Why I own CSCO,too...................King of the jungle
By Lisa DiCarlo
02/19/99 05:09:00 PM
Cisco's grip on the networking market
keeps prices high, rivals out
In a 20th-floor hotel boardroom overlooking San Jose, Calif., top
executives at Alteon Networks Inc. are huddled in an all-day strategy
session. A key discussion topic: staying out of Cisco Systems Inc.'s way.
The 3-year-old networking startup doesn't even compete head-on with
Cisco. So why do its executives fear being steamrolled?
"Because Cisco is the IBM of the current decade," said Dominic Orr,
Alteon's CEO. "Even if Cisco has an inferior solution, customers
perceive them as less risky, and [Cisco] is adamant about [maintaining]
architectural control."
Such is the current state of affairs in the data networking business.
Since installing its first routers in customer sites in the mid-1980s,
Cisco has risen to a dominance rivaled only by Microsoft Corp. and Intel
Corp. among computing powerhouses.
Thanks to a combination of proprietary technologies, savvy marketing
and what one analyst describes as an "insane" focus on its customers,
the San Jose company has assumed the 800-pound gorilla role in the
market for routers and switches, which help form the backbone of the
Internet.
"Without Cisco, there would be no Internet," said Stephen Koffler, an
analyst with New York-based Donaldson, Lufkin & Jenrette Inc.
Pricing at a premium
By leveraging its proprietary IOS (Internetwork Operating System)
software and related protocols that run on its networking hardware,
Cisco has created a de facto industry standard for networking. But
there's a flip side: Customers are effectively locked into Cisco's
architecture and, as a result, must pay premium prices for Cisco's
products--in some cases, double what competitors ask. Those
premiums keep Cisco's revenues humming along, with margins at a
robust 65 percent. Many customers, fearing incompatibility issues, won't
even consider rival products.
"In the Internet space, we're forced to use [Cisco] technology to maintain
compatibility [with customers] because everyone else is using Cisco,"
said Tony Zies, vice president of network services at Concentric Network
Corp., in Cupertino, Calif. "The reliance we must have on Cisco
ultimately forces us to pay a premium."
That premium could show up in new areas as Cisco aggressively
expands its business. Last week, the company announced an alliance
with leading electronic commerce vendors to offer customers Internet
commerce consulting and solutions. It's planning similar programs in
areas such as supply chain management and customer care.
Its primary sights, however, are set on conquering networking's new
frontier: voice/data/video convergence.
There, the $8.5 billion company is butting heads with much larger
competitors--Lucent Technologies Inc., with $30 billion in revenues and
in the midst of acquiring data networking vendor Ascend
Communications Inc.; and Nortel Networks, a $15 billion
telecommunications equipment provider that recently purchased Bay
Networks Inc.
Eye on convergence
But Cisco has what its larger rivals do not: leverage, in the form of its
IOS software and the lion's share of the market for IP-based equipment.
Just as it used IOS and its proprietary networking protocols to sew up
ownership of the corporate router market, so it hopes to lock in ISPs
(Internet service providers) and telecommunications companies.
It's off to an impressive start. Eighteen months ago, Cisco launched the
CPN (Cisco Powered Network) logo program, a variation on Microsoft's
Designed For Windows and Intel's Intel Inside programs.
Qualified partners receive access to Cisco's customer list and an early
peek at product information, among other perks. Service providers also
get to display a "Cisco Powered Network" logo on their Web sites and in
advertisements.
The number of partners has swelled to 127, including big-name service
providers Bell Atlantic Corp., Digex, GTE Internetworking and US West
Communications Inc.
But there's a catch: An eye-popping 85 percent of an ISP's networking
gear must be supplied by Cisco to qualify for the program. To ensure
compliance, Cisco does an extensive, on-site audit of the service
provider's network before granting admission.
Those deals ensure millions of dollars in guaranteed sales for
Cisco--while keeping rival equipment makers on the outside looking in.
Access to Cisco's channel partners and its list of enterprise customers
is a major incentive for ISPs to switch to Cisco equipment.
As a result, the CPN program has become a wedge for Cisco to cut into
its rivals' customer base of service providers, claims Kurt Bauer, vice
president of product marketing for Ascend's switching division, in San
Jose.
Cisco officials maintain that the CPN program is designed more as a
"Good Housekeeping" seal of approval than as a sales tool.
"We're not telling them to swap out Lucent or Ascend [equipment]," said
Kevin Outcalt, Cisco's senior director of service provider marketing. "It
started when ISPs asked us if there was any way they [could]
communicate to their customers that they should select them, and it's
evolved to [become] more of an identity card for service providers."
Key to success
Much of Cisco's success lies with IOS. Developed by Cisco's
co-founders simply because no other software was available to run on
the router they invented, IOS has become a launching pad for Cisco to
enter new markets. It's a key part of Cisco's growth strategy: Buy smaller
companies developing innovative products, take their technology and
build it into IOS, with which most network administrators are already
familiar.
"[IOS] is the most leveraged piece of software in the industry next to
Windows," said Esmeralda Silva, an analyst at International Data Corp.,
in Framingham, Mass.
Competitors certainly agree with that assessment. "It's an easy way [for
Cisco] to maintain profits and market share," said Tony Clark, vice
president of strategic planning at Nortel, in Santa Clara, Calif. "IOS can't
be in the best interest of customers."
Cisco executives acknowledge that IOS, because of its widespread use,
gives the company a big advantage when moving into new markets.
"IOS' overriding benefit is that it provides a common set of services and
has a common look and feel [across a lot of Cisco products]," said Peter
Alexander, vice president of marketing for Cisco's enterprise products.
"There are times when that adds value and times when it doesn't."
As it attempts to expand its dominance in the era of convergence,
Cisco's next challenge will be to extend IOS to seamlessly
accommodate voice as well as data.
Today, Cisco licenses bits and pieces of IOS to partners, providing
some level of interoperability. But Cisco has no plans to broadly license
IOS for third-party development.
And although it has turned over portions of its technology to standards
groups such as the Internet Engineering Task Force, rivals charge that
Cisco deflates those efforts by casting doubt on the compatibility of
third-party products based on those standards.
"They create FUD [fear, uncertainty and doubt] by telling customers they
can't guarantee the reliability of the standard if it's not running on Cisco
hardware," said an executive at a Cisco competitor who requested
anonymity.
Cisco officials deny the charge, saying their strategy is to introduce
technologies into the marketplace and, after gaining enough
acceptance, bring some of them to the IETF for standards approval.
FTC investigation
In many ways, Cisco's success mimics that of the Wintel duopoly. But
while Microsoft and Intel have come under intense antitrust scrutiny,
Cisco's business practices have gone virtually unnoticed by government
watchdogs, with one exception.
In October, Cisco disclosed that the Federal Trade Commission was
investigating talks that Cisco initiated separately with Nortel and Lucent
in 1997. The investigation involves whether those talks were legitimate
offers of partnership or a proposal to illegally divide the networking
market. The discussions, according to one source, involved Lucent and
Nortel focusing on PBX-based equipment while staying out of Cisco's
data networking back yard.
After the talks ended without the sides making a deal, Cisco bought
Selsius Systems Inc., a small maker of PBX-based gear, for $155
million. Lucent and Nortel are now entering the data communications
market through their respective acquisitions of Ascend and Bay.
The FTC has requested information from Lucent, Cisco and Nortel
regarding those meetings. Although still ongoing, the investigation does
not appear to be a high priority among FTC brass.
"It is not front and center in my awareness," said Willard Tom, deputy
director of the FTC's antitrust division, in Washington. "If we were about
to sue, then I think I would know about it."
An FTC spokeswoman declined to comment further.
Not 'held hostage'
How has Cisco managed to escape the government's increasing focus
on high-tech? One main reason may be that customers rarely complain
about the company's pricing, products or services.
"I don't feel like I'm being held hostage," said Dave Berkshire, vice
president of IT at Magnet Interactive Communications LLC, also in
Washington.
When Magnet Interactive was looking to buy new switches last year,
Cisco's bid was about $20,000 higher than 3Com Corp.'s. Magnet
executives complained about the price difference, but Cisco didn't lower
its bid. Instead, it sweetened the deal with training and Gigabit Ethernet
interfaces--and won the sale.
Cisco's attention to detail also helps keep customers in the fold.
"Cisco has spent a lot of time understanding how we work as a service
provider," said Marty Kaplan, senior vice president and chief technology
officer at Sprint Corp., in Kansas City, Mo. Sprint is working with Cisco
and Bellcore to develop Sprint's next-generation Integrated On-Demand
Network.
Some IT managers simply shrug off Cisco's control of the networking
market. "Once you get the foothold, you have the power to set pricing. I
really don't see a problem with it," said Drew Spesard, senior network
consultant at Internetwork Experts Inc., in Dallas.
Some rivals, not surprisingly, see that attitude as a major problem in
terms of maintaining a competitive landscape. Cisco, analysts say,
wields such enormous clout that some new networking markets, such
as Layer 3 switching, are not considered legitimate until Cisco commits
to them.
"Having proprietary control over an architecture in the heart of a tornado
market represents the acme of gorilla power ... and Cisco has it," said
Geoffrey Moore, chairman of The Chasm Group, in San Mateo, Calif.,
and a partner at Mohr Davidow Venture Partners, in Menlo Park, Calif.
Cisco executives dispute suggestions that the company has a
monopoly in any segment of the networking market. "It's factually not
correct," Alexander said. "Our [products] may be the most common
implementation, [but] there are many startups. It's not impossible to join
our market."
Joining Cisco's market is not the concern of Alteon. Staying alive is. In
April, the company plans to release its flagship product, software
code-named Genie that improves the performance of Cisco Catalyst
5000 switches by providing load balancing, data caching, firewall and
bandwidth management capabilities.
During their strategy session in San Jose, Alteon executives took great
pains to position Genie as a complement to Cisco's switches. The
company is so cautious about being perceived as a direct threat to
Cisco that Vice President of Business Development Bart Burstein
objects whenever someone uses the word "infrastructure" during the
meeting to describe the company's Internet agenda.
"We have to make an effort to stay out of Cisco's way," said Burstein,
"because they own the architecture."
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