Cisco turns 20

Having grown from start-up to industry behemoth over the past two decades, the company claimed it was once again proving its technological prowess while laying a foundation for the next 20 years.

Marketing hype? No doubt. But, as Cisco celebrates its 20th anniversary on Friday, the release of its Core Router Series-1 highlights important changes at the world's largest networking gear maker as it casts around for new growth opportunities.

First, the box appears to be the real deal. It's winning customers and has closed the technology gap with rival Juniper Networks, which for the past two years has steadily eaten away at Cisco's share of the core router market. More broadly, the CRS-1 points to the re-ascension of nuts-and-bolts engineering in a company that over time had increasingly given precedence to financial, sales and marketing tactics over technology innovation.

"I think the company has gone through multiple transitions throughout the years," said Mike Volpi, vice president and general manager of Cisco's routing group, who has been with the company since 1994. "In the early days, we prevailed because of the engineering, and while we've always maintained a good balance between marketing and engineering, I feel today we are getting back to our technology roots. There's a lot of innovative spirit within Cisco now."

Recent signs of Cisco's reinvestment in engineering include its purchase of Procket Networks this summer for $89 million, and the return this week of prodigal son Tony Li. Li created Cisco's flagship Gigabit Switch Router 12000 routers before leaving to work at Juniper; he later helped found Procket. In addition, Cisco acquired start-up BCN Systems on Thursday, a move that could help expand its new networking operating system, IOS-XR.

At 20, Cisco stands as a paragon of entrepreneurial success, growing out of a living room into a global dynamo with thousands of employees and billions of dollars in annual revenues. Its founders and employees have been rewarded with vast personal fortunes built on stock options, spurring deep loyalty among insiders.

But, much like Hewlett-Packard, Apple Computer and other Silicon Valley icons, the company now stands at a crossroads, arrived at in large part by its tremendous achievements.

The company's fortunes soared in the 1990s on the back of the Internet rocket, only to come back to Earth when the telecommunications boom ran out of fuel. Suddenly, demand for its key lines of corporate networking routers and switches slackened, destroying an aura of invincibility produced by years of 90-percent-plus dominance in its most critical markets.

Cisco has emerged from the boom and bust with a more sober outlook on its future, even as the long-term prospects for telecommunications and network spending appear to be on the rebound.

To chase new growth, however, Cisco has been progressively forced to forage outside the corporate networking market it dominates, into the highly competitive carrier market and the risky, lower margin consumer market.

Over the next few years, large telephone companies around the world are expected to build out huge IP networks to support broadband and new services like IP telephony and IP video. The market is expected to surge about 20 percent a year, nearly twice that of the corporate market, which is where Cisco has traditionally made its money.

Analysts have said that this new market offers Cisco one of its best chances to meet growth targets of 10 percent to 15 percent a year over the next three years--projections that the company reiterated this week at its annual analysts conference on its sprawling San Jose, Calif., campus.

"The carrier market is key for Cisco," said Dave Passmore, an analyst with the Burton Group. "There's tremendous upside here. This is the only market that they don't have to dominate, and they can still find some significant growth."

Rivals in the wings
With its broad portfolio of products, Cisco is in a perfect position to offer carriers IP solutions, soup to nuts. But Cisco faces stiff competition from rivals that are eating away at its opportunities.

Juniper is one of the biggest threats, especially in the high-end core IP routing market. Over the past year, Juniper gained 16 percent market share, while Cisco's market share dipped by 14 percent, according to Infonetics Research. This is a market that, until 1998, Cisco had exclusively to itself.

Earlier this fall, Cisco lost a huge chunk of business to Juniper at China Telecom. The carrier, China's largest phone provider, selected Juniper routers for the bulk of its new IP core, and split other pieces of the network contract among Cisco and a few other vendors.

Cisco also faces increased competition from foreign companies such as China's Huawei Technologies, a dominant player in the Chinese market that also won a chunk of the China Telecom deal. Huawei is expanding internationally. It is expected to become a bigger threat to Cisco in Europe as well as in some third-world markets.

"The lack of a high-end router has really hurt Cisco severely for the last couple of years," said Erik Suppiger, an analyst with Pacific Growth Equities. "Juniper has demonstrated better success than any other Cisco competitor in the recent past."

The CRS-1 could prove a major stabilizer for Cisco. Although the CRS-1 came two years after rival Juniper Networks launched its own router upgrades, Cisco has finally closed an embarrassing technology gap that was responsible for lost business. With Cisco announcing its first customers earlier this week, the CRS-1 promises to stem a further slide in market share.

This, coupled with such recent acquisitions as Procket and BCN, could help Cisco appeal to a broader customer base.

"I think Cisco has no choice but to try to diversify its product portfolio," Passmore said. "The enterprise market, where it's traditionally been strong, is growing in the single-digits. Growth will likely have to come from new technologies and new markets like home networking and service provider."

Looking toward the next frontier
Cisco was incorporated on Dec. 10, 1984, by Leonard Bosack and Sandra Lerner, a married couple who worked in computer operations at Stanford University. Using software originally written by another Stanford staffer, Bosack adapted the code to connect computer systems across a network. He and Lerner, who have since divorced, commercialized the product, and Cisco was born.

As legend would have it, the couple maxed out their credit cards to fund Cisco. They recruited friends to help assemble routers in their living room. Twenty years later, Cisco has more than 30,000 employees and is the largest networking company on the planet, bringing in $22 billion in revenue during fiscal 2004, with a market capitalization of $127.61 billion.

Over the past two decades, it has built a brand synonymous with the Internet. John Chambers, the smooth-talking CEO who took over for John Morgridge in 1995, has been at the center of Cisco's success. One industry analyst said Chambers, who talks with a southern twang, is so slick he could sell snake oil to a snake oil salesman. According to industry lore, Chambers has flown all over the world when his charm has been called into action to close important deals.

At the end of the day, however, Cisco fancies itself an innovative technology company. In fiscal year 2004, which ended in July, it spent about $3.3 billion on research and development.

In its effort to find the "next big thing," Cisco has already earmarked a separate category of products it calls the Advanced Technology Group. So far, Cisco has identified six new technologies for this group--security, IP telephony, wireless, storage, optical and home networking--each of which it hopes to grow into a $1 billion business.

In aggregate, these technologies make up a relatively small proportion of Cisco's revenues. But they're growing. In the fourth quarter of fiscal 2004, Advanced Technologies made up about 16 percent of the company's overall revenue, up from 5 percent in 2003. Cisco isn't stopping with these six. Chambers says he hopes to add at least another six.

Cisco doesn't see any of these technologies exclusively as standalone product segments. Instead, it plans to integrate the technology throughout its many product lines.

"One of the ways we choose whether or not a technology should be added to the Advanced Technology Group is if it can fit into our existing IP products," said Cisco CTO Charles Giancarlo. "If the answer is no, then Cisco questions whether it makes sense to go into that market."

For example, Cisco is already embedding security features into its routers and switches as part of its new Network Admission Control, or NAC, security architecture.

Cisco is also trying to expand its business downstream. Last year it entered the consumer business with the $500 million acquisition of Linksys, a small company focused on selling home routing gear. It has quickly jumped ahead to control about 50 percent of the market in the United States, despite a slew of competitors.

But the consumer market is a totally new beast for Cisco. Gross profit margins on these products are often much lower than they are for Cisco's enterprise or service provider products, which traditionally have hovered around 68 percent. Though the consumer market is an important new area for Cisco, it will likely only be a small contributing factor to the company's overall growth. So far, Linksys contributes only about 6 percent of the company's revenues.

"You can't be a multibillion dollar a year company and remain focused on a niche market, like the enterprise," said Tom Nolle, an analyst with CIMI. "Cisco has to be in the mass-market consumer business. There's money to be made here, but Wall Street has to brace itself for lower gross margins."

Acquisitions on the rise
In addition to developing technology on its own, Cisco is also still looking for acquisitions. In 2004, it has so far announced 10 acquisitions, up from four in the previous year.

It spent $89 million to buy competing core IP router start-up Procket earlier this year. Cisco justified this purchase by saying it wanted the 130 engineers who worked for the company.

Cisco announced earlier this week that it has acquired BCN Systems, a start-up that Cisco had funded. Some experts speculate that Cisco plans to use the BCN routing technology to refresh the aging 7600 and 10000 edge routers, which Cisco sells to carrier customers.

The BCN technology could be used in Cisco's ongoing project to extend the new IOS-XR software, originally developed for the CRS-1, onto other routers in its carrier portfolio. The BCN technology and engineers could be just the trick.

The recent rehire of Procket co-founder Li is also an indication that the company is getting serious about its software development. Li is considered an IP routing guru, having helped Cisco build its first core router, the GSR 12000. Li also helped Juniper develop its M-series routers. And he was the software architect behind Procket's core router.

Dan Scheinman, senior vice president of Cisco's corporate development, said the company will continue to use acquisitions to enter new markets.

"We are looking for companies with products at an inflection point where a market is about to take off," he said. "We take advantage of our strength and customer knowledge to accelerate the growth of that technology."