How a Once-Smart Cisco Temporarily Lost Its Mind

In his book One Up on Wall Street, Peter Lynch warns investors to watch out for "diworsifications," misguided attempts by a company to boost its slowing business through expensive acquisitions. More often than not, the acquisitions fail to pan out, forcing the company to go through a period of restructuring to undo the damage.

To see a case study in misguided acquisitions, just take a look at Cisco Systems' (Nasdaq: CSCO  ) failed attempt to enter the consumer-electronics market.

The shopping spree
Cisco's diworsification began innocently enough, when the company purchased the home-router company Linksys in 2003. On the whole, this move made sense. The acquisition allowed Cisco to move into consumer products without straying too far from its bailiwick.

Unfortunately, Cisco didn't stop there. In 2005, it bought Sipura Technology, a maker of VOIP hardware, and Kiss Technology, a maker of networked DVD players. It followed these purchases up by acquiring the No. 2 set-top cable-box manufacturer, Scientific-Atlanta, in early 2006. Shortly thereafter, Linksys announced that it would form a new business unit focusing on home entertainment and then proceeded to release an unbroken string of flops over the next four years.

It seemed that every device Linksys brought to the consumer market after Cisco acquired it was either rendered unnecessary by some other product or was simply a bad idea. For example, the Linksys Media Center Extender played DVDs and also streamed media from a windows PC over Wi-Fi. Sounded great, but the Microsoft (Nasdaq: MSFT  ) Xbox360 offered the same features, along with the ability to play games, rent movies, and stream Netflix. The Linksys iPhone, which was specifically for VOIP services such as Skype (and had no relation to that other iPhone), quietly transitioned over to a line sold by Netgear (Nasdaq: NTGR  ) . Finally, its multi-room music system died -- because multi-room music systems have failed to interest the public since the 1960s.

The poor consumer-products choices eventually spread beyond Linksys to Cisco proper. The company's acquisition of Flip, a company that made handheld camcorders, quckly floundered after smartphones such as Apple's (Nasdaq: AAPL  ) iPhone 4 began offering HD video. Umi, Cisco's grossly overpriced home-teleconferencing system, had no chance against the free alternatives offered by Skype, Apple, orGoogle, or even lower-priced offerings from Logitech (Nasdaq: LOGI  ) .

Meanwhile, the company began to lose market share in its core businesses as new competitors such as Hewlett-Packard (NYSE: HPQ  ) and Juniper Networks (NYSE: JNPR  ) entered the market. Investors started wishing that Cisco would leave consumer gadgets to Apple and return its focus to its core business. This past April, CEO John Chambers had to admit it was time to change course.

Restructuring and ramifications
In a message sent to Cisco Employees, Chambers outlined the company's main priorities as "leadership in core routing, switching and services; collaboration; data center virtualization and cloud; architectures; and video." Consumer products failed to make the cut. The company killed its Flip video camera and shifted Linksys' focus back to selling home-networking equipment. The Umi seems to have survived in some form, but only because Cisco plans to integrate it into its Business Telepresence line.

Although I believe that Cisco's forays into consumer electronics were somewhat boneheaded, I don't think they did much long-term damage. For all of its missteps, the company has remained profitable and generated a five-year average return on equity of 20.2%. Its trailing-12-month return has dropped to 15.3%. Now that Cisco has come back to its senses and is focusing on fixing internal organization issues that kept it from competing effectively, I expect the downward trend to reverse -- that is, unless the company decides to go on another spending spree.  

Want to keep an eye on Cisco? Add it to your Foolish Watchlist.

Fool contributor Patrick Martin owns no shares of any of the companies mentioned here. The Motley Fool owns shares of Google, Apple, Logitech International, and Microsoft and has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Logitech International, Cisco Systems, Netflix, Microsoft, Google, Netgear, and Apple, as well as buying puts in Netflix, shorting Juniper Networks, and creating a diagonal call position in Microsoft, a bull call spread position in Apple, and a write covered call position in Logitech International. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 17, 2011, at 9:02 PM, showme wrote:

    Another issue I have with Cisco is it has continued to buy back shares and issue them to management as low priced options. When done on the scale Cisco does it hurts shareholders. My big mistake is not dumping it when it became obvious it could care less about shareholders.

  • Report this Comment On June 17, 2011, at 10:10 PM, ZZyzxZZ wrote:

    "Investors started wishing that Cisco would leave consumer gadgets to Apple and return its focus to its core business."

    I find it hard to believe that John Chambers is involved in the day-to-day operations of everything Cisco does. When they bought Linksys, did they fire the existing management? Or tell them what products to develop? Or simply let the current management run the company, and make the mistakes that were made?

    'Focusing' on their core business, the one that made them the money to buy other businesses: What exactly does that mean? Ever heard of a conglomerate? Berkshire Hathaway? Warren Buffett? Wells Fargo isn't doing so good lately. And his re-insurance companies are paying a lot of claims this year. Should Buffett sell off these companies and 'focus' on textile manufacturing which was the original business of Berkshire hathaway?

  • Report this Comment On June 17, 2011, at 10:47 PM, pmart wrote:

    ZZyzxZZ,

    come on due, invoking Buffet is hardly fair. The man is in a class of his own. Remember, I said that more often than not these acquisitions fail. Buffet is the not. Even so, he wouldn't move into a business he didn't understand. Clearly Cisco didn't understand consumer electronics (other than home networking, I still love Linksys's routers).

    I also probably didn't make this clear enough in the article, but I actually like Cisco and John Chambers. Yes the company went astray, but I think it woke up and is now moving in the right direction.

    -Patrick

  • Report this Comment On June 17, 2011, at 10:47 PM, pmart wrote:

    and by "due" I meant "dude," my bad.

  • Report this Comment On June 17, 2011, at 10:59 PM, ZZyzxZZ wrote:

    You didn't answer my question. Do you think Cisco fired management, dictated to management, or let management continue to run the companies they bought?

    I think Buffet let's the companies he buys run themselves.

  • Report this Comment On June 17, 2011, at 11:27 PM, Room4Rent wrote:

    Cisco didn't get in trouble because of Linksys; Cisco got in trouble because of John Chambers. They have been in trouble for 6 to 10 years, depending on how you mark the turn.

    Chambers forgot, or never knew, the real strength of Cisco was the Cisco Culture and Cisco people. They all benefited when Cisco did well; all suffered when it did poorly. As such, everyone helped everyone so that as a team, Cisco prospered.

    But Chambers ended that. He laid in a process that it was every man for himself. Helping someone didn't benefit you, it hurt you in your Focals. So the savvy realized teamwork would cost them bonuses and raises and even their jobs.

    So things fell apart.

    Then Chambers was dead-set on global economy. Send work to China. Send work to India. Get rid of Americans. The Chinese stole the technology (surprise!) and the Indians just don't produce the work right the first time through. We knew that. Chambers didn't. And the stock has fallen for 10 years.

    The salvation of Cisco is the resignation of Chambers and most of the management he put in place.

  • Report this Comment On June 17, 2011, at 11:32 PM, pmart wrote:

    Sorry, I got distracted by Buffet. Based on how closely Linksys's consumer products matched Cisco's acquisitions, I'd say that Cisco had a pretty heavy hand Linksys's moves. The rational seemed to be (remember this is all supposition based on what I've observed) buy a well known consumer product and then use it to launch a bunch of consumer electronics. The important thing is these days are behind Cisco. I respect John Chambers for his willingness to recognize that the company's organization has gotten in the way of its success and to take steps to fix it. If you haven't read it I recommend checking out the memo he sent to his employees earlier this year. http://blogs.cisco.com/news/message-from-john-chambers-where...

    I think you're right about Buffet. He buys good companies and lets them continue to be good, although he's had his failures as well. Geico offered it's customers a credit card a while back. It bombed so severly that Buffer apologized to share holders in his annual letter that year.

  • Report this Comment On June 18, 2011, at 5:45 AM, ZZyzxZZ wrote:

    I read John Chambers memo. There's not a lot of meat on that bone. It's basically a cheerleading effort to boost employee moral. He could have simply said: "I'm sorry your stock options are worthless because the stock has gone down not up. Try harder."

    The problem investors have with Cisco is their once huge margins aren't so huge any more. There's competition. It was bound to happen. Do you think Apple is great at innovation? Well, there are more Google Android phones now that there are iPhones.

    The reasons the acquisitions are so criticized is because their margins never were as great as Cisco's core business.

    If Cisco were not developing new products (like at Atari in the early 80's when they owned the video game industry and were bankrupt a few years later), then let me know. I don't know squat about the state of the art in switching and routing. I do know that they spend a lot on R&D and are still by far the leader in these areas.

    Is Routing and Switching vulnerable to new technology? Could Cisco wind up like Research in Motion and become a loser? I don't know, but their declining market share seems normal to me and not falling off a cliff.

    The press on Cisco has been bad all year. One commentator said, as Cisco dropped one day, that 'Nobody was buying the stock." I got news for him: 80 million shares were traded that day. For every seller there is a buyer. Last year the same thing was happening to Qualcomm. Once it bottomed out and then reversed, the stories all got positive again. Maybe John Chambers should keep his mouth shut during conference calls. Cisco stock went UP 5% after the last earnings announcement in after hours trading. Then Chambers gloom and doomed everybody in the conference call and it lost that 5% and a whole lot more in minutes.

    I thing at $15 this stock is a bargain. But I don't know much about Switching and Routing for servers and big business. I'm trusting they won't be a Research in Motion and get left behind.

    TMFpcmart03, tell us what you know. Your article has lots of details about Cisco's acquisitions.

  • Report this Comment On June 18, 2011, at 7:14 AM, khaledmrd wrote:

    I personally Like Logitech Strategy of new

    * Consumer Push into Tablets accessories, Smart TV, Digital Home & Video calling

    *New Business Division focusing into Accessories, Solutions, Devices for the Business and the big move into Unified Communication and Video/Audio Communication

  • Report this Comment On June 18, 2011, at 11:33 AM, BradReeseCom wrote:

    Hi Patrick,

    Regarding Cisco's breathtaking greatness as the self-anointed masters of the business universe, Cisco's Senior Vice President, Strategy and Planning, Worldwide Operations - Inder Sidhu stated:

    "Over the past seven years, in a highly unstable global economy, Cisco doubled revenue, tripled profits, and quadrupled earnings per share. How?

    "By Doing Both.

    "When companies face key strategic decisions, they often take one path and abandon the other. They focus on innovation and new business models at the expense of core businesses or vice versa. They stress discipline and sacrifice flexibility. They focus on customers and ignore partners.

    "And they struggle.

    "Cisco believes there is a better way: Doing Both."

    http://www.bradreese.com/blog/7-11-2010.htm

    Sincerely,

    Brad Reese

  • Report this Comment On June 19, 2011, at 8:01 AM, msteg01 wrote:

    There are other problems at Cisco:

    - During the boom years Cisco beat the competition by hiring away the 'talent'. A lot of that 'talent' was actually deadwood that still clutters Cisco to this day: deadwood that is a lot harder to get rid of than to take on.

    - Cisco's core business is selling to enterprises - let me rephrase this: their core business is selling to ~500-1000 'buyers' who make up most of their business and all of their profit. 'buyers' who are extremely subject to price scrutiny by accounting departments, 'buyers' who hold grudges for years and years and who get fired if they make a poor decision, 'buyers' who are prone to bribes and getting bought off and who often retire and who are generally required to justify purchases through competitive bids.

    - Cisco's core business is extremely prone to commoditization: IETF 'standards' specify exactly how Cisco routing/switching products will interoperate. So why exactly would a customer buy from Cisco rather than a competitor? How can Cisco differentiate their product line when the products are built exactly to IETF specs and when Cisco diverges from IETF spec customers will not buy their product (interoperability standards are a big deal in the network business)?

    - For years Cisco's strategy was to monopolize the industry talent (as stated in the first point). This took the form of direct hires as well as 'certifications' where reseller's discounts were based on the number of Cisco certified techs they had. This worked when the industry was booming and the internet was distracting potential talent and Cisco was able to create a situation where everyone in the industry had sworn allegence through certification programs. In a down economy this does not work well - there are currently may people happy to learn and / or become certified in Ciena or Juniper gear or some other competitor.

    - Cisco is prone to getting squeezed out of their market. Both carrier network suppliers and computer/database manufacturers make overlapping equipment that can be easily re-purposed to route/switch data packets. Don't be surprised if Oracle decides to turn their Sun UNIX servers (that already provide a software stack and routing that is better than Cisco's) or Oracle's database technology into hardware routers that make Cisco's gear obsolete. In fact, the network routing equipment is really just a little database that looks up address pairs (in the case of switches) or network to interface pairs (in the case of routers) to decide the next hop: Oracle's second string engineers would eat this network hardware market like a snack and add 100B into Oracle's revenue stream.

    - Cisco rode the 'y2k' wave that is gradually winding down. During Y2K there developed tremendous momentum for 'same vendor systems': corporations got this idea that buying all their equipment from one vendor was a good idea: and corporations paid a premium for buying this way. Cisco was able to temporarily freeze out the competition. Gradually this 'same vendor systems' sentiment has faded away and companies are returning to the previous competitive bid environment.

    Good luck to Cisco: there are a lot of other beaten down tech companies right now to choose from that don't have all the problems that Cisco does.

  • Report this Comment On June 26, 2011, at 1:27 AM, marvin83 wrote:

    @ZZyzxZZ

    Kinda late to the comments, but didn't read the article until tonight.

    Anyways, while I appreciate you opinion, regarding the iPhone statement you made, it's clearly simple-minded. There's just 1 phone sold with the iOS. Do you think that the Android would be a huge threat to iOS if Apple put iOS on 50+ different phones like they did Android, I highly doubt it. You have to remember, count how many devices run the Android OS; phones, tablets, netbooks; a handful of devices from dozens of manufactures. How many run the Apple's iOS? Apple iPod (Touch only), iPhone, iPad; 1 manufacturer.

    Sorry, I just hate that idiom people always use to scapegoat to price Android is better by saying they have a greater market share. Well, no sh-t, it's 1 phone vs 50, are you really surprised? But it's how Apple wants to be, proprietary.

    @Patrick Martin

    Great read. I prefer Netgear over original Linksys and post-Cisco Linksys, but that's mainly, originally, due in part to the ugly plastic-y feel of Linksys devices over the more rugged, robust Netgear devices. It's not the case so much anymore for Netgear since I'm sure it's easier and cheaper to make everything inside plastic, but nonetheless it's my brand of choice. I did receive CCNA 8+ years ago and if I could afford it I'd run all Cisco, not Linksys, in my house, but that's just something that doesn't lie in the cards for me.

    Anyways, keep up the good work.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1509033, ~/Articles/ArticleHandler.aspx, 12/21/2014 11:53:00 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement