Cisco has long been a market darling in the IT vendor community with good reason. It has been an incredibly consistent vendor in the networking space with great margins, and a focus on R&D and the channel which made it a benchmark both for financial and industry analysts. In more recent times, notably since the 2008 financial crisis hit, it has had some tougher financial times and made some less than stellar corporate decisions. This has included an expensive focus on the consumer market and investment in “adjacencies”, many of which did not achieve corporate goals.
At the same time, increased competition in both quality and volume has had a significant impact particularly in the router and switch market. The leadership of Cisco has come under increased pressure, most notably John Chambers, the long-serving CEO. This was unheard of until recently.
The Cisco share price has been down about 40% since April 2010, and is well off Dow Jones and NASDAQ growth in recent years. (see http://tinyurl.com/68d3fvf). This is a clear indicator that the time to re-evaluate Cisco’s business moving forward with a focus on revenue and EPS growth was well overdue.
The way forward was revealed at its investor day this week in the US, and in subsequent calls with industry analysts. The Asia Pacific analyst community was fortunate enough to have the opportunity to speak directly with CFO Frank Calderoni. Key highlights from my perspective are below.
- Services as a pivot of growth – From the numbers provided by Cisco, services is expected to grow from approximately 20% to 25% of revenue across the 2011-2014 period for Cisco. Additionally, in this period, Cisco has indicated that the margins from services will continue to grow at a rate above the overall average margin for Cisco. The challenge is to get high margin services growth from collaboration and mobility alongside traditional areas of strength.
- Switching will move in the opposite direction, and shift from approximately 25% to 20% of Cisco revenue. Margins will continue to be under pressure in this business, clearly this is where competition is biting.
- Data Centre products are a small part of the overall Cisco business, representing about $1B in run-rate revenue. What was surprising is that this was not visibly going to change in any significant proportion through 2014. They will grow roughly in alignment with the overall business for Cisco. Margins will also be below the Cisco average. HP in particular will breathe easier at this.
- Consumer Products are gone – No surprise here, this has been announced, and highlights when adjacencies do not work for an organisation. HP is not the only leading firm to write off major acquisitions in 2011. Cisco and Google also have had to do it.
- Layoffs were significant. Approximately 13,000 people were laid off. The process and outcomes of this strategy was not articulated in the most compassionate way in the briefing (not by the CFO), but it is clear that Cisco had to transform its people.
In a similar briefing last year, Cisco highlighted about 25 strategic focus areas. There was a “3.0” business model for everything from Mexico to consumer set top boxes it was noted at the time that it was a sprawling strategy. The refinement to 5 strategic priorities and subsequent workforce redeployment is designed to drive focus on margin. The key strategic priorities are;
- Leadership in the core – Switches, Routing, Services etc
- Data Centres/Virtualisation/Cloud
- Architecture for Business Transformation.
Overall, the tightening of the strategy is overdue. Emerging markets are realigned into each of these strategies. Most clearly, for Cisco to make its targets at the corporate level, it needs to make sure that it can grow and localise in emerging markets, and not just in BRIC markets but across emerging markets of ASEAN, the Middle East and Latin America.
I am not a product expert, so from my point of view there are four key areas to hold caution for Cisco.
- Services – Cisco has stated an intention to aggressively grow the proportion of services to 25% of revenue, yet maintain margin. Growing services groups for product companies whilst maintaining margin is notoriously difficult. Failure usually leads to services acquisition; just ask Dell, HP and others. The other risk is alienating your partner network. This is the challenge for Cisco. This sort of growth will have an impact on their high end partners such as Dimension Data and IBM as well as local country based providers. As a result, it is a realistic expectation that they will have increased partner conflict around solutions as the boundaries become more overlapped as Cisco looks to drive growth. The other alternative is to buy a services provider. Strip out adjacencies or non-core businesses from CSC and quite easily Cisco could have a very strong professional services group with annuity revenue for minimal outlay. Margin is the issue for this.
- Competition, especially China – Cisco has stuck the boot into Juniper immediately, declaring them vulnerable. This is an indication of how much of a threat Juniper is. Juniper has come a long way quickly to rattle Cisco. Huawei is of course the biggest challenge to Cisco. This is not just true in China, but in Asia Pacific more broadly, and in emerging markets where China wants an influence. Cisco is going to try to go head on with Huawei in their home markets in China. Success here will be very difficult. Anyone who has dealt with Chinese organisations, especially the State Owned Enterprises (SOE), will understand how difficult it is to sell into this business, and how much the local connections and relationships around the SOE’s work. Huawei is a listed company, but relationships and contacts will put Cisco behind the frontrunner in the market. There have been some negative media reports about Cisco’s business dealings in China in recent days. It is hoped that this will not be what Cisco has to resort to in order to grow its Chinese Business.
- Research and Development – This analyst put the question to Cisco to understand if they were going to continue to fund R&D at similar levels to the past. As HP and others have shown, once corporate razors come out, R&D has to fight to survive. Cisco has assured that this will not happen and that they are a going to maintain their levels of R&D investment whilst focusing on margin growth. We will take Cisco on its word, but if R&D and as a consequence innovation is denuded, the results will be very clear to see.
- Cloud – At the Cisco Live events earlier this year, the cloud offerings from Cisco was frankly underwhelming. It was clearly undifferentiated and reliant upon the VMware and EMC ecosystem as much as Cisco. That is not a bad ecosystem to be involved with, but more is required from Cisco to ensure that it is a genuine player in the cloud space, rather than a provider of tools.