For Cisco, It’s Change or Perish
By BRET SWANSON
April 18, 2001; Page A22
Oh, how the mighty fall.
It wasn't so long ago that Cisco Systems was
the world's largest company and the envy of all the
technology industry. It had exceeded published earnings
estimates 14 straight quarters in a row, was hiring like
crazy, and had topped $555 billion in market
capitalization. These days, Cisco is slashing 15% of its
workforce, missing all its numbers and wondering
where more than $400 billion of market value went.
To his credit, Cisco head John Chambers saw
things coming and was the first chief executive to
smartly call on the Federal Reserve to cut interest rates
and for Congress to cut tax rates. But unfortunately for
Cisco, Washington getting its act together won't be
enough to put the networking company on the rebound.
That's because Mr. Chambers's real problems aren't
economic. Cisco is increasingly in the wrong business.
Heroic Processing
The company that defined the 1990s and made the
Internet possible is being squeezed from above by fiber
optics and from below by microchips. It has a core
competency in neither. Cisco's great advance was its
vision for the first post-telephone network. It developed
the architecture and crucial software standards that
made the Internet work. Then it cobbled together the
chips and wires and code into high-margin boxes that
few others knew how to make. But unless Mr.
Chambers can set his firm on a new path, Cisco will be
remembered as a transitional, if temporarily
transformative, enterprise.
The key to understanding Cisco's prospects is
to understand the history of communications networks.
Real-time communication over a distance was first
made possible by Samuel Morse's telegraph, or copper
wire carrying electromagnetic signals. As technology
evolved we were soon able to send voices, rather than
just simple dashes and dots. Voice calls were switched
by operators plugging wires into a switchboard. Later,
this switching function would be overtaken by
mammoth electronic boxes from Lucent and Nortel.
Still, the architecture remained the same for
nearly a century: Each telegraph or phone call received
its own connection. You may have only used your
telephone 20 minutes a day, and you may have only
spoken 15% of the time, but the connection was always
there. Relative to the application, we had a lot of
bandwidth to spare.
Enter the Internet. With the first online
services in the early 1990s and the introduction of the
Netscape browser in 1994, the data-centric Internet
became a phenomenon. E-mails, Web browsing, and
later e-commerce threatened to overwhelm the voice-
optimized telephone network. The mostly copper
telecommunications infrastructure wasn't ready.
Broadcom, Applied Micro Circuits,
EZchip and others are integrating more
and more of the functionality of Cisco
boxes
Cisco foresaw this data explosion. And it
found a way around the narrowband copper links to
offices and homes, as well as the more capacious -- but
still not big enough -- fiber-optic strands connecting our
cities. Cisco discovered that if you didn't give everyone
a connection, but instead chopped up the messages and
gave the packets a destination, you could throw the
packets out into the Internet, let them take any number
of paths, and then have them reassemble at the other
end. The new Cisco-powered network was ruthlessly
efficient. There were no more circuits between users.
There was no more silence. The Cisco network used
every bit of bandwidth available.
Now, bandwidth scarcity is over and Cisco's
time has passed. The new all-optical network doesn't
need heroic processing of billions of bits each second.
All it must do is change the direction that light travels.
The Cisco network treats messages as bits rather than
lightwaves, laboriously processing what should simply
be steered. It's as if rivers worked not by banking the
flow of the stream but by checking and sorting each
H2O molecule for its KMI reports that in 1999 and
2000 some 150 million kilometers of optical fiber were
laid world-wide. Avanex, the leading optical networking
company, can make and sort and direct thousands of
colors of light, each carrying distinct messages, down a
single fiber strand. Yipes is connecting urban business
directly to fiber, and wireless start-up Soma Networks
can supply residential broadband connections that are
faster than copper DSL or broadband cable TV. Cisco
and its big, central routers can't handle this second wave
of data. And right now it has no back-up strategy.
Focused for too long on routers and other
electronic network modules, Cisco doesn't now have the
optical capabilities to prosper in a new world of
bandwidth abundance. Just weeks ago Cisco announced
it would shut down one of its lone optical plays,
Monterey Networks. Commenting last May, we noted
in the Gilder Technology Report that there were too
many real optical companies for Cisco to simply
dabble: "Cisco's $500 million investment in Monterey is
suddenly irrelevant and will never be a significant
factor in the network. . . It's Sonet hardware investment,
$7 billion for Cerent, may be even more fruitful than
anticipated in the short term . . . but faces an even
shorter life expectancy." Indeed, while Cerent was a
revenue star in 2000, in 2001 it has already been
rendered obsolete by the continually multiplying colors
of light from Avanex, ONI, and Sorrento.
Creative Destruction
Of course we will still need electronic terminals and
routers and switches at the edges of the network. But if
Cisco's failing optical strategy weren't enough, its
products are increasingly being disrupted by Moore's
Law of microchips. Broadcom, Applied Micro Circuits,
EZchip and others are integrating more and more of the
functionality of Cisco boxes -- all the wires and
separate processors and software -- onto single silicon
chips. If the router becomes a chip, what does Cisco
have to sell except its software and protocols?
The destruction in the market affords Mr.
Chambers a perfect opportunity to practice some
creative destruction on his own company. Namely, he
needs to remake it in the image of the new all-optical
network.
Mr. Swanson is a technology analyst at the Gilder
Technology Report.