Cisco Systems: Poster Child for the Digital Firm?

What went wrong for them?

Cisco Systems advertises itself as the company on which the Internet runs, and this San
Jose, California, company does dominate the sale of network routers and switching
equipment used for Internet infrastructure. Under the leadership of CEO John Chambers,
it has been so successful that it even briefly became the most valuable company on earth
in early 2000, reaching a valuation of $555 billion and a stock price of more than $80 per
share. One key to its success is that Cisco uses information systems and the Internet in
every way it can. However, by April 2001 the stock closed below $14, a decline of more
than 80 percent, while the company value fell to around $100 billion. What was to blame
for this precipitous plunge? What role did Cisco's information systems play?

Cisco was founded in 1984 by Stanford University computer scientists looking for an
easier and better way to connect different types of computer systems. By 1990 the
company was growing at a double-digit rate, which it maintained for 10 years, even
surpassing 50 percent in growth during some years. The company claims it now has 85
percent of the Internet switching equipment market.

Cisco's growth was based on two main strategies. First, the company outsources much of
its production, and second, a significant portion of its growth has been through strategic
acquisitions of and investments in other companies, amounting to $20 billion to $30
billion between 1993 and 2000. Cisco's investments were carefully selected as a means of
building internal competencies in areas where the market was evolving. In September
2000, six months after the stock market decline began, Cisco announced its sales were
growing at an annual rate of 66 percent.

Cisco was very proud of its use of the Internet to drive its business and has actively
promoted itself as a model for other companies. It is generally believed that "Cisco uses
the Web more effectively than any other big company in the world. Period," according to
Fortune Magazine. If any company epitomized the digital firm, it was—and still is—
Cisco.

Cisco began selling its products over the Internet in 1995. In 2000 Cisco was selling
about $50 million in products daily via the Web. Customers can use Cisco's Web site,
called the Cisco Connection Online, or CCO, to configure, price, route, and submit orders
electronically to Cisco. More than half of the orders entered on CCO are sent directly to
the supplier, and once the product has been manufactured, it is shipped directly to the
customer. Those orders are never touched by Cisco. The result is that the company has
reduced its order-to-delivery cycle from six to eight weeks to less than three weeks.
Moreover, this has enabled Cisco and its suppliers to manufacture based on actual orders,
not on projections, lowering inventory costs for both Cisco and its suppliers, while
leaving customers pleased with the speed of fulfillment. In addition, 85 percent of
customer support queries are handled through Cisco's Web site, saving the company $600
million in 2000 alone, according to Chambers. Cisco claims it has seen a 25 percent
increase in customer satisfaction since it established these portals in 1995.

Cisco uses the Internet in many other ways. It has established a business-to-business
supply chain extranet called Cisco Manufacturing Connection Online (MCO) for its
manufacturers and suppliers, which is used to purchase supplies, make reports, and
submit forecasts and inventory information. This Web site has helped Cisco and its
manufacturing partners reduce their inventories by 45 percent.

Cisco shares a great deal of its own knowledge on its intranet, whereas many
corporations believe that most of their knowledge must be guarded. The company's stated
goal for admitting many customers, suppliers, and distributors to selected portions of its
intranet, according to Peter Solvik, Cisco's CIO and senior vice president, is "to create a
relationship where customers can get access to every aspect of their relationship with our
company over the intranet or Internet."

Although the employee turnover rate is very high in most technology companies, at Cisco
it is very low. One reason may be Cisco's use of its employee intranet, called the Cisco
Employee Connection. Employees use it to enroll in company benefits and file expense
reports, and they are usually reimbursed within 48 hours. Four-fifths of employee
technical training take place on-line, saving the company employee time and travel
money while enabling employees to receive more training. Managers review their
employees, collect information on competitors, and monitor sales or other functions the
manager is responsible for, all on-line.

The company's sales database is updated three times daily, enabling managers to
determine which salespeople and regions are not meeting quotas. Engineering managers
receive e-mail alerts if a big problem occurs that is not solved within one hour. The
manager will then call the appropriate customer and offer help. When customers call
Cisco with problems, Cisco employees use its Web site to help solve the problems. About
85 percent of 25,000 monthly job applications to Cisco come over the Internet. If most
came on paper, the firm simply could not sort or read them all, much less select out and
consider the most promising of them.

Cisco even developed what it calls its "virtual close." Larry Carter, Cisco's chief financial
officer, said that it used to take Cisco 14 days to close its books, "a real hindrance." Now
the finance group achieves its close in only a few hours, giving employees "real-time
access to detailed operating data." Today, "we update our bookings, revenues, and
product margins by the minute," said Carter. "These tools and data have been invaluable
in helping Cisco manage its rapid growth. Executives can constantly analyze performance
at all levels of the organization," he claims. Cisco's systems also are used to forecast
sales. The forecasts primarily are based on past sales and current orders. "Daily
information about our product backlog, product margins, and lead times," are included,
according to Carter, and that triggers decisions throughout Cisco's chain of suppliers.
These forecasts also include information about bookings, shortfalls in supplies, and
delayed product deliveries.
Although the stock market reached its all time high in March 2000 and then started to
correct, Cisco continued to thrive a while longer and its management remained absolutely
optimistic. During market declines in past years when sales of networking devices slowed
(1994 and 1997–98), Cisco had continued to aggressively expand even though its
competitors slowed their activities or merged with other companies. Each time Cisco had
increased its market share.

However, this time proved to be different. Cisco faced a decline of two-thirds in the
technology-laden Nasdaq stock market which included a major pull back in
telecommunications, a pivotal field for Cisco. Cisco had previously projected
telecommunications sales to double in 2000–2001, but the opposite happened, resulting
in the sharp decline in Cisco's stock. In the summer of 2000 Cisco still believed its
situation was very positive. It received an outpouring of orders, so many in fact that it
lacked many parts, causing massive delays in fulfilling orders. Many customers waited as
long as 15 weeks for delivery. Cisco launched a two-fold strategy to resume filling orders
quickly. It started purchasing key components months before they were ordered, so they
would be available when needed. Also the company lent $600 million interest-free to its
contract producers so they could purchase the missing parts. Although some of these
manufacturers were concerned that Cisco was being too expansive, Cisco's July 29 year
end showed a revenue jump of 60 percent from the previous year. By September the
company backlog was more than seven weeks with a value of $3.8 billion. Although the
stock for Nortel Networks Corp., a Cisco rival, did fall 33 percent in two days because
Nortel announced slower-than-expected sales, Michelangelo Volpi, Cisco's chief strategy
officer, said Nortel had fallen prey to management "exuberance." This was not true of
Cisco, he said, because, "We try to very precisely set expectations [using our virtual
close]." Chambers emphasized that Cisco could meet Wall Street projections. Meanwhile,
two Cisco manufacturers informed the company that their shipments were slowing.

In November 2000 Cisco's orders for its telecom division reported a sales decline of 10
percent from the previous quarter. Moreover, Cisco's sales to newer companies didn't
grow at all. Some of these companies, including several that had borrowed funds from
Cisco, declared bankruptcy. Yet according to Chambers, orders were "comfortably" up
by more than 70 percent from the previous year, and Carter said Cisco expected sales to
grow by nearly 60 percent in the current quarter. The company aggressively hired new
staff. On December 4 Chambers again described the perceived slowdown as a Cisco
opportunity, following its earlier slowdown strategy. "Cisco is actually better off if the
stock market stays tough for the next 12 to 18 months," he said. However, just before
December 15, after Chambers's vaunted virtual close system told him that daily sales
were 10 percent below expectation for two weeks, he called his top sales executives, who
verified the unexpected numbers. He then met with his senior executives to let them
know about his concern over the sudden drop in quarterly sales. The group agreed to
delay both hiring and inventory building for the next 45 to 60 days.

Earlier, in late spring 2000 as Cisco was planning its 2000–2001 fiscal year to begin in
October, Chambers had said the dot.coms "had money" and "they were buying." His view
was, "To not plan to meet that growth is the quickest way to lose customers." However,
at the end of January 2001, Cisco's second quarter ended with sales to young telecom
companies down by 40 percent. Sales to dot.coms were down by half rather than rising
by half as the Cisco's vaunted computer systems had predicted. Between November 2000
and March 2001, the company had hired about 5,000 new staff, but on March 9 Cisco
announced it would lay off 5,000 (soon increased to 6,000) employees and up to 3,000
temporary workers while restructuring its business. By April Cisco was selling to only
about 150 young telecom companies, down from 3,000 companies only one year earlier.
On April 16, 2001, Cisco announced it would write off $2.5 billion of its swollen
inventory, although it was still left with an inventory of $1.6 billion, one-third higher than
the previous summer. In addition, with so many bankruptcies, barely used network
equipment had come on the market at steep discounts of around 15 cents on the dollar.

What went wrong? It was crystal clear the company was suffering from overordering.
Cisco was focused on what their customers were ordering. No one looked at the
macroeconomic factors overshadowing the entire communications industry. Someone
should have said, "These orders can't be sustained." One explanation was that, facing
delays in shipments after ordering, many customers began ordering from Cisco and also
ordering from two or three other suppliers, causing the backlog to look greatly larger than
it actually was. When an order did arrive, those companies cancelled the other orders,
resulting in a sudden, rapid backlog decline. Cisco's information systems could not
account for that situation, and so the company was misled by the very systems in which it
had so much pride. "We knew there were multiple orders," said Volpi. "We just didn't
know the magnitude." Cisco's forecasting software focused on growth data and ignored
such macroeconomic data as debt levels, economic spending, interest rates, the bank
market, and the stock market. The software was not designed to deal well with declining
demand. Misleading, though accurate, information had resulted in bad decisions.

Some observers expressed their belief that Cisco sales forecasts were way too high
because the company suffered from overconfidence after years of remarkable sales
growth. It had relied on past rosy sales and never considered the possibility that sales
might actually decline. Management was more concerned about turning away orders than
about whether the orders were real. Moreover, "People see a shortage and intuitively they
forecast higher," commented Ajay Shah, the CEO of Solectron Technology Solutions
Business Unit, a company that produced networking parts for Cisco. He went on,
"Salespeople don't want to be caught without supply, so they make sure they have supply
by forecasting more sales than they expect." Shah also noted that his company (and some
others ) saw a decline and began to cut back. He did not urge Cisco to do the same,
because, he said, "Can you really sit there and confront a customer and tell him he doesn't
know what he's doing with his business? The numbers might suggest you should." M.
Eric Johnson, an associate professor of business administration at the Tuck School of
Business and an expert in supply chains, said Cisco's outsourcing business model
ultimately worked against the company. He said the outsourcing model has "done some
wonderful things. But Solectron has to watch its own business. It matters less to them if
Cisco's numbers look off."
In sum, Cisco may have overrelied on forecasting technology, leading people to
undervalue or ignore human judgment and intuition. In November 2000, when the
economic troubles were clear to many, Volpi said, "We haven't seen any sign of a
slowdown," and Chambers announced, "I have never been more optimistic about the
future of our industry as a whole or of Cisco." Only when the virtual close showed the
actual sales line crossing under the sales forecast line in mid-December did the company
see a problem for the first time, according to Peter Solvik, who was in charge of Cisco's
information systems function.

Chambers has expressed a very different view. According to him, Cisco is suffering
because of the sudden and unexpected economic deterioration. He denies that the
company relies exclusively on its software. "Do our systems do a great job of telling us
where we are today? Yes, but they don't tell the future." He admitted that if they had
instituted a hiring freeze in the autumn of 2000, there would be no layoffs now. But, he
added, that would have cost sales and market share. "We will always err on the side of
meeting customer expectations," he said, also noting that pausing when sales hit a small
decline would have prevented the company from reaching its $19 billion sales mark last
year.

In late August 2001, Cisco underwent a major reorganization, abandoning its "line of
business" organization that had been in place since 1997. The old lines of business,
including commercial, consumer, enterprise, and service provider, were less useful as
Cisco customer interest increasingly cut across multiple product lines. Cisco replaced this
structure with a centralized engineering and marketing organization with 11 technology
groups, focusing on access; core routing; Internet switching and services; network
management services; and optical, voice, and wireless technologies. The reorganization
enables Cisco to more closely track which products and technologies are the most and
least profitable so that it can focus on them. Cisco found through this reorganization, that
its service provider business was its poorest performer and that wireless networking
technology promises rapid sales growth. The question is, how quickly and effectively can
Cisco rebound? Can it maintain its leadership role in networking technology? And is its
digital firm strategy a recipe for future successes or pitfalls?

Case Study Questions

1. Analyze the relationship between information systems, Internet technology and

Cisco's business strategy. How successful was Cisco's reliance on information
systems and the Internet? Explain their Business Model

2. Why did Cisco react so slowly to deteriorating economic conditions and declining
sales in 2000? What management, organization, and technology factors
influenced the way Cisco responded? Include evidence to support your analysis.

3. What do you think Chambers and Cisco could and should have done differently in
2000 and early 2001? Do you agree or disagree with Chambers's conclusion that
the company had to take the steps it did? Why or why not?
4. Chalk out the performance of the company after the 2001 slowdown. How are
they doing things differently now. Analyze the current competitive landscape
alongwith company’s internal and external environment scan