Chambers Promises Changes For Cisco After Disappointing Investors, Confusing Employees

In a candid admission that left the technology world buzzing Tuesday, Cisco CEO and Chairman John Chambers told Cisco employees that aspects of Cisco's current "operational execution" are flawed, admitting that Cisco had disappointed its investors, confused its employees and lost some credibility in the market.

According to Chambers, Cisco will "make a number of targeted moves in the coming weeks," and as Cisco moves toward its fiscal 2012, to get back on track.

"Bottom line, we have lost some of the credibility that is foundational to Cisco's success -- and we must earn it back," wrote Chambers in a memo to Cisco employees this week. "Our market is in transition, and our company is in transition. And the time is right to define this transition for ourselves and for our industry. I understand this. It's time for focus."

The nearly 1500-word memo, which was an internal message from Chambers, was originally sent to Cisco employees Monday. It was published in full on Cisco's Platform blog Tuesday in response to what Cisco called "a few media inquiries."

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"As I've said, our strategy is sound," Chambers said in the memo. "It is aspects of our operational execution that are not. We have been slow to make decisions, we have had surprises where we should not, and we have lost the accountability that has been a hallmark of our ability to execute consistently for our customers and our shareholders. That is unacceptable. And it is exactly what we will attack."

Chambers' comments come as Cisco continues to play defense following two less-than-stellar quarterly earnings reports and the loss of nearly one-third of the value of Cisco shares over the past year.

In the most recent of Cisco's earnings reports, for Cisco's second quarter, Cisco reported year-over-year profit declines, a decline in its switching revenues, and disappointing guidance for upcoming quarters.

Cisco's major vendor rivals, especially HP, have also sharpened their attacks on Cisco's core businesses, and are touting substantial market share gains as a result. At the recent HP Americas Partner Conference, for example, HP cited several Cisco Gold Partners it had successfully recruited, and said that HP's networking business grew 183 percent in the first quarter including the computer giant's acquisition last year of 3Com.

"Our goal is to change the market and we are doing that," said David Donatelli, executive vice president and general manager for HP's enterprise storage, servers and networking (ESSN) business at the conference. "Today we are number two in worldwide global share in networking. We are growing. The leader is shrinking."

In his memo, Chambers reserved plenty of praise for Cisco's bright spots. He reiterated a number of the advances -- including stellar growth in new product segments like data center, collaboration and video -- that he had mentioned on Cisco's most recent earnings call, and also in a February interview with CRN.

"It is clear to me that we have incredible foundational strengths -- our people, our relationships, our innovation, and our strategy to extend the role of the network," Chambers wrote. "We have anticipated market transitions and made good decisions in capturing them. We are disrupting the data center space. We are redefining the collaboration market. And we have gone big on video, a market that is changing society and business completely."

As for the "targeted moves" Cisco plans to make, Chambers laid out four guiding principles. First, he said, Cisco "will not fix what's not broken," and second, Cisco "will take bold steps and we will make tough decisions."

Next, Chambers wrote, Cisco will "accelerate our leadership across our five priorities and compete to win in the core," highlighting switching as a specific area of improvement, and one where Cisco was challenged by competitors.

"Again, our strategy to extend the role of the network will not change," he wrote. "Our approach to leadership in the core amidst this transition will change. In switching we understand that our customers are buying across broader segments and specific needs in this market. We understand that our competitors in this area are fierce, with different models and architectures. We will not be defined by them."

Chambers closed his list by promising to "make it easier for you to work at Cisco, as we make it easier for our customers and partners to work with Cisco."

"As I've said before, we will look back at this time in Cisco's history and remember it as challenging, and important to the future of the company," Chambers wrote at the end of the letter. "Plain and simple -- we need to roll up our sleeves and work it out, together. I'm ready, your leadership team is ready, and I know you are ready."

Next: Cisco Channel Partners And Observers React

Kent MacDonald, vice president, business development at Long View Systems, a Calgary-based solution provider, said partners should see the memo as a call to action.

"It says he's not only listened to partners and the market, but he's heard," MacDonald said. "What we've been asking is where does Cisco want us to focus, and let's make sure we maintain the leadership of those crown jewels. We're seeing gaps close by some competitors, so we'd like to see Cisco widen that gap again and lead in those market verticals. It's good to see this doubling down on our bets and see the emphasis [from Chambers] on the channel."

MacDonald said the memo is a clear message that change is coming, and to be ready for it, and for partners, to champion it.

"It's good protocol to get people excited about it: 'OK, let's hear the game plan'," he said. "How do we need to change our selling? How can we be mutually successful and how can we complement the Cisco sales team?"

Several Cisco solution providers reached by CRN late Tuesday said neither the tone nor the message of Chambers' memo was surprising.

"I don't agree that he has failed his investors, because his is a market in transition," said Gary Berzack, CTO and COO of eTribeca, a New York-based solution provider. "There is no way you can project a company that goes from a $20, $30, 40 billion company to a $60 to $80 billion company without cracking some eggs. Cisco has to go crack some eggs. You can only sell so many routers and so many switches."

The core switching and routing markets that have long been Cisco's bread-and-butter -- and still, according to its most recent quarterly earnings report, account for 46 percent of revenue -- are mature, Berzack noted.

"When you come out with a product that in 2001 was $10,000 and in 2011, should be selling for $2,500, and you can't add new features that people need, you need to find new markets to be a new player," Berzack said. "Mr. Chambers is the smartest, longest surviving CEO of a public growth company, and he understands what this is all about."

Berzack added that Chambers' public remarks to partners at Cisco's recent Partner Summit might have benefited from the franker tone of what was found in his memo.

Several other partners who attended the Cisco Summit agreed.

"I'd love to have had John make this message at Partner Summit," added MacDonald. "That's kind of the message I was hoping for, because it tells me, OK, Cisco does get it, and they are going to take the leadership role and widen that gap. I think we can all agree that there is narrowing [of that market leadership] going on."

"You hear it in interviews and all the speeches, and you get to a point where you just wonder what he's really getting at sometimes," said a senior executive from a national Cisco partner, who asked to remain anonymous. "You know he knows what the problems are, so why can't we talk about them plainly? That's why what he's said in the note here is a big deal. Cisco is being challenged right now and it's ridiculous to believe otherwise."

Next: What's Coming From Cisco?

Several partners wondered aloud what Chambers' planned "targeted moves" would be.

Members of the financial analyst community also highlighted the deeper implications in Chambers' statements. Ehud Gelblum, managing director at Morgan Stanley, said Chambers' admission was "refreshing" and that "any change should be good for the stock, since the current strategy is not working, in our view."

"The most telling part of the memo to us is the clause stating that Cisco 'will not fix what's not broken,' which seems to imply Cisco could radically reform areas that are 'broken' including potentially backing away from many of the 30 market 'adjacencies' Chambers had set the company on course to go after three years ago," Gelblum wrote in a research note Tuesday.

In a February note, Gelblum and Morgan Stanley floated the idea of Cisco splitting itself into several businesses with different margin and growth targets. Gelblum brought that up again Tuesday.

"In its current form, Cisco appears to be trading revenue for margins, by attempting to optimize a mature business for growth, resulting in a loss of focus on core switching and routing while aggressive growth targets are forcing it into lower margin businesses, such as consumer," Gelblum wrote.

Gelblum added that Morgan Stanley expects "major changes" to Cisco's internal management structure.

"In short we expect people and [marketing funds] to be moved from the more fringe businesses to Cisco's core routing, switching, data center, video and collab," he said.

Steve Burke contributed to this article.