Cisco Systems: New Millennium – New Acquisition Strategy? 03/2010-5669 This case was written by Nir Brueller, Adjunct Professor of Strategy and Affiliated Senior Research Fellow at INSEAD, and Laurence Capron, Professor of Strategy at INSEAD and Research Director of the INSEAD-Wharton Alliance. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2010 INSEAD TO ORDER COPIES OF INSEAD CASES, SEE DETAILS ON THE BACK COVER. COPIES MAY NOT BE MADE WITHOUT PERMISSION. Returning to his office in San Jose from the Christmas break on 2 January 2007, Richard Palmer, Senior Vice President of Cisco Security Technology Group, was still reflecting on his intense discussions over the past few months with Cisco Corporate Development Group about the ongoing negotiations with Scott Weiss, CEO of privately-held IronPort Systems of San Bruno (California). IronPort was the leading provider of email security solutions, focusing on spam and spyware protection for the enterprise market. By 2007, Cisco was the world leader in networking technology for the internet, having grown from two employees with one product in 1984 to more than 63,000 people, 200 offices worldwide, and 50 product lines. Its product portfolio consisted of several categories: network systems (routers, switches, optical networking), data centre (application networking services, storage networking, data centre switches), collaboration, voice and video (voice and unified communications, video, IPTV, cable and content delivery solutions), mobility/wireless (access points, outdoor wireless, wireless LAN controllers) and security (firewall, virtual private networks, security management). Cisco was also considered to be a best-in-class acquirer of high-tech companies by industry experts as well as corporate strategy practitioners. Weiss had not yet accepted the handsome offer of $830 million made by Cisco. Palmer was convinced that the price he had offered was justified by the great strategic fit of IronPort with Cisco’s portfolio. The security products and technology from IronPort added a rich and complementary suite of messaging solutions to Cisco’s industry-leading threat mitigation, confidential communications, policy control and management solutions. At a meeting with Cisco’s Corporate Development team in December 2006, Palmer explained: “We feel there is enormous potential for enhanced e-mail and message protection solutions to be integrated into the existing Cisco Self-Defending Network framework. Using the network as a flexible platform to integrate IronPort’s technologies, Cisco will be able to build new security applications as customers’ demands evolve”1 Palmer wondered how he could further negotiate with Scott Weiss to clinch the deal. During the last meeting, Cisco Corporate Development Group, which had forged a great reputation over the years for providing discipline on the acquisition process, had made it clear that the proposed $830 million was the walk-away price. Among the non-price factors, Palmer had to negotiate a number of post-acquisition “integration” issues. In particular, he knew that IronPort was keen on remaining a standalone business unit within Cisco. Weiss wanted to retain the relationships and go-to-market strategies that he had built. Although the IronPort acquisition offered opportunities to weave together the two firms’ technologies, it represented a significant stretch from Cisco’s security strategy, moving it from the network to the application layer.2 Furthermore, despite Cisco’s interest in IronPort’s subscription-based pricing model, it had no real experience with it. Lastly, there was also internal resistance within IronPort’s ranks to being integrated into Cisco. 1 Hagendorf Follett, J. (2007). Cisco Gets The Message With $830M E-Mail Security Acquisition. ChannelWeb, 4 Jan, http://www.crn.com/security/196800933;jsessionid=DL2OXYG2RW4KNQE1GHOSKHWATMY32JVN 2 http://www.ironport.com/company/pp_commweb_01-04-2007.html Copyright © 2010 INSEAD 1 03/2010-5669 Palmer was wondering what would be the right integration approach for IronPort and how much he should give up in the negotiation. Should Cisco depart from the tried-and-tested formula for managing young high-tech firm acquisitions for which it had become so famous? Should Cisco adopt an integration approach closer to its recent big acquisitions of Linksys and Scientific-Atlanta, both of which were focused on the consumer market? IronPort, in focusing on Cisco’s core segment – enterprise customers – presented some unique opportunities and challenges. While addressing these issues was important, Palmer did not want the talks to lose momentum. He had made good progress so far and was hoping to come to an acquisition agreement in the next few days, when IronPort and Cisco’s employees returned from the Christmas break. Cisco’s Early Years (1984-1993) Cisco was founded on December 10, 1984 by husband and wife Len Bosack and Sandy Lerner, two former Stanford University computer scientists whose efforts to enable email between computers on different networks led to the invention of the first multiprotocol router. This seminal breakthrough played a major role in fuelling the growth of the internet. The first challenge came very early on when Len and Sandy failed in their attempts to sell to existing computer companies the technology they had designed to connect two separate local area networks (LANs).3 They decided to market their routers directly to universities, research centres, government facilities and the aerospace industry. In 1986, Cisco shipped its first product, a router for the TCP/IP (Transmission Control Protocol/Internet Protocol) protocol suite. With just eight employees, Cisco managed to sell $1.5 million worth of routers in the fiscal year ending July 1987.4 With limited financial resources, marketing relied on approaching computer scientists and engineers via ARPANET (Advanced Research Projects Agency Network), the precursor to the internet. In 1988, the company started marketing its routers to mainstream corporations with geographically dispersed branches using different networks. To this end, Cisco had to further develop its technology and extend the range of communications protocols it supported. Over time, its ability to support more protocols translated into a differentiation advantage over other router manufacturers.5 By the late 1980s, when the commercial market for internetworking began to develop, Cisco’s reasonably priced, high-performance routers gave it a head start over its networking competitors (Bridge Communications Inc., 3Com Corporation, Proteon Inc., Wellfleet Communications). Cisco was developing industry standards and now had a list of customers including the US Army, Boeing, Hewlett Packard, General Electric and Morgan Stanley. These early days, in which it had to survive on a very tight budget, shaped Cisco’s frugal nature for many years to come. In fact, to get the venture off the ground Bosack and Lerner had to mortgage their house, run up credit card debts, and defer paying salaries to friends who worked for them. For a while, Lerner even maintained an outside salaried job to supplement the couple’s income. 3 http://www.fundinguniverse.com/company-histories/Cisco-Systems-Inc-Company-History.html 4 ibid. 5 ibid. Copyright © 2010 INSEAD 2 03/2010-5669 In 1987, when sales started growing quickly, Bosack and Lerner were forced to turn to venture capitalists for support.6 Donald T. Valentine, the founder of Sequoia Capital, agreed to invest $2.5 million in first-round financing in Cisco.7 As part of the deal he took over management of the company and required the owners to sign that Sequoia Capital retained the right to force the founders out at will.8 Valentine became chairman and quickly hired an outsider, John Morgridge, a Stanford MBA and a veteran of laptop computer manufacturer GRiD Systems Corp., as the company’s new president and chief executive officer. Over the next few years, Morgridge replaced top management with outside hires and in February 1990 Cisco went public. Six months later, following an ultimatum by seven of the company’s vice presidents, Lerner was let go. Shortly afterwards, Bosack resigned from the board of directors and then left Cisco entirely.9 In the period 1991 through to 1993, Morgridge set the tone for Cisco’s culture and operational methods. He ran the business with an emphasis on cutting costs and made sure that Cisco continued the strong customer focus that had enabled it to progress so rapidly in the mid 80s. Morgridge built up direct sales to market the products to large corporate clients. At first, Cisco focused on the high-end corporate network market, targeting corporations which already maintained large internal networks. Few companies were able to offer the same array of end-to-end networking services and products. Among those who could, Cisco’s four largest competitors were Lucent Technologies, Alcatel, Juniper Communications and Nortel Networks. As operations expanded, Cisco started to face competition from innovative and lean niche players such as 3Com Corporation and Bridge Communications Inc., notably in the small- and medium-size business sector. Cisco’s Corporate Strategy (1993-1999) As Cisco’s client base grew, the company’s greatest challenge became meeting customer service and support needs. With the coming-of-age of the internet and the growing popularity of corporate in-house intranets, more demands were put on Cisco to provide a complex variety of networking solutions.10 To dominate such a market, Cisco executives knew that they would not be able to develop internally all the technologies needed with enough speed, especially with product cycles dropping below 18 months. In order to keep abreast of the changes,11 Cisco resorted to external sourcing and set a relentless pace for acquisitions. John Chambers, who joined Cisco in 1991 as senior vice president of worldwide sales and operations and operated as John Morgridge’s right hand man for four years before replacing him as CEO, observed: “We got very bold.