It's easy to understand why Internet infrastructure giant Cisco Systems needed to get out of the consumer electronics business, but did it have to send a popular product, like to the Flip camcorder, to an early grave?
Cisco on Tuesday announced that it will stop making the Flip camera, a popular pocket-sized video camera it bought only a couple of years ago from a company called Pure Digital. The reason? The company said it is strategically realigning its business to focus on selling its core products.
"We are making key, targeted moves as we align operations in support of our network-centric platform strategy," Cisco CEO John Chambers said in a statement. "As we move forward, our consumer efforts will focus on how we help our enterprise and service provider customers optimize and expand their offerings for consumers, and help ensure the network's ability to deliver on those offerings."
Cisco bought Pure Digital, the maker of the Flip camera, in 2009 for $590 million. While not a small acquisition, it was by no means huge by Cisco standards. In fact, Cisco spent a total of nearly $6 billion to acquire Tandberg and Starent Networks that same year.
That said, $590 million is nothing to sneeze at. Many experts and fans of the Flip camcorder wonder why Cisco didn't try to sell the business unit, especially since the Flip products are considered market leaders. According to NPD's Stephen Baker, "there is no compelling evidence that Flip was failing. It remains far and away the leading consumer video camera company."
And yet Cisco still decided to stop selling the Flip camera.
"I'm very surprised that Cisco chose to simply shut down the product given what they paid for it," said Zeus Kerravala, an analyst for Yankee Group, who has followed Cisco for more than a decade. "But I'm not surprised that they got out of the consumer business."
Restoring investor confidence
Indeed, Cisco needed to do something drastic to show Wall Street that it was getting back on track. For more than two decades, Cisco has dominated its core markets of Internet Protocol routing and switching. It has provided networking equipment to almost every large company, government entity, broadband and telephone service provider, and thousands of small and medium businesses around the globe.
To many in the tech industry, CEO John Chambers is viewed as managerial guru and technology oracle. Investors, customers, and even governments listen carefully to what he says and the tone of his comments for glimpses of advice and insight. Unlike many other tech companies, Cisco has managed to weather dips in the economy and almost always emerges from recessions stronger than it did going into them.
But as Cisco moved into new markets, sales in its core businesses slowed and Cisco lost market share. While Cisco still dominates in the IP routing market, it has been more challenged in its Ethernet switching business, where it faces stiff competition from a slew of competitors, including Hewlett-Packard and Chinese manufacturers, such as Huawei. Investors have begun questioning whether the company can hit its long-term growth projections of between 12 percent and 17 percent.
"Investors were losing confidence," Kerravala said. "I don't remember a time when what John Chambers said was not considered gospel by Wall Street. Now he must restore confidence. So it may be that desperate times, call for desperate measures."
Cisco has a long history of growing its business through acquisition to enter new markets. In fact, its lucrative Ethernet switching business was the direct result of an acquisition in the mid-1990s. But for much of its history, Cisco has kept it acquisitions close to its core business: Internet and corporate network infrastructure.
In the past five or six years, Cisco has ventured beyond its core competencies as it tries to enter new markets. The company's first major foray into the consumer market was its 2003 acquisition of home routing company Linksys.
For several years, Cisco toyed with the idea of offering more products in the consumer space. Then, at the Consumer Electronics Show in Las Vegas in 2009, Chambers revealed Cisco's ambitions for the consumer market. He said that he expected Cisco's consumer business to generate between $5 billion and $10 billion over the next few years.
"We are really committed to this market and we're putting the whole company behind it," he said. "We will be very aggressive."
But Cisco's consumer strategy has largely been one failure after another. Cisco's home-grown products, such as the Linksys Wireless Home Audio system and the Umi telepresence product, have all been priced too high for consumers. And even though Cisco acquired a successful consumer business with the acquisition of Pure Digital, it has managed to stifle growth in that product area.
According to market research firm NPD, Flip has actually lost market share since Cisco acquired it in 2009, even though overall sales of products in this category have increased 5 percent between 2009 and 2010. Flip, which had led this product category in early 2010 with 26 percent market share, had a disappointing 2010 holiday season, according to NPD. The business unit's sales fell 19 percent versus the prior year, and its market share dropped to 17 percent, NPD's data shows. But NPD analyst Stephen Baker attributes the decline in Flip camera sales to "strategic marketing missteps, and more aggressive competition, as opposed to any evidence of an underlying fall in demand."
But slowing sales momentum is not likely the main reason that Cisco decided to abandon the Flip product. The biggest problem for Cisco was likely rationalizing the thin product margins in the consumer business. Cisco is used to getting profit margins in the 60 percent to 70 percent range. But consumer electronic products are lucky to get profit margins in the low 30 percent range. Even though Flip was already an established brand, its cameras, which generally sell for between $100 and $200, were likely not profitable enough for Cisco.
Keeping intellectual property for a rainy day
Still, the Flip camera could have been an attractive and profitable business to another company, even if Cisco felt it was a drag on its earnings. While Cisco does not break out sales of individual products, Simon Leopold, an analyst with Morgan, Keegan & Company, estimates that Flip camera sales total about $400 million annually. This is small compared with Cisco's total yearly revenue of about $40 billion, but sales of this product could have been significant to a potential acquirer.
So why didn't Cisco simply sell the Flip product line? After all, NPD's Baker said that despite the rise in smartphones with similar functionality, there was still a growing market for small, mini camcorders.
A Cisco representative was unable to provide insight into the decision-making process except to say, "In theory, at a high level (selling the division) may have been possible, but Cisco's team did a detailed analysis, and it was determined that the best thing to do was to shut down the business."
Yankee Group's Kerravala suspects the company may want to hold onto the intellectual property.
"The fact that they aren't selling off the technology makes me think that the technology may wind up in other Cisco products down the road," he said. "For instance, Cisco has talked about adding recording capabilities to its telepresence products."
Cisco wouldn't comment on whether the company has plans to use the technology from Pure Digital in any specific products. But Cisco still sees video as an important part of its strategy.
"We learned so much from this acquisition," said Karen Tillman, a spokeswoman for Cisco. "We gained a lot of understanding about video and how people consume video. And those things will only help as we work to advance and drive demand for our core products."