Toward the end of each quarterly earnings call, Cisco CEO John Chambers lists challenges the company faces that contribute to its "healthy paranoia" about competition and market leadership.

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

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