Global CIO: Cisco Zapped By Destructive Power Of Innovation

The really big problem for Cisco—as is true of so many large, sclerotic companies that count on the government for a lot of their business—is that the prices that the firm can charge for its core business are dropping faster than sales, writes Markman in a piece called Cisco Systems Inc.: The Story That Wall Street Missed.

Think about that for a moment. Revenue for switches—a huge part of Cisco's business—fell. That was bad enough. But margins thinned—which is even worse. (End of excerpt.)

How can this be? At a time when companies are frantically expanding their use of online communications and networks for everything from collaborative design to meetings to research to blueprints and video and so much more, the demand for high-capacity and ultra-reliable networking gear has never been stronger.

Why has Cisco not been able to exploit this market demand more aggressively—and, beyond that, why have its growth projections receded to the point where Chambers is reluctant to say if his company can return to its recent 12%+ growth rates?

Ironically, it appears that Cisco, which for the past 15 years has sold products, services, and know-how that helped its customers in every industry accelerate their pace of business and be able to move at the speeds their marketplaces demand, failed to take its own medicine.

Here's how Markman describes the profit-pounding dynamic Cisco is undergoing:

Yet the elephant in the room is the fact that competitive pressures are forcing Cisco to move customers to new products more quickly than it intended, according to research analysts for Signal Hill Capital LLC. Channel checks suggest that sales of the company's largest switching platform, the Catalyst 6500, slowed at the end of 2010 as the product rapidly become uncompetitive from a price and functionality perspective. Responding to this trouble like a SWAT team, Cisco did finally migrate customers to its hot new product lines, the Nexus switch family and the ASR routers family. Both of these are more competitive—but at much lower margin. Ouch! (End of excerpt.)

So because it was not—and perhaps still is not—keeping pace with the requirements and demands of its customers, Cisco's high-margin legacy products are being cannibalized by its new gear, which offers the performance levels customers need but can't yet deliver the profit margins investors demand. And this deep-seated problem of Cisco's, says Markman, is not going away anytime soon.

"This is not a problem that can be fixed in three months," he writes, because as Web traffic booms and enterprises buy and deploy more-powerful networks to keep up, those recession-hardened customers aren't willing to pay the premiums Cisco used to be able to command—and competitors like HP and Juniper are more than willing to ensure that pricing pressure only intensifies.

So although Cisco's been able to migrate its big customers to its new high-end products, the whipsaw effect has been that "because [Cisco] has so many employees and so much overhead this increased business is not dropping to the bottom line," writes Markman.

And as a result, "We are watching the destructive force of innovation at work."

It is ironic indeed that Cisco, which over the past couple of decades has helped thousands of customers unleash that very same "destructive force of innovation" on their competitors, is now feeling some of the blunt-force trauma of innovation's unyielding edge.

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