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Is Cisco ready for a challenging year?

As 2000 closes, the company faces serious challenges as it grows at a breakneck pace and fights a set of smaller companies for technological dominance and market share.

Cisco Systems chief executive John Chambers has always maintained supreme confidence concerning his company's ability to maintain its momentum, even in hard times.

Year in
review special report But the state of the network equipment market as the year 2000 comes to a close may test his resolve.

Cisco's opportunity to dominate new markets in networking and solidify its position as the largest maker of Internet equipment seemed secure at the outset of the year, despite encroachment from a new round of eager start-ups such as Juniper Networks, Sycamore Networks and Redback Networks.

But as the year closes, the company--widely viewed as the technology bellwether of the Nasdaq Stock Market--faces serious challenges as it grows at a breakneck pace, hones in on the telecommunications market even as that niche is in flux, and fights a set of smaller companies that appear to have a technology advantage in an ongoing war for market share.

Cisco executives remain relatively bubbly despite a stock that continues to flirt with 52-week lows and telling signs of an economic downturn that could hit a wide cross-section of the technology industry. The executives believe the company is better positioned than others to weather a market downturn, given its huge market presence and strategy to acquire companies to grow.

"This might sound callous, but Cisco is better off if the stock market stays soft during the next 12 months," Chambers told analysts at the company's annual analyst conference earlier this month.

Others see the company's continued expectation of 50 percent to 60 percent year-over-year growth as a challenge that will test Cisco, which for years has been a model of operations. The company now hires more employees in one quarter than many of its smaller competitors employ in total.

Given Cisco's size, some believe the company has lost touch with the cutting edge of technology and risks becoming a marginalized behemoth that throws its weight around to retain customers. Competitors already bemoan a "you won't get fired for buying Cisco" mentality among some customers.

"Since they're growing the way they're growing, and they're going to be this $50 billion (in sales) company, and you're hiring more than 3,000 a quarter, it's hard to stay close to the customer," Jeremy Duke, analyst with industry watcher Synergy Research Group, said in a recent interview.

"You have areas growing so fast you can hide a lot of things," Duke said. "The proof is in the numbers. But if you're moving that fast, you increase the risk of pitfalls."

Keeping the edge
One reason for Chambers' optimism is that Cisco relies on innovation from start-ups it acquires to drive new technologies into the market. If the stock market and related venture capital industry remain down over the next 12 months, that may make it easier for Cisco to acquire the companies it needs at lower prices.

A boom among publicly traded start-ups threatened that strategy in 1999 and earlier this year, because it seemed Cisco would have to pay huge premiums--such as the $5.7 billion it laid out for ArrowPoint Communications--to buy smaller companies.

With that problem solved by the market downturn, another concern continues to be raised in the networking industry: Is Cisco spreading itself too widely across various markets--with dominance in corporate networking, Internet equipment, and emerging strength in telecommunications gear--to keep its reputation as a technology leader?

As one analyst put it: "The risk is that Cisco becomes what it really didn't want to be, which is a general store. They have a lot of stuff on the shelves, but it's generic, with no technology expertise."

Underscoring this sentiment is the success stories of smaller companies, including Redback Networks, Extreme Networks and Brocade Systems, which have carved out large niches in areas that would be likely candidates for Cisco.

Juniper eating into Cisco's market share Furthermore, ongoing executive departures have pushed Cisco into a defensive position as it insists the departures are not a sign that the company is suffering from brain drain.

Perhaps the most telling example is rival Juniper's rapid ascent as a strong second choice for Internet service providers looking to buy high-capacity Internet routing equipment. Routing technology has been the engine of Cisco's growth since its inception. Nevertheless, the start-up now boasts a 30 percent share of the high-end market for such technology, up from nothing two years ago.

But for every Juniper, there remain victims. Foundry Networks, once a highflier, recently warned of shortfalls due in part to sagging sales to Internet service providers. Though not explicitly pointed to as a cause, Cisco's market dominance is likely to have hit its smaller competitor.

"Any company that would underestimate Cisco would make a large mistake," said Juniper chief executive Scott Kriens.

But Kriens also suggested in an interview earlier this year that it is unlikely for a company to execute successfully on a strategy of being all things to all people--dubbed "end to end" at Cisco.

"The premise that anyone is going to execute to that is historically unprecedented, to be kind," Kriens said.

Greatest challenge: boosting stock price
Cisco's greatest challenge in 2001 may be to prop up its sagging stock.

On Dec. 20, the giant's stock could be had for $36.50 a share after it fell 13 percent and dropped for the seventh straight trading day in a row. That's far off its 52-week high of $82.

Rise and fall "There's a lot of pressure on execution," Paul Johnson, equities analyst with Robertson Stephens, said in a recent interview.

Wall Street now frowns on Cisco and rival Nortel Networks based on data that indicate an expected slowdown in equipment spending among network operators. There also is concern about the vitality of several start-up telecommunications businesses that are served by the two companies--the same niches that helped Cisco and Nortel drive to new highs earlier in the year.

Lucent Technologies, once a third rival among the first tier of large equipment providers, could serve as a warning sign for its competitors.

Lucent continues to seemingly spin out of control, caught in a flurry of bad earnings news, ramifications from shaky loans to start-up ISPs, bad decisions by overzealous sales executives, and overall management flux.

See 2000 timeline This decline has left Lucent's stock approaching all-time lows, dating back to its spinoff from AT&T in the mid-1990s.

Amid this climate, Cisco looks comparatively strong, despite the various start-ups nipping at its heels and continued battles for market share with Nortel, international player Alcatel, and others. As Ammar Hanafi, Cisco's vice president of business development, said: "I think we were all surprised at how quickly things changed."