Nortel certainly wears its desperation on its sleeve.
Dow Jones Newswires -- March 15, 1999
WSJE: Convergence -- Spring 1999: Too Big, Too Slow?
By William Boston in Bonn
Staff Reporter
Size isn't everything in technology markets. Take Siemens AG. The German industrial king - along with other telecommunications suppliers - basically missed the networking revolution as Cisco Systems Inc. and Ascend Communications Inc. started grabbing headlines and market share about 13 years ago. "We clearly underestimated the market for data communications - and by we I mean us, the Lucents, Alcatels, Ericssons, everybody," says Volker Jung, the Siemens board member responsible for information technology and networking. "We always saw it as a niche market..."
Sound familiar? The story is reminiscent of how Microsoft Corp., while enjoying dominance in personal-computer software, slept as upstart Netscape Communications Corp. in 1994 launched its Web browser - the event many industry insiders agree marks the beginning of the Internet Age. Though Microsoft has since fought back, the event made it appear vulnerable for the first time.
Similarly, Cisco makes Siemens and other telecom suppliers look vulnerable. To understand the significance of that feat, consider this: One in ten phone calls around the globe is switched by Siemens equipment; for GSM digital cellular networks, its one in three. But when it came to the upheaval in the data-communications business - which includes everything from faxes and electronic mail to video conferences and downloading computer programs over the Internet - its size probably hobbled the company. Although it and other venerable telecom suppliers were too slow to get in, they are fighting back now; some have made splashy acquisitions, others focused on buying small and forming alliances. As they scramble to avoid becoming the ancien regime, there's one key question: How much will it take to get in the game?
"(They're) used to product cycles of around seven years, not six months like in the Internet world," says Pim Bilderbeek of consultancy International Data Corp. "Cisco's always worked in an environment where product cycles are just six months. That's why I'm a little bit concerned about the Siemens, Alcatels and Ericssons of this world. They have a big customer base, but they have to move faster."
Until just a few years ago, data networking was done by corporations in their own internal networks, working together with equipment makers like Cisco, Ascend and 3Com Corp. - not telephone companies. But that all began to change when the Internet burst out of its corporate and academic enclave and entered the business and consumer world in the early 1990s: The Net became the data network.
"It evolved from the local-area-network world that was being developed by companies, and the phone companies didn't really know what was going on," said Mr. Bilderbeek. "As soon as people saw that the Internet was becoming very large, the companies associated with it - the Ciscos, Ascends and the others - saw the opportunity."
Telecoms entered the fray around 1994. Now, they face competition on their traditional turf. Since telecom liberalization unfolded across the European Union last year, some Internet service providers have moved to offer basic phone services over their networks. Less than 20% of European ISPs plan to offer phone services this year, but that portion is expected to rise above 30% next year, says Mr. Bilderbeek.
Naturally, these changes affect the traditional telephone suppliers: In response, they have made a nervous push for alliances and acquisitions in data networking. Siemens, for instance, formed an alliance with Newbridge Networks Corp. in 1996, its first move to get back into the data market. A year later, it formed a second alliance, this one with 3Com and Newbridge. At the end of last year, Siemens and 3Com formed a joint venture in the U.S. to develop and manufacture products that allow companies to handle basic phone calls and data transmission over a single network. In early March, Siemens planned to buy Argon Networks Inc. of the U.S. for $240 million and was in talks to acquire Castle Networks Inc. for about $300 million, people close to the company say.
Last summer, Telefon AB L.M. Ericsson was courting its long-term cooperation partner Bay Networks Inc. But Ericsson - with Chief Executive Sven-Christer Nilsson complaining of "overpriced and overrated IT companies" - said it was interested in just part of Bay. (Enterprise networks made up 70% of Bay's work, and Ericsson wasn't interested in it.) Talks with Bay collapsed and Northern Telecom Ltd. of Canada swooped in and bought the data-network company for $9 billion last year.
Lucent Technologies Inc., meanwhile, stunned the industry on Jan. 13 when it agreed to pay $20 billion for Ascend Communications. The price is nearly 20 times Ascend's annual sales, which totaled $1.2 billion in 1997. Founded in 1989, Ascend is the leading maker of Internet access equipment.
The deal-making didn't end there. In early March, Alcatel SA agreed to buy Xylan Corp., a U.S. Internet equipment maker, for about $2 billion.
The flurry of deals is aimed at battling the agile knight that grew into a new-tech monarch. Cisco, based in San Jose, California, went from sales of $69 million in 1990 to $10 billion last year. This company - which ranks as the third largest company on the Nasdaq market, in terms of capitalization - controls two-thirds of the market for the basic gear that directs traffic on the Internet and is poised to play a key role in setting the technical standards for new developments. "We have never been better positioned to lead in the Internet economy," boasts John Chambers, Cisco's president and chief executive officer, during a conference call with journalists.
The data-communications business that Cisco dominates is poised for phenomenal growth. In the U.S., telephone companies now carry greater volumes of data than basic phone calls. The same is true for trans-Atlantic networks, the busiest route in the global phone business. "By 2003, data-traffic volume in the world will be 23 times larger than voice traffic," says Tom Wyrick, vice president of data services at Global One, the international business-communications venture owned by Deutsche Telekom AG, France Telecom SA and Sprint Corp. Global One's sales from data transmission surged between 120% and 180% last year.
That shift raises the question of whether a company like Cisco isn't better positioned than, say, Siemens, to create so-called New World networks. Both data and voice traffic will flow over these networks, powered by the hubs and routers on the Internet rather than traditional telephone switches. Home-market clients of Siemens and Alcatel already have turned to Cisco for Internet products: Deutsche Telekom says it mainly uses Cisco and Ascend equipment for the IP portion of its network; France Telecom recently ordered next-generation routers from Cisco.
The traditional vendors have played different hands in trying to improve their odds. Lucent and Nortel took the quick route and bought data-networking companies, giving them instant market share while taking on the costs and complexities of a takeover. Siemens, meanwhile, appears to be following a strategy of small, strategic acquisitions. Commenting on the Lucent and Nortel megadeals, Mr. Jung says: "Our shareholders would never go along with something like that." Instead, Siemens will buy smaller companies that can fill in its gaps. "We'll have to invest quite a bit," he adds, declining to give a ballpark figure. "Our weakness is in routers and we will do something in this area and in the area of Internet access."
Merrill Lynch's Mr. Barton sees some danger in Siemens' strategy. Traditional telecom vendors, he argues, will have to take the plunge and buy their way into the core IP technologies - if they don't develop them in-house. "Partnerships work well if the equipment is peripheral," he says. "But we're moving to a situation where data carriage is so important that it's critical to carriers and therefore we feel it's necessary to own it."
Cisco, meanwhile, is eyeing an alliance of its own. Theo Wegbrans, Cisco vice president in charge of Northern European operations, says in an interview that he has been courting Ericsson for a potential partnership that would combine Ericsson's strengths with the phone companies and in wireless networking with Cisco's might in data networks. "We've been having ongoing talks with Ericsson for some time," he said. "When we look at the marketplace we see that companies like Lucent and Nortel have declared war on Cisco, so we and Ericsson share a common enemy."
The battleground has moved from the perimeter to the very heart of the enterprise-communication system, which the phone companies see as their core business. "Now it's the PTTs, the traditional phone companies who are spending more money on these New World networks," said Mr. Bilderbeek of IDC. "The battle is going to be fought in the networks that the PTTs and the service providers are building."
Consider the case of Telia AB. In February, the Swedish phone company tapped Cisco to build a national communications backbone network based on Internet technology. This, of course, is happening in Ericsson's backyard. "This shows that we are now moving out of the traditional $25 billion data-networking market into the $200 billion telecoms market," says Mr. Wegbrans. "That's where the people like Nortel, Lucent and Ericsson operate. Telia is Ericsson's largest data-networking customer. But Telia bypassed Ericsson and chose us."
Cisco has had other breaks. Swisscom AG enlisted Cisco to build a similar network, as have Qwest Communications International Inc., Sprint Corp. and Internet service provider VoiceNet in the U.S.
Neil Barton, technology analyst at Merrill Lynch in London, expects conventional phone networks to be overtaken by Internet-based systems. "We think carriers will have to go to the next step and fully implement IP in their backbone networks. Many in the U.S. have decided that the case has been made, but it's a different story in Europe. British Telecommunications has, KPN in the Netherlands or Sweden's Telia have been convinced, but the majority has not," he says.
Some improvements will have to be made, though. The data networks weren't made for carrying real-time traffic like a telephone conversation. As a result, when voice is packaged into bits and sent over the Internet, there are small delays that diminish transmission quality. New developments in the Internet protocol are expected to smooth out some of the wrinkles.
As carriers adopt IP networks, some of the traditional suppliers will probably make a successful transition. "The market is not such that it will develop over the next five years and if you're not there you'll be behind," says Stewart Anderton, manager of the networks and infrastructure group at Ovum. "You still have to be making the right decisions in the future. The large vendors - maybe not all of them - should have opportunity."
So far, though, the data- and voice-network suppliers are heavily North American: Cisco, Lucent (fortified by Ascend) and Nortel (bolstered by Bay). Apart from the partially European alliance of Siemens, 3Com and Newbridge, there's Alcatel of France in the field. The Nordic wireless giants Nokia Corp. and Ericsson are conspicuously absent, both having said they plan to develop wireless data-networking products.
"Lucent and Nortel are the best positioned - Nortel for acting swiftly and acquiring Bay Networks," says IDC's Mr. Bilderbeek. "Siemens has very little revenue in data networks right now."
Siemens, however, doesn't sound worried about its legacy. "I don't see that danger at all because it's not that easy to transmit voice over IP networks," says Mr. Jung. "These newcomers that have been addressing data traffic have underestimated the difficulty of voice."
That may well be a dangerous short-term view. n
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