In Focus

The 100 Year Flood That's Not in Minnesota

Last month, Cisco CEO John Chambers described his company's unexpected drop in orders as "greater than a 100 year flood." Like so many living on the Mississippi River without flood walls, Cisco lacked models anticipating anything of this magnitude. Their plight caught my attention last week, when an article in the Los Angeles Times by Charles Piller was accompanied by a picture of a Cisco Systems building that had halted construction midway due to plummeting product orders. Given that Cisco's stock (CSCO: Nasdaq) is among the most widely held, I thought I wouldn't be alone wondering what the heck went wrong. Not only am I a shareholder, but so are the Chicks Laying Nest Eggs investment club.

First, would a tiny review as to what it is they do be helpful? Cisco is one of those tech companies that really makes me stretch when I use the Chicks' criterion, Keep It Simple Sister. Their main invention was the "router." It is one of the most basic building blocks of the internet. Think of the router as the internet traffic cop, directing every single piece of information to its proper destination. It looks like a nondescript box, varying in size and price, and sells for as high as $1.5 million dollars. Cisco also has its hand in software and other hardware that help run the internet. Their most recent venture has been in the fiber-optic cable business, which directs the data over light beams.

Like another Chick holding, Yahoo!, Cisco has been greatly affected by the implosion of much of the dot-com industry. For Yahoo!, the problem has been diminished advertising revenue. In Cisco's case, due to the economic climate, fewer companies seem to be entering the internet arena these days, thus decreasing demand for Cisco's products. To make matters worse, many failed dot-comers are unloading barely used Cisco hardware at garage sale prices on EBAY. Following an incredible average annual sales increase of 75% from 1990-2000, sales have now fallen 30%. In fact, the problem has become so serious that Cisco had to write off a whopping 2.5 billion dollars worth of inventory last quarter! John Chambers and his company are shell shocked. Many argue that the warning signs were there, but were simply ignored. Reliance on models that could anticipate supply and demand may have made them a tad cocky. They assumed they would have seen the slowdown coming -- well, you and I both know what happens when you assume!

Back in February, during our CEO month, I wrote an article about John Chambers. In reviewing it now, I'm amazed at how much has changed for Cisco in such a short time. The most glaring change I see is in mergers and acquisitions. Cisco has been famous for them. The acquisitions made them too big to be bought out and powerful enough that they could simply buy a company with a new technology instead of competing with it. Well, Houston, we've got a problem! The model is no longer working and Cisco knows it. Here's the evidence: Cisco acquired a whopping 23 companies last year. Their tally to date this year? Zero.

When you buy a company, you're obviously taking a risk. You're buying something that you want because you think that others will want it, or so you hope. Cisco's first risk, the acquisition of Crescendo Communications, garnered them a huge reward. They bought the company for a cheap $89 million dollars and were able to turn it into billions of dollars in sales. Good move.

Then there's the risk of spending a lot of money for something that turns out to be a lemon, as seems to be the case with Cisco's acquisition of Cerent Corporaton. It was an as-of-yet, unprofitable start-up company that Cisco hoped would help them gain market share in the optical network components business. Cisco paid the equivalent of an unimaginable $24 million dollars per each of Cerent's 287 employees! The acquisition has yet to show its worth. I credited Chambers with being the "master of assimilation," able to swallow up new companies seamlessly. Well, according to a former Cisco engineer, Viranjit Madan, the transitions may not have always been as smooth as they appeared. Imagine the frustration when new employees entered the Cisco workforce with all their new-found wealth simply because the parent company wanted the product they were making. Apparently, such riffs would often cause a mass exodus of engineers.

Okay, so that's all the bad news I could find. And yes, Chickie, if you're a stockholder like me, don't worry, I did find some good news. Being the cheerleader Chick that I am, I always like to end with the positive. Cisco is not another internet company that is about to crash and burn. Remember Chicks like cash and Cisco's got a lot of it -- $4 billion in the bank at the end of last quarter to be exact! Excelling in another Chick criterion, they are definitely a leader in their field, dominating the router market. Also, this economic downturn (I'm so sick of saying that!) will turn around. The internet is not going anywhere and new companies will certainly need Cisco's building blocks once again. Lastly, John Chambers. I loved him in February and I love him now. He is known for his modesty, his receptiveness and his integrity and above all, puts his customer's satisfaction first. I can't think of any better qualities for a leader in management to have. Yep, I can just see John out there with his waders on doing the sandbagging himself!