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What makes Cisco run?

Cisco chief John Chambers talks about the drive to be No. 1 and his company's ideal takeover target.

Does Cisco Systems CEO John Chambers know something about his company that continues to elude most of Wall Street?

Given the investment community's propensity for herd behavior, Cisco may be one of the most underestimated big-name technology stocks out there. The networking giant finished last week trading near its 52-week low, even though it continues to rack up record sales and earnings.

But after living through the go-go days of the bubble and the desperation of the post-dot-com recession, Chambers remains convinced about the best way to manage the company through good and bad.

Taking his managerial cue from former General Electric CEO Jack Welch, Chambers, who took over as chief executive in 1995, has been at the helm as Cisco's annual revenue has soared from $1.2 billion to its current run rate of close to $24 billion.

Chambers recently sat down with CNET reporters and editors to talk about his management philosophy as well as his plans for steering Cisco through the latest round of consolidation in the technology industry.

Cisco keeps talking about being a growth company, but shareholders haven't been as impressed. The company hasn't grown the way they would have hoped. How do you address those concerns?
Chambers: It's hard to grow faster than your segment of the industry. Yet, year in and year out, we've grown faster than our segment of the industry in each category.

We've been growing pretty consistently in terms of our orders, and we think we will grow at 10 percent to 15 percent. Our order rate has been in that range for the last six quarters in a row.

But Cisco isn't that little scrappy start-up anymore, is it?
Chambers: No. But if you look at it mathematically, we have six advanced technologies, which we've gone into, where we lead. To the best of my knowledge, there has never been a major IT company that

I think what you're seeing now is just a period of uncertainty about growth rates and then a period of uncertainty about the economy overall.
is the leader in more than one or two product areas. Each time we move into the market, we become the No. 1 player, almost without exception. That has never been done before.

If we were a start-up with those types of growth numbers, with three of these groups approaching the billion-dollar-a-year run rate, the stock would be a different value. So that's pretty good.

Why do you think Wall Street is not getting the message?
Chambers: I think Wall Street always gets the message. The issue is, at the present time, there are a lot of people looking at what the most recent quarter might be. But we don't run our business on a quarter by quarter or month-by-month basis. We run it for the long-term.

Time will tell if our growth rate is in the high single digits, where the market clearly has us, or if it's in the 10 percent to 15 percent range--or potentially, even slightly above that.

One quick follow-up question: Will stock-option reporting affect Cisco?
Chambers: No one really knows...We deal with the world the way it is. We'll adjust either way, and we'll adjust based on what the shareholders say. I think what you're seeing now is just a period of uncertainty about growth rates and then a period of uncertainty about the economy overall.

What do you see happening in the second half of this year in terms of IT spending?
Chambers: I can tell you what our customers say. Our customers say that 80 percent to 90 percent of their businesses will see increased earnings this year versus last year. Of that, about 60 percent of the total, I believe, says capital spending will increase but only about a third will hire.

People are talking about the Federal Reserve raising interest rates, and oil prices have been going through the roof. Are companies going to hold back on spending in the second half of the year?
Chambers: Everybody wants a single silver bullet--"If this occurs, will that occur?" As we all know, the economy probably has five or six major bullets going on at the same time, or variables in the equation, if you will. So I think there are a number of variables in the equation that can have a positive effect on the market, and there are a number of variables in the equation that can have a negative effect. It really comes down to what are their earnings per share. When that tends to go up, they can spend more.

What's your current thinking on paying out a dividend?
Chambers: If you ask shareholders what they want us to do, a growth company with this type of (price earnings) ratio, I'd say 90 percent of

Everybody wants a single silver bullet.
them want us to use our money to either acquire our stock back, or to use it to invest in companies or to acquire other companies.

So, at some point in time will we pay a dividend? As we have said many times before, yes.

Not this year?
Chambers: No. Most companies that are growth companies pay nominal dividends or not at all. If the market would have a changed perception on that and want us to pay a dividend, then we'd pay that.

What about acquisitions? I mean there's been a lot of talk about acquiring Nortel Networks or something big like that.
Chambers: I don't know how to do large acquisitions--which is a very nice way of saying I haven't seen any that would be successful.

Our strategy is more to use acquisitions to enter new markets. Our ideal target is about 100 people, primarily in an engineering product area, with good engineers that are just about to bring a new product out (or has just come out.)

What about this chatter about Nortel?
Chambers: Nortel is a very good company...I've been wanting to partner with Nortel for five to six years. I still believe that--much like we did with IBM and with Ericsson--strategic partnership is the right way to go. Acquisitions have a much higher risk. I would argue in the industry, the hit rate on acquisitions is probably 10 percent...To do large ones across geographies, across cultures--we don't think they have a very high probability of being successful.

Speaking of consolidation, the telecom market has been fragmented, but in the last several months there's been this move toward consolidation. There are fewer standards and architectures as a result. What do you think the impact on equipment makers might be?
Chambers: Are you talking primarily about the U.S.?

Chambers: In the macro sense, too much competition is just as bad as too little. I think the consolidation is absolutely healthy for the U.S. I think the people who are more exposed are those that have a substantial amount of their IT spend coming from those companies mentioned. We have a small percentage of our IT spend coming from those companies.

Moving on to a different topic, you've been CEO for quite a while. It seems like it's becoming harder and harder today to be a chief executive. Boards are much more stringent, and then you've got Sarbanes-Oxley. What are your plans?
Chambers: Well, I committed to my board within the last year that I'd be here--assuming they want me--for another three to five years. I serve at the board's pleasure, my shareholders, employees and customers. My view is that having the support of all of them is very, very key. And I think you've got to be fair with your board, if you have an intention of leaving in the next year. So, unless you are telling me something in terms that I should be thinking about succession planning, I intend to be here at Cisco.

Is there a succession plan?
Chambers: Oh, there always is.

I mean, what happens after you?
Chambers: You always want to make sure there's a smooth transition. People tend to think of that as individuals, I tend to think of it as an organization evolution. Most companies do not do well after their core group or management rolls over. We are on our fourth CFO, our fifth head of engineering, our fifth head of sales...We've been able to make

I admire Jack Welch. It doesn't mean he was perfect, but he did an amazing job at GE.
management transitions very smoothly in ways that other companies have not. I expect us to do the same thing for the CEO ranks. We have a very deep and very wide leadership team.

Was there any pressure for you to move on?
Chambers: I've had no pressure. You've got to understand one thing about Cisco: We're trying to build a company that's not only built to last, but built to lead. Almost no one's done that consistently in IP...Most of the predictions we've made have come true in the industry. So, I'm having a good time. I think my age is about average for a CEO at a large company. I make decisions three-to-five years at a time.

What do you see in that three- to five-year period? I assume you didn't throw that number out just randomly.
Chambers: I've always had three- to five-year (outlooks) since I became CEO. It's kind of the working arrangement I have with the board and with my own team.

Why do you think there was so much corruption in the telecom industry? You were selling to some of these folks. Was it a surprise? Is this an issue that's getting worse?
Chambers: Clearly, it was a surprise to all of us that people would do this?For those people that truly, knowingly, deliberately did things that were very, very inappropriate, I think they'll be held accountable--and firmly held accountable. What surprised me was how deep this went.

At Cisco, there's a culture of integrity. It doesn't mean we won't make mistakes. We sure as heck will, but we have a culture where people are very open. It's knowing that we expect them to do the right thing ethically and that if they see an issue, that they escalate it.

Do you think it's getting worse now, or do you think that there's more scrutiny, so people are kind of watching their backs?
Chambers: Well, I think more important than that issue is that people have realized that this is wrong--not just at the top, but throughout the organizations--and needs to held unacceptable. I think it's having a culture that just views this as unacceptable.

What nontech CEO do you most admire?
Chambers: I admire Jack Welch. It doesn't mean he was perfect, but he did an amazing job at (General Electric), and many of the things that we implement at Cisco we probably learned more from GE than others.

I admire very much statesmen like (Former U.S. Secretary of State) Colin Powell and King Abdullah of Jordan. I admire my dad. He was a stabilizing influence throughout my life. He had an ability to look out not one to two years, but five, 10, 15, 20 years, and had the courage to stay with his convictions.