Yves here. I’m old enough to remember when Cisco was the dominant Internet infrastructure company during peak dotcom. A falloff in Cisco’s orders was the sign the bust had started. Now it’s an also-ran.
By Marie Carpenter, Professor of strategy, Institut Mines-Télécom Business School. Vice-President, Academic-Industry Research Network, and William Lazonick, Professor of Economics, University of Massachusetts Lowell, President, The Academic-Industry Research Network. Originally published at the Institute for New Economic Thinking website
Cisco Systems: From Innovation to Financialization
Once the global leader in telecommunication systems and the Internet, over the past two decades, the United States has fallen behind global competitors, including China, in mobile-communication infrastructure—specifically 5G and Internet of Things (IoT). This national failure, with the socioeconomic and geopolitical tensions that it creates, is not due to a lack of US government investment in the knowledge required for the mobility revolution. Nor is it because of a dearth of domestic demand for the equipment, devices, and applications that can make use of this infrastructure. Rather, the problem is the dereliction of key US-based business corporations to take the lead in making the investments in organizational learning required to generate cutting-edge communication-infrastructure products.
No company in the United States exemplifies this deficiency more than Cisco Systems, the business corporation founded in Silicon Valley in 1984 that had explosive growth in the 1990s to become the foremost global enterprise-networking equipment vendor in the Internet revolution. In our Institute for New Economic Thinking Working Paper, “The Pursuit of Shareholder Value: Cisco’s Transformation from Innovation to Financialization”, we provide an in-depth analysis of the corporate resource-allocation decisions that have underpinned Cisco’s organizational failure.
Since 2001, Cisco’s top management has chosen to allocate corporate cash to open-market share repurchases—aka stock buybacks—for the purpose of giving manipulative boosts to the company’s stock price rather than make the investments in organizational learning required to become a world leader in communication-infrastructure equipment for the era of 5G and IoT. From October 2001 through October 2022, Cisco spent $152.3 billion—95 percent of its net income over the period—on stock buybacks for the purpose of propping up its stock price. These funds wasted in pursuit of “maximizing shareholder value” were on top of the $55.5 billion that Cisco paid out to shareholders in dividends, representing an additional 35 percent of net income. Besides absorbing all its profits over the 21 years, Cisco took on debt and dipped into the corporate treasury to fund these two types of distributions to shareholders.
In our INET working paper, we trace how Cisco grew from a Silicon Valley startup in 1984 to become, through its innovative products, the world leader in enterprise-networking equipment over the next decade and a half. As the company entered the 21st century, Cisco was positioned to build on its dominance of enterprise-networking equipment to upgrade its technological capabilities to become a major infrastructure-equipment vendor to service providers. We analyze how and why, when the Internet boom turned to bust in 2001, the organizational structure that enabled Cisco to dominate enterprise networking posed constraints related to manufacturing and marketing on the company’s growth in the more sophisticated infrastructure-equipment segment of the communication-technology industry. We then document how, beginning in September 2001, Cisco turned from innovation to financialization, as it used its ample profits to do massive stock buybacks to prop up its stock price. Finally, our paper ponders the larger policy implications of Cisco’s turn from innovation to financialization for the competitive position of the US information-and-communication-technology (ICT) industry in the global economy.
Cisco as an Innovative Enterprise
In 1987, Cisco’s co-founders Leonard Bosack and Sandy Lerner turned to venture capitalist Donald Valentine of Sequoia Capital for an infusion of cash and access to management expertise. Valentine then recruited computer-industry veteran John Morgridge to run the company. Morgridge led the process by which Cisco wrote enterprise-networking software for all existing protocols, giving the company a competitive advantage when, in 1993, the US government opened the Internet that it had developed to commercial uses. As Cisco expanded production in the early 1990s, Morgridge favored the practice of direct selling to customers so that Cisco engineers and programmers could design and implement software solutions for clients’ specific needs. At the same time, Cisco outsourced manufacturing of its enterprise-networking equipment to electronic manufacturing service (EMS) providers—a defining characteristic of the “New Economy” business model in the rapid growth of the ICT industry in the 1990s.
In 1995, John Chambers, whose career experience was in sales, took over from Morgridge as Cisco CEO. To enable the rapid growth of Cisco’s output of routers and switches, Chambers favored reliance on value-added resellers (VARs) to provide Cisco’s enterprise-networking equipment to customers (business corporations, government agencies, and civil society organizations), configuring and programming the Cisco boxes to these buyers’ particular requirements. In 1996, 62% of Cisco’s revenues came from direct sales and 38% from VARs. By 1998, revenues from VARs slightly surpassed those from direct sales, although in 1999 and 2000 direct sales saw a resurgence as Cisco entered the communication-infrastructure segment, in which service providers demanded that an equipment vendor such as Cisco provide implementation and maintenance services.
Within its own organization, Cisco was an exemplar in the integration of its personnel to serve the rapidly changing requirements of enterprise networking, thus limiting employee turnover in the hypermobile labor market for which Silicon Valley is known. To gain control over rapidly emerging enterprise-networking innovations, Chambers continued a practice begun under Morgridge of growth-through-acquisition. From fiscal 1994 through fiscal 2001 (years ending in the last week of July), Cisco made 71 acquisitions, gaining a reputation for its system of integrating the incoming employees into its organizational-learning processes.
In fiscal 2000, Cisco did seven optical-networking acquisitions, including Cerent ($6.9 billion), Pirelli Optical Systems ($2.0 billion), Qeyton Systems ($887 million), and Monterey Networks ($517 million), positioning the company to challenge “Old Economy” incumbents Lucent, Nortel, Alcatel, and Ericsson in the infrastructure-equipment market. As part of this move to become a major vendor of high-quality and complex equipment to telecommunication service providers, in May 2000 Cisco acquired a former DEC manufacturing plant on 110 acres in Salem, New Hampshire, to assemble and test infrastructure equipment. Cisco recruited senior managers and engineers from the nearby Lucent Merrimack Valley Works to lead the plan to employ 2,500 people at the Salem facility.
Cisco as a Financialized Enterprise
After listing on NASDAQ in its initial public offering in February 1990, Cisco’s shares became integral to Cisco’s growth. In the process of expanding from $70 million in revenues and 254 employees in 1990 to $22.3 billion in revenues and 38,000 employees in 2001, Cisco relied heavily on its stock as both a combination and compensation currency. The purchase price of Cisco’s 71 acquisitions from 1994 to 2001 totaled $34.2 billion, of which 98% was paid in Cisco shares. Especially in the last years of the 1990s to the end of fiscal 2000 (ending July 29), in doing acquisitions Cisco had the financing advantage of its soaring stock price. As for the compensation function, virtually all of Cisco’s employees were included in a broad-based stock-option program. With stock-market speculation becoming the key driver of Cisco’s stock price in the last years of the Internet boom, the estimated average realized gains per worldwide employee (not including the five highest-paid Cisco executives) from exercising stock options was $193,500 across 18,000 employees in 1999, $291,000 across 27,500 employees in 2000, and $105,900 across 36,000 employees in 2001.
For Chambers as CEO, the actual realized gains from exercising stock options were $120.8 million in 1999 and $156.0 million in 2000, representing 99% of his total compensation in those two years. The other four highest-paid executives named in Cisco’s proxy statements averaged actual realized gains from stock options of $24.9 million in 1999, $36.7 million in 2000, and $14.9 million in 2001 (97% of their total compensation). In 2001-2003, Chambers took $1 in salary and exercised no stock options. But, with the company’s stock price in a slump, Cisco’s board granted Chambers an abundance of new stock options at very low grant (i.e., exercise) prices, and in 2004-2007, he raked in an annual average of $55.1 million (96% of his total compensation) in actual realized gains from exercising stock options.
In March 2000, Cisco sported the highest market capitalization of any company in the world. In 2001, however, the company’s stock price collapsed as the speculation disappeared, even though Cisco’s revenues increased to $22.0 billion in 2001—up 18 percent from 2000. Subsequently, the company largely lost the advantage of using its stock as a combination currency, and since 2004 has used cash for most of its acquisitions. Cisco’s stock still functions as a compensation currency, but, except for 2007 when the average estimated gains from stock-based pay were $73,500 across 55,700 worldwide employees, these supplements to salaried compensation have ranged from a high of $32,800 in 2004 to a low of $3,200 in 2009.
From an all-time peak of $82.00 on March 27, 2000, Cisco’s stock price plummeted to $17.99 one year later and dropped as low of $11.04 on September 27, 2001—just 13.5 percent of its level exactly 18 months earlier. On September 14, 2001, with US stock markets closed after the 9/11 terrorist attacks, Cisco announced a $3.0-billion two-year stock-repurchase program, portraying it (as did many other US business corporations) as a patriotic response to prevent a stock-market collapse when the stock markets reopened. It soon became clear, however, that the purpose of Cisco’s buybacks was to give manipulative boosts to the company’s stock price.
In the decade 2002-2011, Cisco spent $71.6 billion repurchasing its own stock, equal to 126 percent of net income, while paying its first dividends in 2011. In 2012-2021, Cisco’s buybacks totaled $72.5 billion, 81 percent of net income, along with $47.0 billion paid out as dividends, another 53 percent of net income. In 2022, Cisco’s distributions to shareholders were 117 percent of the company’s all-time high net income of $11.8 billion, with $6.2 billion in dividends and $7.7 billion in buybacks.
As we document in detail in our INET working paper, over the past two decades, Cisco’s “financial commitment” has been to boost its stock yields, not to invest in its innovative capabilities. As the company ramped up buybacks from $1.9 billion in 2002 to $10.2 billion in 2005, it largely abandoned its previous investments in optical-networking equipment, including its manufacturing plant in Salem, New Hampshire. Instead of moving toward a direct-sales model, which would be required to compete in the infrastructure-equipment segment, Cisco increased its reliance on VARs, which accounted for more than 80% of the company’s revenues by 2008.
Many of Cisco’s acquisitions in the last half of the 2000s were in seemingly innovative technologies that quickly became commodities. One potentially cutting-edge acquisition was Webex in 2007, but in 2012 Cisco’s vice-president of corporate engineering, Eric Yuan, frustrated by Cisco’s failure to commit to the enhancement of videoconferencing, took more than 40 Cisco engineers with him to launch a startup called Zoom.
Socioeconomic and Geopolitical Costs of Cisco’s Financialization
Despite financialization, Cisco has grown over the last two decades because of the greatly expanded demand for enterprise-networking equipment. In 2022, Cisco had 2.3 times the revenues and 2.2 times the employees it had in 2001. In terms of employees in the United States, the increase was 1.5 times, up from 27,000 in 2002 to 39,900 in 2022. The company has been a job creator.
Yet, the dominance of financialization over innovation within Cisco Systems over the past two decades has had a negative impact on its capacity to develop the capabilities needed to compete as a systems integrator in the infrastructure-equipment segment of ICT. As a result, as is widely recognized, the United States has fallen behind China and the European Union as a locus of innovation in 5G and IoT. Particularly in the case of China, the home base for world leader Huawei Technologies, it is all too easy and convenient to blame unfair competition for the innovation deficit of the United States.
Cisco is not the only US-based communication technology company to succumb to financialization. In the late 1990s, Lucent Technologies, at the time the industry’s global leader, adopted Cisco’s growth-through-acquisition model, using its stock as a combination currency to acquire optical-networking capabilities. Lucent was unable, however, to achieve the organizational integration required to transform these acquisitions into innovations. Then, in the first half of the 2000s, Lucent lacked the financial resources to invest in wireless technology. In 2006, Lucent was acquired by France-based Alcatel, and in 2015 Finland-based Nokia acquired Alcatel-Lucent. Canada-based Nortel, which was more advanced technologically than Lucent in the late 1990s, with a large R&D footprint in the United States, suffered the same financialized fate as Lucent and went bankrupt in 2009, with its physical assets and intellectual property being sold off in pieces in its subsequent liquidation.
In 2005, when the United States still had innovative capabilities in communication infrastructure-equipment at the iconic Old Economy company Motorola and innovative New Economy companies such as Qualcomm and Ciena, Cisco CEO Chambers announced six new strategic “advanced technologies” to be targeted by the company with a view to attaining a number one or number two position in terms of market share. The objective of the diversification was to reduce reliance on the company’s core markets of enterprise routers and switches by taking advantage of future high-growth markets.
One of these “advanced” technologies was “home networking” and, as documented in our INET working paper, Cisco’s acquisitions in this line of business proved to be expensive and unsuccessful attempts to move into the consumer sector over the next decade. Three of the six technological areas—optical networking, IP telephony, and wireless—were, however, relevant to equipment for the service-provider sector.
In 2005, however, when Chambers announced Cisco’s plan to invest in innovation, the company had $5.7 billion in net income but did $10.2 billion in open-market repurchases. Had Cisco not been so focused on doing buybacks to boost its stock price, it might have joined forces with companies like Motorola, Qualcomm, and Ciena to build a US-based global competitor to Ericsson, Alcatel, and Huawei. But both Motorola and Qualcomm were themselves becoming highly financialized at this time, while Ciena, which had been founded in 1992, had only $427 million in revenues with $436 million in losses in 2005. Motorola’s infrastructure business was acquired by Nokia Siemens Network in 2010, and Qualcomm, the US pioneer in the CDMA wireless standard, focused on maximizing the return from its patent portfolio as a fabless chipset designer.
As early as 2006, Cisco removed optical networking from its group of “advanced technologies.” The company’s vice president and chief development officer at the time explained that this was because “optical is more of an access technology, where the market is not going to grow as aggressively as it had in the past.” Meanwhile, in 2009, the rising China-based company, Huawei, became the world leader in optical networking, which it integrated with wireless and Internet capabilities, succeeding in global competition, where Cisco failed. Despite numerous acquisitions in the area, Cisco’s focus on a radical ‘‘all-IP’’ solution combined with its lack of radio base stations and ‘‘account control’’ left it without the capability of becoming a systems integrator that could displace the incumbents and counter the growing competitive strength of Huawei.
More broadly, the impact of growing financialization in the sector has left the United States without the capability to innovate in the development of a communication-infrastructure network. While failing to recognize the role of financialization within the sectoral dynamics, US policymakers have chosen to respond to the US loss of competitiveness with aggressive protectionist measures against Chinese competitors and by attempting to introduce a new standard that will favor US, Japanese and Korean competitors without systems-integration capabilities.
During the 1990s, Huawei built on its domestic success to become a global leader in the industry. China-based ZTE also emerged as an important global competitor, but with only one-third of Huawei’s infrastructure-equipment revenues in recent years. In 2012, US policymakers concluded in an intelligence committee report that these Chinese firms were potentially open to influence by the Chinese government for “malicious purposes.”
Without the capacity to build a 5G mobile network and aware of the importance of the “Internet of Things” for future digitalization and competitiveness, the United States became much more aggressive under the Trump administration. Huawei was added to the “Entity List” in 2019, blocking US suppliers and their customers from selling machinery, components, and software to the Chinese company, thus halting its rapid expansion in the mobile handset market. William Barr, the US attorney-general (who, in that position, displayed scant capability in enforcing the law), even suggested that the United States should buy controlling stakes in Nokia and Ericsson to help build a stronger competitor to Huawei. Perhaps Barr’s perspective on how to attain global leadership in critical technologies was influenced by the demonstration by Cisco, among other US tech companies, of a “core competence” in purchasing their own shares on the market to manipulate their stock prices.
A RAND Corporation report suggested that counteracting the Chinese threat required a standardization body that could pioneer an alternative to the global standard that had emerged in the 4G era and facilitated the success of the new entrants from China. Cisco and Japanese firms, NEC and Fujitsu, have been actively promoting the alternative standard, OpenRan, as an opportunity to challenge the dominance of Huawei, Ericsson, and Nokia in the mobile-infrastructure market. By “opening” interfaces at certain points in the 5G mobile network, the new standard seeks to replace the vertically integrated model that has traditionally dominated in the sector and introduce more competition. The White House and the Japanese government began actively coordinating technology policy in this area with a view to promoting “a transparent and open 5G network architecture to support security and vendor diversity”. The extent of the challenge that operators will face to integrate multiple suppliers within the OpenRan standard is not yet clear, nor is it evident that a return to the fragmentation of the standardization landscape for mobile infrastructure will lead to cost savings overall for operators.
Deregulated by the Telecommunications Act of 1996, it took about 15 years for the United States to become a has-been and also-ran in a sector that is at the center of the ongoing technology revolution and that is critical for productivity growth, cutting-edge employment opportunities, and national security. Despite its original position as the country with the potential to foster global leaders in the converged communications landscape, US policymakers have found themselves scrambling to come up with a solution to the nation’s loss of sovereignty in a technology sector that is strategic to both socioeconomics and geopolitics.
Given its trajectory at the turn of the century, Cisco could have played a central role in an industrial policy aimed at maintaining and enhancing US global strength in this critical sector. Without additional capabilities in wireless and optical networking, it would not have been able to become a systems integrator. But such resources were becoming available in North America as other vendors struggled to overcome the fall-out of the bursting of the Internet and telecom speculative bubbles. Rather than suggesting the unlikely acquisition of European leaders in the 2020s, US policymakers could have recognized the need to develop these innovative capabilities in an era that one might now call America’s “lost decades”. A company such as Huawei did not impose this loss of global leadership on the United States. Hundreds of billions of dollars wasted on stock buybacks did.
Rather than accusations (often unfounded) against Chinese competitors and an alliance with Japan and Korea to counter the lack of US success in competing as infrastructure vendors in an era of global standards, US policymakers need to recognize the damage that has been wrought on this sector by financialization over the past twenty years. The future of communication-infrastructure equipment may be influenced by the success or failure of a new US-promoted mobile standard. Its success will only be possible if those firms that have contributed to them continue to maintain the necessary level of investment in productive capabilities to support their development. It is far from evident that Cisco will voluntarily favor investments in building technologies and markets rather than do massive payouts to shareholders.
Companies in the S&P 500 Index, including Cisco within the top ten, did a record of about $850 billion in buybacks as open-market repurchases in 2021 and in excess of $900 billion in 2022. The destructive and illogical ideology that, for the sake of economic efficiency, a company should be run to “maximize shareholder value” continues to cripple the United States in global competition in a range of critical technologies. The evolution of Cisco Systems from innovation to financialization is one extremely important case in point.
There is a Re-arranging the deck chairs on the Titanic aspect to Cisco and many other companies. Their innovations add smoother wheels.
There’s something bold about Cisco as an Innovative Enterprise…and everything that follows.
Most of US Hi Tech companies are following CISCO’s example; buying back their own stock to enrich the corporate officers and drain resources that can be used for R&D. Apple is following this road and is only protected by its “walled garden”. For how long can it survive before it becomes a has been?
Since the article is about Cisco, a relevant example would be Juniper Networks — the big rival from the USA that was once eating Cisco’s lunch, but that has also been involved in share buybacks ever since 2010, and in an accelerated fashion since 2014.
In other words: while it seems that other firms could have been leading innovation in networking technology, the rot of dividends and share buybacks instead of investments is way too widespread amongst listed corporations to let them go that way.
How about another relevant example?
Anyone here remember IBM ?
Or Hewlett-Packard? Or Sun Microsystems?
But seriously, this is about networking. Lucent, Motorola, Nortel: gone; Cisco, Juniper: constantly slipping back.
There are still US component manufacturers that are world-class and whose products are at the core of those high-performance networking gear from Europe, China, Korea and Japan, but regarding the development of entire systems (and their associated technology and IP), the USA have not been seriously in the race for decades.
This list can’t be complete without Oracle.
Cisco and Oracle have become the place where good tech goes to die.
Taking a break from using a recently semi-installed Oracle product right now.
Pretty sure I could do accounting quicker using an abacus.
Sorry about your national industrial fetish objects and the church of “public ownership” but techies consider that capitalist lot the enemy and would rather build their networks on FOSS, i.e. route around you. At least they did before the woke weakening of the materialist nature of the FOSS movement. Maybe brands and other
intangible horse manureintellectual property will have meaning and value again and we can all be slaves to the PMC. Sounds like a great career, where do I sign up? /s
I hear IBM bought Red Hat “recently”.
Why invest in R&D when government institutions will just do it for you, hand over the IP on the cheap or free, and maybe even let you patent it later?
An oldie but a goodie. Going back to the NSA spy revelations, there were predictions American corporations would cede ground all over at a much faster rate than would develop naturally.
Glad i am not the only one that remembered that one.
As best i recall, it involved NSA intercepting shipments of Cisco hardware in order to install additional components.
Funny thing is that this was similar to the accusations Bloomberg was directing against Chinese companies either before or after the NSA reveal. Yet nobody that looked could find any such tampering.
The blob is more and more looking like the preacher that decries sin in public, yet partake in private.
It is the Karl Rove school of crisis management: whenever embarking on a nefarious undertaking, immediately accuse your rival of that crime in order to inoculate your team against discovery. You see that policy frequently on both red and blue teams.
Plenty of that going round these days…
This! CISCO is not the exception in America today – it’s more the norm. Ronald Reagan wanted to get government out of business, and this is the result. But even he would be appalled at America today.
The question is why are American elites NOW trying to get the horses back in the barn after they spent forty years deconstructing the barn, and then lighting the pile of barn debris on fire? Is this what happens when the elite bubble gets so completely out of touch with reality?
Because it doesn’t take a genius to see the results:
War in Ukraine – LOST
War with China – LOST before it ever gets going.
Multi-polar world – accelerated by America elite blindness
This is all very predictable after watching American CEOs and Wall St outsource American technology, factories, and jobs especially over the last twenty years. But the DOD was warned about forty years ago that the out sourcing of Silicon Valley would result in this eventual situation. (I believe the short answer from the DOE to the DOD amounted to “GAME OVER” if off shoring was allowed to continue.)
You “hit the nail on the head.” All these tech companies have played fast and loose in purchasing derivatives, credit default swaps, stock buybacks, etc.
The end result of this enormous greed and self-aggrandisement:
“America is the only nation that went from Barbarism to Decadence with no Civilization in between.” Attributed to Oscar Wilde, Churchill, George Bernard Shaw, etc.
Runaway bold tag alert.
Kinda like! Easier on my eyes :)
fixed it. Thanks!
Ah yes, mobile tech. Motorola comes up with the concept and initial implementation, but then gets so stuck in litigation with AT&T that the Nordics get their NMT network going beforehand. A network that allowed a phone to roam all over the Nordic nations, laying the conceptional foundation for GSM and standards to follow.
Even during the GSM heydays, Motorola was well-positioned (it was one of the big three with Ericsson and Nokia). But a big issue that would sink the North American mobile equipment companies was the balkanization of standards in the USA.
The EU prescribed that mobile networks had to be GSM — one interoperable standard to rule all.
In the USA, no such constraint: the free market had to be free to chose the best technology. Henceforth, Motorola and other North American firms were exhausting themselves supporting a whole menagerie of wireless technologies for the mobile networks in the USA: mainly TDMA, CDMA/CDMA2000, GSM, but also iDEN, ReFLEX, TETRA…while the rest of the world (except some Latin American countries, and a few Far Eastern ones) went for GSM — which had more suppliers competing for the growing market of mobile communications.
Don’t forget Motorola’s multi-billion $ venture into satellite phones – Iridium. However, I will give them credit that at least they were spending (wasting?) money on product development rather than stock buybacks… at least back then.
GSM also had mandated SIM card, while CDMA2k had it as an option.
This to allow for easier movement between devices and providers.
And now we have come full circle with Apple etc pushing for an internal only “SIM”.
I wouldn’t say Cisco was innovative. Even the article states:
So… very little home-grown, just acquired. I remember their manuals too, they were pretty bad. Certainly, taking the example of Linksys, they made acquired products worse. Again the article states:
I’ve downloaded the 35 page paper for leisurely reading.
I’m not criticizing the article. It has remembered the history of networking telecomms 90s to 2010s well. At least it fits my recollections.
Long before Linksys was gobbled up, Cisco had a good track record on acquisitions. They built a reputation for rolling acquired products into a cohesive uber brand.
Cisco licensed their original router source code from Stanford from the beginning (multiprotocol routing computers were invented in academia, good story and a fine piece of journalism from a better time).
Having a near monopoly on networking and a solid reputation resulted in Cisco growing quickly where a large bureaucracy made non-incremental innovation from within difficult. As a result Cisco’s acquisition strategy promoted stuff like employees spinning off startups with seed investment and acquiring those companies once a product was sufficiently incubated. They also invested in or cooperated with promising companies working in areas they were targeting to get an inside lane on future acquisitions.
Cisco moving manufacturing to China around 2000 is where the rot started in my opinion. To almost no one’s surprise China’s home grown industries got everything sent over there and it wasn’t long before Huawei switches were booting Cisco software. Cisco has been in slow decline from short term profit motivated thinking ever since.
One of my college friends co-founded a company that got rolled up into Cisco. My friend and his two partners were paid $25 million for their company, and I honestly can’t think of a nicer guy for this to happen to.
My friend and his partners signed a contract that required them to work for Cisco for three years. While they were in the employ of Cisco, the stock started going down, down, and DOWN. The guys wrote a program that they called Sharp Stick, and it tracked the stock price declines in real time.
The reference? The stock price may be declining, but it’s better than a sharp stick in the eye.
Oh, as soon as the guys were no longer required to work for Cisco, poof! They were outta there!
Modern management: Sounds like parasitism or those web spiders that ensnare their prey and then take their time to suck it dry before discarding the husk.
This article well describes what CISCO did, and criticizes it, but doesn’t address well root causes.
I think a good case can be made that corporations that engage in aggressive stock repurchases are essentially self-liquidating (e.g. Nortel, Lucent, Motorola, etc.). This article could have done a better job at diagnosing the why of this process. The root causes are straightforward and can be remedied, imho.
1. Tax Code. Stock re-purchases rather than dividends are encouraged by the tax code. Such re-purchases were prohibited until 1982 for the very good reasons described in this article (e.g. stock price manipulation), and also because income was supposed to be returned to stockholders via dividends (taxed at the much higher ordinary income rate).
2. Risk and return to maximize “compensation currency”. Since 1982 the neo-liberal idea behind such tax cuts was to encourage capital formation, innovation and job creation! Allowing stock re-purchases created an inherent conflict: prop up the stock price (compensation currency) NOW with stock repurchases or retain the earnings. The latter is convincing to Boards and Wall Street only if management knows its technologies, markets and customers intimately. Only then should a company throw the dice on risky R&D and acquisitions. That’s hard. Repurchasing stock is always an easy way to make stockholders (and those paid with stock options) happy.
3. Paucity of technical competence at the top. When Boards and executives financialized, they lacked the technical smarts and “animal spirits” for technology innovation. Rather, the “animal spirits” were in cash flow, ROE, stock price, etc. Engineers and scientists — i.e. the founders of companies like Cisco — typically have a very different mission, i.e. to advance technology, and they get squeezed out. At that point it was a no-brainer for the former because it was the “keep it simple” approach. Also, innovation is not just a matter of funding more R&D. Successful innovation is hard. Even good venture capitalists succeed only 1 out of 10 times.
4. MBA hubris. MBAs (I’m one, also a mechanical engineer) are generally taught to believe that, whenever they needed technical competence, they had the innate ability to hire it and use it (because they are so smart!–Dunning Kruger bias). The problem is, many MBAs lack the technical competence to recognize it in the first place, render technical judgements about what will be “the next big thing” and how to bring it successfully to market.
4. Did CISCO have better ways to use its cash flow? This article assumes that CISCO could have avoided its fate if it just invested more in R&D and maybe good acquisitions. But perhaps this assumption is plain wrong. Also, neoliberal “efficient markets” dogma tended to support stock re-purchases. If a company doesn’t know what to do with its cash flow, they should give it to the stockholders. Stockholders will find, via the information transmission magic of “efficient markets” (and “the wisdom of crowds”) to put that money to best use. Well, in fact, returning this money to stockholders just seeded speculative market bubbles and ponzi finance for zombie corporations. In the end, stock markets didn’t know what to do with this capital either.
Maybe one conclusion from this article is that, since Boards and Managements are so responsive to tax incentives, more carrots and sticks are needed in the tax code to encourage more innovation, if that’s what’s needed to keep the U.S. on the cutting edge. I’ve always been in favor of limiting the capital gains rate to gains from brick and mortar investments, start-ups, R&D, etc. not paper gains.
Another recommendation: go back to the pre-1982 world of prohibiting stock re-purchases altogether. If a company has no good investment opportunities, return income to stockholders only via dividends. “Oh, but that’s double-taxation!” Well then, find good investment opportunities! “But that’s hard.” Yeah, so if stockholders want it easy and now, Uncle Sam gets an extra cut.
Funny how many of the great depression lessons were rolled back barely a generation later, with economists crossing fingers thinking they had it all worked out this time…
I remember having to figure out how to negotiate with Cisco back in the 2000s. They sure had a monopoly and what seemed like total pricing power if you were a telecom operator or an outsourced service provider. Pricing grid took their list prices as a given and you then argued about discounts but these were all pretty much fixed centrally anyway dependent on volume. The typical strategy to try to put pressure on this was to figure out which parts of their enterprise monopoly you could threaten to introduce Huwaei into. But it was hard work, a hard sell internally and only applicable to a tiny part of the book of business! Was not overly fruitful. How the world has changed.
All of your bullets make sense to me and I would double down on points 3 and 4. Theoretically and in the absence of tax distortions, the market will only value share buy backs if it believes that cash retained in the firm will not achieve an investment return above available alternatives outside of the firm. This assumes relatively rational investors and clearly that is impacted by speculation but is not a totally bad long run assumption over many years. The question then is whether share buy backs were a symptom rather than a cause. Or, was there an underlying executive focus on quick bucks that share buy backs were just one part of and which meant that Cisco stopped focusing on innovation, stopped finding ways to use its cash productively and the market started believing too that it could not.
The other perspective is that all companies have a life cycle. They rarely stay innovative for ever. So the question then to ask might be why Huawei developed in China and not a similar company in the US.
That excellent question got me to thinking some more. Maybe Huawei is just a sign that the USA will not always be the place where highly successful new technologies will bloom. China reputedly generates 2x the STEM graduates as the USA, and China’s firms are now closer to the manufacturing ecosystem than those of the US. So, maybe China will indeed be the technological powerhouse of the future.
The response of US companies like Cisco to the competitive challenge is not encouraging. And the response of the MSM and the political class is to cast China as a hostile rival rather than dynamic competitor. These seem to be signs of a declining effete US empire.
“In the end, stock markets didn’t know what to do with this capital either.”
What puzzles me is why stock re-purchases increase stock valuation that much. Perhaps this golden sentence is the answer.
I don’t think “consumerism is the fastest treadmill to hell.” I think that honor goes to competition. I wonder how distant the point of no return is. Somebody please organize the Better Business Behavior Bureau.
We were there in the thick of it. Put our home up for sale just south of Olympia to move to Boise where Husband had been hired by Cisco to work with a salesman as ‘tech support’. He had been working as ‘the firewall guy’ for the State of Washington – Information Services. All that equipment was Cisco Systems and it made Husband’s knowledge of state-sized information networks valuable and him the Golden Boy. Cisco poached a lot of willing Golden Boys. ‘We only hire the best of the best; the top 10%.’ The flattery was backed by more money than they could ever hope to earn from their current employers.
Six months later the bubble burst and Husband was ‘work force reduced’ in the first big layoff in Cisco’s history. He was picked up by HP and worked for that company before being ‘workforce reduced’ again in the next recession.
He took a contract to work for TIAA’s service provider then, AT&T. TIAA was looking to bring their information services back in-house, forming their own teams and discontinuing with AT&T. Husband was hired at the end of his contract and has been with TIAA ever since. It’s been a good company to work for, good money and benefits, and he hopes to continue till he retires in a few more years.
My limited experience of Cisco as a company was one that was deeply sales driven. The sales team there was inclined to a lot of high risk behavior, thrill seeking… and they were family men one and all. Weirdly, every wife was white and blonde. I never met them, just walked around the cubicles looking at family photos and thinking, ‘man, that’s weird!… what’s with all the blondes?!’ It was a little Stepford Wives… oh yeah, I was also blonde then. It would take me another 18 months before I figured out it was also very Boise.
For an interesting experience should you find yourself in Boise, pick up the phone book and look up ‘dentists’ in the Yellow Pages.
“Yellow Pages” You actually have Yellow Pages?
I interned at Cisco in 2001, and even then I felt that the company had lost its mojo. Cisco laid off a couple of thousand of people while I was there, and at one time I thought I too would be let go :) What really made me uncomfortable while working there was the adulation that Cisco employees showed towards John Chambers, when he made an entrance in one company all hands, you would think that you were attending a concert by some rock star ……………
Once upon a time, if I recall correctly, stock buybacks were illegal as inside trading. Perhaps we should go back to those days. Paying executives with stock options also appear to have unfavorable consequences, which might be reduced by requiring that executives who wish to purchase stock should do so on the open market.
From an investor perspective, if a company is doing stock buybacks, that is a message that the people running the company do not know what to do with their money, and as a rebuttable presumption are incompetent, so you should invest elsewhere.
Sun Microsystems is one of those once-great-now-defunct names of silicon valley. I was hired by Sun in the late ’80’s when it was still on an exponential growth curve. I was a permanent hire, but worked there only 2 weeks to check it out. I never left my previous employer having taken a 2-week vacation for this brief but educational tour of Sun. It was one of the most dismal experiences of my career. Everyone in my group worked 60 hour weeks at least; they were pretty young yet they all looked like zombies from the hectic pace. It wasn’t to last. At the height of the dotcom bubble its stock was at $250 and after the bubble burst it crashed to $10. Needless to say, I returned to my former stodgy job with great relief to have it.
Cisco never really was in the telecom infrastructure game. They partnered with system integrators, and Cisco seems like they treated them as another sales channel.
Even if telecom retained the earnings, they’ve outsourced and offshored everything. The service providers don’t know how to run their own networks. They set KPIs, and their system integrators run their networks to meet those KPIs. And I can speak from first hand experience, as I worked for a telecom equipment manufacturer. Since they’re all foreign owned, the engineers who debugged the networks were covered by a National Security Agreement. Seemed like half the issues we saw were due to faulty installation by the contractors (who replaced unionized labor) were using. Most common solution was to check and clean the fiber optic cables.
The top tier equipment manufacturers have largely moved to service contracts and system integration, with the various hardware developed and bought from their suppliers. Even if they make the hardware in house, it uses key parts and chips (System on a Chip, SoC) developed by someone else. And if the equipment manufacturer gets rug-pulled on a key part, or the supplier’s roadmap doesn’t match up the product cycle, that’s a loss of several billion dollars in future contracts.
I really want to comment on this piece as I was literally at the scenes of the crimes – hired by IBM in 1984 to devise new network management architectures using AI, became massively disillusioned, started a Stanford Ph.D in 1987 in Decision Sciences, became massively disillusioned, left to start up a, well, start-up, ran into the teeth of the 1989-1994 tech recession and had to take a job at Cisco Systems in 1992, was forced out due to the machinations of a friend whom I’d got hired by Cisco, and ended up at 3Com Networks, left there to write a book on management mechanisms in computer network protocols published by Artech House in 2000, started my second startup in April 2000 just as the dot-com implosion began. As far as I can see, I have almost perfect timing for doing the right thing at the wrong time. Unfortunately, that extends to this moment, as I just had abdominal surgery on Tuesday and am recovering.
During the extended dot-com turndown I started to write a book reflecting on the subject of this very NC piece that I titled “The Monkey Trap”, a meditation on high-tech companies, their horrific management styles, and the crucial role played by stock options, golden handcuffs, and the extraordinary boom-bust.swings that have characterized tech since the 1980s. I put the book project aside and returned to Silicon Valley to try a third startup in – wait for it- March 2008. As I said, timing is not my strong suit.
There is a huge amount to be said on this topic beyond what the authors of the excellent paper discussed above had written, not least the deeply corrupt practices of Stanford University with respect to Silicon Valley and the commercialization of technology research payed for by US taxpayers. However, my pain meds are wearing out as I type this so I think I’ll conclude for the moment.
Cheers (or not)
I hope you’ll one day finish it.
There is no mention of the fact that Cisco was originally a “disruptor” in that there were no industry standards when they started offering VOIP telephone systems in the 90s.
I was tasked with migrating our organization from analog PBX to VOIP back in 1996 or so, and I remember being very afraid of purchasing technology that had no agreed upon standards.
It was a “Might-makes-right” situation, Cisco was the default standard in an industry with no standards, so a bully, and disruptive, in a somewhat similar way to UBER who leveraged wide-spread ignorance on the part of local governments, and an army of lawyers to run rough shod over regulations pertaining to taxi licensing.
Cisco had the tech ready to go, and everyone wanted to go to VOIP, so they dominated the market, until they didn’t.
In the long view, so much of American business looks like varieties of sophisticated pump-and-dump schemes, and fraud.
The seeds of Cisco’s destruction were sown during what most would call the “good times.”
When Cisco was the only game in town for networking or network telephony gear, they sold excellent equipment with eye-wateringly high prices. It was also painfully complex and difficult to configure. So much so that “Cisco Network Engineer” certifications were a significant credential.
This left a lot of room for someone to come in with simpler, cheaper gear and swipe business from Cisco. I remember buying HP ProCurve Fast Ethernet switches, and three 50-port switches (gave me the 100 ports I needed with a hot-spare) was half the cost of a Cisco 100-port switch (or 2 50-port switches) with a maintenance plan. And I could swap a failed switch in ten minutes vs. waiting up to 6 hours for Cisco to show up.
The ProCurve had an onboard web server (GASP!) and you could do all the configuration work on a point-and-click basis. It still had a CLI that came in handy when you wanted to do the same thing to a bunch of ports.
The Chinese are merely the latest in a long string of competitors who ate Cisco’s lunch.