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The Cisco Skid

The Cisco Skid

Cisco's history is like Mount Saint Helens. Its explosive success blew the side off the old economy rules of slow, steady growth.

Cisco rose above a crop of small networking companies through two strategies: outsourced manufacturing and growth through acquisition. From the time it went public 11 years ago, Cisco was never not growing. Sometimes its growth was staggering. Its stock split 12 times in the 90s. Its revenues went from millions to billions to tens of billions as fast as the Internet would let it. At its height - say, May 2000 - 44,000 people worked at Cisco, and thousands of them were millionaires.

For a New York Stock Exchange minute, Cisco topped GE as the most highly valued company in the world and earned a half trillion-dollar market capitalisation. If growth continued at the same pace for another decade - and why wouldn't it? - Cisco would be as big as the US economy. Without a hint of irony, analysts suggested Cisco might be the first company to have a trillion-dollar market capitalisation.

In May 2000, Fortune put Chambers on its cover and asked if he was the best CEO in the world.

At the same exact time, a few components for Cisco's networking equipment were rumoured to be in short supply. Privately, Cisco was already twitchy because lead times on delivering its routers and switches were extending. Eventually those lead times would reach nearly six months on some products. Not having the components could push those delivery dates out even further. So Cisco decided to build up its components inventory. Doing that would accomplish two things: it would reduce the wait time for its customers, and it would give the manufacturers of Cisco's switches and routers a reserve to draw on if components makers ran out.

Of course, everyone else wanted those components and the manufacturing capacity to build the networking devices too. So in order to get both, to make sure they would have them when they needed them (and they knew they'd need them; the virtual close told them so), Cisco entered into long-term commitments with its manufacturing partners and certain key components makers. Promise us the parts, Cisco said, and we promise to buy them. No matter what.

"Our forecasts were still dramatically high," recalls Selby Wellman, a retired Cisco executive. A self-proclaimed outsider, Wellman retired last US summer, for reasons he says are unrelated to business. Some of his last meetings at Cisco were about the components shortage of summer 2000. "We wanted to make sure our growth was strong, so we ordered up big time," he says.

That seemed to work. Year-over-year growth was robust, 55 per cent for the last quarter in 2000, and then a whopping 66 per cent in the first quarter of 2001. As late as September, Cisco looked at its virtual close and saw plenty of bookings. It also had the pleasant problem of not being able to deliver products to customers fast enough. Combined, those numbers were enough to convince executives who literally had never seen a down quarter that everything was fine.

But some Cisco suppliers were not so sanguine.

"People see a shortage and intuitively they forecast higher," says Ajay Shah, CEO of Silicon Valley-based Solectron Technology Solutions Business Unit, a company that manufactures parts for the networking industry and for Cisco. "Sales people don't want to be caught without supply, so they make sure they have supply by forecasting more sales than they expect," Shah explains. "Procurement needs 100 of a part, but they know if they ask for 100, they'll get 80. So they ask for 120 to get 100."

Demand forecasting is an art alchemised into a science. Reports from sales reps and inventory managers, based on anything from partners' data to conversations in an airport bar, are gathered along with actual sales data and historical trends and put into systems that use complex statistical algorithms to generate numbers. But there's no way for all the supply chain software to know what's in a sales rep's heart when he predicts a certain number of sales, Shah says. It's the same for allocation. If an inventory manager asks for 120 when he needs 100, the software cannot intuit, interpret or understand the manager's strategy. It sees 120; it believes 120; it reports 120.

Furthermore, there's a growth bias built in to the business of forecasting. If there's a rule of forecasting demand, it's to err on the side of needing more, not less. Be aggressive, because you don't want to end up like Sony did in 2000 with its PlayStation 2 video game system: 100 people clamouring for three units. When that happens, 97 empty-handed customers might go buy a Nintendo. Hence, if demand is dropping off, it can be hidden behind over-commitment. Financial systems say sales are strong today, which managers who have never seen a bad quarter take to mean that sales will be strong tomorrow. So they forecast high demand. Everyone's forecasting high demand, which in turn means it's time to build up inventory.

Even as sales begin to dwindle.

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