The Future Is CISCO's To Lose

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The Future Is CISCO's To Lose

John Chambers, president of Cisco Systems Inc., has pushed the company's aggressive acquisition binge.

Cisco Systems Inc. just can't stop growing.

Cisco's stock value has multiplied more than 100 times since it went public in February 1990 and is now worth more than $40 billion. Revenues reached $4.1 billion in the year up to August 1996, almost double the $2.2 billion taken in during the company's previous financial year.

The San Jose, Calif., company's bread-and-butter business is selling communications technology to large companies trying to build their own internal communications networks and companywide mini-Internets, dubbed intranets. These easy-to-use internal networks, the hot productivity tool of the late 1990s, are used to provide customer services, manage employee benefits, schedule product deliveries, coordinate research efforts and disseminate marketing information.

The company's runaway growth is propelled by Cisco's aggressive development of new data communications technology, the purchase of rival technologies and the acquisition of promising technology companies.

"If they did not have the products in-house, they went out and bought them," said Jeremy Duke, director of research at In-Stat, a market research firm based in Scottsdale, Ariz. The high prices that Cisco paid for some of its rivals shocked observers. "Most of the world thought they were crazy [to buy Kalpana Inc. in October 1994 for $203 million]. But they were totally justified," said Duke.

Kalpana has developed devices to switch data around a local area network of connected desktop computers.

Over the last two years, under the leadership of its president, John Chambers, Cisco has bought minority stakes in six technology companies and absorbed 14 rivals, including StrataCom Inc., which it purchased in April 1996 for $4 billion because of its expertise in an extremely fast communications technology called asynchronous transfer mode. Before joining Cisco in January 1991, Chambers worked at Wang Laboratories Inc., Lowell, Mass. Chambers took over the top job at Cisco in November 1994.

Cisco's future growth is also paved by its proprietary Cisco IOS software, used to knit together all of the company's networking products. By licensing that software to rivals and allies, Cisco has made Cisco IOS an industry standard, making it difficult for rivals to cut into its dominant market share.

"They dominate just about any [networking] market they are in," said Don Miller, an investment analyst at the San Jose, Calif., office of Dataquest, an investment analysis firm.

Cisco's rivals - Bay Networks Inc., Santa Clara, Calif.; Cascade Communication Corp., Westford, Mass.; Cabletron Systems Inc., Rochester, N.H.; and 3Com Corp., Santa Clara, Calif. - could only threaten Cisco if they could combine with a larger company, such as Lucent Technologies Inc., Murray Hill, N.J., Armonk, N.Y.-based IBM Corp. or Newbridge Networks Inc., Herndon, Va., said Val Sribar, vice president of the META Group, an investment analysis firm based in Reston, Va.

At its current rate of growth, Cisco will reach an annual revenue of $10 billion by 2003, said Duke.

The future "is ours to screw up," said Alex Mendez, Cisco's vice president of corporate marketing.

Where Next?

The markets for Cisco's digital communications products - routers, switches, as well as local area networks and ATM devices - are growing at 30 percent to 70 percent per year, said Mendez.

Cisco's primary market is large companies striving to build and expand their intranets and internal communications networks.

Cisco's second main source of revenue comes from large communications companies, such as AT&T, Sprint and a variety of Internet service providers. These network companies are spending freely to expand their communications capacity to cope with accelerating corporate and consumer demand for intranet and Internet services.

Next on Cisco's client list are smaller companies - those with less than 500 employees - where demand for digital communications devices is picking up as they build their own intranets and hook up to the worldwide Internet, said Mendez.

Future clients include at-home businesses and consumers, said Mendez. "The next logical step is the consumer marketplace," said Mendez. This marketplace will grow as consumers make increasing use of the Internet for games, shopping or digital television - all of which will spur demand for high-capacity networking technology. To meet growing consumer demand, Cisco may develop its own low price, low maintenance technology, buy a share of another company's technology or acquire a rival with promising products, he said.

Cisco executives also see future profits from the replacement of the existing wireless backbones with Cisco-developed products. Already, Motorola Inc., Schaumburg, Ill., has bought Cisco's digital switching gear for some of its latest wireless networks, whetting Cisco's appetite for the fast-growing wireless marketplace. "It is a huge market with tens of billions of dollars of installed base [technology]" that will need replacing, said Mendez.

The international market for the company's products is expected to grow as international markets are levered open, said Mendez. Thus, Cisco is selling sophisticated communications technologies to help European-based companies squeeze the most data possible - at the lowest cost - through the tightly regulated and very constricted European communications networks, said Mendez. Roughly 35 percent of Cisco's revenue now comes from outside the United States.

Growing demand for new services will also propel Cisco's revenues through the next decade, said Mendez. For example, all of the major communications companies want to offer their customers the ability to buy guaranteed service or to reserve communications capacity for short-term needs. For example, a video production company might not want to rent a high-capacity communications pipe 24 hours a day, but would pay a premium price for the ability to send live-action images through a network any time, providing there is no slowdown in transmission or a break in service, he said.

Eventually, Cisco wants to move beyond communications gear to offer anything to do with networking, said Mendez. Via research and buyouts, "we are pulling together all the building blocks for a complete networking solution," he said.

Cisco took another step Jan. 15 when it announced an alliance with Hewlett-Packard Co., Palo Alto, Calif. The alliance commits both companies to become each other's preferred customer, said Miller, improving Cisco's access to HP's Internet-server technology and improving Cisco's penetration of the enterprisewide Internet business.

However, Cisco does not intend to venture into the systems integration or the communications service businesses, said Mendez. "We are going to stick to our knitting."

Even without future acquisitions, the company's powerful research arm will generate a flood of new products. The company should spend roughly $650 million on research and development during 1997, allowing it to spit out a plethora of new products, said Mendez.

This variety is reflected in a suite of new devices being developed for the company's Internet business unit. Dubbed "network appliances" by executives, they include:

Antihacker firewalls, which are intended to let companies keep snoopers outside their intranets.

The Local Director, which speeds online transactions by directing World Wide Web surfers to underused Web servers.

Another new product, released in mid-January, is the Cisco Micro-Web Server. This compact, low-maintenance device lets up to 10 Web surfers hook up to a Web page every second, said Christine Hemrick, chief of Cisco's Internet business unit. Its small size and low maintenance are suited to small businesses or people who work from their homes, she said.

Market Domination

Cisco's growth and continued dominance of the networking business has generated enormous value for the company's shareholders - and enormous confidence among its management.

"Our fair share of the market ... is between 40 and 60 percent," said Mendez. Cisco's main opportunity is "taking IOS - like Microsoft [with Windows 95] - and doing that at the networking level," said Mendez.

"If you average it all together, we are providing 80 percent of the market [for networking technology]," said Art Feather, Cisco's director of IOS software marketing.

Cisco's position invites comparison with Microsoft Corp., which has relentlessly used its own industry standards - DOS and Windows 95 - to grab market share from aggrieved rivals. Industry criticism of Microsoft as a predatory monopolist has generated several investigations by the Department of Justice, but no real slowdown in Microsoft's growth.

The IOS software "is the key asset for the company," said Feather. It allows the company's various communications devices to work easily together, and via extensive licensing to industry allies and rivals who install IOS in their networking products, allows Cisco's devices to work with other companies' networking devices, he said.

The IOS suite of software includes roughly 600 separate components, which can be mixed and matched by the company's 1,000 software engineers to meet particular needs, he said.

For example, Cisco shared some IOS software with Metricom Inc., Los Gatos, Calif., allowing faster deployment of Metricom's new digital wireless devices, he said. The IOS software is also being upgraded to allow voice communications, reservation of bandwidth and easy transmission of multimedia data, he said.

But Cisco can't be compared to Microsoft, said Cisco executives. "Cisco's commitment to partnership for joint wins [by several companies] ... is the key difference," said Feather.

"There has been grumbling for the last couple of years, mostly from its rivals .... [But] if Cisco was the size of Microsoft, we would start to hear those antitrust rumblings" from the government, said In-Stat's Duke.

"When Cisco becomes a $10 billion company, that could change," ensuring tighter government oversight, Duke said.

Obstacles? What Obstacles?

Given Cisco's excellent outlook, what could go wrong?

"It becomes harder the larger you get," said Mendez. Two critical tasks include staying close to an ever-rising pool of clients and selecting new executives to run Cisco's ever-expanding line of services and products, he said.

But top company officials, including Chambers, have created several new business units to keep senior managers in close contact with customers, said Duke. Also, pay for the senior managers is tightly linked to consumer satisfaction, which is gauged by an outside polling firm every year, he said. "If customer satisfaction decreases, the [managers] lose money," he said.

Also, Cisco's ambitions have propelled it into competition against major players such as Washington-based MCI Communications Corp., which also offers its clients a complete range of networking technology, said Mendez. Cisco's advantage over MCI is its ability to quickly develop or acquire new technology, he said. MCI's reliance on other companies for equipment "makes it difficult to move quickly," he said.

"Usually vendors don't say those things about one of their best customers," said Leslie Aun, a Dallas-based spokeswoman for MCI, which only buys Cisco routers when deploying Internet services to its customers. Although MCI does not manufacture anything, "we are working very hard to offer our customers total solutions," said Aun. MCI uses equipment provided by a wide variety of manufacturers, such as Cisco, Microsoft or Sun Microsystems Inc. of Mountain View, Calif.

MCI had 1995 revenues of $15 billion.

"There is no one thing that will trip Cisco up, except Cisco .... [To lose their lead], they would have to make a whole bunch of mistakes," such as failing to develop new products as fast as their rivals or delivering faulty products, said Miller.

But competition and growth are unlikely to significantly curb Cisco's revenue growth, said analysts.

Fueled by the growing demand for Internet and corporate intranet technology, the market for Cisco's products is growing by leaps and bounds.

"Right now, the future is Cisco's to lose," said META Group's Sribar.


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