Topic 7: Cisco Systems

1. Topic 7: Cisco Systems • A. Why acquisitions are so interesting at Cisco • B. How does the strategy work in practice? • C. Under what conditions will this strategy work? • Retention of Personnel • Internal consistency: Is this behavior consistent with wider firm strategy at Cisco? • External consistency: Is this behavior consistent with firm position in market? Cisco, M&S 463

2. A. Why acquisitions are so interesting at Cisco • Regularity of activity is astounding • 61 acquisitions between late 1992 and late 2000 • Accelerated to 20-30/year in 1999-2000 before the “crash” • Employees numbers usually small for acquired firm • 0-50 (13 firms), 51-100 (9 firms), 100+ (6 firms) • Employees stay after being acquired (44 of 61 CEOs) • Features of acquisitions generally similar. Why? • Why does Cisco tend to acquire small firms? • Firms tend to be young, R&D intensive, why? • Products tends to be nascent or pre-production, why? • Low turnover of personnel post-acquisition, why? • Almost always friendly acquisitions, why? Cisco, M&S 463

3. A. Does Cisco’s market require such an acquisition strategy? No! • Networking equipment with TCP/IP technology • “Complete” internet infrastructure solutions • Service component (IOS, maintenance, etc) • Some sense of how to plan for future. Why? • Target user anticipated to make many purchases • Large and medium sized firms w/networking • ISPs, ASPs, communication firms, etc… • 20 B (?) in revenue in 2000 & growing until recently. • Is acquisition obviously best strategy? No! • Other firms in this market do not do this. Cisco, M&S 463

4. A. It is unusual for core strategy to involve acquisitions • Stated goal from ’93 on: Become the lead architect & provider for TCP/IP voice, data & video. • Firm philosophy from ’93 on: • 1. Be one-stop shop for business customers • 2. Systematize acquisitions • 3. Set industry-wide standards for networking • 4. Pick right strategic partners • Few firms make such a tenet (e..g, #2) core priority • Why at this firm in this market? • Something special about this set of strategic priorities? Cisco, M&S 463

5. B. How it works: Four necessary conditions for moving forward • 1. Share a common vision • B/w who & whom else? What indicates commonality? • 2. Be culturally compatible • What does this mean? What does incompatibility mean? • 3. Provide a quick win for shareholders • Why is this metric here? Mostly over a 2-3 year horizon. • 4. Provide long term strategic win for constituencies • Shareholders, customers, employees, partners • Assertion: 1 & 2 about personnel, 1 & 3 about fit w/market environment, 4 about corporate strategy Cisco, M&S 463

6. B. More how it works: execution follows similar timeline • “Due-diligence” ahead of time • How they use the checklist? Quit in the face of any issue. • Note: Smaller operations are easier to check. Why? • How does that lead Cisco to select smaller firms? • Include financial incentives to stay longer • Always a part of every package • Trade options w/old firm for options w/new • Time-line for integrating operation always announced • Learning out-sourcing, MRP adoption, etc. all predictable • HR issues: Buddy system to ease transition Cisco, M&S 463

7. B. What due diligence looks for: avoid poor fit w/Cisco • Mismatch procedures & post-acquisition trauma • Each gets things done a certain way & neither party “gets it” (Cisco is web-based, small firms use informal processes) • Outsourcing requirements ill-suited to new product • Delegation of authority & structure not as anticipated • Mismatch to broad product line goals • Overlapping or incompatible product lines • Transition painful to identity and team production • Difficulties with new loyalties •  Due diligence is best way to prevent poor fit Cisco, M&S 463

8. C. Why it works this way: Avoid problems w/ new personnel • Departure of key personnel. Why does this happen? • Their pet project is inconsistent w/new ownership • Not financially worth their trouble to stay • Uncomfortable w/new procedures or perceived rigidities • Why personnel departures are so worrisome • Tacit knowledge about frontier product • Talented management may be key asset in acquisition • Lost time in executing strategy in new product market • Team members may have misplaced loyalties • Cisco wants entrepreneurial spirit, innovativeness, but not us/them Cisco, M&S 463

9. C. Preventing loss of personnel: analysis • Avoids acquisitions where such clashes frequent • When small firms have 70% staff engineers… • How does a common vision avoid nightmare? • Aligning vision/perception of direction of change • Less likely to find disagreement in future • Why is this important in young growing market? • How does cultural compatibility avoid nightmare? • Tacit understandings about what is valuable in future • In technically intensive firms especially valuable, why? • Timeline/financial terms known ahead of time • Limit misunderstandings & limit ambiguity, why? Cisco, M&S 463

10. C. Why it works this way: Consistency with Cisco strategies • How to get a win for existing employees/customers • Strategy for broad product line? • Possibly, if acquired firm has best-of-breed product • Often product is on the frontier of special niche & rare • Acquisition as a “commitment” to a broad product line • Strategy to set industry standards for networking • Possibly, but not if acquired firm has product w/o too many embedded designs features  nascent market easier • Opportunities in market w/evolving technology • Right strategic partners (what does this mean?) • Best partners want to work with Cisco if Cisco a leader or buys all leaders Cisco, M&S 463

11. C. The acid test: Consistency w/existing organization • Develop it in-house in own labs, why or why not? • Two thirds of Cisco products developed in house • Advantages to in-house development • Commitment in fast-changing environment • Quick redeployment if things change • Juggling overhead expenses & portfolio of risks • Drawbacks to in-house approach • In-house personnel unlikely to have every idea • Unanticipated changes in demands • Time to market (or prototype) faster elsewhere, possible? •  Existing personnel must see strategic fit Cisco, M&S 463

12. C. More acid test: Why acquire instead of cooperative contracting? • Cooperative contracting for R&D, why not? • Marketing joint-venture of another firm’s product • Contract for deliverable R&D service • License a patent or other IP & build own version • Drawbacks to contracting approach • Tacit knowledge is not-contractable in license • Potentially passing up economies of scope in design • Coordination of operations (e.g. production or marketing) • Commitment to after-sale service difficult •  Employees/customers have to see downsides to contracting Cisco, M&S 463

13. C. Final acid test: acquired firms benefit from acquisition • Access to established distribution channels • More valuable for nascent firm in young market • More valuable for unrefined product • Access to established overhead & HR functions • More valuable to small/young firm • The culture/bureaucracy/capabilities of a large firm • When is Cisco’s rigidity advantageous? When it eliminates bad habits/poor operations of smaller organization . . . • Inevitable loss of autonomy • Small firms cooperates when senior management sees a visible win Cisco, M&S 463

14. C. Lesson: When consistent w/market environment? • Asymmetric acquisition easier for Cisco • Cisco stock more likely attractive bargaining tool • Assets & focus of large firm bring stability to small • Dispersed knowledge about tech frontier & R&D • Easy to be picky when so many to choose from • An era of many small firms (easy VC money) • An era of many new technological opportunities • Small firms collectively act as incubator for large • Market in transition enables consistent strategy • Opportunity to set standards in nascent markets • Growth & high margins helps to cover potential errors Cisco, M&S 463

15. C. Open Q: Will acquisitions survive the recent slow down? • Cannot use growth in demand to cover error • Do recent layoffs break an implicit contract? • Cannot promise all acquired employees smooth ride • Difficult to get buy-in • Financials much more risky • What to do w/ a capability that is less valuable now? • Positioned to take advantage of new demands? • Adjust through acquisition, but through shedding too? • Possible mismatch of capacity w/user demand • Will this still work? Acquire at a new buy-out price? Cisco, M&S 463

16. Learning Points • Cisco as illustration of process acquiring technology through purchase of other firms • Why use M&A instead of markets transaction or in-house R&D? • Analyzing a strategy • For internal consistency • For consistency with outside environment • How will it work in the present environment? Cisco, M&S 463