It is important neither to overestimate nor underestimate Cisco. However, when a company stands so clear of its competitors in terms of profitability, capitalisation, and cash, how does one avoid the danger of overestimation?
Certainly a large number of punters continue to take the view of Cisco as a heroic and uniquely able company, so that although the companys shares have continued to fall during the year, the company still stands on a PE ratio of around 32. This is not especially high in itself but extremely high in the context of a depressed stock market and collapsed communications sector, and many times that of its peers. Is this valuation based on false assumptions? If so, which ones?
It may be argued that Ciscos relatively good performance compared to most
other companies in its sector arose actually as much from its weaknesses as its strengths, notably in the wireless and optical markets and also from its relative failure to penetrate the service provider market. This epic failure by the company meant that when the wireless infrastructure meltdown came, Cisco was barely affected at all, except collaterally.
This 100+ page report, based on interviews with the company as well as observers outside it, attempts to:
- Understand Ciscos management style
- Document its acquisition record
- Clarify its product positioning
15% of the report is taken up with a forecast of Ciscos market share and billings by product segment. (Request sample)
Purchasers of the report will receive updates in July and December 2003.
THE CONCEPT OF A NATURAL SHARE
The concept of a "natural share" (or what some might prefer to call a "reference norm" share) has been used in this analysis: Cisco's current sales level for 2002 is about $18bn in a total market for communications equipment of maybe $200bn - ergo at the margin Cisco has a 9% share of the total communications market. This might be considered as the company's "natural share". What do we mean by this? Our definition of "natural share" is the eventually stable share a company might normally expect to achieve in a particular market if every participant in the market was competing with it, and neither it nor its competitors did anything extraordinary or had any exceptional advantage, either in terms of having entered the market early or in terms of captive markets or in terms of technology.
Understandably many may not regard this as a particularly useful definition, since the environmental conditions for which it is defined probably have never ever occurred and probably never will! However it does have some usefulness as a point of reference when, for instance, there are no separate objective measurements of a company's share in a particular market, and this concept, sensibly used and subject to the qualifications below, can be used to make a reasonable estimate. The second advantage is that to some extent a market assessment viewed from a competitive viewpoint can help to explain a company's market share rather than merely record it, thus offering an analytic model from which strategic actions aimed at improving share may be generated.
The third application (which is our current main use of it) is in looking forward at the likely market shares that Cisco in particular may expect in the markets it is now engaged in entering, or exploiting, as the basis for our medium term forecast for the company. It is intuitively obvious that actual shares can and do diverge from the "natural share" number by large amounts in either direction; most obviously a company can, by ineptness, perform well below its natural share for a time (though one presumes management eventually makes some kind of correction if the results are too awful, tending to narrow the divergence).
Obviously, also, only a relatively small percentage of the total competitor list participates in any particular market, particularly in its early stages when the likely longer term outcome of a particular market thrust initiative may still be obscure. However the top six competitors in the communications market including Cisco serve about 60% of the total market and it is reasonable to assume that all of these will normally sooner or later enter any particular market that Cisco might consider worth its participation, which somewhat simplifies that argument.
Within such an (again highly simplified) scenario, one might expect Cisco to end up with a 15% share minus its percentage of whatever is taken by "others" not in the top 6 competitors.
Turning back to the real world, it is obvious that specific markets develop and competition develops within them in a multiplicity of ways, so such numbers can only be of general use as benchmark reference points. After that, it is a question of assessing how many other significant minor competitors there are contesting the sector. In some cases these minor competitors may have actually invented the sector and will initially own a very large share. Other factors affecting objective expectations of a company's divergence from its natural share will be the extent to which a company is early or late in the market. The issue of brilliance is in fact a rather marginal one in most cases; whilst the phenomenon exists, it is by definition rare and almost invariably individual rather than organisational, and most likely to be associated with a single standalone company founded on that achievement. Organisations may be more or less efficient but in a large company there is a natural tendency for averaging to take place at many different levels, thus diluting whatever special capabilities may exist within that organisation. Finally it is worth making two very fundamental observations which may help to clarify a general view of Cisco's future prospects:
1. Outside Cisco's core router and switch market, where it claims ca 70% of the market it serves, Cisco's share is actually only about 2% ie outside these sectors it is quite a minor player. The (maybe belated) recognition that Cisco's writ does not run universally large outside its core businesses may have contributed to the announcement made by John Chambers early in January 2003 that the company planned to spend $150 million on strengthening the company's brand image.
2. It is generally only possible to have a much larger share than one's natural share if
- &Mac183; One has invented the market in the first place and by definition therefore on starts with a 100% of it, losing it systematically as the market develops and gets more interesting to competition at various levels. Generally Cisco has not been very good, certainly recently, at inventing markets and anyhow large companies cannot achieve significant growth over a five year period from really new markets, since it takes a few years to develop them.
- The market is of a size that will only support a limited number of competitors; similar remarks as in A. apply.
- One acquires competitors with a major share of the market; this can be a successful medium term strategy but is often anti-synergistic (ie total share afterwards less than the sum of the shares before), and often turns out to be only a temporary success. Cisco in any case has shown little propensity so far to take the route of wholesale market share acquisition.
- One throws disproportionate resources at the market; the risk here is analogous to that of trying to make a plant grow faster by overwatering and overfeeding it. Up to a certain level this works, after that level the extra resource is wasted (and in the plant's case will usually kill it).
In fact in almost all the markets it has entered with the objective of achieving corporate growth, Cisco is coming from behind and in the large and highly contested markets which of necessity are the ones it has to target, one can envisage that certainly in the medium to long term, Cisco is likely to find its share restricted to the range 10-20%. Obviously in those markets such as storage networking, where Cisco had practically no share to start with, this will give the company some medium term gains, but when one actually does the raw calculations nothing like, one suspects, the gains that many of its investors have been hoping for.
The markets on which we have focused are obviously Cisco's core markets plus those which Cisco itself has defined as the ones from which it hopes to achieve overall accelerated growth: ie
7. Internet Security (incl VPN, firewalls etc).