Is Cisco ready for a turnaround?

Cisco on Monday announced an earnings shortfall, job cuts, and a series of one-time charges in an effort to arrest a steep decline in sales at the network equipment provider. The company's woes are symptomatic of a larger downturn in the telecommunications and technology markets, and in the overall economy.

But for years Cisco has remained the exception, not the rule--growing at rates well above the market average and eschewing the notion that it could suffer the same slow-growth fates as its larger rivals, such as Lucent Technologies and Nortel Networks. As a result, Chambers, 51, has become an icon of the Internet and one of the most highly regarded corporate managers.

Cisco at one point became the most valuable company in the world. But now its fortunes have fallen so dramatically that its troubles have taken on a dot-com-like quality.

In March 2000, Cisco's value was $555.4 billion after its stock touched $82. At the time, Cisco was the fastest--and one of the elite few--to reach $500 billion in value. The company's shares now hover around $16, giving it a market capitalization of about $118 billion. Its stock is down more than 57 percent for the year.

In the aftermath of the darkest day in Cisco's financial history, Chambers discussed a wide range of issues facing the company in an interview with CNET News.com, including how his company could be forced to write off $2.5 billion in technology component inventory, how the networking boom and the current bust have affected Cisco, and how it feels to be forced to lay off employees.

Q: Cisco is known for its sophisticated internal computing systems that tracked sales. But you are now warning of a 30 percent reduction in sales this quarter from last quarter and a $2.5 billion charge for excess inventory--raw materials used to build networking products. How did the earnings warning and an inventory excess of this magnitude crop up?
A: (Computer) systems are not a crystal ball for the future, but a good indicator of where you are. But what happened is we never had a quarter lower than 3.5 percent growth in our history. We thought it would be extremely challenging to have growth down in the low single digits. And in a "100-year flood" as we talked about (in our conference call with analysts), we were (multiple times) over that. It was like having sandbags in your house, and it floods over your house.

A 100-year flood is possible, not just down to the single digits. If you talk to any business and ask them, 60 percent (revenue growth) is great, 23 percent is OK, and poor is 10 and down. And down 30 percent is a whole different issue. I'm not in any way dodging this issue, but anyone who can project that this market was going to have this decrease is in the wrong job, and made quite a few million in the projections. Did we learn from this? Yes. Will we adjust? Yes.

From both Cisco's and an industry perspective, did the boom--the runaway growth in the networking market--blind you to the possibility of a downturn?
That's too simplistic. If a company has grown 30 to 50 percent, and on the higher end of that range for the past 10 years...if each time a hesitation occurs in the market, and the company pulls back on inventory and (does) not have an aggressive acquisition strategy, then you can't be the major company we are today. We take calculated risks and we're not going to change that. You will not always be right. No one bats 1,000."

A management question for you: You've discussed your time as an executive of Wang (a large computer company in the 1980s) and the layoffs that occurred there. What have you learned from this latest experience?
From a business perspective this was not avoidable unless we were not going to take business risks at all. You have to bring expenses down. Employees understand people are getting laid off. They're saying, "John, we agree with what you're doing. We wish we were not involved." Clearly, they understand it's a business.

I had a strong personal goal never to do layoffs again. From a personal point of view, it's the worst thing I've ever done. I thought given our productivity and our systems and others, I'd be able to handle a terrible quarter in the low single digits. Never did I anticipate a 100-year flood that was five times higher than possible.

Going forward, how will you learn from it?
We will absolutely tighten inventory controls and drive productivity to higher levels. So we're constantly learning and, just like the acquisition strategy that we've done, you get better at it each time. We will continue to take business risks, absolutely. We will be tougher on market share and profit contribution (of products).

Can you equate this 100-year flood to anything you've ever seen?
No. You look at the whole technology industry. The people affected first were the PC and server players, then the infrastructure and applications players, then the consultancies. So Microsoft and the PC makers saw it first, then the service providers, then the Ciscos and the application players.

I have not seen anything comparable to this since the semiconductor industry in 1984 and 1985, when Intel fell from $1.6 billion to $1.1 billion (in yearly revenue). We did that almost in a quarter. In terms of orders, we had a growth rate that was accelerating to negative growth in 35 days.

(Editor's note: Intel's yearly revenue actually fell from $1.6 billion to $1.3 billion from 1984 to 1985.)

You mentioned some products are not up to snuff, that they are not generating the expected revenue. Did you and your executives take your eyes off the ball? Is that an unfair assessment?

You get more credit when everything goes well and more blame when things don't. It goes with the territory as CEO. I don't take it personally. Our key goal is No. 1 or No.2 in market share and profitable contributions in new markets. Do I think I need a tighter focus across the whole company? We are a company that empowers its employees, (and I'll do that) more aggressively than I have in the past.

Is there a need for executive changes?
I think I have the best management team. Peers we talk to tell us that, and everyone in the industry is trying to poach them. I don't lose many people, but when I do, I do it smoothly.

You've averaged more than 20 acquisitions a year in the past few years. Do you plan a change in your acquisition strategy?
Not at all. We are going to modify it. It absolutely works to our benefit. In our first six or seven years, we waited for companies to come out with products. In the last 12 to 18 months, (because of the market boom), that was not an option. We had to buy them before they had product working, and maybe just when they had a design. The risk went up and our hit rate dropped. Now we're back to the days where we wait until the products are out there before we acquire them. Our hit rate should go up.

Are we going to be more selective? Yes. Will we wait longer? Yes. We will wait until the slowdown is over.

In talking to financial analysts, some are questioning your theory that you can continue with 30 to 50 percent yearly revenue growth when the market recovers. With your revenue between $6 billion and $7 billion a quarter, is the law of large numbers catching up to Cisco?
Every year we've been criticized and questioned about the 30 to 50 percent growth. When we were above (50 percent), people criticized us as too conservative. When we were below, people said we wouldn't return to that growth.

In the enterprise, we're still at the early wave of changing businesses. There will not be a company that won't be an e-business 10 years from now: General Electric, Ford Motor, Wal-Mart, General Motors...They all understand.

If the industry is consolidating, that plays big time to our advantage. We have end-to-end products. Customers don't want the experience with (smaller) XYZ companies when they've seen 10 XYZ companies go out of business. They don't want to buy from them and not have a follow-up on their products. The next element is how do companies manage themselves?

We empower. We have the management philosophy you need. For all the above reasons, it plays to our advantage.