Cisco Seeks Bigger Role in Phone Networks
By MATT RICHTEL
The telecommunications boom of the late 1990's was cruel to Cisco Systems. Now the company is trying to benefit from those harsh lessons.
Cisco, which built its reputation in data networking equipment, angered many major telephone companies a few years ago by trying to expand its small share of the voice-and-data market by focusing on a group of upstarts that were competing with the telephone companies. Because Cisco acted as lender in a lot of those purchases, the company lost tens of millions of dollars on the deals when many of those start-up companies went bankrupt.
But Cisco's chief executive, John Chambers, has engineered a recovery that has left the company in surprisingly strong financial shape despite the continued technology recession, and Cisco Systems may be in a position to dip back into the telecommunications waters, wiser for its troubles.
As the major makers of telephone network equipment paddle furiously to keep afloat, particularly Lucent Technologies and Nortel Networks, Cisco sees an opportunity to increase its relatively small share of that market — this time by concentrating on traditional long-distance and local phone providers.
So far, telephone companies are still spending relatively little on new equipment. Some industry analysts say the lull has given them a chance to reassess their investment strategies. Once spending picks up, these analysts say, the phone companies may be more inclined to begin adopting a new generation of technology in which voice calls, video and other data are transported in the same manner as Internet traffic. Although a major changeover to such technology could be two decades away, any steps in that direction could be good news for Cisco, the current leader in Internet traffic-routing gear.
In recent months, in fact, Cisco has inked several deals of that sort with telecommunications companies, including AT&T and Sprint. To promote its push, Cisco operates a showroom at its headquarters in San Jose, Calif., displaying telephones that can be used to send and receive voice, e-mail and other Internet data.
"The longer the downturn lasts, the more opportunity there is for Cisco to build market share," said Tim Luke, a telecommunications analyst with Lehman Brothers.
So far, Cisco controls about 4 percent of the estimated $75 billion global telecommunications equipment market. Securing a firmer foothold in that market is crucial because Cisco's dominant position in the Internet market is showing signs of eroding as other companies enter the field, including Dell Computer and the Chinese company, Huawei Technologies.
Cisco's financial soundness — more than $21 billion in cash and equivalents, an annual revenue run rate of about $20 billion and a profit of around $1 billion in its most recent quarter — could help make Cisco look like a solid vendor to the big phone companies at a time when Lucent and Nortel seem to be living quarter to quarter.
With only about 20 percent of Cisco's revenues now coming from telecommunications companies, executives say that Mr. Chambers's long-term goal is to build telecommunications sales back up to 40 percent of revenue, but this time with most of it coming from major carriers like AT&T and British Telecom.
But Cisco may still have some trust and credibility issues to overcome. Not only are many telecommunications carriers still most comfortable dealing with longtime vendors like Lucent, Nortel and Alcatel of France, said Stephen Kamman, an analyst at CIBC World Markets, but there are fences to be mended with the conventional phone companies that recall Cisco as the supplier to their upstart competitors in the boom years.
The bigger challenge, though, will be inducing the carriers to begin scrapping hundreds of billions of dollars of network equipment that is based on conventional telephone network architecture and replacing it with newer, Internet-based technology that makes much more efficient use of network lines.
In the five years since the first experimental efforts in sending voice calls over the Internet, 10 percent of international voice traffic now travels by that means, as users seek to avoid the high tariffs that many foreign telephone companies charge to complete the calls. But among telephone companies in the United States, capital investments and institutional inertia are working against adoption of Internet-based technology, generally known as I.P., for Internet protocol.
"It's a bit like bringing an Apple Computer into a PC environment; you can do it, but people have tended to not want to try," said Eric Rabe, a spokesman for Verizon Communications, the nation's largest local telephone provider.
Eventually, the carriers know they will need to replace their aging network. Because Internet technology has proven itself a more efficient and flexible way to move digital information of all sorts, industry executives say the mass migration to Internet-based technology is simply a matter of time.
In the interim, "it's more expensive to operate two networks than one," acknowledged Charles H. Giancarlo, general manager for product development at Cisco. And yet, he said, "there's a general agreement that over the long run, it's cheaper to consolidate."
In the short run, telephone companies have begun integrating Internet-based technology at points along their networks. And even in this nascent piece of the market, Cisco is seeing competition from Lucent and the other big equipment vendors, which recognize the inevitability of Internet-based technology.
Telephone companies are not the only customers for such equipment. Businesses large and small have begun using Internet-based technology to route data and voice within their internal networks. Burger King and Ernst & Young are among Cisco's corporate customers for the systems, and Cisco has struck alliances with the phone companies AT&T, SBC Communications and Sprint to offer packages of equipment and service for the corporate market.
As the business world and carriers embrace Internet-based technology, Mr. Giancarlo predicted, telecommunications companies will develop pricing plans based not on individual telephone minutes but on services — whether voice, data or video.
"We're moving from a world in which carriers charge for how long someone is on the phone and how far the call travels," he said. "We're moving to a world of bandwidth and services."
Within the telephone industry, even within individual companies, opinions are mixed on how fully and how soon Internet-based technology will arrive. Mr. Rabe, the Verizon spokesman, said the company already conducted a significant amount of business with Cisco and was generally interested in increasing its ties to Silicon Valley companies and their new technologies.
But a Verizon manager, speaking on condition of anonymity, said Cisco had "angered a lot of people by promoting the advantage of I.P., but not always acknowledging that it is expensive to deploy" and not always as reliable for voice traffic as conventional network technology.
"We get up in the morning knowing we have to move 1.5 billion phone calls on our network everyday," the manager said, "and there's no guarantee we can do it reliably with I.P. technology."
"We just can't roll out the technology because it's neat," he said.
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