3Com CEO Claflin focuses on revenue growth

Bruce Claflin, a former network executive at IBM and Digital Equipment, joined 3Com as president and COO in 1998. At the time, 3Com was riding high after its huge merger with U.S. Robotics. But the Internet bubble burst in 1999, the merger didn’t pan out and 3Com’s fortunes went downhill fast. By 2001, Eric Benhamou was out as CEO and Claflin was at the helm. He moved quickly to get 3Com out of ill-conceived ventures such as Internet radio. As revenue continued to plummet and losses mounted, Claflin switched the company’s target market from service providers back to the enterprise, abandoned manufacturing altogether, and entered into a bold joint venture with a Chinese network gear manufacturer. Joel Shore recently caught up with Claflin.

These last three years haven’t been easy.

There are lots of captains of companies who in the late 90s were convinced that they were wonderful captains of their ship because they could get up every morning and every quarter and successfully sail the ship from point A to point B. But a good captain is someone that can sail a vessel safely from point A to point B regardless of the conditions. It’s easy to do when there are fair winds, great visibility and calm seas. The question is, can you do it in fog, rain, lightning and thunder? And we had a whole cadre of CEOs who went year after year after year with sunny skies, fair winds, and thought they were captains. And then all of a sudden when the stormy times hit, they found that they didn’t know how to captain the ship.

I really believe that as much as it’s a pain, what we’ve been through, it is really the ultimate test of whether you can lead a company – can you lead it in good times and in bad. And in that regard it’s been quite a challenge. It’s exciting. And because we think we’re coming out of it, it’s also exhilarating. If the ship had gone down, maybe I wouldn’t feel quite so positively.

A lot of people think it almost did.

I don’t think it almost went down, because we did one thing really well early on: and that is we made absolutely sure we protected our balance sheet. We kept lots of cash, high liquidity, did everything we could ensure that we’d never have to face any underlying financial problem. So while the company had lots of difficulty and had to do all kinds of downsizing and make changes, there never was a question as to whether or not our existence was in jeopardy. And that was something I’m very grateful we avoided.

You decided to outsource all of your manufacturing and to create a joint venture with Huawei, a Chinese manufacturer of switches and routers. How has that been going?

So far so good.  You’ll recall we had already outsourced quite a bit of our manufacturing a few years ago so this was an extension of something we were already doing. And in that regard it’s not new or revolutionary. It’s still difficult, but we had some experience.

The Huawei joint venture is a different deal. We were creating the company from scratch; it’s the first major company that’s a joint venture between an American and a Chinese high-tech company that has, as its principal mission, R&D.

Most ventures up to now have been just sales and marketing into China or maybe in manufacturing. This is the first time we actually put R&D inside a China-based joint venture and it was very new for China and new for our industry. So far we’re very encouraged. But it’s early; we just began in November.

What’s the customer reaction? 3Com has been in businesses, out of businesses, and back in again. Customers don’t know what to make of it.

I think you’re, to a large degree, right, but not completely right. First thing, there are certain attributes we have that are really great anchors to the strategy. We do have a large installed base in the enterprise and it’s a satisfied installed base. The reviews we get in terms of service, quality, reliability and support on this large installed base are extremely high. They have our products, they know what they do, and they like them. We have a strong brand. All of the brand studies show that it’s very well known and generally well regarded around the world, whether it be channel or end customers. So while there have been lots of changes in the company, there are some things that have endured such as, a good quality installed base, a good customer base and a strong brand, which we’ve been able to leverage as we go forward.

Now it’s true we’ve changed a lot of the specifics of the businesses we’re in and which products and so forth, but there is, if nothing else, one thing that’s helped us in the downturn is that we were not alone. Just about all of our competitors did downsizing, closed or restructured parts of their businesses. So in that regard we had lots of company.

3Com will keep R&D in-house in certain growth areas such as VoIP and security. 

We source products from a variety of places. We do some inside 3Com. We do some inside the joint venture. We do some from original design manufacturers (ODM) and we do some from OEMs. The sum of this is where we source products. In that, we’re not really different from anyone else. What is unique is that we have a joint venture.

We try to do our development and sourcing wherever the best capabilities exist. For example, we might do OEM on a product that has moved to more of a commodity basis. There is very little value-add; we do this at the lowest-cost location. ODM might be an area where there’s a product that someone else has and if we contribute a little bit of engineering, we can differentiate in a way that meets our needs.

Then, you have an area where we get into core technology that we want to own. We develop it either in-house or through the joint venture. Even then we divide it up. The venture is really good at box-builds, Layer 3 and the operating system. So they have that mission for us, all of our high-end switching and Layer 3 software. We’re good at network management and VoIP. We do the engineering in-house, they do the box design, and between the two we have an extended reach, certainly beyond what we could have done on our own.

One of the beauties of the joint venture is the resource we have in engineering. A year ago 3Com had about 300 engineers on its payroll developing product. Today, we have closer to 900 engineers working on our behalf. Yet the cost of this is off our books. We had to make an investment in the [joint venture].

Is there customer reluctance to buy these products that weren’t developed under 3Com’s roof?

We know how customers respond to knowing that some of the products they’re buying from 3Com may have been developed inside a Chinese company. And I laugh because everybody sells products from China, Taiwan or Asia. The fact that we are sourcing product in Asia is not unique. What is unique is that we’re sourcing it inside a venture that we have a substantial ownership in, and that we’re doing it in a collaborative way where we share intellectual property. And we think that will help us be more effective than an arm’s-length relationship where we’re just buying product.

In March 2003, when you got back into the core switch business, you said “as we go forward, we’ll demonstrate that we’re a tier-one networking company that has a broad line of products for businesses of all sizes.” Having the products is great, having the technology is great, but people have to have faith in you before they’ll buy those products. How is 3Com restoring the faith that customers have lost?

Restoring implies that it doesn’t exist. I’ll go back to the fact that there is a large installed base of very happy customers who buy from us. But let’s agree that while we have an installed base it’s a small one relative to the total market size. How do we penetrate the customer who does not have us today? There are several things.

The first is…you can’t just come in and say I have a box and it costs x. You have to really be able to demonstrate that you have range of products and solutions – and not just that they’re cost-competitive to buy – but that their cost of ownership is competitive. You have to show they have all the right features and attributes. And you have to have confidence that you’ll meet customers’ needs now and in the future.

So whenever we go and talk to a customer, before we talk about proposing products and solutions, we always start by talking about 3Com. We’re a company with an installed base of billions of ports, 30 years in the business, with an intellectual product portfolio that is second to none – even larger than Cisco’s or any other datacom company – that we have a balance sheet with a $1.4 billion in cash, no debt; all of those attributes that give them comfort. Then we talk about the range of our offerings, that we have wired and wireless products, we play in data as well as voice and other convergence areas, and that we have a broad portfolio of end-to-end products.

Then we typically show our road map. They want to know if they buy today, that you’ll be there tomorrow. So we show them not only the existing product, but also the roadmap. And then last, we show them our commitment to service and support. And if you do all of that, I’d argue that convinces them you’re a credible supplier. And then you can go and propose the specific products and solutions. So we always talk about our value propositions: tier-one capabilities, innovative product solutions and value. And that literally is the order in which we approach the customer.

What was the rationale for getting out of the enterprise business?

Two things: Why did we do what we did then, and why don’t those factors apply today. If you think about how networks are being designed today, it’s basically Internet protocol and Ethernet. While yes, there are legacy protocols and transmission types, they are going away; IP won. Four or five years ago you had to support multiple protocols, and that was capability we did not have at the time. Nor did we have the scale or the capability to keep up.

Today, they aren’t important. It’s Ethernet and IP. Second, back then, the competitive environment was much different than it is today. You had a whole series of “hot” product companies with enormous market capitalizations. You had Europeans that were aggressively expanding internationally. You had new entrants, like Marconi. Even Intel had said were going to be a network product solution provider. Today, Marconi is largely gone, the Europeans have largely retrenched, the once hot hotbox company is largely struggling as customers look for a broader supplier. I think the competitive environment is much different today.

There was a time when Digital was strong and had its day and even Compaq was going to get into networking and switching and they went out. So there’s a whole set of competitors that don’t exist today or have substantially restructured. So I’d argue that today the world is much different, we’re moving much more to standards. IP and Ethernet are the two core standards. As customers move to standards, we think that if we continue to build innovative products and solutions around standards, we can fundamentally improve the cost of ownership for the customer. By simplifying their network design and reducing complexity, we think customers are going to value that.

In late 2000 3Com acquired Kerbango, basically an Internet radio for $80 million. And the company introduced Audrey, the home Internet appliance. Yet just a few months later both products were killed. It looked like 3Com was out of control, but you’re suggesting that this was part of the larger vision?

Yeah, it is. Look, we can go back in history 30 years and talk about products that did or didn’t work. I tend to use my moment of history as when I became the CEO, and for understandable reasons, I’m on the line. That was Jan. 1, 2001. It was very clear to me that the bubble had burst, that many markets we felt were going to grow rapidly weren’t. And included in that was the nascent consumer market. As a part of the response to that downturn in the bubble, I made the decision to exit markets where there was little likelihood of a profitable business in a reasonable period of time.

If you were to look at most analysts’ assumptions in the late 1990s about growth in broadband, home networking and consumer network appliances, they were very bullish. By 2001, when I became CEO, it was obvious it wasn’t going to happen. And we scaled back accordingly. There’s a common message to all of this, and it goes back as early as 1999 when we spun out Palm. The message beginning then was to narrow the company down to markets and products where we believed we could build a leadership position and re-affirm our commitment to networking. Palm was a great product but it was not a networking product. While there have been a lot changes inside 3Com over the last five years, they have been with the idea of having products you can be a leader with within the network business.

There was a lot of talk that when 3Com acquired U.S. Robotics, it didn’t know what Palm was, that it was just some little thing that no one really understood.

Well I think that’s true. I wasn’t here at the time, but I think everyone who was here said that of all the things they hoped to get out of U.S. Robotics, Palm was probably lowest on the list. But you know it’s interesting, I like to reflect on good decisions and bad decisions from a standpoint of learning. Again this was all before my time and it was while Eric Benhamou was CEO. Talk about the value a CEO can bring. In early 1998, the founders of Palm approached Eric and basically said let’s spin the company off. Eric reviewed it and concluded that it wasn’t the right time. He didn’t rule out doing it eventually though. At that time, the investment bankers said he probably could get $2 billion for it. He waited about a year and a half, and got $20 billion. I’d argue that was a pretty good decision. And in that interim period of time, 3Com did a very good job of scaling the product, ramping it rapidly, moving it into multiple channels and building up the brand. So while at the time of the acquisition Palm was the least important part, by the end it was the most valuable part. And it wasn’t luck that got us there, it was some really good decision making.

One of the things I’ve noticed about CEOs is that whenever something goes wrong, the CEO is blamed. Palm was brilliantly scaled. It was taken from a $35 million business when it was acquired to a billion-dollar business when we spun it out. This was from something that was a nothing inside another company to one of the premier IPOs of 1999. It wasn’t luck. It was good management along the way. We created a lot of shareholder value.

How do you grade your efforts since becoming CEO in 2001?

I have no problem assessing my time and my watch. I give our senior management team exceptionally good marks in recognizing that there was a fundamental change in the marketplace, that demand was going to drop and that is wasn’t just some short-term thing. We took a set of actions very early on in the meltdown that ensured that we would not only survive the downturn, but survive it was a really strong underlying financial position. There are a lot of companies in the market today – I call them zombies, the walking dead – they’re not out of business yet, but they don’t have the financial underpinning to do much of anything to change their fortunes.

We cut a lot of cost and expense, but you can’t just cut your way to success. You have to create growth businesses. I think what we are doing now is demonstrating a very attractive growth strategy. It’s one of the reasons the stock is up almost 300% from it’s low. I think that investors see that not only did we survive the downturn, but we have an attractive strategy for growth. So the jury’s out on whether we’ve achieved the second part. But if the goals were to survive and thrive, we clearly get good marks on survival. We’ll see how we do when it comes to thriving.

But earnings per share are still negative.

To turn that around, we have to grow. If the accent was on cost-cutting two years ago and growth was secondary, it is reversed today. We’ll continue to take cost and expense out, but we absolutely are driving the growth strategy this coming year.

I think over the next couple of years, the company becomes a rapidly growing enterprise. I believe we achieve profitability and can accelerate based upon leveraging the strategy we have. The [Chinese] joint venture is an important element of it. I think our voice initiatives, where we’re spending very high amounts of R&D and sales development, will drive growth. In new areas, such as security, we’ve been expanding our product offering. Network management is another. All of these are initiatives that I believe will drive profitable growth.

I’ve been in the industry 35 years. I’ve watched mighty companies stumble. And basically there’s a common pattern. The early leader in almost every segment of technology builds its leadership position around a new technology in which it had a proprietary advantage. It wasn’t a matter of standards vs. proprietary -there were no standards. And there was a price that the customer willingly paid because the vendor demystified and de-risked the technology. Over time, new entrants come in, but it’s usually just “hot” technology. “I’ll give you a better mousetrap.” And they have their day but they typically don’t survive long, and then the industry moves to standards. Management experience becomes extensive. Customers know how to manage the technology. Standards are either set or they are de facto. New entrants come in, and their business model is not proprietary, it’s based on industry standards. They will fundamentally undercut the prices and costs of the leaders in the industry, not by being cheap, but by having a better cost model than the leader.

IBM owned the mainframe business. There was the BUNCH (Burroughs, Univac, NCR, Control Data, Honeywell) but they all faded. The guy with more than 30% market was Gene Amdahl. He had a tier-one – nobody ever said it was a cheap or cheesy company – but he said, “I’ll accept that the System 360/370 standard is the standard.” He even said, “I’ll run IBM software unaltered.”

He used technology to drop the cost of ownership, and he introduced an air-chilled product at every point where IBM had water-chilled products. He fundamentally changed the price to buy, and cost to own. He took a huge share out of IBM’s hide. That could have never worked five years earlier. But by the time he came around, management experience was extensive, standards were beginning to be set, technology was not quite so mystifying, and the customer came to resent the lock-in that came with proprietary technology.

The same thing happened to PCs, where Compaq took leadership from IBM and then Dell took it from them. You can argue this has been happening in storage over the last couple of years. I believe it’s going to happen in networking.

I don’t believe there’s a CIO in corporate America who buys low bid. The CIO must be certain that whatever product he’s buying, and that the vendor he’s buying it from is going to be reliable, can be counted on. And then, if he is confident within that framework, he looks for what the value price to buy and cost to own is.

Our goal is that we’re never going to be cheap. But we are going to be a tier-one supplier who has great products, great technology and excels in value. It’s the sum of these three that we believe will set us apart.

So where was I going with this soliloquy?

IBM in 1985 was, arguably, the most powerful company on the face of the earth. As we went into that year, Time magazine had a feature story on IBM called “IBM: The colossus that works.” It was the most admired corporation in the world. The PC was Time’s “Man of the Year.” IBM was on a roll as it entered 1985. The whole thing collapsed by the end of 1985; they went on over a 10-year drought. The point is they never looked stronger until just before they collapsed.

Are you drawing a parallel between IBM and Cisco? Or Microsoft?

Oftentimes people say to me, “Do you intend to compete with Cisco,” and I say, “Yes we do.” But we’re also very different in that we’re going to leverage standards as opposed to proprietary and change the value proposition. They say well that’s all well and good, but they’re so powerful. And I say so was IBM in 1985. So was the IBM PC in 1992. So was EMC in 2000. All of them, all of them had their comeuppance as new entrants came in and recognized that standards were increasingly important. And that is what we’re trying to do as a company.

The cycle always repeats.

It does repeat. There are always a few minor changes, but the cycle is always the same.

Microsoft and Linux is a classic example. Highly proprietary. Customers switching off [Windows] five years ago would never have happened. Today it is happening. An open industry standard vs. something proprietary and closed. Is Linux cheap? No. It had to be backed by a set of vendors who gave it credibility. It’s an expensive free operating system. It’s expensive because it’s getting the tier-one backers. No one was going to go with Linux just because it was free and you could get it off the Web. Once the tier-one providers took and leveraged it as an open standard, it took off.

You agree that 3Com has had brilliant successes and spectacular failures?

3Com, if you look backwards, is a company with a rich legacy. It’s had ups and downs. If you go back 15 years, the company was on the ropes. It restructured and turned itself around for an enormous growth period. 3Com was the first company in the U.S. to take an existing ballpark and rename it [when San Francisco’s Candlestick Park became 3Com Park]. Controversial. There are people who still hate the company today for having done it. The point is, 3Com has done a lot of things as a company; some worked and some didn’t. The competitive environment is such that we can gain substantial market share and create a high-growth, high-value company.

What is the relationship with 3Com’s partners?

Today, most companies’ products move either with or through somebody who’s adding value along the way. I think that is perhaps in the near term, our greatest opportunity, even greater than the value to the end customer. We are finding, particularly with Cisco products, that they are grossly over-distributed, they are all competing with one another for the same business, they are driving down their margins, and all the value is flowing back to Cisco. I had a partner tell me that the Cisco idea of a partner strategy is a feudal model where there is the lord of the mansion and the serfs who till the fields. And the channel today is serfs who till the fields. They are not making money selling Cisco product. And that is creating an enormous opportunity for us.

We’ve recognized this opportunity for over a year, but when we first approached channels, maybe two years ago, they said, “Your product line is too limited. We want to be with a company that is a real alternative to Cisco, that has an end-to-end line of products.”

That’s why we’ve spent the last year and a half building out a complete portfolio of enterprise products. Now that we have it, the higher value-add channels that can sell complex solutions are welcoming us in. For example, EDS announced in December that it had picked 3Com as a strategic supplier. Beyond the hoped-for revenue that this will produce for us, the immediate benefit is that it’s a badge of endorsement for our strategy. EDS sells to some of the most demanding customers in the world. When they do, they commit to service-level agreements – performance, reliability, availability, features – and they are not going to commit to those unless they have a vendor that is going to meet their needs. So EDS’s selection of 3Com is an important proof point that the strategy makes sense. And it illustrates that perhaps the fastest way to success is through the channel where the competitive environment seems to be of the most advantage to us right now.

You’ve controlled distribution rather tightly.

One of the things we did right [during the downturn] as markets began to soften and our revenue was exposed, was one of the easiest things you can do, sign up more distributors and more channels. It may postpone the slowdown in your growth, but it creates a long-term strategic problem where you’re over-distributed. We avoided that like the plague. As a result, our channels today find that it’s worth their time investing money in 3Com, learning the product and promoting it. They can make more money selling it. I think the opportunity in the near term is as much through the channel as it is to end customers. That’s one of the ways we expect to grow.