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Wall Street Demand for Growth Is Killing Cisco

When Cisco (CSCO) announced its earnings for its FY 2011 third quarter, it beat expectations, and yet Wall Street was unhappy. Why? Because the company's Q4 outlook is below what analysts forecast.

Cisco shares are down 30 percent over the last 12 months because growth has been slower than the company traditionally achieved. CEO John Chambers vowed to cut spending by $1 billion and headcount by an unspecified number. Ironically, in doing so, he is likely to only make worse an underlying problem: unchecked worship at the altar of growth.

Every company makes mistakes because executives are fallible. The important thing is to identify which ones are systemic and within management's ability to control. With Cisco, a common criticism has been that the company indulged in too much diversification.

But that's a symptom, not a cause. The root of the diversified hash that Chambers made of Cisco was the desire to buck what happens at almost any large company -- other than Apple (AAPL), which seems to be in its own category -- and accept that some things go with maturity: eyesight, hearing, and growth rates.

For years, Cisco has pushed for business growth over all else, regardless what customers and business could realistically sustain. The emphasis drove all aspects of the business, from how it tried innovation through acquisition to entering consumer markets. In fact, Apple probably helped fuel the mistakes at Cisco.

Why acquire the Flip camera? Blame Apple. Anyone doubt that Chambers likely looked over, saw what Steve Jobs was able to accomplish with a move into consumer electronics, and decided that he wanted some of that?

You can get a sense of how desperately Cisco began to cling to growth, the sure sign of everlasting youth and high tech stock prices, by counting how often the words grow and growth appeared in each annual report's shareholders letter. The number should show how important the company thought mentions of growth would be to investors:

  • 1999 -- 3 times
  • 2000 -- 4 times
  • 2001 -- 8 times
  • 2002 -- 4 times
  • 2003 -- 8 times
  • 2004 -- 26 times
  • 2005 -- 17 times
  • 2006 -- 12 times
  • 2007 -- 11 times
  • 2008 -- 11 times
  • 2009 -- 3 times
  • 2010 -- 11 times
Not a straight line increase, but there's a pattern in the numbers: more average mentions of growth to investors, not fewer. Here's a telling selection from the letter for 2004, a time that seems to have been pivotal in the company's relation to emphasizing growth:
Cisco successfully delivered on all three of the financial priorities outlined in fiscal 2003. First, we balanced the need to grow our business while achieving pro forma net income in excess of 20 percent of revenue. During fiscal 2004, we had a year-over-year increase in revenue of approximately 17 percent, marking the first year of double-digit revenue growth since fiscal 2001. Our revenue growth is a result of a gradual global economic recovery, coupled with increased information technology-related capital spending.
In a 2010 contrast, by the time Apple mentioned grow-related words 11 times in its 10-K, it was 35 pages into the document, and 10 out of the 11 mentions were for year-over-year comparisons of detailed financial information. Google (GOOG) hit the 11 mark at page 6 of its 2010 10-K. In its 2010 annual report shareholder letter, Microsoft (MSFT) used the words grow and growth five times, with two referring to specific comparative statistics.

Not that there's anything inherently wrong with growth. It can be the sign of a healthy business, when it follows from satisfying customers and identifying market opportunities that are a good match for the company's underlying strategy.

But a cancer is unchecked growth that is no longer tied to the needs of the organism. Cisco has a bad case of it, and looking to cut costs as a way to stimulate even more growth is like going to an oncologist for something to stimulate cell multiplication.


Image: morgueFile user karpati, site standard license.
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