Networking equipment industry roiled
San Jose Mercury - Posted at 1:37 a.m. PDT Monday, June 15, 1998
Bay Networks Inc., which makes computer network hardware, rejects
a bid from Northern Telecom Inc., which makes telephone network
hardware and desperately wants to expand into Internet technology.
But rumors persist that the two companies are still talking.
Bay competitor Cisco Systems Inc. will buy about a dozen companies
next year, says chief executive John T. Chambers. Many of the
takeovers will be aimed at strengthening the company's ability to offer
products that move sound -- as well as data -- over computer networks.
The computer networking equipment industry -- where four Silicon
Valley companies alone employ 25,000 people, sell $15.3 billion in
products globally a year and dominate the business of tying computers
together -- is roiling with takeovers real and imagined.
Propelling the action that promises to reshape networking and
telecommunications is the concept of ''convergence.'' It's the idea that
one day every form of information -- data, voice and perhaps even
video -- will be distributed over a single system and maybe even a
single wire.
Traditional telephone companies -- the people who carry voice traffic --
are afraid that new competitors using Internet technologies from
companies such as Cisco in San Jose, 3Com Corp. and Bay in Santa
Clara and Ascend Communications in Alameda will offer voice service
more cheaply. Most phone companies are insisting that new equipment
be designed with Internet architecture in mind.
And that's causing the huge telephone network equipment
manufacturers like Nortel and Lucent Technologies Inc., who supply
systems to traditional telephone companies, either to develop such
technologies on their own or to try and buy them by taking over
computer networking companies.
''Everybody agrees data traffic is growing 10 times faster than voice
traffic,'' said David L. House, chief executive of Bay Networks. ''Data
networks are much more efficient at handling data than voice networks,
and data networks can handle voice as well.''
A new generation of telecommunications companies, such as Qwest
Communications Corp. of Denver, is building systems based on
Internet-related technologies instead of traditional telephone methods.
These new companies are not burdened by the need to jury-rig ways
for their systems to work with old-style networks. More established
telephone companies such as AT&T Corp., MCI Communications
Corp., and Sprint Corp., meanwhile, are terrified of adding to the
traditional technology in which they have already invested heavily but
which may soon be obsolete; most are trying to figure out a way to
build that uses Internet-related technologies to carry all traffic.
The Silicon Valley companies may well be the dominant force in
creating the technologies critical to making the vision of one unified
network come true. But the telephone network equipment makers
dwarf the computer networking equipment companies in terms of sales;
they've got huge cash flow, terrific distribution channels and long-term
relationships with buyers.
That means companies such as Bay, Cisco, 3Com and Ascend are
faced with a choice. They can hope to be bought out -- though all say
they don't like that option -- or they can keep developing products that
help integrate voice and data traffic, go head to head with the telephone
equipment manufacturers, and try to capture the market.
Everybody involved is trying to reposition him- or herself for an
all-or-nothing, one-system world. The enormous companies that make
and service equipment for telephone systems, such as Nortel, a
Canadian company with 73,000 employees and annual revenues of
$15.6 billion, and $28.2 billion-a-year Lucent, of Murray Hill, N.J., with
134,000 employees, are eyeing the much smaller companies that build
computer networking equipment.
Lucent, for example, has agreed to pay $1 billion in cash for Yurie
Systems Inc., a Lanham, Md., company whose products make it easier
to send data and video over the Internet. Analysts say Lucent paid a 20
percent premium.
Such free spending has added to rumors that the smaller Silicon Valley
networking companies such as Bay and Ascend are acquisition targets.
Any acquisition will be expensive. Cisco's stock price gives it a market
capitalization of $82 billion; Ascend's is $9.5 billion; 3Com's is $8.5
billion and Bay's is $6.3 billion. But analysts say the traditional voice
vendors have no choice but to pay the premium.
''They came late to the game,'' said Abner Germanow, a research
analyst for International Data Corp., a research company in
Framingham, Mass. ''That means it's going to cost more for them to get
in. But they're worried that if they don't get in soon, the upstart
companies -- Bay, Ascend, Cisco -- will wind up the winners.''
John Roth, chief executive of Nortel, acknowledged as much at a
recent trade show in Atlanta, saying, ''Our whole drive is to become a
stronger player in (Internet) networks.''
The key to convergence will be the development of systems that allow
telephone traffic to run reliably on Internet technologies, expected
eventually to emerge as the common standard. Many analysts say there
won't be significant voice traffic on an Internet-style network -- with
significant being defined as 15 percent or more -- for at least four
years.
That's because a lot of technical problems must be worked out before
voice traffic can run on the Internet.
Internet technologies take information and chop it up into smaller units
known as ''packets.'' Each packet has the address of the ultimate
destination of the original message attached to it. When you send
electronic mail, for instance, the message is converted into packets,
which are then deposited on the Internet. The packets zip along to the
final destination through the switches and routers made by companies
like Cisco and Bay, where they're reconstituted into the original
message.
But all the packets may not arrive at the final destination at the same
time. That's not a problem for e-mail, but it's a huge issue for something
like a telephone conversation, where delayed packets can reduce the
sound quality to that of talking underwater. The issue becomes
especially troublesome when the network is particularly congested.
Although companies have had reasonable success building functional
private voice networks based on Internet technologies, it's going to be a
long time before the technologies exist to make the public Internet
robust enough to carry the world's voice traffic, much less ''Baywatch''
reruns. Nonetheless, the Internet model is attractive because, in the
future, most of the information transmitted on the telephone system will
be data rather than voice, and it's most efficient to configure your
system to best suit the majority of traffic.
Researchers believe they'll be able to solve the problem of voice quality
relatively soon, creating one system to handle all kinds of traffic.
For now, most companies are forming cooperative arrangements to
help them break into an unfamiliar market, each using the other's
business relationships or technical expertise in uneasy alliances against
competitors, to sell more product. Ascend, for example, has is working
with Lucent, while 3Com is working with Germany's Siemens AG,
which dominates much of the telecommunications market outside the
United States.
There are hazards in such an approach. ''I think there's certainly an
opportunity for conflict,'' acknowledged Kurt Bauer, Ascend's vice
president of access product management. ''But the critical conflict will
be a few years out.''
3Com is attempting to improve its hand by altering its management; the
company is looking for a new chief operating officer to take over some
key duties from Eric Benhamou, but the company insists he'll stay on as
president and CEO.
Cisco has an advantage over the other competitors in that its high stock
price -- providing a market capitalization of $82 billion -- makes it too
costly for many would-be suitors.
Bay executives, in contrast, have had to deal with the nuts and bolts of
takeover proposals for some time. ''It's flattering on one hand, but it's
very distracting on the other,'' said House.
Chambers acknowledged that he believes his company's strongest
competition will come from today's telephone network equipment
manufacturers like Lucent and Nortel, especially if they manage to
acquire a company like Bay.
But Chambers said his company will fight to hold its leadership role.
Chambers didn't hesitate when asked whether he'd consider buying
Bay, for instance, to keep it from falling into the hands of a company he
considers more of a threat, like Lucent.
''No. I'm not going to play defense,'' he said.
Wait 'till next year!
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