But in the consumer market, the combination of high quantities, low prices, and steep competition gave us margins in the 30 percent range. Try as we might, given the systems we had in place for operations and R&D, we simply could not stretch our existing business model sufficiently to cover this market. We needed to build a new operations base and business model from scratch, expressly tailored to the growing consumer segment. We had to introduce this model as soon as possible, and make it fully operational, so our company wouldn’t miss out on a great wave of customer buying. Given these realities, we recognized that the right approach would be to acquire a business already pursuing this model. We selected Linksys, the maker of the equipment that Chambers’s son had bought for the family home.
Founded in a garage in Irvine, Calif., in 1988 by the husband-and-wife team of Victor and Janie Tsao, Linksys was already a consumer networking leader when Cisco came calling in 2003. It earned more than $400 million in annual revenue and employed more than 300 people. We understood that we were getting into a very different business. Never before had Cisco sold products in stores that offered Bubblicious chewing gum or Britney Spears CDs.
Cisco was known for its skill in integrating acquisitions; the company has made more than 130 such deals. But most of our acquisitions were rapidly integrated into our existing business model. In this case, to keep a separate business model alive and prevent it from imploding, we handled the acquisition differently. We kept much of Linksys independent, at least at the onset. We integrated common business functions, such as human resources and finance, but preserved many of Linksys’s distinctive components, including its engineering, sales, and marketing functions. Linksys was, after all, a market leader, and we were eager to learn from its expertise in consumer technology.
The hands-off approach worked. Since the acquisition, Cisco’s consumer business has maintained or improved upon its business metrics. Annual sales have doubled. Linksys has also diversified its business and entered new markets. Today, one-quarter of the sales of Linksys products come from outside the United States — more than doubling the percentage of a few years ago. Linksys has also enabled Cisco, as a whole, to become a more consumer-friendly company, with a better understanding of branding, the retail channel, and the consumer market supply chain. We are inching closer to our vision of selling devices, software, and services as an integrated solution.
Putting in place a separate business model has not been easy for us. We had to continually remind ourselves that we were not giving up control; we were creating an opportunity for significant gains. But if not for this acquisition, Cisco might have missed out on this large and growing opportunity in the home networking market. Moreover, the Linksys experience provided convincing proof, for us, of the value of explicitly looking at our management practices, and deliberately experimenting with them. Thus, in the mid-2000s, the company’s management team turned its attention to other challenges, including innovation.
Managing Disruptive Innovation
Though recognized primarily for core networking equipment, Cisco has a product line that spans handheld digital cameras, sophisticated security solutions, microprocessors, and even routers for use in outer space. To maintain its lead in some product categories and catch market leaders in others, Cisco invests between 13 and 15 percent of revenue in research and development each year. This is in line with other leading technology companies, including Intel (16.4 percent) and Microsoft (13.5 percent).
We are immensely proud of our innovations; our most advanced CRS-3 router, for example, can download every motion picture ever made — from The Great Train Robbery to Avatar — in just over four minutes. At the same time, we recognize that the more we focus on optimizing existing products, the less attention we have available for disruptive breakthrough innovation.