Cisco, Are You Spending the Right Amount on R&D?

Technology companies all face similar issues when it comes to their product portfolio:

  • Relatively short product life-cycles
  • Need to continually innovate
  • Uncertainty of outcomes
  • Build or Buy decisions

We took an outsiders view of Cisco, and its major product lines, excluding its services business which is becoming more important, but will not require major resource investment decisions.

Product information we considered while developing the model included:

  • Size of market
  • Point in product life-cycle (when it was released)
  • Typical life-cycle length for the type of product
  • Investment required to develop new product with similar profile
  • Latest date when a product would still be viable
  • Acquisition cost of companies/products in the market

The data is not exact, but strategy development does not require precise forecasts to give you useful directional guidance.

If we look at the existing portfolio and new product development (NPD) by R&D (or acquisition cost) required (on horizontal axis), and the risk-adjusted Net Present Value (NPV) of the cash flows for each opportunity, it looks like this:

The potential products would be pre-vetted with the usual process to see that they fit within the overall company strategy, that the company has or can acquire the necessary organizational capabilities to develop and deliver the product, and uncertainty has been considered.  In other words, all of the considered projects would be done if resources were available. Also note that the values are risk-adjusted, with at least three cases made for each forecast.

The big provisional note there was, “…if resources were available.

There are no companies with infinite resources, and if there was one, it would have acquired all the others and owned the entire market.  Even a company as large as Cisco has to control its spending on new products. In the most recent quarter, it spent $5.6B on R&D, which was 15% of its product revenue of $37B.

I wanted to see if they were spending the right amount, if they wished to achieve near and long-term growth goals.  Using npv10’s Portfolio Optimizer, it was simple to set constraints on R&D spend as a percentage of the resulting cash flows.  We ran seven different cases, with R&D as a percent of product revenue ranging from 0% to 16%. Once data was in, it took a little over an hour to run this set of analyses.

Each scenario selected a different set of new products with different start times (within the time-constraints allowed).  Sometimes the scenario decided an acquisition would be more appropriate, and other times not. An acquisition may speed things up, but they also come at a higher cost because much of the development has been de-risked.

The results were interesting.  Obviously cutting off all R&D spending helped near-term cash flow, but also dramatically impacted the future as existing products reached the end of their competitive life-cycle.  Spending the most on R&D constrained cash flow over the first few years, but then dramatically increased as all of the new products entered their markets and generated revenue (which in turn provided more cash flow for future R&D).   It also showed how almost all of the cases resulted in the same cash flows 2 ½ years out, but had vastly different numbers leading up to that time and afterwards.

We did not consider additional goals (such as growing revenue, paying dividends, improving margins, etc.) or constraints (headcount resources below some level, number of simultaneous product launches, etc.) but those can rapidly be layered onto the analysis.

In the end, your company needs to decide what your corporate goals are, and what’s holding you back from achieving them.  It’s up to us to help you quickly and optimally determine various paths forward and the trade-offs among them.

Why Apple Needs to Build an iCar

To everything … There is a season
— The Byrds – Turn! Turn! Turn!

Every company has to manage its portfolio of products or projects, as each undergoes its life cycle of birth, growth, decline.

Apple derives the majority of its revenues and profits from just a handful of products: iPhone, iPad, and personal computers. Each of the segments has had its day as a growth driver, and the iPhone is just now showing signs of slowing unit growth.

Their big question is what product line can become the growth driver, given that the phone segment generated over $140B in sales during the last year? (I realize that most Fortune 500 CEOs would love to have such a problem…)

They could of course come up with a new or improved existing product, and dominate the space, as they did with music players, tablets, and smartphones. The Watch is an early attempt at identifying the next market, and it’s doing well relative to other competitors, but not in sufficient volume to be relevant.

The company reportedly considered the TV market, which in some regards helps fill a short-term gap, as TVs are high-ticket item consumer electronics, but competitors seem all too willing to drive prices down on the latest innovations as quickly as possible. Apple could still develop something here, but seem content for now to use their Apple TV box to let them continue working on this segment.

There are only a few other industries with companies that generate revenue of Apple’s magnitude: Oil, Retail, Automotive, and Financial Services.

Only one of those plays to Apple’s core strength of developing cutting edge products for consumers: Oil. Just kidding!

Apple has experience with retail, but I don’t see them wanting to go beyond their high-end niche, and try competing with Wal-Mart or Amazon, purveyors of anything and everything.

The company is making forays into the financial world with Apple Pay, but for now need to leverage other competitor’s infrastructure, and it seems more like incremental efforts to bolster their ecosystem.

That leaves the automotive world. They started integrating their technology as infotainment devices, with Apple Carplay. This is again an incremental play, and enables them to build relationships, and see where they can add value, and play to their strengths.

But could Apple expand their forays into cars with an actual car? And would they compete with the BMWs of the world, or with Uber with a self-driving car service? The current rumors suggest they went down the path of having their own car design, but may have shelved it while continuing development of self-driving systems.

Nothing in their past suggests Apple wants to be solely a technology provider to other companies, and it’s unclear what competitive advantage they would have in the self-driving tech space. Pausing the development of the entire vehicle could simply be a pause, while they think through their options, and see the pace of the industry’s evolution from a “car in every driveway” to an “always available taxi service.”

Apple’s strength has always been in providing an integrated hardware/software/service experience, and the only way to achieve that in the auto industry is to develop or acquire their own car design. Others have suggested Apple acquire Tesla to quickly establish a strong position in the industry, but they have never used major acquisitions to enter a product category.

Where does that leave us, or Apple?

Our goal-based planning approach tells us that Apple need a replacement for the iPhone as its main growth driver. Their strategy has always been to have a focused product line, rather than a large collection of products. Together, these tell me that Apple will soon be filling its new spaceship-like headquarters with car designers and engineers.