Channel Decisions for Cisco Systems" In 2000, Cisco Systems was the world’s most valuable company, with a market capitalization in excess of $500 billion, sales of over $18 billion, and an elaborate structure of 6,000 channel members worldwide, Although it had originally started as a direct sales company, its explosive ‘growth through the 1990s (due in part to the rise ofthe Internet) required the addition of channel partners to serve the large increase in customers across a wide variety of market segments. In- deed, with the rapid rise in the Internet and associated technologies, and caught up in its own. “tornado,” Cisco's channel strategy was one of “box pushing”: Offering its products for sale through the largest nurnber of channels allowed the company to grow very quickly Cisco's Historical Distribution Channel Strategy Its various routes to market (distribution channels) can be seen in Figure 9.1 with the following breakdown: + Cisco direct sales (through its own sales force to business customers): 10% of total sales + Information technology (IT) consultants and “systems houses" (such as IBM and Accen- ture) who provided full-service consulting for IT needs and bundle a total solution for their business customers: 25-30% of total sales + Value-added resellers (VARs) who added unique value in regional and niche markets, serv- ing not only large enterprise customer accounts, but also small and medium enterprise (SME) accounts: 30-35% of total sales + Distributors (such as Tech Data) who handled stocking, logistics support, and order fulfill- ment for smaller VARS: approximately 10% of total sales Despite its “box pushing” approach, an important pat of Cisco's strategy was collaborative selling between its 10,000-strong worldwide sales and field marketing organization and its VARs to gener- ate demand, design solutions, and fulfill orders. Indeed, roughly 22% of Cisco's revenue was gen- erated by channels prospecting for customers on their own, while the remaining 78% was generated from leads prospected by Cisco itself and then placed with resellers and other channel members. In the late 1990s, Cisco categorized VARS according to both the volume of business they did ‘with Cisco Systems and the level of technical suppori/certification of the VARs’ employees. Each category received differential discounts from Cisco, Of the 3,000 VAR in the United States, ap- proximately 2,200 were in one of three preferred categories, with about 5% in the Gold, 5% in the Silver, and 90% in the Premier categories. 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Cisco's Distribution Channels Hosvever, with the technology slowdown in early 2001, Cisco found tbat dividing its dimin- ‘ishing total US. sales volume among 3,000 VARS caused extreme levels of inrubrand competi | ‘on in its channels; this was competition among Cisco's own channel members selling Cisco | products (in contrast (0 interbrand competition, which occurs between Cisco and competitive networking products). In order co retain te loyalty and commitment af VARS to its product fine, it was faced with reducing the total number of VARs: “With brisk demand for routers ancl switches gone, Cisco VARs were increasingly at loggetheeds with one another and with Cisco."? ‘The channel conflict wes due aot only to overcrowding in he shrinking marke, but also tout least three other factors: + Telecomimanications providers who previously had been Cisco's end users began reselling Cisco products as par oftheir own services to their own customers, Because these telecom ‘munications companies owned the wires that connected their customers’ wide-area com- paler networks, geting into network solutions was a natural way for them to grow their own, revenues and offer more services to their customers. Cisco could realize a large volume of sales through this channel, bt it ended up commoditizing their products, For example, one | telecommunication provider offered the Cisco products for Itee as an incentive to close the { dead. Telecommunications companies could use this strategy beeanse, rather than being a focal part of the telecommunication provides solutior to customers, the Cisco component ‘was typically less than 5% of the total package being sald, VARs complained bitterly of these new competitors’ “dumping” techniques (i.c., selting products below costs in order to | maintain their customer base) *+ tn 2001, Cisco pioneered « direct onfine sales channel that bypassed or disinlermediaied the VARs and allowed Cisco to connect directly to the end customer. The goal was to sll317 preconfigured low-end equipment (“network in 1 box") that required wo advanced network- ing skills to install (o smaller ex customers. Although Cisco inaintained that this channel would “merely funnel away low-volume, fow-dollar-amount (ansactions on a limited num- ber of low-margin products so that resellers could forus ov obtaining more leerative busi- ness," the fact hat Cisco's new werefess networking line, an area of high growth, was also available on this website seemed to undermine Cisco's pledge to resellers, Moreover, as one reseller said, “We have customers who would be buying these proxucts, and our design services and implementation as well. This online site pegs the price forthe market [limiting our pricing flexibility]. And. you can bet that big customers will be clicking there too. Cisco competitors moved rapidly to exploit the unhappiness of Ciseo's VARS, offering them generous deals to carry their produets instead, Clearly, Cisco faced a challenging channel situation, 2004 Channel Redesign ‘In aradical approach lo channe} management, Cisco completely changed the criteria for VARs to participate at the Gold, Silver, or Premier fevels; it eliminated the sales volume requirement, and instead implemented a point system in which VARs were categorized based on the value they saddled to the Cisco solution, Value-added points could be earned by: + Technology speciatication: Selling products and building expertise in Ciseo’s new product initiatives + Engineering expertise (certification of employees): & previous criterion that wes relaincd, but made more stringent + Customer satisfaction levels: Uiizing surveys conducted by an independent research provides to award points for exceeding numerical targets for customer satisfaction, including pre-sales and post-sales support, responsiveness, communications, systems engineer avail- ability and shill levels, an the ability to diggnase problems { This recategorization now allowed small bet highly slled VARS to compete with larger ones j based on value added, since the discount they received from Cisco was exactly the sumte. More- over, the inclusion of customer satisfaction allowed small regional VARS to show the value they provided to Cisco end users. Cisco continued with its collaborative approach between its own sales Force an the VARS, | including the resellers earlier in the sles eycle in pursuing Cisoo-generated leads. In addition, Cisco provided sophisticated advice to its VARs about how to enhance their ovn profitability, of- fering consulting about, for example, how to cralt sophisticated service offerings, On the basis of this channel redesign, the number of VARs fell from 6,000 worldwide to 3,000, with about 1,200 dropping out in the United States alone. The overall effec was to de- crease competition among resellers. Cisco now had 1,000 partners going alter $9 billion in U.S. business, instead of 2,200. Now, Gold, Silver, and Premier pariners consiituted 15%, 10% and ‘75%, respectively, of the total number of VARs, and—importantly—Cisco represented up {0 70% of a specific VAR's overall revenues, Many VARs were pleased wit the new strategy. saying that the field was naw competing on the basis of value and solutions, rather than price discounts, Channel Challenges Based on New Technologies and Products Cisco's product strategy focused on identifying high-growth markets with a forecast of $1 billion per year in sales, For example, early in 2003, Cisco identilied the home consumer networking j market, with a growth rate of nearly 40%. Although this market was only $800 million in 2003, it was projected to be a $4 biflion-a-year business in 2008. So, Cisco purchased Linksys, a (continued)