In addition to competition, Cisco's challenges include general economic conditions; government intervention into and regulation of the high-tech industry; component supply; new technology; attracting and retaining talented employees; and maintaining Cisco's culture. All healthy concerns for a company that grows bigger, richer, more powerful and more envied every year.
But coming off a disappointing fiscal 2001 second quarter, which ended Jan. 27, Cisco may have more to be concerned about than usual. Some users and analysts say the sheer size of the company -- Cisco's market cap is $222 billion, just behind Intel at $241 billion and Microsoft at $314 billion -- and its rate of growth is Cisco's biggest potential pitfall.
"There's one major problem with Cisco, and it has to do with size," says Frank Dzubeck, president of Communications Network Architects in Washington, D.C., and a Cisco analyst for many years. "You can't sustain growth rates because you get into the law of large numbers," which states that the larger a company grows, the slower the rate of revenue and earnings growth.
With slower revenue and earnings growth comes pressure on the stock. For a company that grows through acquisition -- Cisco has purchased 71 companies since 1993 -- that means a devaluation of its currency.
"I think Cisco's biggest challenge is Cisco itself," says a user at a large New England technology company. "With size comes a certain amount of inertia."
Inertia has set in on top- and bottom-line growth. Cisco's earnings between the first and second quarters were flat at 18 cents per share. Cisco says revenue growth will range from being flat to being down 5% in the third quarter, and flat in the fourth compared to the third.
Analysts were expecting earnings of 19 cents per share, and prior to the second quarter Cisco had beaten Wall Street estimates by a penny for 14 consecutive quarters. Revenue for the second quarter also missed Wall Street estimates by $250 million to $450 million.
Cisco blames general economic conditions, dramatically decreased capital spending by service providers, a falloff in enterprise spending -- particularly in the manufacturing vertical market -- and increased inventories due to component shortages. Cisco was caught off-guard by some of these events.
"What has changed dramatically is the speed at which customers make and change decisions on both head count and capital spending," Chambers said during the second-quarter earnings conference call two weeks ago. For example, one such customer decreased its capital budget to $800 million from $2.5 billion, he said. And spending among alternative service providers -- competitive local exchange carriers -- is off 40% from last year, he said.
"It's extremely difficult to avoid these types of [spending] slowdowns," Chambers said. Despite these challenges, Chambers said Cisco will grow 40% in fiscal year 2001 and can continue to grow at 30% to 50% over the next three to five years.
Inertia may also be setting in where the company's ability to develop and ship cutting-edge technology and products is concerned. Cisco had to extend lead times for its popular Catalyst 6500 switch from three weeks to three months due to component shortages, reportedly from supplier IBM.
Some users say the Catalyst 6500, which is a $5 billion line of business and helped Cisco garner the lion's share of the LAN switching market, is actually not market-leading technology but market-leading marketing.
"It seems that no matter what other hardware manufacturers do and invent, Cisco is the name that the people in my organization want to hear," says Raymond Santana, network engineer at the University of California, Davis, Medical Center in Sacramento. "In most cases, I cannot convince anyone that there is a better switch at lower cost than the Cisco 6500 series. I can't believe that Cisco is so far behind on the gigabit trail yet is still considered a top gigabit supplier."
Others, however, vouch for the capabilities of the Catalyst 6500 in a Forum exchange on Network World Fusion. "There is no better [switch]," two participants stated in the exchange.
Still, specific areas of pinpoint focus for the company -- voice over IP, Internet routing and optical networking, to name a few -- pose additional challenges for Cisco, users and analysts say.
With voice over IP, Cisco likes to claim it is installing 2,000 IP phones per week. The company has signed on some major IP telephony wins: Dow Chemical, with 40,000 IP phones; the New Zealand Ministry of Social Policy, 8,000 phones; and Merrill-Lynch, which plans to have at least 8,000 IP phones in a new "PBX-free" campus.
But 2,000 phones per week is "a pebble in the lake" compared with the millions of handsets Lucent, Nortel and Siemens install per month, Dzubeck says. A report in the New Zealand press says the New Zealand Ministry of Social Policy had such a difficult time implementing its voice-over-IP network that it endangered the welfare of children because calls concerning abused youngsters couldn't go through.
Another user who claims to be knowledgeable about the Ministry's voice-over-IP network says it's actually two parallel IP networks -- one running voice, another running data.
"This, I understand, has added to their costs significantly," wrote Richard Shorter, a technology manager at New Zealand Insurance, in an e-mail to Network World. "Unfortunately, I am not sure what the problem was that led them to this parallel network solution, as it appears that they had many problems during implementation."
Neil Miranda, technology director for the Ministry, says Shorter is incorrect.
"The man is off the wall," Miranda says. As for the child abuse issues, he strongly denies that disruptions in the voice-over-IP network endangered children at any time.
"It's wrong," Miranda says of the report. "It didn't put anybody at risk because the [child abuse] calls come from a call center. The call center had nothing to do with the IP network."
The voice-over-IP network handles an average of 150,000 calls per day, Miranda says.
In addition to voice over IP, Cisco faces a major challenge in its bread-and-butter business: routing. Juniper Networks is giving Cisco a run for the money in Internet core routing by beating the company to market with key technology -- such as OC-192c interfaces -- and stealing more market share every quarter and every year.
Cisco's share of the Internet core router market dropped from 80% in the first quarter of 2000 to 69% in the third quarter, according to Dell'Oro Group. Juniper's share almost doubled during the same time period, from 17% to 30%.
In an effort to stall Juniper's momentum, Cisco plans to roll out the 12400 Gigabit Switch Router in March. The 12400 will have a 320G bit/sec switch fabric and 10G bit/sec OC-192c line cards to compete with Juniper's M160, which has been shipping since last March.
"Juniper is taking market share, and Cisco has to address that," says Dave Passmore, research director at The Burton Group. "They're rolling out the 12400 to counter the M160, and they still have a terabit [routing] system in the works."
Terabit routing is still a ways off, but by the time Cisco's OC-192c router ships, Juniper will have already had a year's head start. Service providers usually remain loyal to their vendors, which means Cisco may have a difficult time winning back the customers and market share it lost.
Cisco seems to be gaining customers in optical networking, however. The company's ONS 15454 product -- obtained through its $7 billion acquisition of Cerent -- is one of 12 Cisco products with $1 billion or more in sales.
But Cerent is one piece of an optical array cobbled together via various acquisitions. Products obtained from the purchase of Pirelli, Monterey and Qeyton Systems are not enjoying the momentum that the Cerent products are.
Cisco's overall market share in optical is minuscule compared with entrenched giants such as Lucent, Nortel, Alcatel, Ciena, Fujitsu and Marconi.
"Cerent has done really well, but a SONET mux is not an optical strategy," Passmore says. "They still haven't shipped much of Monterey, and they still have work and acquisitions [to complete] to compete."
Size and product/technology concerns aside, attracting and retaining talented employees and maintaining the Cisco culture may be the company's biggest challenge. Fifty percent of Cisco's workforce has been at the company 18 months or less, Chambers said.
As Cisco gets bigger, it loses a little bit more of its identity and unique characteristics. Couple this with the law of large numbers -- declining revenue and earnings growth with increasing size -- and the value of stock options, a key carrot for attracting talented people, declines.
"You've grown at an accelerated, rapid rate," Dzubeck says. "To keep up with that rate you have to keep stoking the coals."
