to Stephen Pritchard
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The Independent Online

This month marks 10 years at the top for Cisco Systems' chief executive John Chambers. In that time, the former IBM and Wang executive has seen the company he heads grow to dominate the computer networking industry. But Cisco has also had to weather some severe storms.

Chambers, whose time in Silicon Valley has not diminished his rapid-fire Southern delivery, joined Cisco just after the company's 10th birthday. He recently committed to stay on for at least a further three years. "I would like to stay at Cisco," he says. "I like what I am doing, most of the time, and am interested in doing it for the next three to five years."

What Chambers has been doing, and what he wants to keep doing, is to run Cisco as a fast-growing company, but also one that leads in its chosen markets and makes strong profits. This is by no means an easy task.

Much of Cisco's business comes from telecoms companies and internet service providers, markets that were severely hit by the downturn in that sector in 2000-01. Cisco was not immune: the company suffered severe inventory over-stocking problems in 2001. It was forced to write down $2.2bn (£1.2bn) of inventory.

Cisco's shares have slumped to around $18.50, underperforming the technology-heavy Nasdaq market, and are a long way from their peak of $82 in April 2000.

Chambers concedes that it has taken time to recover, but he believes the actions the Cisco board took then have created a company that is in much better shape today.

"Everyone likes to think that what we do today will determine the next quarter and next year. But the next quarter and next year are largely set, with the key variables being the economy and how well we execute," he says. "The key strategic decisions we make usually have an impact three to five years out. It is how well we made those decisions three to five years ago that determines our growth this year."

Over the next three to five years, Chambers expects the IT industry to have a normal "run rate", ie buying and revenue patterns. "Having said that, we don't know what normal means yet," he cautions. "It won't be like the second half of the 1990s but probably won't be like the last four years either." But he firmly believes that advances in internet technology, from home networking to telemedicine, will drive demand for Cisco's products.

Service providers will expand their networks to meet the demand for new services such as video calling. Small and medium businesses will invest more in IT, because of the productivity improvements it can bring. Domestic users will spend more on networking kit, as gadgets such as the iPod and hard-disk-based video recorders bring hi-tech into the home.

And Cisco is well placed to exploit all these markets, Chambers maintains.

"Most people would probably give us the benefit of the doubt and say that for the first time we are leading in terms of product capabilities in most categories. That is not something people would have said a couple of years ago," he admits.

"If you look at what we are doing in high-end and low-end routing, few people would disagree that we are clear leaders there. Look at what we are doing in terms of security architecture or wireless capability storage or home networking: we have among, if not the very best, products in the industry. That is very unusual. No company in hi-tech has had more than two products where they are number one [combined] with good profitability and rapid growth."

But Chambers is even more ambitious than this suggests. He plans for Cisco to have $1bn businesses in as many as 12 different categories. The company has disclosed six of these, but executives will not be drawn on the other six.

Much of the additional growth, though, will come from what the company calls its Advanced Technology Group. This group is home to the company's efforts in IP (internet) telephony, security, wireless, storage, home networking and optical equipment. In the fourth quarter of Cisco's 2004 financial year, the group contributed 16 per cent of turnover. In 2003, this was just 5 per cent, suggesting that Chambers has picked a number of winners.

One is certainly the home-networking business. Cisco bought Linksys, a specialist in the field, for $500m in 2003. It has since gone on to take 50 per cent of the US home-networking market.

Analysts questioned the decision to buy Linksys. Cisco had, prior to the acquisition, been a high-end networking business selling mostly to telecoms companies, large businesses and government departments. It had little or no knowledge of the consumer market.

But the consumer and small business sectors are growing faster than enterprise and telecoms. Cisco runs Linksys as a separate business - its headquarters are about 50 miles away - and Linksys has kept its own branding and distribution channels.

But Chambers believes that demand from home computer users and small businesses ultimately drives demand for Cisco's higher-end products as telecoms companies and ISPs expand their product portfolios to service new markets.

He also thinks the company can capitalise on its widespread expertise, especially in advanced technologies.

"If they make decisions as individual networks, as just service providers, as just enterprises or just as home users, we won't do quite as well. If they make decisions on routing and switching, storage and security combined, we do pretty well," he says.

Chambers adds that although Cisco has rivals in most of its markets, no single company is a rival in all of them. This makes Cisco attractive to IT managers who want to reduce complexity by buying from fewer suppliers.

But in order to succeed in building a dozen $1bn markets, Chambers acknowledges that Cisco will not only have to have the right strategy, but will have to execute it well. "It really comes back to the key variable," he says. "How well do you align what you do as a company with what your customers will pay a premium for?"

And it will have to learn to live in a world of lower margins, too. Historically, Cisco has enjoyed gross margins of around 68 per cent, driven by sales to telecoms networks and enterprises. Margins in sectors such as consumer and small business are lower.

Cisco executives concede that the cost of sales will rise as the company enters new markets, and lower margins in some of these markets will push down gross margins overall, perhaps to 65 per cent. But higher sales will make up for this.

"We believe entering into new markets will have a positive impact on our revenues. In the first quarter of our 2004 financial year, for example, orders for our advanced technologies crossed the $1bn per quarter mark for the first time," Chambers says. "They grew over 40 per cent year over year."

He adds that while some of the company's advanced technologies, such as home networking, will have lower gross margins than the current average, others, such as security equipment, will be more profitable.

"Our challenge," says Chambers, "is to manage the growth of both our gross margins and our operating expense through improved productivity, so that we see a consistent relationship between our top-line and our bottom-line growth."

Wall Street hasn't forgotten that the company has been through bad times, and it fears Cisco's ability to disappoint. The big challenge for Chambers is to prove the doubters wrong.