Did CEO John Chambers underestimate Silicon Valley rivals?

Even in the depths of the Great Recession, during other businesses hunkered down, Cisco CEO John Chambers was eager to expand.

In early 2009, Chambers announced the San Jose networking giant would begin selling commercial computer systems. It was a dramatic challenge to big computer makers like Hewlett-Packard and IBM, even though it was just one of several moves in which Chambers took his company into new business markets. Three days later, as a matter of fact, Cisco Systems announced it was buying a maker of pocket-size video cameras.

The expansion strategy had worked for several years

The expansion strategy had worked for several years. However Cisco, one of the valley's best performers over the past decade, has stumbled in recent months: Profits are down from a year ago, its core business is in accordance with attack, and the company's stock has plummeted to near its lowest point in more than two years -- costing shareholders billions of dollars and prompting Chambers to announce a corporate overhaul that could lead to significant layoffs this summer.

With then-regarded products and outsize market share, Cisco has long commanded high prices and hefty profits for its networking gear. "They were the dominant vendor and they took advantage of that," said Gartner analyst Mark Fabbi. "They took their core business for granted."

The landscape is shifting

But the landscape is shifting. Business clients hit hard by the recession started looking for ways to cut costs. Others began revamping their networks to take advantage of new tech trends just as cloud computing and virtualization software, which increase the efficiency of computer systems. Forrester analyst Robert Whiteley said these new trends have made clients open to considering new suppliers.

Smaller companies just as Juniper Networks and Brocade Communications saw the possibility and expanded their switch offerings. So did tech behemoth HP, which earlier had been content to sell its own computer servers and let Cisco sell networking gear.

Although HP and Cisco had worked at the same time for years, competition was already simmering between them in March 2009, when Cisco announced plans to challenge HP and others in the server business. That brought their rivalry to a boil. By the end of 2009, HP had bought another networking company, 3Com, and beefed up its sales force to aggressively court Cisco clients.

A top Cisco executive characterized those numbers as minor fluctuations. In an interview, senior vice president John McCool argued that competing vendors are unlikely to increase their market share much furthermore. He added that Cisco is able to outspend its rivals on innovation and developing a wide range of new switch research, especially higher-performing products with desirable features.

Third of Cisco's total revenue

While switches account for near a third of Cisco's total revenue, its switch sales dropped 8 percent in the quarter ending in January and 9 percent in the quarter that followed. The company's overall profit was down 18 percent in the latest quarter, though it nevertheless reported $1.8 billion in net income on total sales of $10.9 billion.

Many analysts believe the company lost that focus as it expanded into a host of other businesses. Some have as well blamed Chambers' reliance on interdepartmental "councils" and "boards" to steer new initiatives. Critics say the unwieldy structure hindered Cisco's response when rivals began selling switches with lower prices and improved features.

Meanwhile, the company has reported rising sales in some of its other new businesses, including wireless networking gear, business communications software, videoconferencing systems and server computers. Those segments should provide more growth for years to come, Pacific Crest Securities analyst Brent Bracelin said in a recent report.

But Cisco's attempt to sell handheld cameras fizzled. Analysts say other gadgets, including smartphones, take videos just as so then. And in hindsight, selling cameras had little to do with Cisco's core business of sending data -- even video signals -- across computer networks.

The Flip camera business

Chambers has announced he's closing the Flip camera business and will cut 550 related jobs. Now he's scouring the company for other "underperforming" units; he's vowed to trim $1 billion in spending, partly by cutting more jobs this summer.