John Chambers and You

Silicon Valley jaws dropped. Wall Street, too. "Was he panicking?" some wondered. "Was he out of his mind?"

In retrospect, it appears that Chambers may have been the only CEO of a network-infrastructure company that wasn't. His six-point plan to fix the company added stability to the entire economy. More important, he says, it put Cisco in an enviable breakaway position. His goal: to gain an unprecedented 10 percent market share over his rivals in a single year. Thanks to their near collapse, he did far better than expected.

"If the analysts are right that we are flat or slightly up,and I'm not saying whether we are or not,that's a 45 percent market-share difference in one year," he says.

With momentum finally building again, Chambers is cautiously taking the first few steps at building enthusiasm for his beleaguered sector. Whenever possible, he sings the praises of IT advances in networking and the continued productivity boosts that result from shrewd investments in them.

But not all is well at the San Jose, Calif.-based company,at least as far as partners are concerned. In addition to several of Chambers' biggest partners creating a huge headache for the rest, the economy has yet to rebound, especially the high-tech one he says has endured a 100-year flood.

"People teased me for saying that, but as it turned out, it was probably worse than a 100-year flood in technology," Chambers says. In a recent interview with VARBusiness, editorial director Robert C. DeMarzo and senior executive editor T.C. Doyle, Chambers addresses a variety of issues,everything from partnering to price erosion to technology advances. As we did with interviews with Microsoft chairman Bill Gates and Intel CEO Craig Barrett, VARBusiness posed questions submitted by readers to Chambers, who demonstrated a unique grasp of partner issues. In fact, he concedes that he's closer to their concerns than at any other time in his tenure with the company.

Given the challenges that remain, it's not a bad position to be in.

VB: If you were running a small, Silver- or Premier-level partner organization today, what would you be doing, and what would your priorities be?
Chambers: If I were a typical partner today, I would be modeling for where we are going today. The market, as we have said publicly, in our opinion, appears to be leveling out with a slight upward bias. Whether that's going to last one quarter more or six quarters more remains to be seen. Further- more, the market is going to consolidate. That's true for both my partners as well as within my customer base. You want to be on either side of this, except for the side that gets left without

a chair.

Being a consolidator is fine and being a consolidatee is fine, but not the one that's left without a chair in the process. Finally, there's understanding your profit contribution by segment. There's going to be money to be made in each segment. You can make money just installing equipment and doing network design. But the problem is, you're going to have to do that at a much higher level of productivity than you would have two years ago. You can make money adding value-added services on that, or even business-value services or outsourcing. So you need to determine which segments of the market you're going to play in, and what your cost structure for each of those is. That's changed dramatically.

Cisco is saying we're half the industry cost-structurewise, and yet we are going to drive [productivity by 50,more like 100 percent,more over the next three to five years. My partners have to do the same. So, at the end of the day, it's outlining your strategy and making the changes as quickly as you can.

VB: Do you have too many partners? One VAR wants to know how you can better manage the sheer number to mitigate conflict.
Chambers: The issue isn't one of the number of partners. Remember, in an industry that even the pessimists say will grow 10 percent,and the optimists say will grow 25 percent,there's going to be room for a large number of partners. Secondly, Cisco does not believe that it should be part of our strategy,so long as I'm president and I'm sure long after I'm gone,to do a vertical model where you try to do everything yourself. So for both good business reasons and otherwise, we believe in the partnering model. I think the market will automatically determine how many partners will go into an industry segment. And the market will automatically determine whether Cisco has 30 percent of that industry segment or 50 or maybe 70 percent. Then you have to ask how many partners you have in an area that differentiate themselves. And you don't want to be in a dot-com bubble where you have 30 companies providing a bid and no single one adding any value. In situations where it's all about price, nobody wins. It's how each of the partners says, "Here's my differentiation; here's how I position myself in the market to customers, to joint customers and to Cisco." They need to say what segments they are going to play in and to be realistic.

If you haven't got a differentiated plan, and you've got other large competitors that are much more cost-effective with

higher productivity and higher customer satisfaction, you're not going to win. So, you've got to say it is a race. But, of equal importance are the brand, the culture and the talent you have to win. I think that is one of the most fundamental changes of all. So, to answer the question directly, no, I don't believe we have too many partners. But I think we have all got to do a better job of saying what is our differentiation. And we have to do a better job on a couple of our large channels that aren't playing within the guidelines and bringing in value-add [but are instead putting through products at or below cost.

VB: That leads into the next question. Andy Swenson, president of Integration Specialists, Clearwater, Fla., wants to know: Will Cisco work to rectify the telco-carrier problem and what they are pushing through at or below cost?
Chambers: It's only two major ones. And with the two major ones, I expect to get that corrected. This is an issue where the telco is not making money, my value-added partners are not making money, and Cisco isn't either. This isn't a win for any of us. We've got to ask how we work together,where you add value to where everybody makes money in the process and where is the extension of it. You do this not by drawing a line in the sand, but by saying to your large partners, "You're not within the spirit or essence of the agreement" in terms of why you are getting the discounts in terms of value-add. You share with them what you think the best model is to partner with our other partners. The ecosystem, I think, actually works well. [Carriers are after transport and volume off transport. My value-added partners are after what value they add on to that, which generates more load, and I'm after getting a satisfied customer and good profits. Those three actually go well together.

Having said that, we have to be firmer with the partners that are misusing their positions in the industry, which we will do. After a meeting at our partner event, two partners involved in this came up to me afterward and said they didn't realize the strength the Cisco value-added partners bring. They said, "We now understand it's better in the combination than it is individually, and we clearly understand we are putting you in a no-win [situation with your partners in terms of what we are doing pricing-wise, and probably misinterpreting what our commitment was to you." So, that's a classic approach where nobody's winning and you say, "Can we turn it into a win-win-win?"

Is the question right? Yes. Do we have to fix it? Yes. Am I committed to fixing it? Yes. And that includes my commitment to the top CEOs [of those companies and to the partner groups. As long as you do it without drawing a line in the sand, people are fair. And if you point out to them that it has to change, as long as they know that you are really serious and that you aren't doing this as a nicety and to "yes" somebody, then they will change.

VB: Steve Struthers, a Cisco specialist from TekConnect, Cherry Hill, N.J., wants to know whether your gamble with specialization turned out as well as you thought. His company, like others, was told a year ago to specialize. He's wondering if it netted you the benefits you wanted.
Chambers: You can't specialize in six months or a year. When you make transitions, it's three to five years. That's why you outline three-to-five-year goals, like we have in each of our [groups inside Cisco. We have one-year initiatives, but then you also build off your mission and vision. And remember, our mission statement is to create unprecedented opportunities for our customers, our employees, our shareholders and partners. Those have been the four cornerstones since I got to Cisco.

So, is specialization absolutely the right way to go? Yes, because if you think of the value- add that our distribution partners or systems integration partners have, it varies. You can make money on value-add for only reselling the equipment and providing the network and design and making sure it works. But if you're doing that, you have to do it at a much lower cost, because the margins are going to be squeezed at the top end. If you don't bring your costs down dramatically, you're not going to make any money. Or you can make money saying, "Let me bring applications into that." Or you can make money on outsourcing. Or you can make money helping to transform a customer's business. Or combining with others to accomplish those goals. It's like an equation in the economy. You have got to say which variables you are going to plug in. And you have to be realistic and know what your margins will be. So, moving into new market opportunities with higher potential margins, if done right, is absolutely what a number of our partners will do. If you aren't going to do that, you have to realize that you have to really bring down your costs, because just as other distribution channels have found over time,and Cisco is no different,you have to ask where the value-add in the market is. It doesn't mean that for basic services you can't get a good profit. But it does mean that you have to do it at a lower cost.

Using Cisco as an example, we've realigned our resources. We've moved a large part of our resources to where new growth opportunities are going to be with higher margins. But we

didn't abandon some of the opportunities of today that [weren't as profitable, we just took the resources down on those or increased the productivity in a different way. And, I think our partners have to do the same thing. So, a fairly long answer to your question: It's headed in the right way, but, unfortunately, we all saw a major capital spending slowdown hit us very squarely at the same time, which has been tough for all of us.

VB: Roger Killion, from Access Data Now, Bettendorf, Iowa, asks: "I would like to know what product Cisco is focusing on for the year."
Chambers: The major product we are focusing on is productivity. If you can explain to your customers the productivity advantage they get by the network architecture, that's when they buy. The second product we are focusing on is an overall architecture for data, voice and video, but also the network of networks, not just an end-to-end architecture in an account, but how that works seamlessly with service providers, the Internet, the combination of cable, etc. Whoever figures that out will find huge opportunities. Finally, routing and switching will continue to do well, probably better than people anticipate. Time will tell whether I am right or wrong on that, but our core markets really look solid. On top of that are growth markets that we are very excited about: storage, as you said, IP telephony, security,we are going to bet a little bit heavier in those areas. And we won't do it with pinpoint products, but instead begin to think about how these play in the whole system architecture and how we implement that.

The storage strategy is this: We look at where we are and add value. We don't add value in large disk arrays. Others do that dramatically better. But we add value in making it transparent, as in where the storage is located in the network. You're going to see us using a combination of doing things ourselves and partnering with traditional players who are ready to go after that market.

VB: Oli Thordarson, president at Alvaka Networks, Huntington Beach, Calif., asks whether you'd like to [flesh out security and strengthen the portfolio a little bit?
Chambers: Well, I try not to be too specific on which acquisition areas, or even more importantly, which companies I'm looking at because that drives my costs up and tells my competitors what I am going to do. But security is big enough that you'll probably see us address that through internal development, partnering and acquiring. It will probably be all three, if we get our act together. While we are the No. 1 player in firewalls, the No. 1 player in VPNs and the No. 1 player in intrusion-detection, we have to think about how they all play together and how we put that in our routers and switches more effectively as we move forward.

VB: Jim Hunt, CEO at New York-based Ernst and Young Technology, wants to know what Cisco can do to help larger systems integrators maintain large, professionally trained staffs that cater to Cisco's largest end-user customers with very exacting needs.
Chambers: Well, I think partners have to decide, regardless of their size, what their differentiators in the market are and what their competitive advantages are. So, everyone has to decide which elements they are playing in,from very basic levels, with, candidly, lower margins,to very complex solutions with much higher gross margin potential.

Using Cisco as an example, we're investing big time in systems that will not have the payback for 12, 24 or even 36 months out. We're doing that in our systems, our product prioritization, etc., across the board. So, I think, if you really think about what we believe in doing during the economic slowdown, it's to first deal with the slowdown, and then say how you position yourself for the future. Now, if you watched what we did, we had our breakaway strategy already in place. We talked about it in terms of market consolidation, virtual-network organization and the network of networks. We modified it with a six-point plan. We then began to give market share after May [2001 going forward, and then we said focus on what you can control and quit worrying about when the market would turn around. That's cash, high profits, productivity and available market. That's what I think each of our partners has to do, large or small. Then you've got to say how much risk-reward you are willing to take. Now, in my company, I am a person who believes in taking good business risks. You don't win the races we run with one foot on the brake. This is a tremendous race and we beat, or are in the process of beating, hopefully, four generations of competitors. And we do it by having a strategy and adjusting quickly, but also, candidly, by having the pedal down most of the time.

VB: Roy Appelbaum, vice president of networking products, and Nestor Cano, president of worldwide operations at Tech Data, Clearwater, Fla., want to move to more of a global strategy, and thus want a global relationship with Cisco. Your thoughts on global alliances?
Chambers: One of the challenges we face is making sure that, as people move across a larger national theater or global basis, the value-add they bring,on which their pricing is positioned,is consistent. And, not making it a nightmare to have to be certified in a unique way in 130 countries around the world. But the last thing you want is somebody who adds tremendous value-add in one geography, but in the next geography all they do is bring price to the market and no added value. You end up with dissatisfied customers, and it really hurts my other channels. So, I believe, just like the market, that there is going to be room for very small, but tremendous, added value in each of the categories I outlined earlier, on a city, state or country basis. At the same time, I think you will see the other extremes where there is a crying need to do this on a global basis with a large company, so you can support them [consistently. I believe it will be a combination of those partners across the board.

To answer your question, I believe there will be a reasonably good segment of our customers who will purchase on a global basis. But at least as large and maybe a larger [percentage really prefer the unique local valued-added relationships built where it's based on local talent, etc. So, again, we let the market determine that. But I think it will be the combination of the two, and then each one will have to determine what their value-add is, both today and in the future, and we'll have to see how we work together to help them achieve their goals.

A couple of years ago, I would not have challenged my customers or my partners with, "Let's understand your profitability model." I absolutely will today, because we know how a lot of this is going to evolve with a fairly high percentage of probability. I owe it to my partners if I think they are building a business model that is not going to be successful, or if they are building a business model without [realizing they have to overcome pretty dramatic hurdles others have tripped on. That's part of the value Cisco brings to a relationship.

Also, sharing with them what we are going to do and not do and what we look for partners to do. That's a unique relationship in the industry when you think about it. Who else has the relationship [we do with partners? For example, look at the service provider who was in the room today, who got up and said, "I understand the value of your partners, and, by the way, what we are doing isn't right." We need to partner with him.

Who else in this universe can partner with an IBM, a Sun, a Microsoft, an Intel, Oracle, Compaq, HP, etc.? We are in a very unique position because we really believe in partnering. We partner in good and bad times. And we are also not only basing our future strategy on it, but we have the ability to bring partners together in a way that others do not.

Having said that, partnering is harder than acquisitions,and most acquisitions fail. In fact, in our industry, probably 90 percent fail. So, you've got to realize that it is hard to do. We're really committed. We have a much higher hit rate on our acquisitions than anybody else does, by a factor of probably four- or five-fold, and the same thing with partnering. But, partnering with a partner and then partnering with a third party raises the risk. So, it's a process we are starting to learn how to do, and we have a long way to go.

Sizing Up Cisco: Partners Want Answers

More than 10,000 different companies belong to Cisco Systems' Channel Partner Program in the United States, serving nearly every conceivable customer, constituent and client out there. For more than a year, the practice of reselling gear and services at or below cost has manifested itself as the single most important issue within the Cisco extended family of companies. In a nutshell, it has led to nationwide price and,by way of extension,margin erosion of the worst kind. Ironically, only a handful of Cisco's largest reseller partners are believed to be at the root of the problem. They are the small set of telecommunications companies that enjoys some of the steepest price discounts Cisco offers to partners, including WorldCom, Sprint, AT&T, Qwest and SBC Communications. But the damage some of these companies have done to margins in local, vertical and enterprise markets from Bangor, Maine, to San Diego has sent shockwaves throughout the rest of the Cisco ecosystem.

Cisco is moving to correct the problem, and at the highest levels. Since late April, when he was made aware of the problem at a closed-door meeting with some of his best Gold-level partners in Orlando, Fla., Cisco CEO John Chambers has vowed that Cisco will remedy the situation. At the time, Chambers said two companies, which he declined to identify by name,but one of which VARBusiness has learned is WorldCom,were responsible for the overwhelming majority of the problem. They were offering equipment by as much as 45 points off list price to customers. That's three points below what some of Cisco's best wholesalers can buy gear for before selling it to resellers who are expected to sell it once more to customers.

When they learned Chambers was personally looking at the problem, most VARs were convinced the powerful CEO could do what his lieutenants before him did not: Fix it.

"I am anxious and optimistic to see Chambers finally doing something about it," says Mark Romanowski, senior vice president of client services and business development at AMC, a New York-area Cisco partner. "We have complained about this for a long time."

Chambers and his team have communicated to the companies involved that they will not tolerate product dumping and would, if necessary, address the situation when their partner contracts come up for renewal. The implication is clear: Continue to damage the market for all, and you risk getting kicked out of the Cisco community.

Paul Mountford, Cisco's vice president of worldwide channels, hopes not to have to drop the partners. Already, he has received assurances from one of the "culprits" that it will work with Cisco to solve the problem.

A complete resolution, however, has not been easy,though Cisco has already seen a reduction in non-value-added resale activity.

A Vicious Cycle

Partners, meanwhile, say ongoing problems within the economy have left struggling companies with little ability to change their behavior.

"Price erosion is still happening," says Rick Bellerjeau, director of strategic alliances with Cisco partner Datatec Systems. "As a result of the economy, many customers are taking advantage of their vendors by making them work even harder for every deal."

That stark reality has created a vicious cycle: The more the companies struggle, the more they need to cut prices to get new business. The more they cut prices, the more they struggle.

"With the apparent demise of WorldCom looming, we see that the old 'selling at or below cost but making it up in volume' tactic does not necessarily work that well," notes Carl Borsody, a regional sales manager in Silicon Valley with NEC Business Network Solutions.

More Thoughts from John Chambers on Questions Direct From VARs