Amid Sluggish Growth, Ex Partners Become Rivals In Techno Turf War
As Originally Posted at The Wall Street Journal
With a big product launch Monday, Cisco Systems Inc. is propelling the technology industry into a new era: Giant companies that once prized profitable cooperation are invading each others' turfs.
Cisco announced it will start building its own servers, the powerful machines that run corporate computer colocation centers across the globe. Its "blade" server, which it designed and developed for two years under unusual secrecy, places it in direct competition with long-time partner Hewlett-Packard Co.
For years, Cisco enjoyed heady growth in its core business of making the switches and routers that allow computers to communicate with each other. Hewlett-Packard dominated the server market. The two cooperated with each other, as well as with the makers of storage devices and software, each providing complementary pieces of the data centers that make corporations and the Internet run.
But that has been changing in recent years. The maturing tech industry has set giant companies on a collision course, as once-disparate technologies take on new capabilities in a "convergence" of computers, software and networking. With the recession expected to shrink sales across the industry, tech companies are turning on each other in their search for growth.
Since Cisco's core networking markets began slowing in 2005, it has taken on the likes of H-P, Microsoft Corp. and International Business Machines Corp. It is also picking new fights as it expands into home electronics and entertainment systems for sports stadiums.
Cisco Chief Executive John Chambers says the company expects to deploy its hoard of cash during the economic downturn to expand further into areas where it hasn't historically competed. In February, the San Jose, Calif., company took on $4 billion in debt in part to add to its war chest for acquisitions. "The fact that we have $29.5 billion gives us a huge competitive advantage," Mr. Chambers said in an interview just before raising that capital. "Cash is king, queen and the royal family."
Cisco's new rivalry with H-P provides a particularly good window into the industry's latest offensives. As Cisco moves onto H-P's territory, H-P is stepping up its own investments in networking gear that competes with Cisco's.
Those outside Cisco say the move into servers could be difficult. "This is, by far, the riskiest, most bold move they [Cisco] have made in their history," says Zeus Kerravala, an analyst at tech research company Yankee Group.
Cisco's chief technology officer, Padmasree Warrior, says the company has moved boldly in the past, and suggests the old rules are changing. "We're going to compete with H-P. I don't want to sugarcoat that," she says. "There is bound to be change in the landscape of who you compete with and who you partner with."
Battles are breaking out across the industry. Within the past year or so, H-P has fueled a new rivalry with IBM in tech outsourcing by buying services giant Electronic Data Systems Inc. Microsoft set its sights on Internet-search giant Google Inc. by attempting to buy Yahoo Inc. Sun Microsystems Inc. is moving beyond its core market in servers and software to take on database-software leader Oracle Corp. Later this month, Dell Inc. says it plans to introduce new data-center management software that will compete with existing offerings by H-P, IBM and others.
Other growth industries have followed similar paths into maturity. General Motors Corp. expanded years ago into defense contracting, computer services and mortgages. Textile companies responded to slowing growth by expanding into chemicals.
In the past, when big tech companies made similar incursions into others' businesses, they often dismissed it as "co-opetition," meaning they planned to compete in some areas and cooperate in others. Brisk growth across tech markets meant that, even while these companies' products increasingly overlapped, there was more than enough profit to go around. But this downturn's severity heightens the impact of these clashes. World-wide tech spending is expected to decline in 2009 -- by as much as 3%, predicts forecaster Forrester Research.
"Tech companies can't continue to satisfy Wall Street's requirements for growth without encroaching into the markets of their long-time partners," says Joe Skorupa, an analyst at tech-research company Gartner Inc. "All of these guys are banging into one another trying to figure out where they are going to grow, and at whose expense."
Cisco's Shift
Cisco's case is remarkable for how dramatically the company has shifted its strategy since the turn of the decade.
Founded in 1984, Cisco undertook a high-profile expansion throughout the 1990s, its revenue growing from $69 million to $18.9 billion over the course of the decade. But even into the new millennium, the company remained focused on selling routers and switches to corporations.
In the past few years, the company's core networking business has grown more slowly than the company as a whole. In its 2008 fiscal year, which ended last July, Cisco's networking business grew 10%, down from 16% the year before.
Cisco has compensated by expanding into new areas. It is using its Linksys and Scientific Atlanta brands, which it acquired this decade, to get into people's homes with wireless networks and cable boxes. It is butting heads with Microsoft over a recent move into technology that unifies email, telephone and voicemail. It has started installing big-screen networks in sports stadiums. Cisco is also taking on physical security companies by pushing video-surveillance systems.
In January, the company introduced a line of wireless home speakers aimed at consumers, a move unimaginable a few years ago. "It's definitely intimidating," says Adam Castillo, a marketing director at Avid Technology Inc., which sells competing products through its M-Audio division. Mr. Castillo says that Cisco's overall size and manufacturing strength immediately make it a force in the segment.
Cisco's fiercest turf battle is over the data center, the giant computing rooms where companies store, process and route information. Businesses will spend about $100 billion on data-center software and hardware in 2009, research company IDC forecasts.
Data centers typically have been a cozy symbiosis of products from a mix of companies: Cisco networking gear runs alongside servers from H-P or IBM or Dell; software from Microsoft runs along with programs from BMC Software Inc. or VMware Inc. But as lines between software, hardware and network technologies have blurred in recent years, companies like Cisco see an opportunity to grab more data-center dollars.
That's a reversal from 2003, when a team at Cisco studied the market for servers to see if Cisco should make its own. The group concluded that the market was big -- around $50 billion a year. But Cisco decided not to develop a server, say people familiar with the discussions. Profit margins were low, the company decided. The cost of entry would be high, as the most successful server sellers have armies of consultants who help companies choose which equipment to buy.
Plus, setting up a server business would mean competing with IBM and H-P, two partners that were generating huge revenues for Cisco. Field consultants for the two tech giants were pitching not only IBM or H-P servers but also Cisco products -- sales that currently account for $2 billion a year, or 5% of Cisco's overall sales, according to Pacific Crest Securities Inc. H-P's then-CEO, Carly Fiorina, was a Cisco director.
The goal then was to not upset IBM or H-P, say people familiar with the decision.
H-P Moves In
Allegiances began to change in 2005, when Mark Hurd took over as H-P's chief executive. The Palo Alto, Calif., company had been making its own networking gear for more than 20 years, but its ambitions for the products had been modest. Mr. Hurd called attention to the networking products during a company meeting shortly after he was named CEO, says a person who attended -- a surprise because the unit had a low profile under Ms. Fiorina. Mr. Hurd pushed H-P further into the profitable networking-gear business, emphasizing H-P networking gear over Cisco's.
That year, H-P increased its investment in developing new networking products, says Marius Haas, who now heads the networking division. The company would also eventually increase the incentives for its sales force to sell H-P gear, rather than certain Cisco products.
By 2006, the amount of Cisco equipment sold by H-P and IBM was no longer growing at the same rate as Cisco's own sales, say people wi
th knowledge of those numbers.
Cisco laid the groundwork for a counterattack in August 2006, when it paid $50 million for a controlling stake in Nuova Systems Inc., a networking start-up. In early 2007, Mr. Chambers authorized Nuova to develop a Cisco-branded blade server, say people familiar with the matter. Nuova operated as an independent unit with its own offices, heightening the project's secrecy.
Blade servers, named for their slim vertical profile, are the fastest-growing part of the server market. H-P had 55% of the blade-server segment by revenue in the last quarter of 2008, according to research company IDC, followed by IBM with 22%. IBM declined to comment for this article.
Some Cisco executives still agreed with the 2003 analysis that favored partnerships, arguing that taking on H-P in servers was a bad business move. Big tech companies, says one person involved in the project, will often bump up against each other in overlapping projects, but will benefit from remaining cooperative on others. "There are always smoldering fires," this person says. "Deciding to build a server was deciding to pour gasoline on a smoldering fire."
Nonetheless, Cisco moved ahead. By fall 2007, the company was touting the server to customers, say people familiar with its sales presentations. But Cisco didn't tell H-P about the project, even though the two companies routinely had detailed sales discussions, say people familiar with the talks, and maintained an official strategic alliance that continues to exist.
Mr. Chambers kept a tight lid on the project. Ms. Warrior, Cisco's chief technology officer, met with the Nuova team in her first week with the company in March 2008. But she says she didn't learn of its server plans until the next month, when Cisco bought the rest of Nuova. H-P wasn't convinced that Cisco was planning to sell its own server until the second half of 2008, say people familiar with H-P's dealings with Cisco.
Ms. Warrior says the company's system isn't intended as a direct replacement for models from H-P and IBM. She says it is unlike others on the market because it combines server and network, eliminating the need for information-technology staff to integrate the components on their own. It also automates some functions that are currently separate.
To make up for its lack of an in-house consulting business, Cisco in February aligned itself with Accenture Ltd. and India-based Tata Consultancy Services Ltd. Both companies will establish practices to sell Cisco products to businesses.
H-P has stepped up its offensive. For the past several months, it has been trying to fill "holes in our portfolio" by increasing its networking offerings to many large corporate clients, says Mr. Haas, H-P's networking chief. Last fall, members of Mr. Haas's staff started calling smaller companies that sell networking products that compete with those made by Cisco. In the last few months of 2008, H-P struck deals with more than a dozen of them, packaging their products into a single piece of H-P networking gear.
The new product, which H-P rolled out in January, comes with free product updates -- a service Cisco customers need to pay for -- undercutting Cisco's prices, say analysts and companies that sell Cisco gear. Another consideration is he launch of server colocation managed services in key markets across the country. Some scenarios include:
and more.
The turf grabs have gained the attention of the independent consultants who assemble computer networks and data centers that include Cisco equipment. Some of these Cisco resellers spent half an hour at a recent meeting with Cisco executives, complaining that they were losing sales because they couldn't compete with H-P's offer of free support. Cisco's execs had no answer at the time, according to a person who attended the meeting. Another Cisco reseller said "my phone blew up" with calls from angry Cisco executives when he recently announced plans to sell H-P's networking gear as well.
Since then, Cisco has started offering 0% financing on some of its equipment. Overall, Cisco says, resellers account for 80% of its revenue. "Over the years, we've addressed numerous competitive challenges with our partners," says Keith Goodwin, a senior vice president. "Our track record of success speaks for itself."
