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 / Second Quarter 1997 / Issue 7(originally published by Booz & Company)


Growth by Acquisition: The Case of Cisco Systems

So even though Lightstream was on a tremendously successful run rate, we literally ate our own young and acquired StrataCom for $4.5 billion -- getting a much bigger player in the A.T.M. business -- because the market changed quicker than we thought.

When something changes faster than we anticipated, or we make some other mistake, then we adjust very quickly and don't spend a lot of time with the "Not Invented Here" syndrome, trying to protect our political decisions of two years ago.

S&B: How do your acquisitions fit into your strategy?

JOHN CHAMBERS: During 1993, we decided to play across the entire inter-networking marketplace and we began to prioritize which areas we wanted to move into. Remember, this was an era when people thought partnerships and acquisitions did not work. It was a much different philosophy than exists today. Today everyone says acquisitions are an effective way to grow.

Let me tell you, when we did our first acquisition in 1993, we caught unbelievable heat in the press. We paid $89 million for a company called Crescendo that had only $10 million in revenues. A lot of people thought we had lost our frugality and direction. Now that company contributes more than $500 million in revenues to Cisco. In terms of our market cap, selling for eight times sales, it's worth $4 billion to our shareholders. And our acquisitions in local area network switching cost us $500 million and now contribute more than $1 billion in revenues -- or more than $8 billion to our market cap. So the strategy has worked out well. But at the time, it was not so obvious.

S&B: Since acquisitions were not generally in favor then, what made you decide to adopt an acquisition-led growth strategy?

JOHN CHAMBERS: We had a board meeting in August 1993 when we were trying to decide whether to merge with another large company, either SynOptics or Cabletron. Both companies were about the same size as we were, so it would have been a merger of equals.

But there was another alternative. It was to adopt a different philosophy. That philosophy was based on what we had learned from Hewlett-Packard -- about breaking up markets into segments -- combined with what we knew about the General Electric mentality of being either the No.1 or No. 2 player in each segment. When we adopted that new philosophy, we had three choices: achieve it by ourselves, by a combination with an equal or by partnering or acquiring other companies.

Our board was equally divided about what we should do. A merger of equals had a lot of appeal. If you combine the No. 1 and No. 2 players in an industry, by definition, you're No. 1, in terms of size. That much was obvious and positive. And when you are growing that fast, you have a number of key management openings you have to fill. By combining two companies with good management teams, you automatically build up the strength of your management and you do it quickly. You can also overlap your customer sets, which automatically widens your customer base and gives you more distribution channels.

In addition, a merger of equals that creates the No. 1 player in a market automatically makes your remaining competition second tier. As a result, your competition must rethink its strategy because if you are able to successfully execute your strategy, they are in deep trouble. In the end, you force a period of mergers and acquisitions on your competition. They have no choice but to respond to the changes you initiated.

S&B: That argument sounds compelling. What kept you from pursuing it?

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