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“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 90 s, 2000 s… • Non-buyback team • Ericsson • Huawei • Apple • Google (Motorola) Better team to be on in the 2010 s…
NEBM & finance & strategy… Telecom equipment and stock repurchases • Buyback team • Motorola • RIM • Nokia • Cisco - $76. 7 bn: FY 2002 -FY 2012 Good team to be on in the 90 s, 2000 s… • Non-buyback team • Ericsson • Huawei • Apple • Google (Motorola) Better team to be on in the 2010 s…
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 1990 s Cisco Systems was the world’s fastest growing company. • From $70 m. in revenues and 254 employees in fiscal 1990 (year end July), its IPO year, Cisco grew to $18. 9 b. in revenues and 34, 000 employees a decade later. • In FY 2011 Cisco had record sales of $49. 2 b. 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. 9 b. , 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, Wal. Mart, 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 2000 s
Cisco Systems: enormous run-up in stock prices in 1990 s but stagnant and volatile stock-price performance in the 2000 s in line with the NASDAQ Composite Index Stock-price movements, NASDAQ Composite Index, Cisco, and Apple April 1990 -April 2012
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 • 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’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 Strata. Com to shore up optical expertise Strata. Com • April 1996 ($4. 7 B) • ATM & Frame Relay WAN Monterey Networks • August 1999 ($500 M) • Optical cross connect Internet Engineering Grp Skystone • June 1997 ($89 M) • SONET/SDH transport Pipelinks • December 1998 ($126 M) • SONET/SDH router Stratum. One • June 1999 ($435 M) • Optical/semiconductor design (silicon integration) Cerent Corporation • August 1999 ($6. 9 B) • Optical transport • December 1999 ($25 M) • Optical networking software Pirelli Optical Systems • December 1999 ($2. 2 B) • Optical/DWDM Pentacom • April 2000 ($118 M) • Optical/SRP technology Qeyton Systems • May 2000 ($800 M) • Optical, metro DWDM technology Aurora. Netics • July 2001 ($150 M) • 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 – 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. • Competitive/Market Factors – 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 – – • Stratum. One 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 – Staff (Strata. Com sales force; Monterey and Stratum. One founders left) – Geography (Sky. Stone– 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. 600 – Fibercore (U. K. -based maker of specialty optical fibers), 500 acquired as part of S-A, divested February 2011. 400 – Scientific-Atlanta Juarez, Mexico plant closes 2011. Cisco Optical-Related Patent Applications Filed, 1995 -2011 300 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. Decreasing Patenting Activity in Optical (starting in 2006) Optical business moves to “Other Products” from advanced technologies (business potential for $1 B), effective 1 Q 07. Cisco “hides” optical product revenue, splitting it among routing, switching, and “other” categories. Market factors: focused on North American segment, which suffered from recession. Other competitors (e. g. , Huawei) had foothold in APAC/emerging markets. 200 100 0 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 Discontinued Products – Monterey optical cross connect discontinued Apr 2001. – Pirelli DWDM end-of-life announced August 2004. Source: USPTO Search phrase (e. g. , 2010): AN/cisco AND optic$ 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 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 Q 4, 3 rd place in world optical market. – 2006: Number 2 spot in optical, behind Alcatel-Lucent. – 2009: Surpassed Alcatel-Lucent in optical market by Q 3.
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. 7 bn 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 $15 bn Optical Market “challenging” • Since 2010, Cisco is increasingly focusing on commercial 100 G long-haul optical transport, in part because of increasing cloud services driving traffic. • Core. Optics ($99 M) acquired May 2010 for transition to 100 Gbps transmission. • Launches packet-optical transport system (P-OTS) Nov 2010. • Light. Wire acquisition ($271 M), Feb 2012, for optical interconnects (for 40, 100 Gbit/s transitions). • 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? ivity nnect Co Aggregate many towers and transport Services and switching
Drivers of backhaul equipment markets 9, 000. 0 8, 000. 0 7, 000. 0 GSM/GPRS/EDGE 6, 000. 0 TDMA 5, 000. 0 CDMA (Includes CDMA 1 x) 4, 000. 0 WCDMA 3, 000. 0 LTE 2, 000. 0 TD-SCDMA 1, 000. 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0. 0 • 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 $1 bn to $6 -8 bn gobally by 2007
Who would win backhaul contracts? Telecom-Centric Vendors Internet-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 • 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 3 G backhaul technology, ATM was chosen by incumbents • Control of service levels (data and voice) • Connects well with prexisting 2 G copper and fiberoptical SONET – Incremental techs (GPRS, EDGE etc) allowed to add bandwidth through mixing packet protocol with existing 2 G 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 Fine. Ground 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 (3 Com 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 2000 s 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 1990 s 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 1990 s that it needed to diversify into carrier class technologies such as optical networking Cisco Systems began large-scale stock buy-backs in the 2000 s • 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. 9 b 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 Q 3 • 5, 000 employees divested in Mexico when set-top box site sold to Foxconn • 1, 200 layoffs announced for Q 1 2012