Cisco's Extreme Ambitions

During Cisco Systems' (CSCO) annual meeting on Nov. 12, John T. Chambers, chairman and chief executive, strode confidently around the auditorium at Silicon Valley's Santa Clara Convention Center. But he faced a barrage of tough questions about the company and its prospects. At one point, looking a tad dazed by the onslaught, he sat down on the steps of the stage. "At what size does Cisco become so big and diverse that its growth and profitability will plateau?" one investor asked. Chambers considered the question for a few seconds. "Hopefully, well after the CEO retires," he said with a laugh.

It's no joke for investors. Chambers is struggling to show how his $36 billion behemoth can remain a growth company and improve its stock market performance. The challenge has the 60-year-old CEO trying to pull off one of the most ambitious feats in business. He's racing into 30 different markets at the same time, while implementing a council-based management approach that's controversial among top managers. Now Chambers' ambition is fueling a risky fight with some of the mightiest companies in tech, including Dell (DELL), Hewlett-Packard (HPQ), and IBM (IBM). "It's a clash of the titans, and investors are nervous," says analyst Brent Bracelin of Pacific Crest Securities.

SETTING A TORRID PACEChambers may have more to lose than his rivals. As he moves into the computer server market led by HP, Chambers has provoked a counterattack on his core business of routers and switches, which direct traffic around the Internet. HP said on Nov. 12 it would buy networking equipment provider 3Com (COMS) to step up its assault. The trouble for Chambers is that gross margins in the server business are around 20%, compared with 65% for routers. As Cisco gets more revenue from servers, its overall margins will likely fall, while HP will probably see margins rise as it sells networking gear. "I'd rather be HP than Cisco right now," says Steve Deplessie, founder of the research firm Enterprise Strategy Group.

Chambers declined to comment for this story, but he has explained his strategy publicly. He sees the challenging times in the tech industry as an opportunity for the strong to get stronger. He believes Cisco can keep growth high by charging into markets for everything from $149 Flip video cameras to multimillion-dollar data center projects. He established the new councils—48 in all—so managers can make decisions without waiting for approval from him or anyone else. He says the councils are the primary reason Cisco can pull off a greater variety of acquisitions than ever before. "We're going to set a pace, and we'll challenge anyone to keep up with us," Chambers said at the annual meeting.

Cisco is having some success in new markets. The company has become a leader in computer security and office phones. Where it can't beat the competition, it buys them. It's offering $3 billion for Tandberg, a Norwegian company that makes videoconferencing systems that have proven more popular than Cisco's high-end products. "They've done a good job so far," says David Eiswert, portfolio manager at T. Rowe Price's Global Technology Fund, which holds Cisco shares.

Chambers may have few options other than taking on tougher fights. He has pledged that Cisco will boost revenues 12% to 17% yearly, but investors are skeptical. Cisco's stock is off about 20% over the past two years while shares in IBM and HP are up. "I think he has no choice, if he really wants Cisco to be a growth company," says analyst Erik Suppiger of Signal Hill Capital. "But does it raise considerable execution risk? It sure does."

Chambers crossed the Rubicon in March, when Cisco announced a new server. It's part of a broader strategy to reinvent the data centers that companies increasingly use to handle their computing needs. Cisco hopes to charge premium prices for gear that will let companies more efficiently handle their Internet traffic.

Still, HP has years of experience competing with Dell at razor-thin margins, and it has more than 150,000 consultants who help sell its gear to corporate customers. "Cisco has to figure out not only how to beat us but also how to beat IBM and Dell, and compete at margins very different than what they're used to," says Dave Donatelli, executive vice-president at HP.

IBM and Dell have long sold Cisco's networking gear, butthere are increasing signs of strain in those relationships. Big Blue just inked a deal with rival Voltaire and is shipping gear from Juniper Networks (JNPR), including to the New York Stock Exchange (NYX), a former Cisco customer. Dell recently inked a deal with Juniper to resell its gear. "If the enemy of your enemy is your friend, we have a lot of friends right now," says Kevin Johnson, chief executive at Juniper.

Chambers certainly knew the risks of taking on the computer giants. Earlier this decade, former Cisco executives Jayshree Ullal and Andreas Bechtolsheim came up with a prototype for a server, but Chambers wasn't ready to take the leap. The debate erupted again in 2007 after Cisco took a stake in a startup called Nuova, created by longtime Cisco engineering chief Mario Mazolla, which was developing a server. Several top executives, including Charlie Giancarlo, voiced opposition at the expansion, but Chambers decided to proceed. Even the chief information officer at one of Cisco's largest customers is skeptical about the move: "They should have [gone after the data center] without getting into the server business."

FOR THE HISTORY BOOKS?Some people wonder if Chambers' strategy is being driven by ego as well as by Cisco's needs. Two former executives say Cisco's council-based approach, whatever its intended purpose, is an effective way for Chambers to consolidate power. Diluting authority by spreading it across committees may prevent any one person from gaining too much control. Sources also say that Cisco executives considered heirs apparent have rarely lasted at the company for long. "Being No. 2 at Cisco has not been a long-term assignment," says one former mid-level executive.

A Cisco spokesman dismisses any suggestion that ego plays a role in Cisco's strategy as "nonsense. John Chambers and Cisco's entire leadership are focused on driving Cisco's growth and business results." Chambers admits the council structure is unusual but argues it's the only way a company Cisco's size can move as fast as it needs to. He says the councils work and help identify talent throughout the company.

In a sense, Chambers is bidding for a place in the history books. He's trying to use the ambitious expansion and unconventional management strategy to demonstrate how a company the size of Cisco can remain fast-growing and nimble. If he succeeds, he may end up regarded as a business icon, along the lines of General Electric's Jack Welch. "Cisco is trying to rewrite the management books," says analyst Tal Liani of Merrill Lynch. "We don't know yet whether it will be successful or not."

Chambers certainly senses the urgency. "I realize that many of you think we've stretched too far, and you may very well be right," he told shareholders at the close of the company's annual meeting. "In many people's opinion, [30 markets] is too many. In my opinion, it's probably too few."

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