Want to understand the economy? Look at Cisco

So it looks like Cisco will be shedding up to 10,000 jobs in the near future (or 14 per cent of its workforce).

This is a text book example of what is happening in the economy and why I think there is still another tsunami on its way.

The equation is really simple. Cisco has $43 billion of cash that it is just sitting on.

Let's do some quick math. 10,000 people at say an average salary of 100,000 each. That costs the company $1 billion a year (10,000 x 100,000 = 1,000,000,000).

So technically, Cisco could employ those 10,000 employees for the next 43 years until it had used up the cash that it currently has just sitting in the bank.

So why cut so many people? After all, surely they aren't a pure 'cost' to the business - they are 'working' all day, hence doing something that helps the company make money right? So they cost you $100k but they may be tied to the generation of 200k of revenue right?

The answer is simple. You have x amount of people in your business based on projections of growth. You can't just hire and fire based on your needs right this minute, you have to do so based on what you think your needs are going to be. So you hire BEFORE you have increased revenue, because when the opportunity comes for increasing your customer base, you need to have the people already in your business who can act on the opportunity.

So Cisco, clearly, feels that it is not going to need those 10,000 people to service the demand it will be getting from the market for its products and services. Which means it thinks that businesses and carriers won't be growing (and hence not buying ever more Cisco gear to fuel that growth).

Now, some might say, as the article I link to does, that competition is eroding Cisco market share. So what? That's a reason NOT to turf 10,000 people - if one army were losing to another army, would their strategy be to reduce the size of their army? Makes no sense.

Not to mention, the knowledge capital of those 10,000 workers walks out the door and heads straight to the competition (making them even stronger and more able to be a competitive threat against Cisco).

Naw, the only reason you cut that many people is if you think that things out there in the big bad world are really bad and only going to get worse.

Well, actually there is another reason. If you are looking to offload high-cost employees and replace them with lower-cost ones (ie. contract workers) then you might jettison 14 per cent of your workforce.

In that scenario that would basically be a scenario in which you decide to stick it to your workforce because you can (lots of people looking for work, switch out the high cost for the low cost just because you can).

Anyway, I don't think the latter is the case here. I think Cisco is seeing that we are going to be in a recession for a long time - heck, we'll be lucky if we stay in recession and don't crash in to a great depression.

But all this is not the worst of it, nor why Cisco is a great company to look at to understand the economy. What's scary is that Cisco is doing this in part to increase profits for shareholders (if you can't get revenues up, you have to get costs down if you want your 'net profits' to keep increasing).

If Cisco were a private company (ie. it didn't have to worry about its share price) it might very well say to itself "Can people? Are you nuts? We've got $43B in the bank. It will probably be 100 years before we technically have to lay someone off! I want those people working their asses off making us the best company in the world."

Cisco is a great example of a company that doesn't have to lay people off  because it can't afford to employ them. Rather, it can't afford to employ them AND increase profit margins higher and higher to satisfy the demands of shareholders.

So here we are with unemployment at 9.2 per cent in the US and you've got a company (potentially) turfing 14 per cent of its workers not because it has to (not if it were investing in its long-term future), but because its the only way to squeeze just a little more profit out for the shareholders.

The irony being that as other companies do the same thing (same thing will happen with RIM), unemployment rises, which then tanks housing prices and profits of other businesses that depend on the general economy. Those businesses then cut their spending, resulting in companies like Cisco having lower revenues (so they cut more employees?). So you end up in a death spiral and this is how you find yourself in Great Depression.

So to recap, what Cisco is telling us (or at least me) with their announcement is:

1) They do not see a growth economy in the future
2) Maximizing profits for shareholders is still paramount over long-term business growth (ie. short-term profits at the cost of long-term growth - the type of thinking that created the situation we are in right now).

The quote in the article listed above says it all:


"Keep in mind that Cisco did not go through a major downsizing in the downturn of 2008 and 2009. The company cut costs in other ways to lower operating expenses," said Brian White, an analyst with Ticonderoga Securities in New York.

"Chambers does not like to downsize. The company was aggressively hiring early last year," White added. 

What does that tell you? Cisco is a growth-oriented company, if they thought sunny days were ahead would they be right sizing? Of course not. It's clear that they were betting on a nomral two or three year recession. But they have clearly changed their views on what is coming down the road over the next few years.