A research project submitted to the faculty of San Francisco State University in partial fulfillment of the requirements for the degree

Master of Business Administration

By Eric Bravo Eslao San Francisco, California November 5, 2009


I certify that I have read CISCO'S INNOVATION-THROUGH-ACQUISITION STRATEGY by Eric Eslao, and that in my opinion this work meets the criteria for approving a research project submitted in partial fulfillment of requirements for the Master of Business Administration degree at San Francisco State University.

_______________________________________ Mitchell Marks Assistant Professor of Management

________________________________________ Michael D. Meeks Assistant Professor of Management




Eric Eslao

San Francisco State University Fall 2009

The purpose of this project is to study Cisco's acquisition strategy. The research methods to be used will consist of literary review (e.g. Wall Street Journal, Los Angeles Times, and Financial Times). All information is publicly available. The outcome of this project will be to discover how Cisco's has leveraged its acquisition strategy for growth and innovation.

_______________________________________ Mitchell Marks Assistant Professor of Management

_______________________ November 5, 2009


TABLE OF CONTENTS Certification of Approval Abstract I. II. III. IV. V. EXECUTIVE SUMMARY INTRODUCTION METHODOLOGY CISCO SYSTEMS a. Business Description b. Acquisition History VISION & STRATEGY a. Vision b. Acquisition Strategy i. Employee Retention ii. New Product Development iii. Market Share c. Merger of Equals ACQUISITION PROCESS a. Market Identification b. Target Identification i. Vision ii. Culture iii. Short-Term Win iv. Long-Term Wins v. Location c. Due Diligence d. Prior to Deal Announcement e. The Announcement and Closing Period f. First 90 Days g. 90-180 Days CISCO'S FUTURE CONCLUSION REFERENCES ii iii 1 2 4 5 9




33 36 37



This thesis will explore how Cisco has leveraged acquisitions as an essential aspect of their innovation strategy and how the company has successfully integrated their targeted purchases. In addition, this thesis will highlight strategically significant acquisitions throughout Cisco's history. Based on a growing body of literature, this thesis will also reveal how Cisco has adapted its traditional acquisition strategy as the company pursues new markets, opportunities, and technologies.



Acquisitions are a risky endeavor. Layoffs are standard protocol, culture clashes are expected, and key executives leave to greener pastures. The empirical data reveals that while one company will succeed at meeting their strategic and growth goals through acquisition, two or three will not fulfill the same promise (Wall & Wall, 2000, p. 16). And yet, many leading technology companies continue to acquire new companies even with the unlikely chance of success. This was definitely the case during the tech boom of the 1990s. As innovation moved at a new, ever-growing pace, many large tech companies utilized the acquisition of younger, smaller technology firms to quickly integrate new technology advances. "The rate of change has become so high in our industry that it is just impossible to plan your internal developments in such a way that you will have the right technology at the right time," explains Phil Garner, former Senior Director of Engineering for the high-tech acquirer 3Com. "You really have to think about going outside to some little company that might have, through luck or insight, developed the right technology" (Wall & Wall, 2000, p. 11). The promise of acquisition was that it was a short cut to innovation—a quicker and cheaper proposition than the tried and true methods of innovating internally. By 1999, the total value of mergers and acquisitions worldwide reached a recordbreaking $3.44 trillion; by far, making this the most bustling period for M&A activity (Deogun, 2000). However, like with everything else, the Dot Com bust brought all this activity to an immediate stop. As some companies integrated key technology and recruited talented personnel


through acquisitions, and by doing so, materialized the benefits of M&A, many acquisitions failed to create the intended benefits or value: few early-stage technologies blossomed and employees abandoned ship. One study revealed that of 300 M&A deals that were valued at over $500 million, only 43 percent of the merged companies were outperforming their nonmerged peers in shareholder returns after three years (Barr, 1997). In addition, integration of the two companies technologies can result in major problems. After the merger of Union Pacific and Southern Pacific in 1996, shareholders sued the merged company (claiming management misrepresented the benefits of the merger) as the company struggled to integrate the two management systems, which resulted in major delays and business losses for hundreds of shippers (Morse, 1997). In despite of all the pitfalls of using acquisition to innovate, a few companies have managed to execute the strategy correctly. Companies like Microsoft, GE Capital, and Cisco have all grown successfully through acquisitions. While these companies were briefly sidestepped after the high-tech bubble, over the long run, they have realized tremendous growth through their acquisition strategy. As the global leader in networking for the Internet, Cisco has had historical success in consistently profiting from its acquisition strategy. Cisco's success can be best exemplified by a few facts and figures. In March 2000, Cisco became the largest company in the world in terms of market capitalization (Cisco Systems Corporate Timeline, 2008, p. 16). If a share of Cisco stock was purchased at $18 when it went public, it would have been worth $14,000 ten years later. More than 10 percent of Cisco's employees are now stock-option millionaires.



All information from this thesis was collected from publicly available sources. The primary research for this thesis was conducted on Cisco's website. Much of Cisco's information in regards to their acquisition strategy is accessible online: press releases, annual reports, and interviews with the CEO and acquisition team. The popular books Making the Cisco Connection (Bunnell, 2000), Cisco Unauthorized (Young, 2000), and Inside Cisco (Paulson, 2001) were other sources. Additional literature such as case studies and articles in magazines, newspapers, and journals were found via San Francisco State University's library database.



a. Business Description Founded in 1984, Cisco Systems is headquartered in San Jose, California and is the worldwide leader in the Internet infrastructure market. Cisco went public on February 16, 1990 (Cisco Systems Corporate Timeline, 2008, p. 3). As of 2009, Cisco's stock (NASDAQ: CSCO) was added to the Dow Jones Industrial. Today, Cisco employs more than 65,000 employees (Cisco Systems, n.d.a.). The company currently owns over 200 offices in more than 60 countries around the world (Company Spotlight, 2006). Cisco built its business on manufacturing routers, a hardware device that connects networks, and quickly gained significant market share as the need for networking surged in the late 1980s with the use of the Internet. According to Cisco's 2009 Annual Report The Connected World, routing accounts for approximately 17 percent of total revenue, switching approximately 33 percent, advanced technologies (e.g. optical networks, wireless equipment and internet telephony) totals 26 percent, service is 19 percent, and other revenue is approximately 5 percent (p. 4). In terms of customer segments, enterprise represents approximately 40 percent of Cisco's business, service provider approximately 30 percent, commercial 25 percent, and consumer 5 percent (Company Spotlight, 2006). Currently, Cisco is investing in more than 30 new opportunities that are adjacent to their core business. In each one of these opportunities, the technology drives innovation in existing core products (Chairman and CEO, 2009). These new opportunities—what Cisco calls market adjacencies—all tie into the common theme of the network being the platform for transformation in business models, government services, and the connected consumer


(Chairman and CEO, 2009). An example of a market adjacency is Cisco's progress in the area of Smart + Connected Communities, where they continue to advance their initiative to help cities use the network to deliver better city management, enhance quality of life, drive economic development, and cultivate environmental sustainability (Chairman and CEO, 2009). In particular, Cisco has recently reached an agreement with the Korean metropolitan city of Incheon and the city developer Gale International where Cisco will be the acting technology partner in opening the city of Songdo in Incheon. In some cases, market adjacencies have allowed Cisco to lead in key market transitions (technologies or trends that are disruptive to existing markets and create transitions that Cisco can capitalize on) like in video and virtualization (Young, 2001, p. 9). Identifying market transitions has been key to Cisco's continued growth. "The one thing Cisco has done consistently is that whenever we take on a market in transition, we gain market share," explains Cisco’s CEO John Chambers. "To gain market share in normal times you slug it out forever for one or two or three percent growth. But if you catch it in transition, you can gain 20 or 30 or 40 percent share points.... People, and companies, who get their timing wrong will fail" (Young, 2001, p. 9). Cisco outsources much of its manufacturing operations. By doing so, it can quickly increase production without having the added constraint of building factories or hiring people. In addition, it can just as quickly reduce production without the need for layoffs (Company Spotlight, 2006). In 2001, Cisco moved from its line of business organizational structure to centralized engineering and marketing organizations. Cisco's current structure organizes engineering into


technology groups (e.g. voice, storage, optical, video, wireless), while marketing focuses on communicating Cisco's unique technology differentiation (Ceniceros, 2001). Cisco's innovative organizational structure—referred to as “Councils and Boards”—brings together leaders from across functions to define, plan, execute, and monitor its progress in market adjacencies. Councils are teams of executives who make decisions on $10 billion opportunities (e.g. consumer, enterprise, emerging markets). Boards consist of executives who have authority to make calls on $1 billion bets (e.g. connected homes, mobility, sports and entertainment). Altogether, there are about 50 boards and councils, with some 750 members (The World According to Chambers, 2009).

b. Acquisition History As with any great success story comes a tale of luck. After going public in 1990, Cisco's business was threatened by the invention of the switch—a cheaper and faster alternative to the router. Cisco quickly dedicated an internal team of engineers to build a switch of their own, however, executives quickly realized it was going to be late to market. Rather than be a late entrant, they decided to make their first acquisition in 1993: Sunnyvale’s Cresendo Communications, a small switch maker, for $95 million (Bunnell, 2000, p. 34-37). Not only was Cisco the first to enter the switch market, it also retained many of Crescendo's executives and the switch division became a core product of Cisco. Its acquisition of Crescendo was followed by equally successful purchases of switch technology companies Grand Junction and Kalpana (Cisco Systems Corporate Timeline, 2008, p. 6-7). Today, the switching unit generates $12.1 billion of the $36.1 billion of Cisco’s total revenue (Chairman and CEO, 2009).


Since their first acquisition, Cisco has maintained a healthy appetite for purchasing companies. From 1995 to 2000, Cisco maintained a steadfast rise in annual income and rapid growth while the Internet industry was booming; this period paralleled the busiest period of M&A activity for Cisco with the purchase of 69 companies (Cisco Systems Corporate Timeline, 2008, p. 7-19). However, Cisco slowed down the number of acquisitions dramatically and only acquired ten companies from 2001 to 2003. Fortunately, Cisco was able to recover quickly, and from 2005 to 2008, Cisco was back on a steady growth pattern (Chairman and CEO, 2009). Today, during what is clearly the toughest economic challenge for every company, Cisco's revenues have decreased by approximately nine percent: total revenue for fiscal year 2009 was $36.1 billion compared with fiscal year 2008 revenue of $39.5 billion (Chairman and CEO, 2009). In 2009, since the publishing of this thesis, Cisco has only acquired two companies: Richards-Zeta Building Intelligence and Pure Digital Technologies (Musgrove, 2009).



a. Vision Cisco has a well-defined vision of what it takes to be successful within its industry. Cisco's vision shapes overall strategy and guides employees to takes actions that move the company toward the company's corporate and customer-oriented goals and objectives. Furthermore, Cisco’s vision helps define its organizational structure, procedures, and policies (Paulson, 2001, p. 60). Here are major points taken from Cisco's vision (Paulson, 2001, p. 60): • The expectations of customers rapidly change, as a result, the definition of valueadded commodity products and services thresholds is continually redefined • Customers are not just looking for specific products that deal with only one particular segment of the overall network, but end-to-end solutions • • Providing a horizontal business model is better than a vertical business model Proprietary standards are the old way of doing business; compliance with open standards is the new requirement • Speed to market is a competitive advantage

For Cisco, building a clear vision for the future is a key reason why they've been so effective at acquisitions. Cisco's emphasis on vision helps to keep its focus and identity intact while it continually acquires companies. The company upholds the importance of vision to such a high degree that sharing a compatible vision with Cisco is a requirement for any acquisition. Cisco distinctly communicates a vision, providing a sense of identity and purpose, which the acquired company can successfully work towards.


b. Acquisition Strategy Cisco uses a comprehensive mix of acquisition, research and development, and partnering to enter high-growth emerging markets. This growth strategy is referred to as “Build, Buy, Partner” (Cisco Systems, n.d.b.), and in many cases, Cisco employs these tools throughout the lifecycle of a new technology: by first learning through partnering (Partner), then leveraging internal R&D to improve and speed the technology's development (Build), and lastly, acquiring the entire business to quickly bring the technology to a global market (Buy). An example of Cisco executing this philosophy is with its entrance into the optical transport market. In 1995, Cisco made a minority investment of 10 percent in Monterey Network, a small startup located in Texas (Cisco Completes, 1999). Cisco's investment in this company gave it access to the cutting-edge technology and engineering staff, and visibility to the $20-billion-a-year optical transport marketplace. In 1997, after careful consideration, Cisco purchased the entire company for $500 million. What they are most known for—and the focus of this thesis—is the “buy” aspect of this strategy. Cisco’s acquisition strategy focuses on growth and innovation by addressing three key areas: employee retention, new product development, and market share (Bryne, 1998).

i. Employee Retention Cisco views acquisitions as a method to acquire intellectual assets and nextgeneration technology when internal innovation is not enough to enter or to further penetrate


a particular market segment. According to Chambers, employee retention is crucial to this objective: "When we acquire a company, we aren't simply acquiring its current products; we're acquiring the next generation of products through its people. If... all you are doing is buying the current research and the current market share, you're making a terrible investment" (Daly, 1999). Chambers further rationalizes the importance of retaining employees as he puts it in financial terms: "We pay between $500,000 and $2 million per person in an acquisition, which is a lot. So you can understand that if you don't keep the people, you've done a tremendous disservice to your shareholders and customers" (Waters, 2002, p. 94). While industry-wide turnover in acquired companies is typically more than 20 percent, Cisco's is only 2.1 percent (Wall & Wall, 2000, p. 15). Another reason for the emphasis on employee retention, which is less obvious, stems from the difficulty to secure top engineering talent in Silicon Valley. Hiring a whole department of engineers is “the number one reason for M&A in the technology industry,” explains Larry Blohn, CEO of net.Genesis. “It’s the only way to hire 20 to 30 engineers” (Gashurov, Key, & Serwer, 2000).

ii. New Product Development Cisco’s acquisition strategy is also a substitute for in-house research and development (Nee, 2001). High-tech companies use acquisition instead of R&D to establish market position quickly in response to shortening product life cycles (Bower, 2001). While many industries measure product cycles in years, in the high-tech market the average product life cycle is six to 18 months. In this fast-paced environment, Cisco recognizes that if it cannot develop a product with internal resources within six months, it must buy its way into the


market or miss the window of opportunity (Bower, 2001). However, it must be noted that acquisitions have not replaced R&D at Cisco. To put things in perspective, Cisco creates two-thirds of its intellectual property internally while one-third is through acquisition (Kenney & Mayer, 2004). Cisco's strategy is to also acquire technologies that will benefit the company's customers, employees, contract manufacturers, and other supply chain partners. According to Li (2009), Cisco links their complex network of partners, vendors, and suppliers (referred by the author as a business ecosystem) to leverage the acquired technologies for the benefit of the entire network and to maintain Cisco's growth rate (p. 379). For example, the acquisition of GeoTel Communication in 1999 provided the flagship technology to provide all-in-one data transfer (data, voice, and video) over a network. Following that key acquisition, Cisco purchased Signal Works (in 2003), Riverhead Networks (in 2004), Protego Networks (in 2004), P-Cube (in 2004), and Scientific-Atlanta (in 2005) to complement the purchase of GeoTel Communication, yielding products and technology that supported the entire business ecosystem and its objective to provide all-in-one data transfer (Li, 2009, p. 383). Targeting principally small startups with leading-edge technologies, Cisco has been able to take these acquired technologies to market with scale and speed through their global sales and marketing teams. The success of Cisco’s first acquisition of Crescendo solidified this very process (Young, 2000, p. 179). “At the time we made our first acquisition we had a wonderful asset in the form of a channel to sell, install, and service products for the global market,” explains John Morgridge, Cisco’s ex-CEO and current Chairman Emeritus. “As a result, there was tremendous leverage in acquiring a product that met the market requirement and to put it through our channels. We can take [a new product] and leverage it very


dramatically. To a large degree, that has been our strategy with most acquisitions” (Kenney & Mayer, 2004).

iii. Market Share Cisco will only enter markets if it can achieve a first or second leadership position. The company sets to have a 50 percent market share in every market it enters and expects to control 20 percent market share upon entry (Paulson, 2001, p. 29). Cisco's move into digital subscriber line (DSL) exemplifies this very standard; in 18 months, Cisco dominated the market with the purchases of Telesend (in 1997), Dagaz (in 1997), NetSpeed International (in 1998), and Maxcomm (in 1998) (Cisco Systems Corporate Timeline, 2008, p. 9-12). At Cisco, market share growth is an important indicator of success. Given the fact that Cisco expects approximately 60 percent profit margins, market share growth in rapidly growing markets amounts to massive returns (Kenney & Mayer, 2004). Cisco executives justify Cisco’s acquisition prices, which many Wall Street critiques deem as too high, for this very reason (Kenney & Mayer, 2004).

c. Merger of Equals Cisco makes it very clear to the small Silicon Valley startups that any acquisition is not a merger of equals: it will be fully integrated into Cisco and that everything the target currently does and knows will likely be changed in the integration process. And while Cisco has made large purchases like Scientific-Atlanta for $6.9 billion in 2005, Arrowpoint Communications for $5.7 billion in 2000, and Stratacom for $4.67 billion in 1996, Cisco has no interest in merging with the likes of Intel, IBM, or Lucent (Paulson, 2001, p. 32). To date,


many of Cisco's acquired companies have been purchased for under $200 million (p. 32). With any acquisition, there is a level of disruption that occurs at both companies as needed structural and other administrative issues are dealt with. However, with the merger of two large companies in a highly competitive, dynamic industry like networking, their growth rate will inevitably slow as integration is implemented. "There's no better example than the deal between network equipment makers Synoptics and Wellfleet. Our two toughest competitors combined and took themselves out of business," Chambers cites as Cisco's rationale to acquire Crescendo in 1993 rather than merging with a competitor (Paulson, 2001, p. 136). According to Paulson (2001), a merger of equals can be both devastating to the interests of shareholders and to bringing products to market in a timely manner (p. 32).



Cisco has developed a portfolio of tactics, formal and informal, to acquire target companies. Included is the conscious organizational decision to creating the Corporate Development group—a dedicated team of full-time employees focused solely on acquisitions (Cisco Systems, n.d.b.). Cisco created this diverse 150-employee team ranging in expertise from Ph. D's in engineering to MBA's with investment banking backgrounds (Cisco Systems, n.d.b.). From scoping potential purchases to conducting due diligence to integrating new companies, Cisco has professionalized the acquisition process, which many experts have attributed to Cisco's success (Swaminathan and Tomlin, 2006). The employees in the Corporate Development group are divided into three divisions: deal making, integration, and technology management. The Corporate Development group reports to Ned Hooper. Ned Hooper, who joined Cisco through the acquisition of Lightspeed International in 2002, has led the company's acquisition strategy by targeting growth opportunities in new markets and integrating innovative technologies into Cisco businesses (Alberstein, 2009). According to research by Swaminathan and Tomlin (2006), Cisco's creation of the Corporate Development group enables a dedicated team to acquire expertise in the acquisition methodology, which then makes it more replicable, and thus, increases reliability and decreases risks associated with acquisitions. Cisco has grown successfully through acquisitions because of its ability to effectively integrate new companies—a primary role of the Corporate Development group. However, it must be noted that the entire company—from human resources to accounting to manufacturing—is involved in the acquisition strategy in


some capacity since it's such an integral aspect of their overall corporate strategy and engineering development program. At Cisco, acquisition is simply another business decision and process, not an occasional activity. While the Corporate Development group is involved with every acquisition, the team recruits an executive sponsor to help with the acquisition process of each deal (Kenney & Mayer, 2004). In most cases, this executive sponsor is usually the person that identified the need for the acquisition and/or will be in charge of the business unit after it has been assimilated. The executive is involved from day one of the acquisition and develops a good working relationship with the target company and the transition team. This practice, as repeated studies have shown, assures that there is clear ownership to the deal and increases the odds for success (Digeorgio, 2003, p. 263; Kenney & Mayer, 2004).

a. Market Identification Predicting future market trends is a difficult task and requires a blend of experience, industry insight, and data. With its success of finding the products of its future in startups, Cisco makes use of several techniques to scan for knowledge and capabilities that are constantly emerging in this environment. Cisco executives and managers are highly networked in the high-tech startup environment (Kenney & Martin, 2004). Many of these Cisco employees have entrepreneurial backgrounds—often coming from startups and still serving as advisors, investors, and board members at various startups and venture capital firms. Cisco informally encourages its employees to maintain their previous networks. By doing so, these employees are exposed to a rich flow of information about new firms and products that may become important to Cisco


in the future (Kenney & Martin, 2004). Cisco also looks to their customers as a vital source of information about new developments (Goldblatt, 1999). Many of Cisco’s customers are universities, national laboratories, and engineering-intensive firms that utilize the company’s products in new applications; this exploration of new applications helps identify new innovative technologies and the firms that pioneer them. More often than not, when a customer exhibits an interest in a product that Cisco does not provide, the company will look into ways of offering it. Case in point, the CEO of US West, Solomon D. Trujillo, was interested in placing an order for a high-speed xDSL Internet access product from NetSpeed, but Trujillo had serious reservations because NetSpeed was a startup (Products Expand, 1998). In 1998, after evaluating the company as an acquisition target, Cisco purchased NetSpeed for $265 million. US West gets the cutting-edge product it needs without the fear of being left with products and no manufacturer. NetSpeed gets to see its products go to market and employees are able to cash out. And Cisco has a guaranteed order upon its purchase of NetSpeed. In addition, each business unit formally tracks and accesses new technologies that may affect its market. As part of the annual business plan, every business unit must identify emerging technologies and recommend a preliminary “make” or “buy” recommendation (Kenney & Martin, 2004). This practice encourages each business unit to scan the environment for new opportunities and threats. While the company has acquired over 130 companies over the years, it has partnered with many more—directly and indirectly—through strategic alliances and venture funds. Through its numerous investments, Cisco has been able to acquire visibility, knowledge, and experience in new technologies and markets.


All investment targets are screened for both business and technology congruence. Cisco's investments are routed through local regional technology funds. The collective expertise, market reach, and capabilities that are made available through Cisco's investment are actively shared within the company as well as with its global partners (Musgrove, 2008). For example, furthering its strategy into emerging markets, Cisco made an anchor investment in a venture capital fund that focuses on the Russian technology industry. Cisco's investment of $60 million in 2008, in collaboration with the Almaz Capital Partners, targeted high-growth, small and medium-sized companies in technology, media, and telecommunications (Musgrove, 2008). Similar to strategies implemented in China and Israel, Cisco saw tremendous potential in Russia with its growing community of tech entrepreneurs that are building both innovative technologies for global and local distribution. In some cases, Cisco will identify markets it wants to enter, however, it cannot target a suitable firm to acquire. According to Paulson, Cisco pioneered a strategy of creating a sponsored startup or a “spin-in” (2001, p. 157), as in the case of the startup Ardent, which was founded by two Cisco employees and a serial entrepreneur. Cisco management agreed to acquire Ardent if it met a set of functional requirements and milestones. The founders retained 55 percent of the equity and Cisco 32 percent; Sequoia Capital also acquired 11 percent of the firm. In 1997, Ardent met Cisco’s requirements and was acquired for $157 million, and as a result, was spun-in (2001, p. 157).

b. Target Identification When the company identifies a new market opportunity, an informal dialogue is initiated between the business units to confirm the need for the technology and whether to


develop internally or to acquire (Kenney & Mayer, 2004). If their discussions lead to the decision to acquire rather than develop internally, the next step is to have the Corporate Development group draw together a list of acquisitions targets (O’Reilly & Pfeffer, 2000). The Corporate Development group will utilize both existing internal information and proactive market study (Kenney & Mayer, 2004). If the technology is in an established Cisco market, target identification is usually a quick process since management is well acquainted with the firms, as well as, with the founders (Kenney & Mayer, 2004). In situations where Cisco is entering a new market, a long-term strategic plan is developed (Kenney & Mayer, 2004). The Corporate Development group will facilitate the dialogue between the different business units to arrive at a coherent long-term strategy. Though this process is formal, the process is flexible with overlapping stages, discussions about markets, and an investigation of the actual nature of the environment and technological trajectory (Kenney & Mayer, 2004). As previously discussed, Cisco measures the success of every acquisition first by employee retention, then by new product development, and finally by market share (Bryne, 1998). Combining Cisco’s requirements for success and the need for a systemized acquisition approach, Cisco established five primary evaluation criteria to identify target companies. The general acquisition criteria, which will be elaborated in more depth shortly, is based on these basic tenets (Borgese & Borghese, 2001, p. 134-135): i. Vision ii. Culture iii. Short-Term Win iv. Long-Term Wins


v. Location Cisco uses a simple system to indicate the degree that each target company satisfies the acquisition criteria (Paulson, 2001, p. 31). If the target company does not meet at least three of the five criteria, Cisco will not consider the company for acquisition (“red light”). Should only four of the five are met (“yellow light”), then Corporate Development makes a judgment call to determine whether the areas of incompatibility are such that the purchase will result in failure of the acquisition’s objectives. If it does sufficiently meet all five criteria, then the target company will be actively pursued (“green light”). Even if a “green light” is given, the team will make it clear that while there is a likelihood that Cisco will acquire the target company, Cisco may choose later not to make the purchase (Paulson, 2001, p. 31). “We’ve killed nearly as many acquisitions as we’ve made…. I believe that it takes courage to walk away from a deal. It really does. You can get quite caught up in winning the acquisition and lose sight of what will make it successful. That’s why we take such a disciplined approach” (p. 31).

i. The purchased company needs to share a complementary vision of the industry and product Cisco requires that the targeted company share a product and industry vision that is similar to Cisco's. Cisco has learned that unless personnel view the future in the same way, the two parties will have problems working out the details of future product and service offerings. When being late to market can equate to being a market follower than a leader, it is in Cisco's best interest to bring new technologies quickly and effectively to the market. Cisco sees any conflict in vision as a major stumbling block because it will inevitable lead to


personnel conflict, and thus, hinder Cisco's ability to drive innovation (Paulson, 2001, p. 63). Key management's vision of the industry and their desired place in the industry is equally as important. If managers do not share the same view as Cisco, they are often asked to leave as part of the acquisition.

ii. The purchased company needs to share a compatible culture "You have to avoid the temptation to say, 'Well, our cultures are different, but I can still make it work.' They normally don't," explains John Chambers (Paulson, 2001, p. 87) Though there is a level of compromise in any acquisition, the targeted company needs to share Cisco's core values, otherwise, managing the post-acquisition environment will be difficult. According to Stahl's research, the differences in cultures will ultimately undermine the success of the deal (2006, p. 3). From differences in management styles to executives that cannot agree, these issues will almost always lead to integration problems. The following are Cisco's five core values that help define the framework of its culture (Paulson, 2001, p. 92): • • A dedication to customer success: making the customer's priorities #1 Innovation and learning: a commitment to finding new solutions and ways of doing business • • Partnerships: partner with companies that complement Cisco's business objectives Teamwork: create an environment that develops employees as team players, while at the same time, advocate diversity and unique ways of looking at and solving problems • Doing less with more: operate without wasteful or extravagant spending


As previously noted, Cisco judges its acquisition success by its ability to retain employees: if the acquired company doesn't share a similar culture, a large number of employees will likely leave within a short period of time after the acquisition, and take with them, the expertise and skills Cisco purchased.

iii. The acquisition must produce a short-term win for shareholders Cisco contends that every acquisition garner a financial gain for shareholders within 12 months or it will not fit the acquisition profile (Paulson, 2001, p. 74). Cisco acquires targeted companies through the use of Cisco's stock to facilitate the purchases. By doing so, Cisco is able to preserve valuable cash for later investment in such activities as marketing, R&D, and expansion. However, the practice of funding acquisitions with the issuance of stock to the selling company's owners dilutes the stock positions of existing Cisco shareholders. It only makes sense then that an acquisition be in the best investment interest of the shareholders (i.e. higher stock prices), or their support for the deal and the management who performed the acquisition will erode (Paulson, 2001, p. 74). As a result, in times when Cisco’s stock prices are dropping, as in the first half of 2001 or currently, acquisition activity is decreased. By doing so, Cisco prevents further damaging the company’s financial performance, absorbing more debt, and diluting stock with acquisitions (p. 75).

iv. The acquisition must produce long-term wins for major stakeholders: shareholders, employees, customers, and business partners Shareholders aren't the only ones benefiting from Cisco's winning strategy. As Cisco


has made its growth strategy clear to Silicon Valley, engineers and entrepreneurs alike, see a Cisco acquisition as a positive step in the right direction for their company (Vara & White, 2008). "With Cisco, the acquisition is not the end but the beginning," said Ned Hooper, Cisco's newly appointed Chief Strategy Officer. "The people we're acquiring have to feel the same way: It's the beginning of the next generation of that company" (Vara & White, 2008). Ned Hooper, amongst many other engineers and executives, joined Cisco through an acquisition—proof that being acquired can be a win-win situation, leading to better and more opportunities. The market benefits as well. The speed to market, which in the hands of a small startup might result in being late to market, is accelerated in the hands of Cisco. And let's not forget the instant economies of scale and global distribution chains, which Cisco offers with ease. Consumers get the products they need quicker and cheaper—and with the Cisco promise of quality—and innovative companies get to see their technology reach their maximum potential.

v. The purchased company location must geographically be near a Cisco office Cisco has primarily acquired companies near its main headquarters in Silicon Valley. Only one of the first nine companies Cisco acquired—Lightspeed, a switching company based in Boston's Route 128 Tech corridor—was located outside of the geographically desired area (Bunnell, 2000, p. 68). As Cisco has expanded, the company has extended its consideration for making acquisitions to areas like Research Triangle Park in North Carolina, which is located near its East Coast headquarters, in addition to, areas near their global offices (Bunnell, 2000, p. 68).


John Chambers explains that an acquisition creates uncertainty and fear on the part of acquired personnel and that there is a high level of perceived risk by both parties. He contends that full integration is best accomplished with a lot of human interaction and this interaction is simply more difficult when the buyer and seller are separated by a long distance (Bunnell, 2000, p. 68). According to Yurov (2008), targeted companies are more attractive purchases when they are located near the buyer because their emerging technology can be more easily verifiable and proven (p. 27). The study further concludes that targeted companies with reputable venture capital funding reduces perceived risk to the buyer, and thus, makes the purchase more desirable (p. 22). Coincidentally, the most reputable VC firms are located near Cisco's headquarters, and like Cisco, invest primarily in startups located near their offices.

c. Due Diligence As exemplified by Cisco’s acquisition criteria, Cisco places a high importance on the organizational health of the company, the goals and aspirations of its key employees, and its ability to function as part of a much larger company. As continually noted, the key assets are not merely the products currently in production, but the next-generation products that are locked in the minds of the product development teams. As a result, the acquisition process needs to preserve the team. The formal process begins when the executive sponsor and the Corporate Development group concur that a target company (or several companies) could satisfy Cisco’s needs (Kenney & Mayer, 2004). Once the decision to seriously pursue a target company is made, the target company is asked to sign a “no shop” agreement (Kenney &


Mayer, 2004). This agreement is to prevent the company from leveraging the acquisition offer to solicit a higher offer from Cisco’s competitors. Much of the initial discussions with the target company’s management are informal. During this dialogue, Cisco management uses this opportunity to gauge the quality and character of its interaction with the target’s management, in addition to, accessing the interaction between the target’s management amongst themselves. The acquisition team will set joint ventures with the target firm, establishing short- and long-term goals. At this point, Corporate Development carefully scrutinizes the company’s vision, management styles, organizational structure, and cultural fit issues (Ewers, 2006). According to O’Reilly & Pfeffer (2000) “these topics are highly visible in the early stages of discussion because the key personnel at the target company are often far more concerned about their own future than they are about the actual acquisition price of the firm.” According to Paulson (2001), Cisco further disseminates a target company’s vision through these five techniques (p. 63): 1. Examining the annual report. This document is commonly used to present the company’s vision of the industry to shareholders, revealing the ways that it is preparing itself to address the current and future industry conditions. 2. Reviewing the keynote speeches or other public announcements presented by key management. In many cases, these speeches will outline the company’s vision. 3. Looking for articles written by either key management or engineering personnel. It is here that the company will often outline overall perceived trends and the steps that it is taking to capitalize on these trends. 4. Conducting a few detailed discussions with key management personnel who


establish the strategic vision for the company. 5. Speaking to the venture capital or other financial partners of the company. These people will sometimes provide a more objective view of the past, current, and future vision perspective of the key management personnel. Once the Corporate Development manager is satisfied with the informal talks, more formal due diligence begins. Engineering, financial, sales, manufacturing, and accounting personnel study the target company’s technology and operations (Kenney & Mayer, 2004). Simultaneously, Cisco’s HR group looks into the distribution of equity and stock options of the target company. According to Kenney & Mayer (2004), Cisco uses equity distribution as an indicator to which individuals are believed to be the most important. Cisco’s HR group investigates whether these individuals are compatible with Cisco’s culture and environment, looking into previous experience—whether they’ve worked for a big company and whether they have been acquired before. More importantly, HR investigates the post-acquisition plans of key management. As a means to retain employees, Cisco asks them to waive any accelerated investing rights in return for a more gradual vesting schedule (Kenney & Mayer, 2004). Many startups offer employment contracts with “trigger vesting” clauses that immediately vest their stock options upon an acquisition or merger. By waiving their right to vest automatically gives these acquired employees incentive to continue working with Cisco. However, if an employee does decide to leave, Cisco includes in the purchase agreement non-compete clauses to prevent key individuals from leaving and competing against Cisco (Kenney & Mayer, 2004). "We focus on maintaining two major groups—the management teams and the engineers," said John Chambers (Paulson, 2001, p. 186). While Cisco's retention of acquired


executives, engineers, marketing personnel, and sales people is seen as critical to their acquisition strategy, Cisco does not see acquired manufacturing personnel as important and does not make their retention a factor in making acquisition decisions. Cisco does retain manufacturing personnel as long as the plant remains open, and in some cases, will provide opportunities in other departments. Upon the successful completion of due diligence, the Corporate Development group in tandem with the target company, drafts a term sheet including milestones and incentives (Kenney & Mayer, 2004). This last step helps motivate the target company’s employees to help with the integration process by aligning their economic incentives with Cisco’s integration goals.

d. Prior to Deal Announcement After due diligence, the integration process begins once a purchase agreement is forthcoming. This is typically six to eight weeks prior to the announcement. During this integration process the Corporate Development group facilitates the interaction between Cisco and the target company—ensuring that the two parties establish a shared understanding and trust (Kenney & Mayer, 2004). An integration manager from the Corporate Development group is assigned to the process, forming a team of public relations, sales, business units, human resources, and marketing personnel from both the business unit and the target company (Kenney & Mayer, 2004). Specifically, the HR team includes a Senior Project Manager and an HR Specialist; this team manages the tedious duties of payroll migration, employee file conversion, uploading HR data into Cisco’s human resource system software, immigration status,


recruitment support, benefit plan transfer, documentation, presentation, and communications of the acquisition both internally and to the public (Kenney & Mayer, 2004). The forming of this team also gives Cisco employees—who more often than not came from acquired companies—an opportunity to offer their insights, answer questions, and quell worries to the employees of the targeted company (O’Reilly & Pfeffer, 2000). Future organizational structure and location of the firm is also determined at this point (Kenney & Mayer, 2004). For the next several weeks, the integration team conducts weekly meetings to discuss the progress of the integration. The Corporate Development group maintains a website that gauges the progress in ten key areas, such as human resources, product marketing, and finance (Kenney & Mayer, 2004). Similar to Cisco’s target identification system, each area of interest is given a “green”, “yellow”, or “red” light to indicate the degree of completion (Kenney & Mayer, 2004). In addition, the website also hosts an event calendar, on-site visit log, fact sheet, and archived minutes from previous meetings. Finally, once the deal is approved, the final details and formal arrangements, in particular, the buying price is determined (O’Reilly & Pfeffer, 2000). According to Paulson (2001), this is calculated by what Cisco feels as realistic revenue numbers for the target company’s products when sold and manufactured by Cisco (p. 245). Then by including gross margins and its market capitalization multiplier into the equation, Cisco determines a reasonable price for the company. On average, this computes to Cisco paying 15 times sales for a typical startup company (p. 245). By Wall Street standards, paying a 15X multiplier is outrageous, however, Cisco deems their purchase prices as reasonable. “Sometimes in all this speed we end up paying too


much,” explains Mike Volpi, former Senior Vice President. “But the acquisitions are not financial—we don’t do them because we can swing a good deal—they are strategic. We do them to grow the company in the right direction” (Paulson, 2001, p. 231). In some cases, this phase of the acquisition process moves at breakneck speed, sealing a deal after 24 hours of negotiation and closing it in four to eight weeks (Goldblatt, 1999). In 1999, the purchase of Cerent, a maker of optical networking products, involved only a 2.5-hour negotiation over three days before the $6.9 billion deal was signed (Ewers, 2006).

e. The Announcement and Closing Period Only during the announcement day are all the employees of both firms and the public notified of the deal. While key management have been involved in the acquisition, only at this point are other employees informed to what the acquisition means to them. HR holds communication orientations for employees at the targeted company to provide information on key issues such as the impetus for the acquisition, the impact on them, their role and location in Cisco, the effect to their compensation and benefits, and their new titles (Goldblatt, 1999). Cisco also provides the same information online (Goldblatt, 1999). Typically, the acquired engineering group will be integrated into the sponsoring business unit while other departments such as human resources, marketing, and finance are merged into the Cisco infrastructure. While top managers are offered two-year retention contracts to help with the integration, sales teams are either laid off or transitioned into Cisco's sales team. This integration process can take as few as ten days for a small startup to four months for a large 1,200-employee company (O’Reilly & Pfeffer, 2000). This process is


intentionally expedited so employees focus less on personal issues and focus instead on work (O’Reilly & Pfeffer, 2000). In cases where Cisco does not find any value—which is more often the case in integrating an acquired company's manufacturing facility—then the products will often be manufactured by one of many Cisco outsourcing vendors, and the acquired facility will be immediately phased out (O’Reilly & Pfeffer, 2000).

f. First 90 Days Once the deal is announced, the integration division immediately takes over responsibility of the integration. The focus on this phase is to make sure productivity is not lost because of the transition (Goldblatt, 1999). In regards to technology integration, the process varies with the amount of integration Cisco plans for the target company (Perry, n.d.). Standard integration includes the setting-up of infrastructure components such as networks, telephones, data centers, PCs, and printers. Applications are installed such as enterprise resource planning (ERP), sales, HR, and engineering. IT governance procedures are put into place such as development lifecycles, compliance with standards and mandates (e.g. Sarbanes-Oxley Act, data privacy laws), and funding models. In many cases, technology integration only takes a few days. "We had it down to a science," says Tim Merrifield, Cisco’s director of IT acquisition integration. "If we closed a deal on Wednesday, the next Monday the company would be fully integrated, with a brandnew Cisco infrastructure" (Perry, n.d.).


g. 90-180 Days The integration team continues to operate until all objectives of the integration are successfully met, with the foremost objective being the shipping of products under the Cisco logo and through Cisco’s sales channels (O’Reilly & Pfeffer, 2000). In recent years, the shipping of products often occurs on the day of the announcement (O’Reilly & Pfeffer, 2000). During this phase, the team reevaluates and refines any short- and long-term initiatives and also calculates acquisition head count (O’Reilly & Pfeffer, 2000). Any differences in planned and actual results are measured and investigated—and with the reasons for discrepancies explained. This evaluation is both to assess and track milestones so there is no loss of productivity, but also to improve the acquisition process for the next iteration (O’Reilly & Pfeffer, 2000). Often, at this point, the integration is entirely completed and the executive sponsor exclusively works as head of the business unit. Cisco has made a few exceptions to its integration process in recent years. As Cisco has made it clear to the public that it has every intention to enter into new markets and move beyond its core business, it is only logical that this transition demand a new integration strategy. "We can't buy a company and tell it to do as we see fit if we don't have a true understanding of the marketplace," explains Ned Hooper (Vara & White, 2008). While Cisco continues to invest, through acquisition, in the innovation of its core business, the company has spent four times as much, or $11 billion, on deals Cisco calls platform deals. These platform deals, unlike the typical Cisco acquisition, are planned to take one to two years to integrate compared to the standard two months (Vara & White, 2008). The acquisition of Linksys in 2003 was the first of these platform deals (Hakkert,


2003). The products couldn't have been more different: Cisco's typical enterprise product garners prices of $100,000, while Linksys home-networking equipment sells for less than $100. In addition, the Linksys brand was sold at retail locations, a distribution channel Cisco had little experience in. As a result, Linksys was slowly integrated into Cisco. Today, Linksys still maintains the same brand name, existing manufacturing agreements, and original sales teams.



"We're seeing evidence that they need to expand into multiple markets to generate growth, " said analyst Erik Suppinger, a networking specialist at Pacific Growth Equities, about Cisco. "Given the size of the company, there's not much opportunity to generate growth with market share gains in its traditional markets. I would look to the consumer [market] as part of its growth strategy" (Fost, 2007). While not abandoning its cash cow of business-to-business networking products, which it comfortably controls over 70 percent of the market, Cisco is transforming its vision from connecting big company networks to also including IP networks inside consumer's homes to, in recent time, crossing over into consumer electronics (Cisco Systems, n.d.c.). Cisco's diversification into additional markets is partly due to Wall Street's expectations for Cisco to maintain its historical growth than a need for more revenue—the company still makes approximately 50 percent of its annual revenue from routers and switches (The Connected World, 2009, p. 4). However, the real impetus of Cisco's changing consumer vision is following their strategy of driving innovation. As executives at Cisco believe, a lot of innovations driving networks are coming from consumers, not business (Burrows, 2003). Cisco's plan is to capitalize on the forecasted consumers that are looking to put networking technology in their homes. Cisco is planning on providing its products at each stage of the network—from the set-top boxes of consumers to personal hard-drives. Marking its entry into the multibillion-dollar home networking market, Cisco's acquisition of Linksys for $500 million in 2003 provided a fast route to market (Hakkert,


2003). "This acquisition supports our vision to drive innovations into the consumer market and create next-generation home networking solutions," said Charles Giancarlo. "The unique combination of Cisco's networking innovations and Linksys' consumer leadership will enable consumers to benefit from exciting new capabilities and enjoy an easy and reliable networking experience" (Hakkert, 2003). Cisco's networking technology expertise in the business and service provider markets allows for immediate knowledge transfer to the highgrowth consumer networking market. Furthermore, the recent acquisition of San Francisco's Pure Digital, the maker of the popular Flip camcorder for $590 million, solidified its bid to enter into the consumer electronics market (Carvell, 2009). As consumers increasingly use technology in their daily lives, from downloading movies to their TVs to uploading home videos to their computers, Cisco is calculating that the greater demand for consumer network-driven devices will benefit Cisco's bottom-line. The company is also aggressively pursuing emerging global markets with strong potential. Currently, Cisco operates offices in Israel, India, Asia-Pacific, Central and Eastern Europe, Russia, and Western Europe (Cisco Systems, n.d.d.). "We like to enter new markets when there's a transition going on...because it's easier to take market share," explains Ken Writ, Cisco's VP of Consumer Marketing. "If there isn't some kind of transition going on, then you just battle the established players, and there's trench warfare" (Chang, 2009). By doing so, the company looks for opportunities to accelerate, learn about, and apply new technologies that exist across many global markets. To help develop and deliver innovative solutions to consumers, Cisco invests globally to leverage acquired technology amongst all of Cisco's partners.


Cisco made an anchor investment in a venture capital fund that focuses on the Russian technology industry. Cisco's investment of $60 million in 2008, in collaboration with the Almaz Capital Partners, targeted high-growth, small and medium-sized companies in technology, media, and telecommunications (Musgrove, 2008). Cisco sees tremendous technology and innovation potential in Russia: The country has a growing community of tech entrepreneurs that are building both innovative technologies for global and local distribution, as well as, building sound companies with proven business models. Cisco has also made great strides to expand opportunities beyond their hardware divisions, which many of its products are being commoditized by low-cost Chinese competition, in particular, Huawei Technologies Company (Fost, 2007). Asian competition has dramatically changed the business landscape, forcing companies that traditionally built hardware (e.g. Cisco, IBM, and HP) to becoming software companies (Fost, 2007). Cisco's acquisition of software startups, like WebEx for $3.2 billion in 2007, represented this very transition (Burke & Kirkland, 2007). Agreeing to purchase this software company reveals Cisco's ambition to transform itself into a software and services company: Ultimately, what Cisco sees is an opportunity to become a global brand like Sony, Apple, or Microsoft. Cisco's ambitions for the hearts of every consumer might be best revealed with its decision in 2006 to drop the "Systems" from its logo (Fost, 2007). By acquiring companies with popular products like Linksys or Flip, Cisco hopes to expose consumers to the Cisco brand in the same way that the "Intel Inside" campaign put the microprocessor maker on the map.



Cisco's success with their acquisition strategy has stemmed from their professionalism. From targeting companies that have the right technology and products needed to expand Cisco in the direction of growth, to purchasing companies that have a compatible culture and vision, Cisco has perfected the process of acquisition. John Bayless, a general partner at Sevin Rosen Funds of Dallas, a venture capital fund, says this about the Cisco acquisition process: "I haven't found anyone in any industry that has a process that is as tuned" (Goldblatt, 1999). So how successful is Cisco's acquisition strategy? When you can drive growth at a $35-billion-revenue company, keep attracting and retaining good employees, set the standards within your industry, and lead in every market you enter, you are a success in almost in any book.



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