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Inside Cisco's $2 Billion BlunderBy: Paul KaihlaIssue: March
2002Print Article | Email This Article
How the world's most admired supply chain screwed up, and howCEO
John Chambers plans to fix it.As corporate humiliations go, it had
to be one of the worst. In May 2001, Cisco Systems(CSCO) announced
the largest inventory write-down in history: $2.2 billion erased
from itsbalance sheet for components it ordered but couldn't use.
The gaffe was made all the moreembarrassing by waves of prior
publicity about Cisco's brilliant integration of its
vastinformation systems. The network was so responsive, gushed
Cisco CEO John Chambers, thatthe company could close its books in
24 hours, any day of the year. Yet the system wasn'tresponsive
enough to stop building billions of dollars' worth of stuff nobody
wanted.
Cisco blamed the fiasco on a plunge in technology spending that
Chambers called asunforeseeable as "a 100-year flood." If company
forecasters had only been able to see thiscoming, Cisco implied,
the supply-chain system would have worked perfectly. But Business
2.0
has learned that, in fact, flaws in the system contributed
significantly to the breakdown. Ciscorecognized many of these
problems even before last year's inventory bubble, and ever
since,an elite group of execs and engineers has been working on a
top-secret remediation programcalled eHub. Here's the first inside
look at how this ambitious, multimillion-dollar project couldhelp
avoid a repeat of last year's disaster ... if it works as
planned.
Inflating the Bubble
During the late 1990s, Cisco became famous for being the
hardware maker that doesn't makehardware. Instead, Cisco farms out
most of its routers and switches to electronics
contractmanufacturers. This arrangement has several advantages. For
one, it allows Cisco toconcentrate on marketing and product
innovation. It also liberates Cisco from much of thehassle and
expense of maintaining inventory, as Cisco's information systems
make it possible
to ship fully assembled machines directly from the factory to
buyers, more or less on demand.
But the Great Inventory Wreck of 2001 highlighted some ugly bugs
in the system. Cisco'ssupply chain is basically structured like a
pyramid, with Cisco at the point. On the second tierreside a
handful of contract manufacturers -- including Celestica (CLS),
Flextronics (FLEX),and Solectron (SLR) -- responsible for final
assembly. These manufacturers are fed by a largersub-tier supplying
components such as processor chips (Intel and Xilinx) and optical
gear (JDSUniphase and Corning). Those companies, in turn, draw on
an even larger base of commoditysuppliers scattered all over the
globe.
Communication gaps between the tiers eventually got Cisco into
trouble. To lock in supplies ofscarce components during the boom,
Cisco ordered large quantities well in advance, based ondemand
projections from the company's sales force. What the forecasters
didn't notice,however, was that many of their projections were
inflated artificially. With network gear hard
to come by, many Cisco customers also ordered similar equipment
from Cisco's competitors,knowing that they'd ultimately make just
one purchase -- from whoever could deliver thegoods first.
The result was double and triple ordering, which bloated demand
forecasts and put thesqueeze on component supplies. A missing link
in Cisco's supply-chain management systemmagnified this problem.
Suppose Cisco projected sales of 10,000 units of a particular
router.Each of the company's contract manufacturers would compete
to fill the entire order, and togain an edge, they often tried to
lock up supplies of scarce components. Suppliers would beswamped
with orders, but Cisco's supply-chain system couldn't show that the
spike in demand
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represented overlapping orders. If, say, three manufacturers
were competing to build those10,000 routers, to chipmakers it
looked like a sudden demand for 30,000 machines. Ciscobecame
enmeshed in a vicious cycle of artificially inflated sales
forecasts, artificially inflateddemand for key components, higher
costs, and bad communication throughout the supplychain.
Eventually, the bubble burst.
Better Living Through Automation
Cisco's inventory woes highlighted the shortcomings of a
communication system that stoppedonly partway down the pyramid.
That's where eHub comes in.
As it happens, work on eHub began in 2000, when the last thing
on anyone's mind was aslump in demand. Instead, the project was
intended to help eliminate bidding wars for then-
scarce components. "It was created for scaling upward," says
Carl Redfield, Cisco's head ofworldwide manufacturing and
logistics. "It was put in to ensure that enough material
wouldalways be on hand."
By the summer of 2000, Cisco had produced a 3-inch-thick
specification binder that served as
a blueprint for eHub. Its central nervous system would be run by
Irvine, Calif., supply-chainintegration firm Viacore, which would
take Cisco's already advanced supply-chain engine to a
new level.
Private exchanges that link members of a supply chain are
nothing new. In the past,companies like Dell (DELL) and GM (GM)
have created electronic hubs that feed supply-chaindata to
outsource manufacturers and suppliers, and vice versa. These
exchanges typicallyprovide a Web interface where vendors manually
type in things like sales forecasts, purchaseorders, and shipping
schedules. The systems are not real-time, and they're plagued by
data-entry errors.
eHub practically eliminates the need for human intervention.
Instead, the system automatesthe flow of information between Cisco,
its contract manufacturers, and its componentsuppliers. The key
ingredient is an XML technology called Partner Interface Process,
or PIP.eHub's dozen or so PIPs indicate whether a document requires
a response -- and if so, how
quickly. For example, a PIP purchase order might stipulate that
the recipient's system mustsend a confirmation two hours after
receipt and a confirmed acceptance within 24 hours. If
therecipient's system fails to meet these deadlines, the purchase
order is considered null andvoid.
Under eHub, Cisco's production cycle begins when a demand
forecast PIP is sent out, showingcumulative orders. That forecast
goes not only to contract manufacturers but also tochipmakers like
Philips Semiconductors and Altera Corp. (ALTR) "Before, if
Celestica,Flextronics, and Solectron all came to Philips at the
same time, and each said they wanted10,000 of a certain chip, that
was a total of 30,000 chips," says one senior engineer whoworked on
the eHub project. "Now, Philips can say, 'Hold on, I'm on eHub. I
know that totalaggregated demand is only 10,000.'" By requiring all
the systems in the supply network to talkto each other, eHub
ferrets out inventory shortfalls, production blackouts, and other
screwupsalmost as fast as they occur.
Complexity and cost have put eHub a bit behind schedule. Cisco
originally planned to connect250 contractors and suppliers by the
end of 2001. Instead it linked roughly 60, includingAgilent
Technologies (A), Hitachi, IBM (IBM), Intel (INTC), LSI Logic
(LSI), Motorola (MOT),and Xilinx (XLNX). This year the number
should rise to 150 or more, and Cisco's ultimate goalis to
integrate as many as 650 supply-chain participants.
eHub is just the first stage of Cisco's plans for the future.
Ultimately, Cisco hopes to automate
the whole enchilada: A customer purchases a product online, and
that order goes into both
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