Scenes from the supply chain: Cisco Systems

Cisco Systems is seeing strong demand and has record backlog, but its third quarter results took a hit because it couldn't get power supplies and other components due to supply chain issues.

While supply chain transformation is a boardroom issue, Cisco is a bellwether for what other companies may see. Why? The company historically has seen macroeconomic turns before others do. For instance, Cisco's biggest challenge in the quarter was China's COVID-19 shutdowns in Shanghai.

Here are a few quotes from Cisco's third quarter earnings conference call that show the extent of supply chain issues.

The problem: Global uncertainty affecting supplies.

Cisco CEO Chuck Robbins said in February that the company was optimistic about overcoming headwinds impacting the technology sector. That changed when Shanghai was shut down. Robbins said:

"There were 2 unanticipated events since our last earnings call, which impacted our Q3 revenue performance. The first is the war in Ukraine. This resulted in us ceasing operations in Russia and Belarus and had a corresponding revenue impact. The second relates to COVID-related lockdowns in China, which began in late March. These lockdowns resulted in an even more severe shortage of certain critical components. This, in turn, prevented us from shipping products to customers at the levels we originally anticipated heading into Q3. Our Q4 guidance incorporates a wider-than-usual range, taking into account the revenue impact of the war in Ukraine and the continuing uncertainty related to the China COVID lockdowns.

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The problem: Component shortages and inflation hurt margins.

Cisco CFO Richard Herren explained:

"The decrease in product gross margin was primarily driven by ongoing higher component costs related to supply constraints as well as higher freight and logistics costs, partially offset by strong positive pricing impact.

We continue to manage through the supply constraints seen industry-wide by us and our peers. To give a sense of scale of the shortages, we currently see constraints in Q4 on roughly 350 critical components out of a total of 41,000 unique component part numbers. Our supply chain team is aggressively pursuing multiple options to close those shortages."

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The problem: Power supplies couldn't leave China.

Robbins said that Cisco took a $300 million revenue hit because it couldn't get power supplies out of China. Robbins said:

"We had 11,000 PCB (printed circuit board) assemblies built we couldn't get power supplies for because of the lockdown. That's a simple fact of what happened in Q3. When we look at Q4 and you think about the Shanghai lockdown and what we've heard, because in Shanghai, there are lots of components that go into our power supply. So, we're not able to get those components. Shanghai now is saying they're going to open up June 1. We don't know exactly what that means and what that means to when that implies that we would start getting any supply out."

The problem: Transportation and logistics congestion once Shanghai reopens.

Robbins said once Shanghai reopens the congestion in freight movement will occur. He said:

"We believe when they open up and when they do allow transportation and logistics to start up, we believe there's going to be a high degree of congestion. We believe that there's going to be lots of competition for ports capacity, airport capacity. And we just believe that, that, combined with the inbound efforts, trying to get raw materials back into the country, et cetera, we just believe that it's going to be impossible for us to catch up on this issue in Q4."

The fix: Redesigning supply chain networks and products. Robbins added:

"Our teams over the last 6 to 9 months have been working on a lot of mitigating actions, redesigning over 100 products to give us component diversity. We believe that a combination of those starting in our Q1 and in the first half of our year, we'll start to see the benefit of that. So that's when we expect to see it improve to some extent. We need to get through the next 90 days, but I'm just being as transparent as I can about what we see and when we think some of that improvement will occur."

He elaborated that Cisco had a full month of China lockdowns in the supply chain and other peers are going to see the same issue. Simply put, supply chain redesign will be ongoing.

"I would say is that we are constantly evaluating our global supply chain. And so, it's not about one country. It's about resilience. And the way we've designed supply chains over the last 15, 20 years as an industry, I think we all realize we're evolving that now at the same time that we're triaging all of the current issues that we have. So, our teams have a dual challenge. But we are constantly driving geographic resilience. The example I would give is that we — before COVID, we had regional redundancy built in. We did not have a plan for a country to shut down. And so, it takes time to go out and create that geographic resilience, but our teams are working on all of those kinds of things right now."

More supply chain:

• Toyota aims to offset ‘unprecedented’ raw material costs with efficiency

• IBM-Celonis survey: Chief Supply Chain Officers to accelerate execution management, automation, simulation adoption

• How inflation, supply chain and sustainability could drive efficiency gains

• 3M is betting on continuous improvement to navigate supply chain disruption, inflation, logistics hurdles

Larry Dignan

Editor in Chief (former)

Larry Dignan is the former Editor in Chief of Celonis Media. Before joining Celonis, he was Editor in Chief of ZDNet and has covered the technology industry and transformation trends for more than two decades, publishing articles in WallStreetWeek.com, Inter@ctive Week, The New York Times, and Financial Planning magazine.