Cisco Systems - The Supply Chain Story

"Networked manufacturing processes have enabled Cisco to manufacture new world

products with new world processes, resulting in a competitive advantage for Cisco
and enhanced satisfaction for Cisco customers."
- Carl Redfield, Senior Vice President, Manufacturing and Worldwide
Logistics, Cisco Systems, in 2000.
A Company in Trouble
In August 2001, the San Jose, California based, computer-networking company Cisco
Systems Inc (Cisco) surprised industry observers by announcing its first ever
negative earnings in more than a decade. In the third quarter of fiscal 2001, the
company's sales had decreased by 30%. Cisco had to write off inventory worth $ 2.2
billion and lay off 8,500 people. By the end of 2001, the market capitalization of the
company was down to $ 154 billion and per employee profit was $ 240,000 (down
from $ 700,000 in 2000).

This was in sharp contrast to the situation in early 2000, when Cisco was one of the
most successful companies in the Internet world with a market capitalization of $
579 billion (It had become the world's most valuable company surpassing even
Microsoft's market capitalization of $ 578 billion).
According to John Chambers (Chambers), Cisco's CEO, neither the company's
software nor its management were to blame for the company's poor performance.
Analysts were puzzled that while other networking companies, with far less
sophisticated information technology infrastructure than Cisco, had begun
downgrading their forecasts in the wake of the impending downturn in the industry
months earlier, Cisco did not lower its inventory like other companies. What came
however as the biggest surprise were the allegations by some analysts that the
company's 'highly regarded' systems were to be blamed for this situation. According
to analysts, over reliance on technology prevented Cisco from seeing the impending
downturn that was clear to everyone else and led the company down a disastrous
path.
Cisco – The Networked Supply Chain
Cisco was founded in 1984 by a group of computer scientists at Stanford. They
designed an operating software called IOS (Internet Operating System) that could
route streams of data from one computer to another. The software was loaded into a
box containing microprocessors specially designed for routing. This was the router, a
machine that made Cisco a hugely successful venture over the next two decades
(Refer Table I for details of Cisco's growth).
In 1985, the company started a customer support site through which customers could
download software over FTP1and also upgrade the downloaded software. It also
provided technical support through e-mail to its customers. In 1990, Cisco installed a
bug report database on its site. The database contained information about potential
software problems to help customers and developers.

The system allowed customers to find out whether a specific problem was unique,
and if not, how other customers had solved that problem. By 1991, Cisco's support
center was receiving around 3,000 calls a month. This figure increased to 12,000 by
 1992. In order to deal with the large volume of transactions, the company built a
customer support system on its website.
TABLE I
CISCO – THE MILESTONES

YEAR EVENTS
1984 Founded in a living room by the husband-wife team of Sandy Lerner and Len Bosack. Router
used for the first time to move information from one network to another.
1990 Cisco goes public.
1992 Plans a global supply network; outsources manufacturing and distribution.
1993 Acquires Crescendo, a low end LAN switch maker for $ 100 million.
1994 Launches Cisco Connection Online website.
1995 John Chambers becomes the CEO and accelerates the acquisition strategy by acquiring four
companies in the same year.
1996 Cisco moves into the WAN switch market, acquires Startcom for $ 4.5 billion
1997 Cisco starts its global direct fulfillment system. Products are directly shipped by third party
logistics partners from the manufacturer to the customer
1998 Cisco prepares to become a single vendor servicing the network arena. Enters into alliances
with integration partners like KPMG and IBM to provide solutions.
Source: ICMR
In 1993, Cisco installed an Internet based system for its large customers, usually
multinational enterprises. The system allowed customers to post queries, about their
software problems. Cisco also installed a trigger function called 'Bug Alert,' which
sent emails containing information on software problems within 24 hours of their
discovery. Encouraged by the success of its customer support site, Cisco launched
Cisco Information Online in 1994. This online service offered not only company and
product information but also technical and customer support to Cisco's customers.
By 1995, the company introduced applications for selling products or services on its
website. The main idea behind this initiative was to transfer paper, fax, e-mail and
CD-ROM distribution of technical documentation and training materials to the web,
thus saving time for employees, customers and trading partners and besides
broadening Cisco's market reach. In 1996, the company introduced a new Internet
initiative called the 'Networked Strategy' to leverage its network for fostering
interactive relationships with customers, partners, suppliers and employees. Cisco
wanted to ensure enhanced customer satisfaction through online order entry and
configuration. Customers' order information flowed through the supply chain network,
which consisted of Cisco employees, resellers, manufacturers, suppliers, customers
and distributors. (Refer Figure I).
Orders from customers were stored in Cisco's enterprise resource planning database
and sent to contract manufacturers over the virtual private network (VPN2). Cisco's
suppliers could clearly see the order information as their own production schedule
was connected to Cisco's ERP system.

According to the requirements, the suppliers shipped the needed components to the
manufacturers and replenished their stocks. The business model aimed at enabling
Cisco's contract manufacturers to start manufacturing built-to-order products within
15 minutes of receiving an order
Cisco gave top priority to order fulfillment and project management to achieve on-
time delivery to customers.

Third party logistics providers were plugged into Cisco's database via the Internet. As
a result, Cisco could, at any time provide customers with information regarding the
status of their order.

Direct fulfillment led to a reduction in inventories, labor costs and shipping expenses.
Through direct fulfillment, Cisco saved $ 12 million annually.

Cisco's Internet linked supply chain network enabled the automatic testing of
products from any of its locations worldwide.
While earlier prototyping3 used to take weeks, Cisco engineers were now able to do
the same within a matter of days. This was because prototyping could take place at
the manufacturer's site itself. After manufacturing, the product was connected to one
of Cisco's 700 servers worldwide. For a faulty product, the system would not print a
shipping label. This prevented an invoice from being generated and consequently
blocked payment.
Because of rapid sharing of demand information across the supply chain, customers
could receive products faster. To sum up, this networked supply chain:

• Ensured shorter engineering-to-production cycle times in order to increase market

share.
• Ensured flexibility in designing, revamping and retiring products in response to
market demand.
• Ensured product quality though major portions of the fulfillment process were
outsourced.

Even though Cisco dealt with technically complex products like routers, it did not
hesitate to hand over the manufacturing to a set of contract manufacturers.
In order to ensure the quality of its products, Cisco relied on automatic testing. The
company developed test cells on supplier lines and ensured that the test cells
automatically configured test procedures when an order arrived. Cisco defined its
core competence as product designing and delegated the rest - manufacturing,
assembly, product configuration, and distribution – to its partners. In August 1996,
Cisco launched transactional facilities like product configuration and online order
placement. These facilities were connected to its ERP systems. In the same year,
Cisco upgraded its network infrastructure to better handle the increasing number of
transactions. In mid-1997, it introduced dial-in access from desktop computers that
allowed customers to place orders without accessing the Internet.
In the same year, it also introduced customized business applications for its large
customers. These applications resided inside the customers' corporate intranet and
automated the ordering process by linking directly to Cisco's internal systems. By the
end of 2000, more than 75% of the orders for Cisco's products were being placed
over the Internet. Aided by Cisco's Internet initiatives, the company's net sales grew
at an impressive 78% compounded annual growth rate (CAGR), from $ 2 billion in
1995 to $ 9 billion in 1998. The company's fourth quarter revenues in 2000 were $
5.7 billion, up 61% from the same period in 1999.
Operating profits also went up from $ 710 million in 1999 to $ 1.2 billion in 2000.
According to many analysts, the company's networking strategy had played a major
role in its success over the years. Industry observers noted that ever since its
inception, Cisco had demonstrated the power of networking and the benefits it could
offer. Cisco owned just two of the 40 facilities that manufactured its products.

It did not own the distribution system that delivered the products to its customers,
but through its network of suppliers, distributors, partners, and resellers and
customers, it successfully coordinated all the activities necessary to provide products
to its customers on time. In spite of an efficient supply chain network, Cisco ran into
some problems.
Cisco's partners4 typically worked out their supply-and-demand forecasts from
multiple points in the company's supply chain. Transactions between suppliers and
contract manufacturers were not always smooth. There were time lags in delivery
and payment, and thus greater opportunity for error. As a result, suppliers were
plagued by long order-to-payment cycles. In June 2000, Cisco discovered, to its
alarm, that it was running short of some key components for some of its equipment.
Due to the shortage of components, shipments to customers were delayed by 3–4
weeks. Though demand for Cisco's products remained healthy, the revenues of
customers who were used to delivery within two weeks were affected badly. Analysts
felt that above experiences of customers were rather 'out of character' for a
company that prided itself on its relationships with customers and even compensated
many of its executives the basis of on customer satisfaction.
The Cco & Ics Initiatives
In order to address the above problems, Cisco revamped its supply chain
management to reduce the long ordering cycles. The company launched Cisco
Connection Online (CCO), which connected Cisco with all its suppliers and contract
manufacturers online. As a result, when a customer placed an order, it was instantly
communicated to all its suppliers and manufacturers.

In most cases, a third party logistics company shipped the product to the customer.
CCO ensured increased co-ordination and connectivity between supply partners, thus
reducing the operating costs of all constituents. Automated processes within the
supply chain removed redundant steps and added efficiencies. For instance, changes
in market demand were communicated automatically throughout the supply chain.
This enabled the networked supply chain suppliers to respond appropriately. CCO
reduced payment cycles for suppliers and eliminated paper based purchasing. As a
result, suppliers agreed to charge lower product markups. Consequently, Cisco saved
more than $ 24 million in material costs and $ 51 million in labor costs annually.

CCO enabled Cisco's contract manufacturers to find out the exact position of demand
and inventory at any given point of time. As a result, they could manage
replenishment of inventory with ease. This resulted in a 45% reduction in inventory
(Refer Figure II) and a doubling of the inventory turnover. Cisco slashed the
inventory holding of its suppliers and manufacturers and brought it down from
13,000 units (approx) to 6,000 units within 3 months.
To get the most out of CCO, Cisco used intranets and extranets extensively. The
extranet was used for communicating with suppliers, manufacturers, customers and
resellers, while employees used the intranet for communicating about the status of
orders. Thus, through an online information and communication system, Cisco linked
suppliers, manufacturers, customers, resellers and employees seamlessly (Refer
Figure III). However, some of Cisco's large customers were not able to access CCO
because it did not connect seamlessly to their back-end or electronic data
interchange systems.
These firms, typically telecom equipment distributors or network operators, lacked
the time to visit the supplier websites to order the equipment they needed. Cisco
introduced the Integrated Commerce Solution (ICS) for these customers.

ICS provided a dedicated server fully integrated into the customers' or resellers'
Intranet and back end ERP systems. It facilitated information exchange between
Cisco and them, besides speeding up transactions.

It had all the e-commerce applications of CCO, with the additional capability of
pulling order related data directly from Cisco's back end ERP systems online.
At the same time, as the server was integrated into the customers' and resellers'
back-end ERP systems, the end users needed to enter the order information only
once; this order was simultaneously distributed to both resellers and Cisco's back-
end systems, eliminating the need for double entry. With these new Internet
initiatives and sound financials for fiscal 2000 (Refer Exhibit I), Cisco seemed all set
to register even higher growth figures. However in early 2001, the global IT business
slowdown and the dotcom bust altered the situation. Reportedly, Cisco failed to
foresee the changing trends in the industry and by mid 2001 had to cope with the
problems of excess inventory. As a result, the company had to write off inventory
worth $ 2.2 billion in May 2001. Cisco blamed the problems on the 'plunge in
technology spending', which Chambers called as unforeseeable as 'a 100-year flood.'
Company sources revealed that if its forecasters had been able to see the downturn,
the supply chain system would have worked perfectly.
The Problem and the Remedy
Analysts felt that the flaws in Cisco's systems had contributed significantly to the
breakdown. During the late 1990s, Cisco had become famous for 'being the hardware
maker that did not make hardware.'

Its products were manufactured only by contract manufacturers and the company
shipped fully assembled machines directly from the factory to buyers. This
arrangement led to major troubles later on. According to analysts, Cisco's supply
chain was structured like a pyramid, with the company at the central point. On the
second tier, there were a handful of contract manufacturers who were responsible for
final assembly.
These manufacturers were dependent on large sub-tier companies for components
such as processor chips and optical gear. Those companies in turn were dependent
on an even larger base of commodity suppliers who were scattered all over the
globe. The communication gaps between these tiers created problems for Cisco. In
order to lock-in supplies of scarce components during the boom period, Cisco
ordered large quantities in advance on the basis of demand projections made by the
company's sales force.
To make sure that it got components when it needed them, Cisco entered into long-
term commitments with its manufacturing partners and certain key component
makers. These arrangements led to an inventory pile-up since Cisco's forecasters
had failed to notice that their projections were artificially inflated. Many of Cisco's
customers had ordered similar equipment from Cisco's competitors, planning to
eventually close the deal with the party that delivered the goods first. This resulted
in double and triple ordering, which artificially inflated Cisco's demand forecasts.

Cisco's supply chain management system failed to show the increase in demand,
which represented overlapping orders. For instance, if three manufacturers competed
to build 10,000 routers, to chipmakers it looked like a sudden demand for 30,000
machines. As Cisco was committed to honor its deals with its suppliers, it was caught
in a vicious cycle of artificially inflated demand for key components, higher costs,
and bad communication throughout the supply chain. Cisco's inventory cycle
reportedly rose from 53.9 days to around 88.3 days.
According to analysts, Cisco's systems failed to model what would happen if one
critical assumption – growth – was removed from their forecasts. They felt that if
Cisco had tried to run modest declining demand models, then it might have seen the
consequences of betting on more inventory. They felt that Cisco should not have
assumed that there would be continuous growth. Having realized these problems,
Cisco began taking steps, to set things right. The company formed a group of
executives and engineers to work on a 'e-Hub' remedial program. Work on eHub
began in late 2000. The project was intended to help eliminate bidding wars for
scarce components. According to Cisco sources, eHub was expected to eliminate the
need for human intervention and automate the flow of information between Cisco, its
contract manufacturers and its component suppliers.
eHub used a technology called Partner Interface Process (PIP) that indicated whether
a document required a response or not. For instance, a PIP purchase order could
stipulate that the recipient's system must send a confirmation two hours after receipt
and a confirmed acceptance within 24 hours. If the recipient's system failed to meet
those deadlines, the purchase order would be considered null. This would help Cisco
to find out the exact number of manufacturers who would be bidding for the order.
According to the eHub setup, Cisco's production cycle began when a demand forecast
PIP was sent out, showing cumulative orders. The forecast went not only to contract
manufacturers but also to chipmakers like Philips semiconductors and Altera Corp.

Thus, overlapping orders were avoided and chipmakers knew the exact demand
figure. eHub searched for inventory shortfalls and production blackouts almost as
fast as they occurred. However, work on eHub fell behind schedule due to its
complexity and the costs involved. According to Cisco sources, the company
originally planned to connect 250 contractors and suppliers by the end of 2001, but it
could link only 60. It was reported that the number might rise to around 150 by mid
2002. Company sources said that eHub was just the first stage of its plans for
automating the whole process of ordering and purchasing. Meanwhile, the company's
poor financial performance prompted analysts to comment that if the inputs were
wrong, even the world's best supply chain could fail. They added that only the next
boom phase in the IT business would prove the efficiency of eHub.