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Cisco and Microsoft's tricky partnership

The two giants increasingly find themselves competing as much as partnering. Can their relationship withstand the strain?

LAS VEGAS--Cisco Systems CEO John Chambers may not like to say so, but his old friends and partners at Microsoft are quickly becoming his competitors.

A few hours after delivering a keynote address at Cisco's annual Networkers user conference here last week, Chambers, a smooth-talking West Virginia native, sat down with about a dozen reporters in a small conference room at the sprawling Las Vegas Convention Center. He took off his blue suit jacket, cracked open a can of Diet Coke and parried questions with the best of them, particularly when it came to the folks in Redmond, Wash..

"That's why they're falling over each other. Companies that didn't used to be competitors are now competing."
--Dave Passmore, analyst, Burton Group

"Bill Gates and Steve Ballmer are very good friends of mine," Chambers said. "Our customers require that we work together, and you'll continue to see us work closely together."

But when pressed, he acknowledged they aren't always in lock step. "We are both companies that move very aggressively," Chambers said. "And at times don't take a step back to say 'what about the other guy'. That is something we need to do better in the future."

The 900-pound gorillas of their respective markets, Cisco and Microsoft are increasingly butting heads as they venture into new sectors such as security, communications that rely on the Internet protocol, and software for integrating big computer systems.

They're not the only old allies becoming competitors. Microsoft is well on its way to competing with longtime partner Symantec in security. German enterprise software maker SAP is selling integration software and has invested in an open-source database company, taking it squarely into longtime partner IBM's sweet spot. Even Sun Microsystems is starting to add networking functions to its servers--a development that surely has gotten the attention of executives at Cisco.

As reluctant as some of those companies may be to take one another on, they have little choice. Many economists figure the technology industry, five years removed from its boom days, can expect single-digit annual growth for the foreseeable future. That's a far cry from even the early 1990s, when the industry typically grew 10 percent or better every year.

"All the big technology companies are trying to find new areas of growth as revenue from their traditional businesses goes flat," said Dave Passmore, an analyst with the Burton Group. "That's why they're falling over each other. Companies that didn't used to be competitors are now competing."

Some observers wonder if the competition is also impacting sales between the companies.

After five years of using Cisco gear for its wireless network, Microsoft is switching to a new supplier.

After five years of using Cisco gear for its wireless network, Microsoft is switching to a new supplier. Earlier this month, Microsoft announced that it was replacing its existing Cisco wireless network gear with equipment from start-up and Cisco competitor Aruba Wireless Networks.

Technology from Cisco's recent acquisition of Airespace was believed to be a for the contract. But Microsoft went elsewhere with the contract, which is one of largest corporate deployments of wireless technology.

Microsoft execs insist that no one should try to read between the lines of their decision to go with Aruba. "When we make product decisions, we make them based on the best technology," said Ron Markezich, the chief information officer at Microsoft. "We don't make them based on any sort of partnership relationships. For our needs, Aruba came out No. 1."

But the situation has raised some eyebrows, particularly in light of recent initiatives that seem to pit the two companies against one another.

Last week, Cisco announced a new product initiative called "application-oriented networking," or AON, which will move the company beyond its core Internet routing business into application middleware. As part of the initiative, Cisco announced several software partners, including IBM and SAP. Microsoft wasn't on the list.

Microsoft execs wouldn't comment directly on the omission and said in a statement, "This is interesting, and we look forward to hearing more. We continue to work with Cisco on a number of initiatives."

Analysts believe AON differs philosophically from Microsoft's approach. "Microsoft's business is the opposite of what Cisco is talking about with AON," said Passmore. "Cisco wants to take application intelligence out of the data center and distribute it throughout the network to remote branches. A big piece of Microsoft's business is supplying software for servers in the data center."

But this isn't the first time that Cisco and Microsoft have been slow to pair on major initiatives. Neither company mentioned the other when both announced new security architectures last year. The proposed architectures were not interoperable, and customers feared they would be forced to choose between a Cisco implementation or one from Microsoft.

In October, months after the announcements, the companies publicly said they'd be working together. But they've been vague on specifics.

"Cisco and Microsoft continue to make steady progress on the coordination of the embedded security capabilities of Cisco's network infrastructure and security features in Microsoft's Windows," Jeff Price, senior director of Microsoft's Windows Server Division, said in an e-mail.

The two companies also appear to be headed for a collision in the IP communications market, as Microsoft adds new voice over IP, or VoIP, features to its Live Communications Server and operating system software.

"Are we both used to leading? Yes. But that won't stop us from dancing together."
--John Chambers, CEO, Cisco Systems

Live Communications Server is messaging software that provides instant messaging and presence information about users. Today, the server works alongside Cisco's CallManager software, which controls how the calls are connected. But analysts say Microsoft might add call control features to its server software, eliminating the need for telephony software from Cisco and other equipment companies such as Alcatel and Siemens.

If Microsoft gets large companies to adopt Live Communications servers the same way they've adopted Exchange e-mail servers, then Cisco's IP PBX business, which provides the call control capabilities, is in trouble, Passmore said.

Microsoft is also threatening Cisco's IP phone business. It has already added to the Windows XP operating system software that uses the Session Initiation Protocol, a technology that can help turn a PC into a "soft phone." And in 2006, Microsoft will embed VoIP capabilities into its long-waited Longhorn OS, making it even easier for people to use their PCs to make phone calls directly through broadband connections. Longhorn will also tie Bluetooth-enabled cell phones into the VoIP network, so Bluetooth phones can be synchronized with PCs.

These new Microsoft features could render Cisco's IP telephony software and IP handsets obsolete.

This would be a major blow to Cisco, since its IP telephone products are expected to generate more than $1 billion in sales in the fiscal year that ends this month. IP telephony also helps Cisco sell its infrastructure equipment. For every dollar spent on Cisco's IP telephony products, the company generates $4 on switches and routers, according to Charles Giancarlo, Cisco's chief technology officer.

"Microsoft is definitely moving into the communications market, which has got to unnerve Cisco," said Zeus Kerravala, an analyst with the Yankee Group. "There's no question that Microsoft is going to have a big say in how this market evolves."

Cisco's Chambers admits the companies may step on each other's toes from time to time, but he downplays it. "Are we both used to leading? Yes," he said. "But that won't stop us from dancing together. Our philosophy is that it's always better to partner than collide. So it's in our best interest to partner with Microsoft."

Microsoft executives agree. "The partnership between Cisco and Microsoft is extremely healthy," said Microsoft's Markezich. "Most customers use Microsoft software and Cisco routers and switches in their networks. So it's important that our products and roadmaps for the future are aligned."

Of course, Cisco is not about to get into the PC operating system business. And Microsoft is unlikely to start selling routing equipment to corporations and telecommunications companies. But Microsoft and Cisco, with $36.8 billion and $22 billion in respective annual sales, have become so large, it's hard to imagine they won't bump into each other with increasing regularity.

"It's unavoidable," said Frank Dzubeck, CEO of Communications Network Architects, a telecommunications consultancy in Washington, D.C. "If Cisco is going to move up the food chain into software and Microsoft is going to expand into new technologies, they're going to overlap into each other's businesses."