A Do-It-Yourself Plan at Cisco

No more reliance on acquisitions

Over the past eight years, Cisco Systems Inc. (CSCO ) made a fortune for itself and its shareholders by perfecting the art of innovation-through-acquisition. The giant maker of Internet networking gear has used its turbocharged stock to gobble up more than 70 companies since 1993, integrating technology startups into a massive Silicon Valley powerhouse. Today, about half of its $22 billion in 2001 sales can be traced to an acquired company or technology.

That strategy is about to change radically. With its shares off 79%, to just $17, since its March, 2000, high, Cisco's acquisition engine has slowed from 23 purchases in 2000 to just five this year. As a result, it has to find a new way to stoke revenues and fix its tarnished image on Wall Street. So now CEO John T. Chambers wants to concentrate on developing products and technologies inhouse through Cisco's own engineers.

That will be a tough task for a company that has always been far better known for its financial acumen and sales machine than as a developer of dazzling new stuff. It "is not going to be an easy process," says Martin Pyykkonen, senior analyst at investment bank C.E. Unterberg, Towbin. "Cisco has a world-class sales and marketing organization, but it doesn't have the R&D you would expect from a company its size."

The shift comes as part of a broad reorganization Chambers announced on Aug. 23. Key executive roles are also in flux. Mario Mazzola, who flirted with retirement last year after running Cisco's corporate products division, will now oversee all product development, in effect making him No. 2. in the company. And Chamber's former big picture guy? Michelangelo Volpi, who oversaw much of Cisco's acquisition binge as chief strategy officer, will now run the Internet switching and services unit and report to Mazzola.

LESS OVERLAP. Cisco will also carve its product-development unit into 11 technology-specific groups and eliminate three customer-oriented units. Chambers is counting on the moves, in part, to stomp out redundant engineering efforts and boost accountability. Earlier this year, for instance, several divisions were working on similar router projects all geared toward the same customers. "This will help us get a lot more wood behind each arrow," says Mazzola.

But can Mazzola quickly morph Cisco from a savvy buyer of technology to a full-fledged innovator? After all, creating products on your own is entirely different from buying technology and improving on it or integrating it with other products. Furthermore, considering Cisco's entrenched product lines and formula for success, it won't be easy getting executives to suddenly chase new ideas. "The bigger a company is and the more legacy it has, the harder it becomes to innovate," says one former Cisco executive. "People are less likely to think about something in a totally new way."

Success may also require a bigger budget. Sure, Cisco spent about 22% of sales this summer on research and development, on par with rivals like Nortel Networks and Juniper Networks. But quickly squeezing winning products out of R&D without dramatically hiking its budget will be a stretch. "That's going to be a big question," says Merrill Lynch & Co. analyst Sam Wilson.

To be sure, Cisco has had homegrown hits. Its recently released The 12000 Internet Router helped it win back about 5% of the high end of that market from Juniper Networks in the second quarter, according to Infonetics Research.

But Mazzola, a top-flight operations man, will have to build on that success if he hopes to pull Cisco from its Internet slump. After joining Cisco in 1993 through its acquisition of Crescendo Communications, he built the company's switching business from scratch to more than 40% of its $22.3 billion in 2001 sales. "He's a remarkable technologist with a good feel for product trends and fits," says Redpoint Ventures partner Geoff Yang, who sat on Crescendo's board. He had better be. Otherwise, he might start regretting that he didn't opt for retirement.

By Ben Elgin in San Mateo, Calif.

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