2000 Chief Executive of the Year
July 1 2000 by JP Donlon
You have spoken. Chief Executive readers have nominated and a peer selection committee has confirmed John Chambers of Cisco Systems as the 2000 Chief Executive of the Year. Why?
“He symbolizes the impact that high technology has on evolving the economy to its next generation where networking provides the backbone of human interaction,” says selection committee member Aart de Geus, chairman and CEO of Synopsys.
“The Internet is shaping how we live, work, and play in ways that were previously unimaginable,” adds fellow judge Bill Steere, chairman and CEO of Pfizer. “John Chambers has put Cisco on the front line of this revolution.” Deloitte Touche Tohmatsu Chairman Ed Kangas sees Chambers as the “architect and engineer of a new generation company that will drive e-business into the next century.”
When John Chambers became CEO in 1995, the San Jose, CA-based computer network equipment maker had 3,000 employees and $2 billion in sales. Today, it is the third most valuable company in terms of market capitalization; it has 31,000 employees and revenues of $18 billion. Cisco’s total annual average return to shareholders over the last 10 years has been an eye-popping 112 percent. Its annual net income and EPS CAGR are an equally impressive 78 percent and 67 percent respectively. In short, Cisco has been a turbo-charged shareholder value engine for the new economy.
“I believe any CEO’s goal is to achieve consistency of long-term operating performance and shareholder value,” says selection committee member Joe Forehand, managing partner and CEO of Andersen Consulting. “Chambers has led Cisco to exceed the high-water mark in both.”
But financial performance is not the full measure of leadership, according to Autodesk CEO Carol Bartz, who has observed Chambers up close and personal as a Cisco director. “Leadership is tested through difficulty and how one achieves results with others. John has never lost sight of the value of his people while maneuvering through both good times and bad.”
“Having had the opportunity to work directly for John has given me the opportunity to experience his `greatness’ first hand,” offers fellow judge Robert Davis, CEO of Lycos. “He is a man of extraordinary leadership who delivers for his customers, employees, and shareholders.”
“The most significant strength of this unusual CEO,” says Sealed Air Chairman Dermot Dunphy, “is his intense focus on developing and fostering a strong culture-in my view, the only longterm sustainable competitive advantage for any business.”
Perhaps last year’s Chief Executive of the Year, and this year’s chairman of the selection committee, Herb Kelleher, CEO of Southwest Airlines, summed it up best. “John has never let his head forget the existence of his heart, which is why Cisco is not only a legendary story of success, but also acclaimed as one of the best places to work in America.”
Chief Executive salutes John Chambers, 2000 Chief Executive of the Year.
Without Cisco Systems the Internet couldn’t function. Maybe it wouldn’t exist in the way we know it today. Not bad for a company that didn’t exist 16 years ago. When John Thomas Chambers joined the San Jose, CA-based company as the second in command to then CEO John Morgridge, Cisco had $70 million in annual revenues, 300 employees, and a market capitalization of $600 million. Since taking the helm of the world’s largest networking equipment maker in January 1995, the 50-year-old president and CEO has built an Internet powerhouse that has $18 billion in revenue, employs 31,000 people and had a recent market cap of $444 billion, ranking just behind GE’s $505 billion and Intel’s $446 billion, but ahead of Micosoft’s $358 billion as the world’s most valuable company. Most of this increase happened on Chambers’ watch.
That number will probably change many times. Only last March Cisco’s market cap zoomed to $555 billion, where, in addition to the above, it briefly shoved aside GM, Ford, Standard Oil, and Microsoft to become the world’s most valuable company. It took Microsoft a quarter century to hit the top. Cisco did it in 16 years.
Owing to the impact of the technology revolution in business much importance is attached to market valuation because it’s a measure of investors’ perception of a
company’s future worth. Yet, unlike most of those it has jostled aside, and despite its technological prominence, it remains one of the least known by the general public. About 80 percent of the switches and routers that direct data across the Internet bear the Cisco imprint. It also makes most of the networking gear-supercharged computers and software—-that companies rely on to speed up corporate networks. Essentially, Cisco is to networks what Microsoft has been to PC software.
The firm was founded in 1984 by Sandra Lerner and Leonard Bosack, two Stanford University graduates who tried to work out a way to get the university’s disparate computers to share data. The couple (they later got married, then divorced) conceived of the idea of a multi-protocol router, a mysterious black box of twisted coaxial and souped up software which allowed otherwise incompatible systems to talk to one another.
With maxed-out credit cards and an eventual $2.5 million intervention on the part of Don Valentine, general partner of Sequoia Capital, Cisco took off. Today it supplies some 80 percent of the routers that move packets across the Internet. Cisco’s strength is its ability to cobble together dissimilar systems into coherent networks-all managed through its crown jewel, the Internet Operating System (I0S), which has become something of a standard. The expression “no one gets fired for buying Cisco” is reminiscent of IBM in its glory years. Virtually all of Cisco’s administration, from employment applications to expense reports, is conducted over the Internet. And today, 87 percent of its customer business is conducted over the Internet, up from 42 percent in 1997.
Success frequently appears inevitable in retrospect. Contrary to popular lore, Cisco wasn’t the only company hoping to become the IBM of networking. The so-called Internet wind was also at the backs of 3Com, Bridge Communications and Bay Networks among others. Unlike Microsoft or Intel, Cisco didn’t have a near monopoly early on. Also, the now famous aggressive acquisition strategy——-Cisco has gobbled up 58 companies in seven years at a cost of $32.1 billion (see timeline)-actually began under John Morgridge. In addition, according to Silicon Valley mythology, one must either be a founder or an engineer to have true impact on a company; Chambers is neither. Even Cisco’s famed devotion to customer satisfaction can be traced to Sandy Lerner’s fanatical “customer advocacy.”
John Chambers is the company’s third CEO, but today’s Cisco bears his indelible stamp. Born and raised in Charleston, WV, the son of two doctors, Chambers and his two sisters grew up in a tightly knit family. He sang in the church choir, enjoyed fishing with his now retired gynecologist father, Jack, and fondly remembers family vacations spent on Carolina beaches. Chambers married his high school sweetheart, Elaine Prater and dotes on his two children-son, John, Jr. and daughter, Lindsay. He graduated second in his class at high school despite having mild dyslexia, a learning disability he persevered to overcome through working harder and tutoring. Even to this day he dislikes lengthy written memos, preferring to communicate verbally. His presentations are almost thoroughly memorized and dynamically delivered underscoring the preacher-like flair with which he addresses audiences. As a West Virginia University undergraduate he played basketball, still his favorite sport—–notably an intensive team spirited one, and later earned a law degree from West Virginia and an M.B.A from Indiana University.
It’s easy to be lulled by Chambers’ ante-bellum charm and honeysuckle accent. But make no mistake. Fast-talking and energetic, he’s a relentless competitor who is fanatical about putting customers first. The oft-told tale about Chambers being late to his first board meeting because he took a call from a distressed customer and made certain the problem was resolved before joining the meeting is true. But what Chambers is really selling is the culture and its values. And, ever the salesman, he directs his pitch to everyone.
Barbara Beck, senior VP of human resources, remembers when Chambers wanted to promote her from an HR director to her present position. She told him maybe he needed someone with more experience who could scale the organization. Having three young kids that needed their mom also might be a problem, she said. “Barbara,” she recalls Chambers saying, “if we can’t figure out how to do it for you, we aren’t worth much as a company.”
As he relates in the following interview, Chambers’ training at IBM and his later experience at Wang were formidable influences on him. Big Blue taught him the importance of selling at multiple levels. But as Chambers described it to the LAN Times, “they forgot what got them there, and didn’t have the expertise to make the equipment run better, and then got away from their application exercise.All of a sudden they were left with this limited relationship in some of their accounts which they abused.”
In his recent book, Making the Cisco Connection, David Bunnell, CEO and editor of Upside Media, reports that the rigid command system is what really frustrated Chambers. “The pivotal moment came when he achieved nine out of ten self-determined objectives, and as a result, was told that he failed to meet his goal. Shortly thereafter, he began interviewing elsewhere.” Similarly his experience of having to explain to frustrated employees why they were being laid off, traumatized him. “These were good people whose lives were needlessly thrown into turmoil,” he says with an uncustomarily dark expression.
Even before he became CEO, Chambers set about building teams by instilling open communications. Compensation is tied to team success, as is recognition. Among the score of three story buildings that dot South Tasman Drive, the executives have the interior offices-or cubes-while everyone else has windowed spaces. In most companies it’s the other way around. (Chambers’ own office is also an interior space no bigger than any other executive’s.) In pursuing acquisitions, the ’98 ’99well-oiled Cisco merger and integration engine is mindful that the value lies with the talent, not the physical assets. Interestingly, the defection rate of employees at acquired firms is lower than the annual voluntary turnover rate of 5.1 percent of all Cisco employees. (Total annual turnover is 7.1 percent.)
In its Cerent acquisition of August 1999 for example, Cisco lost only four employees out of 300. At $6.9 billion, the most expensive deal thus far, Cisco paid a whopping $23.3 million per retained employee. To be fair, the range Cisco pays per person is somewhere between $500,000 and $2 million, but it shows where the priorities lie. Cisco seeks companies developing a new technology a year or two before its launch. It incorporates the new technology as its own and with all the benefits of the Cisco brand, sales force, and market leadership behind it. It’s a strategy that has thus far moved flawlessly across 15 market segments it serves. Besides, the deals consume little cash since they are done using “Cisco dollars,” i.e., stock.
Chambers and his team long ago became technology agnostics. Although 70 percent of its products are developed internally, they care less about whether something is developed under its roof than whether they have the right stuff to take the market to the next level. What happens when Cisco makes a mistake and the acquisition doesn’t give it the edge it needs? Cisco is content to “eat its young,” according to Bunnell who cites the case of LightStream (1994), whose ATM product line progressed too slowly and had to be pared back to allow for expansion of Strata-Corn’s (1996) superior WAN switching technology. Given that all new employees own options, and the Cisco rule of not laying off employees of acquired companies without the express consent of the firm’s former CEO, the company has turned acquisitions, a notoriously high-risk activity, into a normal 30-day business process.
It has also created an odd workplace of shiny, happy people, which has triggered the incredulity of more than one cynical observer. “Why are these people always smiling?” groused Joe Flowers writing in Wired several years ago, wondering whether the company didn’t attach something Borg-like to the cerebral cortex of every Cisco employee. Then he did the math. “Suppose you are a senior systems engineer who signed on with Cisco in early 1992 with an option for 5,000 shares. If you exercised the options and kept the stock that signing bonus would be worth more than $2.4 million, enough to buy several houses-cash-even in Silicon Valley.” Then there are the stock options.
Microsoft may have its billionaires, but Cisco has battalions of centimillionaires. This is not to say that everything gleams in the Emerald City. Observers grumble that Cisco makes a habit of buying out possible competitors before they become serious threats, although the company denies it uses its market power to feed on rivals. Its high market share in Internet routers precipitated the DoJ to look into whether the company had violated any laws when it approached Lucent and Nortel about splitting the market for telecom gear. Yet no charges were filed nor accusations made. Cisco has clearly learned from Microsoft’s experience not to bully the regulators.
Since Cisco has moved in the direction of Internet telephony networks it is buying up software and modem start-ups. But even here observers wonder whether the company can continue to overpay as bids drive up the price of telecom equipment higher and higher. Then there is the question of what happens if the regulators restrict pooling-of-interest accounting, which critics say dilutes shareholders’ interest and distorts earnings. A 177 P/E can be both a blessing and a curse. And speaking of dilution, the company is a heavy user of stock options, which under present accounting rules, are not counted against earnings. Last year Cisco employees held some 439 million outstanding options. The company reported $2.1 billion in net income in 1999, but, according to a footnote in the annual report, accounting for options would have wiped out $500 million of that.
A greater challenge to Cisco may come in the form of start-ups making equipment for the next generation Internet. Many use an optical technology, which analysts say is way ahead of Cisco’s. Sycamore Networks, for example, makes equipment that allows carriers to easily switch wavelengths of light, each carrying huge amounts of data. Juniper Networks has already established leadership in an area Cisco wants to dominate-ultrahigh capacity Internet switches. Corvis has created a system that shoots photons long distances without any electronic regeneration. The next round of competition in these sectors will be tricky since there aren’t all that many other players that Cisco can acquire and integrate as its own. Also, both Nortel and Lucent have popped the clutch on their own acquisition strategies in an effort to win the gigabyte race in optical data transmission.
For his part, Chambers believes that Cisco, which led the first wave of networks, will lead the next generation of network convergence, be it wired or wireless. Interestingly, he doesn’t see himself as the best CEO in the world, all media attention and stratospheric growth notwithstanding. The competitive edge lies not with the company’s technology, acquisition skills, or business process, he will tell you, but with Cisco people. When he talks about the “soft” stuff, Chambers’ manner takes on a hard, deliberate edge, as if to say, this is serious. While borrowing a little of Andy Grove’s sense of paranoia about competitors, Chambers, whose ambition is to build the most “influential” company since Jack Welch’s GE, thinks it can only be attained if Cisco’s people continue to believe in themselves and in its vision.
And he may be right.