“From Innovation to Financialization:
How Cisco Became Focused on Its Stock Price
and Lost Its Way”
Bob Bell, University of California, Berkeley
Marie Carpenter, Télécom Ecole de Management,
Henrik Glimstedt, Stockholm School of Economics,
and William Lazonick, University of Massachusetts
Ford Foundation Conference
Finance, Business Models, and
Sustainable Prosperity,
Ford Foundation, New York City,
December 6-7, 2012
NEBM & finance & strategy…
Telecom equipment and stock repurchases
• Buyback team
• Motorola
• RIM
• Nokia
• Cisco
Good team to be on in
the 90s, 2000s…
• Non-buyback team
• Ericsson
• Huawei
• Apple
• Google (Motorola)
Better team to be on
in the 2010s…
NEBM & finance & strategy…
Telecom equipment and stock repurchases
• Buyback team
• Motorola
• RIM
• Nokia
• Cisco - $76.7 bn: FY2002-FY2012
Good team to be on in
the 90s, 2000s…
• Non-buyback team
• Ericsson
• Huawei
• Apple
• Google (Motorola)
Better team to be on
in the 2010s…
Cisco, employees, sales, and profits, 1989-2012
A story of unbridled success or a warning tale?
“From Innovation to Financialization:
How Cisco Became Focused on Its Stock Price and Lost Its Way”
A story of unbridled success…….
• In the 1990s Cisco Systems was the world’s fastest growing company.
• From $70m. in revenues and 254 employees in fiscal 1990 (year end July), its IPO year, Cisco grew to $18.9b. in
revenues and 34,000 employees a decade later.
• In FY2011 Cisco had record sales of $49.2b.and record employment of 71,825.
…or a warning tale?
• Yet on Apr. 5, 2011, after “disappointing the market” for two quarters, Cisco CEO Chambers
told employees: “we have lost the accountability that has been the hallmark of our ability to
execute consistently for our customers and our shareholders.”
• What Chambers did not say was that from 2002 to 2011, Cisco expended $71.9b., 126% of net profits, on stock
buybacks in an effort to boost its stock price.
• But on Apr. 5, 2011, Cisco’s stock price was just 51% of its post-2001 peak (Nov. 6, 2007). Its buybacks over the
decade were 1.66 times its R&D expenditures.
• We seek to uncover the real long-term cost of Cisco’s obsession with its stock price by
analyzing its failure to succeed in certain key technology areas for future growth:
• optical networking, its most sophisticated segment, where it had acquired productive resources in the 1990’s,
• Mobile backhaul, where it failed to develop the engineering capabilities
• Data centers, where it appears more successful at levering enterprise networking competencies
5/12/2012
“Oops! Five CEOs Who Should Have Already Been Fired (Cisco, GE, WalMart,
Sears, Microsoft)”
1.
2.
3.
4.
5.
Steve Ballmer, Microsoft
Edward Lampert, Sears Holdings
Mike Duke, Walmart
Jeffrey Immelt, General Electric
John Chambers, Cisco Systems
“Mr. Chambers appears to have been great at operating Cisco as long as he was in a growth market. But since
customers turned to cloud computing and greater use of mobile telephony networks Cisco has been unable to innovate,
launch and grow new markets for cloud storage, services or applications. Mr. Chambers has reorganized the company
3 times – but it has been much like rearranging the deck chairs on the Titanic. Lots of confusion, but no improvement in
results.”
Cisco: an obsession with stock buybacks in the 2000s
12,000
250
buybacks $m
dividends $m
buybacks/net income %
10,000
200
8,000
percent
$ millions
150
6,000
100
4,000
50
2,000
0
0
Cisco Systems: enormous run-up in stock prices in 1990s
but stagnant and volatile stock-price performance in the 2000s in line
with the NASDAQ Composite Index
Stock-price movements, NASDAQ Composite Index, Cisco, and Apple
April 1990-April 2012
100000
April 1990=100 log scale
10000
1000
100
10
NASDAQ
1
CISCO
APPLE
Cisco’s presentation of its financial operations
Cisco Systems, 8-K, September 24, 2001
• "We have tremendous confidence in the financial systems of our country, in our industry and in
our market-leading position both today and into the future," said John Chambers, president and
CEO of Cisco Systems.
2004 – authorised company buyback program reached $25 billion
• Robyn Jenkins-Blum, spokeswoman for Cisco, says the company uses its cash for share-repurchase
programs in combination with acquisitions and product development to "return the most value to
our shareholders."
Rob Lloyd, VP Cisco Systems, 15 September 2010
• across the last 10 years, we've invested $30 billion in acquisitions, and that's in conjunction with
the $45 billion we've invested in R&D in the last 10 years, so there is a combined $45 billion
investment in R&D, $30 billion of acquisitions, and simultaneously a $65 billion stock buyback
since 2002, which took 22% of the shares off the market.
Cisco Sytems 8-K, February 8, 2012, p.1
• “We’ve consistently reiterated our commitment to using the cash generated in our business to
drive shareholder value, and to do so with a combination of stock repurchases, dividends, M&A
and R&D,” said Frank Calderoni, Cisco chief financial officer. “This quarter, with the strength of our
business, we’re pleased to announce an increase in our dividend. Going forward, we will continue
to focus on driving the greatest return for our investors.”
Cisco Systems: gains from exercising stock options, 1995-2012:
When did gains come from innovation, speculation and manipulation?
From routers to switches to…
•
Cisco’s Origins
• Founded in 1984 on campus of
Stanford University
• VC of $2.5 million in 1987 from
Sequoia capital
• Demand > supply
• Don Valentine of Sequoia brought
in Don Morgridge as President
and CEO
• Professional managers appoint
• IPO on 16 February 1990
• Founders, Sandy Lerner and
Leonard Bosack sell back stock to
Cisco in Dec 1990 for ca. $170 m
• 1991: John Chambers hired as
Morgridge’s future successor from
Wang
Number
Value ($m)
% stock
1993
1
95
100
1994
3
414
71
•
Dominant in fast growing market
• Excellent initial product with full
interoperability
• “perfect market conditions”
• Commitment to customer service
• Wellfleet & Synoptics merged to create Bay
Networks
•
1990 – 2000: Aquisition and Development (A&D
model)
• Turnover grew from $0.69 bn to $20 bn
• First acquisition, Crescendo, = ‘grand slam’
•
•
•
Rapid integation of acquisitions
•
•
$95 million for company with turnover of $10
million
Turnover grew to $500 million in 18 months
Small firms located close by, keep all employees
‘VC’ model of acquisitions: 40-60% to ‘stay
afloat’, 20-40% failures and 20-40%
whopping successes
Cisco Acquisitions in the 1990s
1995
1996
1997
4
7
6
467
4714
569
100
96
70
1998
9
1094
87
1999
18
14597
99,8
2000
12
10595
99,9
Cisco’s Acquisition and Development
(A&D) Model & Optical Beginnings
• Cisco’s Optical Beginnings
•
•
•
•
•
7500 Series launched with
packet over SONET (Aug
‘95)
Five-phase optical strategy
(Apr ‘98)
Optical SBU established
1999
IP+Optical strategy in 2000
Acquisitive Behavior (19962001), beginning with
StrataCom to shore up
optical expertise
StrataCom
• April 1996 ($4.7B)
• ATM & Frame Relay WAN
Monterey Networks
• August 1999 ($500M)
• Optical cross connect
Internet Engineering Grp
Skystone
• June 1997 ($89M)
• SONET/SDH transport
Pipelinks
• December 1998 ($126M)
• SONET/SDH router
StratumOne
• June 1999 ($435M)
• Optical/semiconductor design
(silicon integration)
Cerent Corporation
• August 1999 ($6.9B)
• Optical transport
• December 1999 ($25M)
• Optical networking software
Pirelli Optical Systems
• December 1999 ($2.2B)
• Optical/DWDM
Pentacom
• April 2000 ($118M)
• Optical/SRP technology
Qeyton Systems
• May 2000 ($800M)
• Optical, metro DWDM
technology
AuroraNetics
• July 2001 ($150M)
• 10 Gbps silicon for RPRs
Cisco is the world’s most valuable company: March 2000
$541 billion capitalisation
Market capitalisation index, 100 = January 1998
Challenges with Optical Acquisitions (1995-2001)
•
Cisco and Service Provider Customers
–
–
–
–
•
Competitive/Market Factors
–
–
–
•
StratumOne with “virtually no revenues”
Monterey acquired with no revenue/customers.
Qeyton DWDM did not ship as of 2001.
Pirelli not a market leader, and its technology trailed Ciena, Lucent, and Nortel.
Integration challenges
–
–
•
Cisco had late start compared to its competitors (Ciena, Lucent, Nortel)
More nimble start-ups (Ciena, ONI) had manufacturing and “blank sheet innovation”
Inflated demand forecasts (long-haul optical) and 2000/2001 market slump
Acquired products/business challenges
–
–
–
–
•
Historically, Cisco interfaced with enterprise - not SP - customers.
Cisco lacked SP customer expectations, offering less reliable data networking equipment instead of reliable
carrier-class equipment. Also, not used to
Telephone companies initially resistant to Cisco’s revolutionary voice over data packet offering instead graceful
evolution its competitors (e.g., Lucent/Nortel) offered.
Cisco bet on new telco carriers, some of which failed in the early 2000’s, instead of the incumbent operators.
Staff (StrataCom sales force; Monterey and StratumOne founders left)
Geography (SkyStone– Ottawa, Canada; IEng – Ann Arbor, MI; Pirelli – Milan, Italy; Pentacom – Herzliya, Israel;
Qeyton – Stockholm, Sweden)
One successful acquisition in metro segment
–
Cisco ONS 15454 (Cerent 454 Box) most successful optical product. Focused on metro optical segment and
eventually neglected long-haul.
2001: Telecom ‘bust’ and $2.2 billion inventory write-off
Stock
price
“Virtual supply chain” became very unvirtual!
•
•
Customers over-ordering to overcome shortages leading to over-optimistic forecasting
Guaranteed purchasing agreements entered into with suppliers in order to overcome
component shortages in boom-time
Cisco’s Diminishing Optical Focus in downturn
Manufacturing divestments
– Pirelli DWDM manufacturing facility (Salem, NH) sold
May/June 2001.
– Qeyton Swedish plant closes Oct 2002.
– Fibercore (U.K.-based maker of specialty optical fibers),
acquired as part of S-A, divested February 2011.
– Scientific-Atlanta Juarez, Mexico plant closes 2011.
Cisco Optical-Related Patent
Applications Filed, 1995-2011
600
500
400
300
Decreasing Patenting Activity in Optical (starting in 2006)
Optical business moves to “Other Products” from advanced
technologies (business potential for $1B), effective 1Q07.
Cisco “hides” optical product revenue, splitting it among
routing, switching, and “other” categories.
Market factors: focused on North American segment, which
suffered from recession. Other competitors (e.g., Huawei)
had foothold in APAC/emerging markets.
100
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
0
1996
Optical Staff moved
– Dec 2005: 80 employees moved out of optical group
from San Jose, Richardson, and Petaluma sites.
– Nov 2006: 40 optical staff in Petaluma (CA) moved out.
– 2007: Cerent founder Ajaib Bhadare leaves after his
return in Dec 2005.
200
1995
Discontinued Products
– Monterey optical cross connect discontinued Apr 2001.
– Pirelli DWDM end-of-life announced August 2004.
Source: USPTO
Search phrase (e.g., 2010): AN/cisco AND optic$ AND APD/1/1/2010->12/31/2010
Only 1 optical-related acquisition 2001-2010:
•
Scientific Atlanta’s optoelectronics (2006), in
support of video.
•
During this period, Cisco acquired 68 companies
•
Passed up on potential optical acquisition
targets:
•
Siemens networking division (merged
with Nokia Network Business) in 2006
•
Nortel’s Metro Ethernet Division (which
was acquired by Ciena in 2009).
Six growth businesses identified in 2004
Cisco as a 20-year old company
•
•
•
70% of its turnover still from maturing
networking business
CEO John Chambers says. "Cisco fully
intends to expand its current core
markets, expand in service providers,
and expand in advanced technologies“
Six areas identified with potential to
become “billion dollar businesses”
Six advanced-technology areas
Enterprise
1. Security
2. Storage
Service providers
3. Optical
4. IP telephony
5. Wireless
Consumer products
6. home networking
30000
Total Net Sales (Biz Segment data
unavailable)
25000
Sales Adjustments
20000
Service
15000
Other
Advanced Technologies
10000
Access
5000
Switches
0
1995 (e) 1996 (e) 1997 (e) 1998 (g) 1999 (h) 2000 (h) 2001 (h) 2002 (j) 2003 (j) 2004 (m)
-5000
Routers
ON market share remains stagnant for Cisco
but grows for Huawei, ZTE, Infinera, Ciena
Optical Transport Equipment Market Share (1998-2010)
Source: Dell’Oro
Huawei’s growth in optical market
• Established 1988
• R&D Investments
–
–
–
In 2005, Research staff was 48.6% employee
count
60% employees holding master’s/Ph.D.
degrees.
10% revenue for R&D.
• Partnership strategy
–
–
Reluctance to focus on M&A’s for acquiring
technology
Joint ventures as vehicles for accessing new
markets.
• APAC-driven growth
–
–
–
Regional (APAC) and emerging markets that
drove global optical market growth
China to APAC to other emerging markets
(South America, Middle East)
To more developed markets outside North
America (e.g., 2001-2005 Germany, Spain,
Portugal, Sweden, Netherlands; UK’s British
Telecom in April 2005) to North America.
North American difficulties (2001-present)
•
•
•
•
US House intelligence committee investigation 2011:
Huawei, ZTE = security threat
Ren Zhengfei, Huawei founder, left PLA in 1984
Sun Yafang, chairwoman, worked for Ministry of
state security
“The Chinese are aggressively hacking into our
nation’s networks, threatening our critical
infrastructure and stealing secrets worth millions of
dollars in intellectual property from American
companies. This jeopardizes our national security
and hurts U.S. competitiveness in the world market.”
Dutch Ruppersberger, committee member
Optical Market Rise
– 2001: Number 1 in optical for China, APAC.
– 2004: By Q4, 3rd place in world optical
market.
– 2006: Number 2 spot in optical, behind
Alcatel-Lucent.
– 2009: Surpassed Alcatel-Lucent in optical
market by Q3.
Infinera’s growth in optical market
•
•
•
•
•
•
Established 2001 in Silicon Valley, IPO 2007
Photonic Integrated Circuits, PIC, combines dozens of optical components onto 2 tiny chips
1,200 employees, turnover $0.4 bn in 2011, losses $81.7bn
R&D Investments: 31% in 2011, 320 patents filed/granted
Vertical integration: Plants in Sunnyvale CA, Allentown, PA
Tom Fallon, CEO of Infinera since 2010
Cisco : since 1993: Operations manager
– 2001 - 2003: GM of Optical Transport Business Unit
– 2003-2004 : VP of Engineering and Operations
Infinera
– 2004 - 2009: COO & VP of engineering and operations
– 2010: President & CEO
What is most important advice you can give
for someone who wants to run a telecom
company?
“My advice would be make sure you have a long
view of the world. Investors can be shortsighted,
and things can come along that are bright and
shiny. The thing is to pick a technology path that
is hard and big and that creates an opportunity
for your customers to differentiate”. Tom Fallon
Light Reading January 14 2011
2010: Cisco’s renewed optical focus
Renewed focus on Optical
• Since 2010, Cisco is increasingly
focusing on commercial 100G
long-haul optical transport, in
part because of increasing cloud
services driving traffic.
• CoreOptics ($99M) acquired May
2010 for for transition to
100Gbps transmission.
• Launches packet-optical transport
system (P-OTS) Nov 2010.
• LightWire acquisition ($271M),
Feb 2012, for optical
interconnects (for 40, 100 Gbit/s
transitions).
$15 bn Optical Market “challenging”
•
Market share in 2012
– Huawei leading
– Alcatel-Lucent challenger
– Ciena, ZTE, Fujitsu
•
•
Sycamore, Nokia Siemens Network
sold to private equity firm
EMEA, Americas in decline
Mobile backhaul: --what are we talking about?
Aggregate many towers and transport
Services and switching
Drivers of backhaul equipment markets
9,000.0
8,000.0
7,000.0
6,000.0
5,000.0
4,000.0
3,000.0
2,000.0
1,000.0
0.0
1999 2001 2003 2005 2007 2009 2011 2013 2015
TD-SCDMA
LTE
WCDMA
CDMA (Includes CDMA 1x)
TDMA
GSM/GPRS/EDGE
• Increasing numbers of
mobile subscribers
• New mobile internet
services begins to take off
• Demand for bandwidth
• More cell sites
2003: Mobile backhaul projected to grow from $1bn to $6-8bn gobally by 2007
Who would win backhaul contracts?
Telecom-Centric Vendors
• Voice (real-time)
• Centralized control and
network intelligence
• Control Quality of Service
• High-cost scalablility
• Incumbents with +100 years
of experience in selling
telecom systems
Internet-Centric Vendors
• Multimedia, Internet
• De-centralized control and
network intelligence
• Best effort
• Low-cost scalability
• New entrants with highly
scalable (read: cheap)
technology
Cisco in mobile backhaul: Architectural Control
• IP as a potential disruptive technology
– Cheap and scalable access to bandwidth
– But decentralised and less control over data flows
• Architectural control and standards
– Complex system integration dependant on architecture
– Standardization controls architecture
– Cisco outsider in standardization institutions
• Hybrid technologies mixed into existing infrastructure
– For 3G backhaul technology, ATM was chosen by
incumbents
• Control of service levels (data and voice)
• Connects well with prexisting 2G copper and fiberoptical SONET
– Incremental techs (GPRS, EDGE etc) allowed to add
bandwidth through mixing packet protocol with existing
2G voice technologies (TDM)
Cisco in mobile backhaul: Organization and Business Model
• Business Models and Organizational Capabilities
– Cisco develops understanding of complexity and
hybrid technologies (MPLS)
– However, to win customers Cisco would have had to
demonstrate hands-on experience and used-cases
– Cisco had to rely on re-sellers to get business at all,
limiting ability to learn and build up a portfolio of
used-cases
– Non-exclusive reselling contracts led to intense
competition between Cisco and Tellabs
– Also, Cisco was a high-margin ’box-seller’ with little
inclination of providing system integration services for
free as part of the sales proceess
Has Cisco learned?
• Building a full service portfolio
– Starent acquisition in 2009 for $2.9 bn
– Strategic alliance with NEC for BH radio
technology
• Battles for control of architecture outside BH
– Definitions of standards for software defined
networking in data center
Cisco and data centers
A Cisco success story?
• Internal development and acquisitions to bolster to networking solutions into
data centers
– LAN network storage, switch and load balancers
– Acquisitions –
•
•
•
•
•
Andiamo acquisition in 2002 – storage area networking products
Actona acquisition in 2004
Topspin and FineGround Network acquisitions in 2005
Nuova systems acquisition in 2006
Reactivity acquisition in 2007
• Data Center 3.0 Strategy from July 2007
– VMWare patnership for virtualization of server and network ceters
– Green data center launched in 2011 at Allan, Texas
– Tidal Software acquisition in 2009
• Unified computing system in 2009
–
–
–
–
Server business into data centers
Converged solution for data centers: networking, servers, storage and virtaulization
Head-to-head competition with Microsoft, HP (3Com acquisition), Juniper/IBM partnership
10,000 customers by January 2012, global market leader (no. 2 NA, no. 3 global in blade
server)
Cisco and data centers
A Cisco success story?
• Key success factors
–
–
–
–
Market transitions anticipated more easily as present from early 2000s
Acquire companies with complementary technologies
Familiarity with enterprise segment and high brand equity
Leverage core competencies in networking
• Next generation technologies – Software-defined Networking
– Opensource software that shifts control of network from routers to an overarching
control centers allowing data center managers can thus control resources
autonomously via new software layer
• Potential commoditization of routers
• Standardization battle
– Cisco, HP & IBM in short-lived partnerhip in search of ’incumbent advantage’
– Cisco judged the terms offered by others to be unreasonable and entered server
market
– HP now clearly in head-to-head competition with Cisco for market leadership
Cisco, employees, sales, and profits, 1989-2012
A story of unbridled success or a warning tale?
Tentative conclusions
Lack of development of innovative capabilities?
• Can we conclude that Cisco has neglected to develop key innovative capabilities?
• It depends on the industry sector we study:
• In optical networking and in mobile backhaul: problems with service provider
customers and with business model
• In data centers, Cisco appears to have recognized the need to acquire architectural
control – but so have its competitors
Due to financialization?
• Cisco was capable of market disruption in the 1990s in fast-growing, emerging markets
• Unable to gain the architectural control necessary as required huge investment in
engineering skills - at times in non-IP technologies.
• Some competitors already had them and Huawei was willing to invest to develop them
• Starent acquisition in mobile = Cisco has learned its lesson?
Detailed case studies as a methodology
• Allow us to track investments in technologies and follow their adoption or abandon
• Are feasible because of the availability of vast amounts of electronic resources
• Are time-consuming
• Require triangulation with interview with industry executives
• Customers
• Competitors
• Cisco
Conclusions
Cisco Systems has been very successful in its core business
• No company could have been more suitably positioned at this point to benefit from
the growth of the digital economy
• It recognized as early as the 1990s that it needed to diversify into carrier class
technologies such as optical networking
Cisco Systems began large-scale stock buy-backs in the 2000s
• As company stock price plummeted with the telecom bust, the company engaged in
large-scale stock buybacks
• Lower technology applications could not offer the level of returns expected and were
ended (Flip)
• Key technologies requiring intensive investments were relatively neglected during this
period
• Optical networking
• Mobile backhaul
What Cisco did not achieve in terms of market penetration, other companies did
• Ericson in wireless
• Huawei in terms of both optical networking and wireless
Stock repurchases continue to be pursued massively
• For fiscal 2011, ending July 30, Cisco expended $6.9b on buybacks, equal to 106% of
net income and 1.18 times R&DAs dividends are introduced
• As workers are laid off and divested
• 6,500 layoffs in 2011 to save $1 billion = amount spent on share repurchases in Q3
• 5,000 employees divested in Mexico when set-top box site sold to Foxconn
• 1,200 layoffs announced for Q1 2012