Editor’s note: Russ McGuire is the online director of Business Reform Magazine. Each issue of Business Reform features practical advice on operating successfully in business while glorifying God.

There is no question that Cisco Systems ranks as one of the great success stories of the past decade. No company benefited as richly from the Internet boom as Cisco, and arguably, no Internet-centric company has so well weathered the “perfect storm” that sank nearly every company in the Internet industry.

The brilliant strategy that enabled Cisco to become one of the most admired technology companies of all time was its strategy for research and development. In short, the company perfected “R&D by Acquisition” which allowed Cisco to more rapidly adopt and integrate unprecedented innovations than any of its competitors.

Unfortunately, that strategy now threatens Cisco’s ability to continue to innovate, and technology leaders that fail to innovate often fail to survive.

Before we jump to Cisco’s future problems, let’s review their shining past.

Since 1995, the company’s revenues have increased nearly ten fold from $2.2 billion to $19 billion. Net income has nearly kept pace, increasing from $452 million to $3.6 billion.

Much of this growth was directly tied to growth of the Internet. As the dominant provider of the routers on which that global network is built, Cisco naturally enjoyed tremendous revenue growth and value appreciation. Cisco used their blossoming stock value to acquire other companies with complimentary technologies to both grow the revenue stream and to broaden the base of customers and breadth of products.

Other companies, most notably Nortel and Lucent, similarly benefited from Internet growth and mimicked Cisco’s acquisition strategy. The fact that these other companies have struggled significantly more than Cisco during the past few years is further credit to Cisco’s management.

Much of this success can be directly tied to a strategy decision that Cisco CEO John Chambers and his team made in 1995. Chambers realized that Cisco couldn’t keep pace with the rate of innovation being funded by venture capitalists in startups chasing the Internet dream. So, instead of keeping up, Cisco changed its research and development strategy from internal development to external investment and acquisition. In effect, Cisco would stop trying to predict which innovations would work and matter, and stop trying to win the race to build the best in each of those categories. Instead, Cisco watched the venture-backed innovators and positioned itself to buy the winners at the right time for the right price.

Cisco nearly doubled the number of companies it acquired from four in 1995 to seven in 1996, the first year of pursuing this strategy. That pace accelerated so that the company acquired 18 companies in 1999 and 23 in 2000.

But that’s where the brilliance ends and the problems begin.

After five years of focusing externally for innovation, suddenly those external sources dried up. When the bubble burst early in 2000, venture funding for networking startups evaporated. For the most part, new companies stopped being born and many that had been formed quickly withered and died. The small number of startups that remained focused much more on rapidly establishing a revenue base that could cover the most basic operational costs than on research and development. In effect, innovation in the networking segment came to an abrupt halt.

The immediate result was a drastic drop in acquisitions. Although Cisco remained rich in the currencies for acquisitions, there simply were very few innovative technology startups worth betting on. After completing 23 acquisitions in 2000, Cisco only acquired two companies in 2001. The pace has picked up somewhat since then, with five companies added in 2002 and three so far this year. But still, this discontinuity has left Cisco’s R&D strategy in shambles.

This dramatic, and unanticipated, shift left Cisco with two huge fundamental problems.

The first problem is that, despite the company’s focus on rapidly integrating newly acquired companies, the challenge of integrating new technologies and products is exponentially more difficult. Cisco has done a great job of making the mish-mash of technologies and products work well at the most superficial level, but most Cisco customers rapidly realize that the more intricate differences still exist and must be managed.

Even worse, the core software used to provide the surface-level integration has become incredibly complex – which is generally not a good thing for software. For several years there’s been a growing recognition that this software, Cisco’s Internetworking Operating System (IOS), must be rebuilt from the ground up. To state the obvious, this would be a massive and expensive undertaking, fraught with risk.

Cisco’s second huge problem is that the company has forgotten how to innovate. Prior to 1996, Cisco had been a highly innovative technology company. For the next five years, Cisco became a highly effective integrator of the innovations of others. That shift purged the innovation gene from the company’s culture, and even though many innovative employees were retained, there was no framework within which they could stay on the bleeding edge of new networking technologies.

Most telling in Cisco’s inability to innovate has been the company’s inability to bring its one big internally-developed product to market. As early as 1999, rumors have leaked out of Cisco that the company was developing a bold new class of Internet router code named the “HFR” (for Huge Fast Router). So far, the company has failed to bring the product to market. According to LightReading, “Rumors have it that the HFR project has been cancelled and revived at least two times in the past three years. Some sources say that the central problem has been the software, which would require Cisco to come up with a brand new version of IOS.”

Unless there’s a sudden burst in venture-funded innovation in the networking sector, Cisco will need to solve these two huge problems if they hope to remain the industry leader. Already, competitors like Juniper Networks, Foundry Networks, and Extreme Networks are showing their ability to gain market traction based on internal innovation.

In 1995, few could’ve imagined the relative positioning of Cisco to Lucent that we see today. If Cisco doesn’t quickly find some long-term answers, a few years from now we may look back on a similar Cisco slide.

“Innovate or die” may be an over-used clich?, but for Cisco, it may become a true prophesy.

Russ McGuire is Online Director for Business Reform. Prior to joining Business
Reform, Mr. McGuire spent over twenty years in technology industries, performing various roles from writing mission critical software for the nuclear power and defense industries to developing core business strategies in the telecom industry. Mr. McGuire is currently focused on helping businesspeople apply God’s eternal truths to their real-world business challenges through
Business Reform’s online services. He can be reached at [email protected].

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