Countdown To Impact -- Cisco faces the fight of its life against Lucent, as datacom
and telecom collide.
Sep. 25, 1998 (VARBusiness - CMP via COMTEX) -- Lead or follow? That is the dilemma facing Cisco
Systems Inc. as it enters the next millennium. Will the $9 billion networking stalwart lead or follow the
market into the next century? For Cisco and its VARs, "following" is not an acceptable option. Not when
Cisco is hearing Lucent Technologies Inc.'s very loud footsteps and its even louder voice.
Lucent's stated goal is to dominate the market for communications technologies in what its chairman,
Richard McGinn, calls the "ongoing communications revolution." Lucent is also beginning to nibble at one of
Cisco's core strengths-its channel. Last month, Lucent's Business Communications Systems division
debuted its aggressive BusinessPartner program, which it hopes will increase its 1,000-member authorized
partner network by at least 40 percent this year.
Things might have been different.
When discussions between Cisco's and Lucent's top executives on the issue of a potential alliance fell apart in the fall of 1997, the
die was cast.
The relationship between the two companies degenerated into a verbal brawl, with each company calling the other purveyors of "Old
World" technology-fighting words in the singular world of networking.
Cisco, a San Jose-based company that has enjoyed something of a magic carpet ride through the world of data networking, was
about to face some turbulence.
For the first time in its storied existence, Cisco was about to play on the other guy's turf, and it was not the prohibitive favorite to walk
away the victor. For the first time, Cisco would face a competitor that was not only three times its size, but had deeper roots in the
voice half of the converging worlds of voice and data.
Executives from both companies say that the relationship broke down because of a clash between the two companies' divergent
cultures. The most important element is how well the cultures of partners fit together.
"In the case of Lucent, we were unable to find a match, with the cultures of both companies proving to be the largest challenge," says
John Chambers, president and chief executive of Cisco. Analysts believe that the chemistry between Cisco and Lucent, based in
Murray Hill, N.J., is fundamentally bad. It would also be difficult for two companies that large to carve out an agreement without
running into potentially explosive collusive or restraint-of-trade implications.
Fast-forward to today. The face-off between Cisco and Lucent is about to begin in earnest. On Oct. 1, Lucent's SEC-imposed asset
pooling restriction will be lifted, which means the company will be able to pursue large acquisitions with unfettered zeal. Not that
Lucent has been sitting on its wallet. The company has made roughly a dozen "smaller" acquisitions worth some $3.5 billion during
the past two years, but it had to pay mostly cash. Now that the restriction has been lifted, Lucent can pursue bigger game through
multiple purchasing instruments, including stock swaps. The smart money seems to be on Lucent buying either Ascend
Communications Inc. or Newbridge Networks Corp., although there have been more than a few rumors that Lucent will opt for one of
Cisco's data networking competitors such as 3Com Corp. or Cabletron Systems.
"The only smart play for Lucent is Ascend or Newbridge. Newbridge isn't buyable, so I think it will be Ascend. Lucent does not want to
validate Cisco's incumbency by buying one of its competitors," says Tom Nolle, president of CIMI Corp., a Voorhees, N.J., technology
assessment firm, who counts both Cisco and Lucent among his clients. "It doesn't want to send the same message to the market that
Nortel did, that a voice player needs a data player. If Lucent could acquire one of those companies, then Lucent will be an
incumbent in every one of the networks Cisco will have to get into at the data level."
With its recent acquisition of Bay Networks Inc., Northern Telecom, one of Cisco's and Lucent's major competitors, has inserted itself in
what is shaping up to be a race for supremacy in the crucial world of voice/data communications.
While Lucent may be loath to validate Cisco's positioning with the purchase of a major data networking player, it has certainly made
incremental steps in that direction with its acquisitions of Prominet Corp., and LANnet. Prominet is a Marlborough, Mass.-based
gigabit Ethernet start-up that Lucent bought for approximately $200 million worth of its stock last December. LANnet is a Tel Aviv,
Israel-based manufacturer of Ethernet and Asynchronous Transfer Mode (ATM) switching solutions for local area networks that Lucent
purchased in July for $117 million in cash.
Both purchases help validate Cisco's strength in the data networking world. But Lucent also acquired Yurie Systems Inc., a
manufacturer of ATM access equipment for roughly $1 billion in cash, and Livingston Enterprises Inc., a vendor of remote access
networking solutions, for some $650 million worth of Lucent stock.
"The acquisitions, up to now, amount to little more than posturing by Lucent and Nortel, because Cisco still has a captive audience
among the large end-user buyers," says Tom Moylan, director of northeast sales for Solunet Inc., a Palm Bay, Fla., VAR that resells
both Cisco and Lucent equipment. "Internet service providers and much of the Fortune 500 are going to look at Cisco's solutions first,
because it integrates into what they already have. At this stage, it's Cisco's market to lose." Solunet is a 5-year-old integrator of WAN
and customer premise communications equipment that does roughly a quarter of its $100 million business with Cisco. A long-time
Livingston reseller, Solunet has now been acquired into the Lucent family. The company now does about the same portion of its
business with Lucent as it does with Cisco.
High Stakes
The global market for communications systems and technologies is enormous and growing at an explosive pace. It's expected to rise
from $230 billion in 1996 to $575 billion in 2000. But the market is as confusing as it is large. There are multiple overlapping trends
and regulatory issues that conspire to confound industry observers, analysts and manufacturers.
There are at least four major markets within the larger communications market: The carrier market, made up of local exchange
carriers (LECs), inter exchange carriers (IXCs) and a host of large and small independent competitors of each group; the rapidly
growing but tenuous ISP market; the extremely lucrative enterprise buyer or large customer market; and the growing small and
midsize business-user market.
Cisco, Lucent and Nortel have varying degrees of strength and weaknesses in each market. Cisco is strong in the world of private data
networking, particularly among enterprise customers. Through its VARs, its strength in the small and midsize business data networking
market is also formidable. Lucent is particularly strong in the carrier equipment market, an area, analysts say, where Cisco is
comparatively weak. Lucent's profile in the channel is limited to VARs and distributors it acquired through its purchase of Livingston
and other companies. With its purchase of Bay Networks, Nortel is a player in both the carrier equipment and enterprise data
networking market. It also now owns Bay's versatile channel.
This state of affairs leaves analysts in a bit of a quandary in their attempts to frame the contest.
"Lucent is taking its same service model and looking to extend it into the data space. Cisco is taking its products and introducing it
into the service space, so each is breaking new ground," says CIMI's Nolle. "The question is: will Cisco find it easier to sell routing to a
service provider, or will service providers buy a carrier class solution from someone they already know, such as Lucent? Is the
absorption of Bay by Nortel going to be as convulsive as the SynOptics/Wellfleet merger was?"
IP vs. ATM
Complicating any cogent analysis of the market are the large sea changes now under way. Will the market accept routing as its
communications technology choice in the face of the emergence of ATM? Will large end users turn to the public network in favor of
the private networks they have constructed from leased carrier services?
Many analysts are framing the great Cisco versus Lucent war in terms of an IP versus ATM challenge. But ATM's very slow emergence
does not hold much promise that this will be the featured battleground for Cisco and Lucent. Will the cost of nurturing the eclectic
skills necessary to maintain a private network drive large end users back to the public network? And how will that transition affect the
combatants and the channel, which will deliver a significant percentage of the solutions?
"I believe that there will be a move to the public network, but that does not necessarily mean Lucent and Nortel will gain a lasting
advantage on Cisco. Cisco has a lot of money, and in this time of consolidation, it would not hesitate to buy what it needs to remain
dominant," says Solunet's Moylan. "They are all making acquisitions that make them look more and more like each other. I think
Cisco has the inside track because it has a captive audience among large corporations."
While Cisco executives agree with Moylan's opinion, they downplay Lucent's competitiveness in the current market. "Lucent was
essentially a single-customer company. AT&T was its sole customer. It does not have the distribution channels, the customer-premise
product portfolio or the channels associated with distribution of customer-premise equipment, " says Kevin Kennedy, Cisco's vice
president, service provider line of business, who spent 17 years at Bell Laboratories and Lucent. "From a revenue concentration point,
Lucent is heavily North America. From a product point of view, Lucent is Old World. We're trying to open up the technology while
Lucent has billions of dollars worth of its revenue stream that it has to protect and transition."
Cisco's recent acquisition of Summa Four, a Manchester, N.H., manufacturer of programmable switches, lends credence to Moylan's
assertions. It also provides Cisco credibility and an entree into the Class 5 market.
Summa Four switches are designed to allow Cisco to offer value-added telephony applications to carriers and to extend the latter's
services across a voice-over-IP infrastructure. The Summa Four acquisition provides an important indication as to Cisco's direction in
this confusing market, VARs say. Cisco is both shoring up its conversion portfolio and sending a signal to the industry that it is not
about to abdicate whatever position it now holds in the carrier equipment market.
Those moves are being well received by LAN/WAN VARs such as Williams Communications Solutions. "There is no clear leader in
this convergence market, but I think Cisco, with its strong talent for distribution, will compete with Nortel for leadership," says Paul
Mardirosian, vice president of data networking for Williams Communications, Marlborough, Mass. "Lucent will be No. 3-unless it
makes a pretty large acquisition."
Cisco's Legacy
Cisco thrived in a world it helped create: a world of large private networks where big companies built communications infrastructures
from leased services and intelligent customer premise equipment. In the private network business, Cisco is undoubtedly the path of
least resistance. Cisco has also had some success among carriers. That success is grudgingly acknowledged among carrier equipment
manufacturers of all sizes.
"Cisco has been successful selling to AT&T and Sprint. Cisco is the incumbent there and in this business, incumbents are really hard
to unseat," says Paul Strudwick, vice president of strategic planning at Larscom Inc., a Milpitas, Calif., WAN equipment manufacturer.
At $9 billion, and with a business and technology culture renowned for its aggressiveness, Cisco has always been the 800-pound
gorilla in the data networking world. The company literally invented its own market and assembled one of Silicon Valley's most
efficient sales forces to sell its routers into the emerging enterprise network.
From the start, Cisco was a sales machine, able to sell a networking box roughly the size of a VCR for the price of a Jaguar. And,
while its competitors' fortunes ebbed and flowed with the constant cycles of innovation, Cisco's business acumen, its innovation and
just plain old serendipity kept it above the fray. While its data networking competitors 3Com, Bay Networks and Cabletron stumbled
into commodity markets, Cisco was able to maintain relatively high margins as it played in the corporate backbone and on the
periphery of the LAN.
With the margins on LAN products heading inexorably downward, Cisco can't afford to lose its WAN momentum. Cisco executives
agree that the WAN market is the only arena with margins high enough to sustain its phenomenal rate of growth. But this leaves Cisco
with a classic communications/computer market dilemma.
On the one hand, market forces are driving Cisco deeper into the arms of the carriers and other WAN service providers. On the other
hand, its WAN penetration threatens to defeat its own incumbency among enterprise customers: What happens if trends in the carrier
and service provider communities threaten Cisco's core moneymaker-the routed internetwork? When do you cannibalize your base in
favor of something new? Cisco, insiders say, is understandably reluctant to lead a paradigm shift from routing to switching, since such
a shift would devalue its core market.
One former Cisco executive, who requested anonymity, says Cisco's dilemma is exposing some of its internal divisions. "This is a hot
debate within Cisco. Cisco has multiple cultures within itself that don't agree with each other on the direction the customer should
take," he says. "Depending on which sales group is controlling the customer, you might get different advice as to which way the
customer should go. Cisco has never had to make gut-wrenching decisions like this one."
Both Cisco and Lucent have had tumultuous relationships with their channels. Cisco went from an all-direct sales company to one
that does a significant percentage of its business through the channel. That transition has been fraught with growing pains. That
transition has been documented in the VARBusiness Annual Report Card, which measures the channel's satisfaction, or lack thereof,
with its vendor partners. Cisco has made significant improvements in its still-rocky relationship with the channel. Cisco went from the
bottom of the ARC charts in 1996 to fifth place in 1997. This year, Cisco tied 3Com, a perennial powerhouse in the ARC, for third
place.
Lucent has had its own on-again, off-again relationship with the channel-going so far as to disenfranchise its VARs in the
voice-response arena when it decided to take certain portions of its business direct. That was in 1991 when Lucent was still AT&T, but
it's a legacy that VARs frequently point to when they discuss the relative strengths and weaknesses of both companies.
While both companies continue to woo the channel, neither has provided the channel with a coherent short- or long-term strategy.
The message coming from Cisco has been particularly unclear. When Cisco opens its Solunet partner conference in San Francisco on
Nov. 9, its VARs will be looking for a clear, coherent direction. Will networking VARs enter the next century as equipment and
solutions providers, or will they be taken out of the product loop by carriers? Will carriers supply intelligent services that require only
simple carrier-supplied user devices? Where will that leave VARs?
"We're in the process of making a transition to working with the customers of ISPs. Customers need to know how they are going to tie
their systems into the Internet. We're taking the focus away from the ISP [and putting it on] the customer," says Moylan. "We will work
with the ISP on equipment installation if that's what they want, but we're positioning ourselves. We will move to the next level. We
will help the customer and whether that will involve selling equipment, we don't know."
On Nov. 9, hundreds of Cisco VARs will be looking for the answers.
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Sidebar-
Battle of The Titans
CISCO SYSTEMS
1997 revenue:
$8.4 billion
Main products:
Routers, LAN and ATM switches, dial-up access servers, WAN switches and network management software
Key acquisitions:
Stratacom, Summa Four
Key executives:
John Chambers, president and CEO
Larry Carter, chief financial officer;
Judy Estrin, chief technology officer;
Gary Daichendt, senior vice president,
Worldwide Operations
Major alliances:
AT&T and US West
Relative strengths:
Marketing and distribution
Relative weaknesses:
Carrier relationships
Prospects:
Will maintain its top slot
LUCENT
1997 revenue:
$23.3 billion
Main products:
Switches, wireless solutions, access systems, telecom management and billing systems, call center solutions
Key acquisitions:
Prominet Corp, Yurie Systems
Key executives:
Richard McGinn, chairman and CEO
Donald Peterson, executive vice president, CFO
Daniel Stanzione, president and COO, Bell Laboratories
William O'Shea, group president, Business Communications Systems Group
Major alliances:
RBOCs
Relative strengths:
Carrier relationships
Relative weaknesses:
Marketing and distribution
Prospects:
Expected to be a key contender in communications market
---
Sidebar-
Lucent Plots Revolution In Murray Hill
It is media day at Lucent technologies Inc. Members of the press amble into the large billowing air-conditioned tent set up in the
parking lot of Lucent's headquarters in Murray Hill, N.J., a sleepy hamlet less than an hour from New York City.
The assembled press has one thing on its mind: "Who are you going to acquire?" asks one intrepid reporter. "Cisco," says the Lucent
executive as he hurries across the parking lot to the tent. "If you quote me, I'll deny I ever saw you," he adds in mock seriousness. "I
don't think the government will let you," the reporter persists. But the moment of levity is gone for the executive. He shifts quickly into
his Lucent-approved corporate demeanor and disappears into the air-conditioned tent.
The atmosphere inside the tent is almost festive, in a muted, professional way. It looks like a sampling of the convention floor at
Comdex. Lucent has scattered an interesting mix of its voice/data technologies around the floor.
It has been a hectic week for Lucent. The press and analyst communities have been bombarding its executives with questions
because the company is less than a week away from having Securities And Exchange Commission (SEC) restrictions removed from its
purse strings. On Oct. 1, it will be as free as its competitors to use any legal means necessary to acquire any technology and/or
company it pleases- within regulatory reason, of course. Lucent trotted out Dan Stanzione, its executive vice president and chief
operating officer and president of Bell Laboratories, and Carly Fiorina, president of its global service provider group, to field questions
about Lucent's immediate future. If Lucent had made any hard decisions about acquisitions, the press was not about to find out. What
we heard was more coy sparring from the two executives. This is a company on the verge of making a very loud noise that would be
heard across the country at Cisco's headquarters in San Jose.
"We have a lot of respect for Cisco because it is making us better," says Stanzione. "It has dominance in the data networking space,
and it is becoming more dominant. It is working to fill its gaps just as we are, and is acquiring more companies than us."
Fiorina is less cagey: "We have an advantage in data networking because we are not a defender. We're an attacker," she says. "We
think NICs, hubs and routers represent the Old World of data networking. We want to be in the data switching part of the market. We
represent a new approach."
The billowy tent will continue to see activity in the second week of Lucent's inflated Lucent Week-while the world awaits the
company's next move.-C.M
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