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Cisco's prime position in IP networking

Technology bets the company made several years ago may help it stay on top as the telecom equipment market consolidates.

Early investment in new technologies and markets has put Cisco Systems in an enviable position as the rest of the telecommunications equipment market consolidates.

Earlier this week, wireless phone maker Nokia and telecommunications equipment maker Siemens announced plans to form a joint venture to combine the product lines they sell to phone companies. The new entity, called Nokia Siemens Networks, will have assets totaling more than $30 billion.

The new partnership comes on the heels of other big moves by the companies' peers. Back in April, Alcatel and Lucent Technologies announced they planned to merge their equipment companies, creating one of the largest suppliers of wireless and wireline telephone equipment in the world. And in October 2005, Ericsson, Nokia's chief rival, bought most of Marconi of the United Kingdom.

The recent equipment-company pairings, which follow an equally tumultuous consolidation in the carrier market, has many on Wall Street and in the industry wondering who might be next. Some say Nortel Networks and Motorola are likely looking to bulk up.

But what about networking giant Cisco? A relative newcomer to the telecommunications equipment market, Cisco is arguably better positioned than any of the traditional telecom suppliers in the industry to reap big rewards in the next several years as phone companies upgrade their networks to deliver more Internet Protocol-based services, such as IPTV, according to at least one analyst.

"We are in the right spot at the right time," John Chambers, CEO of Cisco said during a press conference this week at a customer event in Las Vegas. "The industry will continue to consolidate. And if you have the right architecture it's a key competitive advantage. We look like we have made the right investments."

The IP key
Big phone companies around the world are already in the process of migrating their voice traffic onto their IP data networks. And soon many, such as AT&T, BT and Deutsche Telekom, will add video onto their IP networks, creating huge demand for IP equipment and network solutions.

Cisco dominates the IP equipment market, primarily by selling IP routers and Ethernet switches to large companies. Its hottest-selling product, the Catalyst 6500 switch, has generated $8 billion in sales in the last two years and $20 billion in the last six years.

In recent years, the company also has increased sales to phone companies as well as cable operators. In its third fiscal quarter, the company showed revenue growth in the service provider market in the upper teens compared with the same period the previous year.

"Cisco is the IP expert," said Michael Howard, a principal analyst at Infonetics Research. "And if all the service provider networks are going IP, then it is sitting in a very good spot. All the new behemoths will have to play catch-up to Cisco in IP."

Cisco's relative strength in the IP sector is no accident. Over the past five years, while other large companies, such as Nortel Networks and Lucent, have struggled with accounting scandals and slumping growth, Cisco has been busy acquiring companies, including a few key investments, that have helped it lay the groundwork for its future.

In 2003, it bought home router company Linksys as a way to enter the home networking market. It then bought a small company called Kiss Technology in July 2005 as an entry into the consumer electronics business. And in November, it made its most ambitious move to date with the acquisition of set-top box maker Scientific-Atlanta, a deal that not only put it deeper into the home entertainment market but secured its position among cable operators, according to Cisco.

Betting on trends
Cisco has also concentrated its efforts in specific new markets and on a business segment it calls Advanced Technologies, which includes digital video, digital-home technology, security, optical networking, storage area networking, wireless, hosted small business and IP telephony. Cisco deems a new technology an advanced technology when it believes the market will generate $1 billion in annual revenue within five to seven years.

Today the entire Advanced Technologies group yields only a small portion of the company's total $20 billion in annual sales, but it is among the fastest-growing segment of the business. And as Cisco looks to grow between 10 percent and 15 percent a year for the next few years, the Advanced Technologies group could help push it toward that goal. During the third fiscal quarter of 2006, the company said, revenue for Advanced Technologies grew 20 percent from the same quarter the previous year.

"Getting trends right is important," Chambers said. "We made our investments three to five years ago when it wasn't obvious to others what the trends were going to be."

New markets such as home networking and video are completely different from Cisco's traditional markets, and they highlight how Cisco's strategy has evolved. The company has moved beyond simply supplying infrastructure gear for networks, Chambers said. Now, it is developing products for businesses and consumers that are expected to drive network usage and demand.

This strategy sets Cisco apart from competitors such as Alcatel, Lucent and Nortel, which derive a lot of their business from supplying gear that simply transports traffic. For example, Nortel leads the market in optical networking equipment. Alcatel has developed a strong DSL (digital subscriber line) portfolio. And Lucent has developed a strong radio frequency portfolio for mobile operators.

Except for optical, which has been a disappointment to Cisco, the company has chosen to stay out of DSL equipment and radio frequency gear. Instead, it has concentrated on adding more intelligence and value to the network.

"I was concerned two years ago when we outlined our strategy and nobody followed us," Chambers said. "It's like when you're out in the middle of a frozen lake and you're catching the heck out of fish, and nobody comes. You have to wonder if you're missing something."

Amibitions for mobile?
While Chambers views the Alcatel-Lucent pairing as a defensive move to better compete against Cisco, he said that the Siemens-Nokia partnership could complement Cisco's portfolio. Both Siemens and Nokia provide radio frequency technology and cellular handsets to carriers, markets that Cisco has chosen not to enter.

For now, Cisco is addressing the mobile wireless network by offering software on its edge routers that provides cell phone users on 2.5G and 3G GSM (Global System for Mobile Communications) networks access to the Internet or to corporate networks. But some analysts wonder if Cisco may not have its eye on bigger ambitions in the mobile wireless market.

"If you look at Cisco's history, they went into the home with Linksys and then they bought Scientific-Atlanta to get further into the cable market," said Infonetics Research's Howard. "It's not too far afield to think they might buy into mobile itself."

Still, Howard concedes that Cisco is unlikely to make a big move right now. Over the past couple of years, the company has been rumored to be in talks with Ericsson and Motorola, but Chambers said it's much more likely that his company would partner with mobile equipment makers instead of trying to buy with one of them.

"Mergers among equals have a high failure rate," Chambers said. "I don't know how to do those" kinds of acquisitions.