Cisco: Hedging Rather Than Betting
hat do you do when you have $40 billion in the bank, net profits of $7.7 billion, an average annual unlevered free cash flow of around $9 billion, the world economy in shambles, and you need to continue to grow because stagnation will kill your stock price?
At Cisco Systems, Inc. (NASDAQ: CSCO) you announce a $10 billion share buyback to protect your stock price, and you try to maximize your sunk costs and IP (pun intended; both Intellectual Property and Internet Protocol). Cisco has a plethora of business units, but most are geared toward supporting packet flow over Cisco’s core business — networking infrastructure. Networking infrastructure, in this case, represents a large portion the sunk costs, because sold gear does not return any post-sale revenue scaled to the use and value it provides the purchaser.
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Cisco doesn’t want to just sell shovels; it wants to be part of the gold rush. The easiest solution would be to attach a packet meter to Cisco’s switches and routers, give them away for free, and charge for their utility. It is unlikely, however, that businesses would buy into this. Option two would be for Cisco to “stuff” the network pipe and exhaust its use, leading to higher online capacity demand, and enabling Cisco to sell more of its routers, Unified Computing Systems, and cloud-enabling virtualization technology—the full data center stack!
Cisco has around 70,000 employees worldwide, and operates many business units—networking equipment; computer servers; data center virtualization; telephony; Web meetings and presentations; TelePresence; consumer goods in HD video and tablet computing (the forthcoming Cius) smart grid meters; video content management systems; spam and spyware protection; cable TV set-top boxes—just to name a few.
Because of Cisco’s size, wealth, and operational excellence, it is difficult for any one company to attack Cisco completely. HP and IBM have the competencies required to go toe-to-toe with Cisco, but none of them will completely replace one another in the market. But that doesn’t mean there isn’t still room for improvement at Cisco.
Vision: Yes. Strategy: No.
Cisco is a prisoner of its own success. Beholden to the stock market, it needs to continually produce top-line and bottom-line growth. On November 11, 2010, even though Cisco beat analysts’ expectations that day, it didn’t beat them by enough and couldn’t give rosy enough guidance for the next quarter. Its stock dropped 17% that day, eroding $23.5 billion dollars of market capitalization.
Strategy requires that companies develop defensible positions. Owning everything is one way to go about that, but Cisco’s all-you-can-eat approach to growing the company is hardly strategic. It is risky however, as it needs every investment and acquisition to have a sizable financial payoff.
A source within Cisco told us that the company will not compete in a market unless it can achieve number one or number two status. But when asked about Cisco’s strategy, the quizzical answer was “world domination?” Really? Cisco’s many business units appear more complementary than synergistic.
Cisco operates more on a vision. Selling more networking equipment is important to Cisco, and enjoying tertiary effects from digital media growth is nice, but pipe stuffing is not infinitely scalable, not sustainable, and ultimately not defensible.
Cisco won’t fail, but as it grows ever larger it will likely repeatedly falter, and investors will not reward this.
Hedging, Not Betting
Cisco is competing at the high-end. It has tremendous brand equity to protect, but its ability to satisfy the needs of the market and adapt to changing usage and consumption patterns is just as critical.
Cisco could easily hedge its acquisition and investment strategy. By pursuing a complementary parallel strategy of offering the customer true convenience by having software equivalents of some of its hardware products, Cisco can expand its markets and become even more customer focused. Rather than investing and betting on one path only, a parallel approach would give Cisco the ability to better protect itself against failure in one segment.
All of Cisco’s products and services deal in digital bits, data, and information. An analysis of three connected yet independently operating divisions—data center technology, TelePresence, and the Flip video camera—reveals that Cisco has much to protect, and many guns pointing at it. And for every situation a software equivalent exists that would allow Cisco to expand its customer base, offer a wider variety of solutions, and hedge its risk by serving the market from multiple angles.
Strengthening the Hub
A core collection of three of Cisco’s units—networking technology, data center virtualization, and the Unified Computing System— combine to present and direct data to the end-user, and form the backbone of the fastest growing consumption enabler: hosted services (The Cloud).
Think Salesforce.com, Facebook, and Netflix, and you get the picture. Who needs local storage, local content, or local applications anymore? But there are chinks in the armor; Cisco only leads the market in networking equipment. The rest—servers and virtualization—it is only very good at, but not market leading. Dell, HP, and VMware hold those crowns. Unlike in software, where powerful suites prevail in the enterprise, hardware buyers prefer best-of-breed over one-vendor shopping. And even in networking equipment, Cisco has formidable competitors, such as HP, 3Com, and Huawei.
Cisco holds the quality and high-end crown, and no enterprise would operate without having Cisco somewhere in its IT infrastructure. But Huawei, with $15 billion in annual sales and more employees than Cisco, is turning out to be a thorn in Cisco’s international expansion plans, and Cisco desperately needs to expand internationally to maintain its growth.
Huawei is beginning to be considered a low-cost alternative to Cisco. Cisco could compete on price, but that would only reduce margins, not necessarily significantly increase market share. Cisco’s real strategic issue is it is cost versus utility. Hardware ties up corporate working capital because of the need for redundancy for disaster recovery and business continuity purposes. It’s like buying two cars in case one breaks. Bean counters don’t like this.
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