What's the reason for all of this? And will it continue? Understanding how the world business environment affects you starts with distinguishing between cyclical and structural change. Cyclical changes are part of business life's normal ups and downs, and any competent executive can deal with them. Structural changes are fundamental, long-term alterations in the basics of making money. They are usually hard to differentiate from cyclical changes in their early stages, which is when you really need to see them. By the time they're obvious, your odds of adjusting well to them are sharply lower.
Three structural changes are driving today's explosion of intensifying worldwide competition: One is the increasing integration of business activity across borders, accelerated by the Internet with its instant communications and vast repository of ideas and dialogues. Its most tangible aspect is the rapid growth of supply chains that stretch from the United States and Europe to all parts of the world - not only for goods, but now for services as well. The second structural change is worldwide overinvestment, fuelled by a vast credit expansion and immense free flow of risk capital. The third is a global buyers' market that has shifted power from the owners and managers of capital to consumers and giant retailers. There's also a wild card. Around the world, government regulators are getting more aggressive, and they are coming at different issues, in different times and places, without coordination or rationalization of their policies . . .
The business model brings rationality to the issue of change. It is the guide for when to change and when not to change, what to change and what not to change. If you link your assessment of the external environment to your financial targets and your internal capabilities, you will have a much clearer picture of the magnitude of change required: whether it's a change in strategy, a change in operations or people, or a change in the business model itself . . .
There is no one-size-fits-all plan of action. What's right depends on the particulars of your business environment, financial targets and internal activities - in short, a thorough assessment through the lens of the business model. Not every business model needs an overhaul. Sometimes a company is simply underperforming in a world of opportunity. That's when leaders have to think hard about how performance links with external realities and internal activities, and be judicious in the actions they recommend. The ability to zero in on precisely the parts of the business that need attention and leave the rest alone is just as much as sign of great leadership as is reinventing the business model when radical action is needed . . .
The Business Model at Cisco Systems
Among the many players humbled in the stock market by the tech meltdown, Cisco stood out for the magnitude of its fall from grace. At its zenith in 2000, the maker of routers and switchgear briefly had the largest market capitalization in the world: At more than $US531 billion, it was greater than that of GE, which had six times Cisco's revenue. By mid-2001, Cisco's stock had fallen from its peak of $US82 to around $US20, eventually bottoming out at around $US8 in October 2002.
Cisco's revenue actually increased between 2000 and 2001, from about $US18.9 billion to $US22.3 billion, before dropping back to roughly $US19 billion in the next two years. But the financial markets were expecting continued blazing growth. And when CEO John Chambers appeared to be brushing off his problems, they weren't quick to forget their dashed hopes, and there was no question that Chambers had a problem on his hands. The evidence was clearest in [the external environment, which is] the first component of the business model. The telecom industry, which accounted for much of his sales, was crippled by overcapacity. Demand was evaporating as the telecoms underwent structural change, and Cisco's profits were evaporating with it.
The bleak prospects might have been enough to panic some leaders into trying to reinvent their business models. Indeed, that's what investors and the business press seemed to be expecting; they all but booed him when he argued that Cisco would weather what he called "a hundred year storm". But Chambers had looked carefully at his model. Though he recognized that Cisco was hurt, he had reason to maintain his famous optimism.
The model had long been admirable. The linkages between the external environment, the internal activity - particularly its strategy - and the financial targets had made the company a standout. Its highly desirable products were aimed at market segments that were exploding with growth, and while they were competitively priced, they earned attractive margins. Cisco kept up with demand through a strategy that relied heavily on subcontracting, and the low capital intensity in combination with reasonably good margins translated into lofty returns and huge cash generation . . .
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Determining the Solution for Cisco
What exactly had changed since then? In his root cause analysis, Chambers reasoned that the telecom business wouldn't disappear forever; it was just getting smaller. There was nothing ominous on the regulatory or competitive fronts, and Cisco's technology was still cutting-edge. So for Cisco, this was a nasty cyclical downturn, nothing more.
The financial targets were obviously in trouble at the moment: Profits were plunging; in 2001, the company lost more than $US1 billion. But Cisco's cash hoard allowed Chambers to take a bold and savvy $US2.5 billion inventory write-down without serious damage. As he continued to revisit the targets, he saw ways to improve margins at lower revenue levels, and to get ready for higher targets when the economy came back. The answer lay in improving cost performance and productivity.
Turning to the internal activities component, Chambers cut nearly 20,000 employees and slashed the numbers of suppliers and resellers. He rationalized his huge proliferation of products, reducing the lines from 50 to 40 and axing hundreds of models within them. Switches and routers were redesigned for lower cost, using fewer parts . . . Cisco had acquired hundreds of companies during the boom; Chambers reorganized to integrate the many that were still only half-digested . . .
Meantime Chambers was looking at the strategy element. He believed he could leverage Cisco's business model in new market segments, especially those where other well-established competitors had come close to bankruptcy. Identifying several markets and segments with high potential, he not only attacked markets for routers and switches, such as the cable industry, but also began increasing Cisco's offerings to include consumer products . . .
By 2003, still using its original business model, the company was making headway in six new product areas it called Advanced Technology markets: optical, network security, IP telephony, wireless LAN, storage networking and home networking. Each of these, Chambers has said, has "the potential to eventually create a $US1 billion revenue opportunity for Cisco." Regardless of how well or poorly Cisco capitalizes on them, they're opportunities that exist only because Chambers made the right decision when calamity struck. It's hard to know where the company would have been if he had misdiagnosed the change as structural and turned the whole business model upside down instead of focusing incisively on the key elements of the three components [of the business model].
EXTERNAL REALITIES: Demand plunged as customers cut back their purchases and confronted the mounting overcapacity in their industry. But Cisco's cutting-edge products were still desirable.
FINANCIAL TARGETS: Revenue growth stalled, margins shrank, and cash generation slowed.
INTERNAL ACTIVITIES: Cisco's operations and organizational processes were designed for high growth. Products proliferated, and controlling costs was not a high priority.
ITERATION: When he read the market downturn, Chambers correctly analyzed it for Cisco, it was cyclical, not structural. He kept his financial targets and strategy intact, and modelled ways to align them with the new and future marketplace realities. After establishing the likely volume of sales, he searched continually and repeatedly for ways to lower costs and get his desired margins. In subsequent iterations, Chambers saw opportunities to get into new markets and segments vacated by fallen competitors; with plenty of cash, he moved to exploit these opportunities.
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