Cisco's Middle Kingdom Alliance


Cisco Systems (CSCO) is teaming with ZTE Corp, China's largest publicly traded telecom equipment maker, to develop telecom equipment technology for China and other Asian markets. On Nov. 22 the pair announced that they will work together on 3G equipment and advanced fixed-line networks.

While the details of the deal are sketchy, the strategy behind it could be summed up by an old saying: The enemy of my enemy is my friend.

For Cisco and ZTE, that common enemy is Huawei Technologies, the privately held company that is China's No. 1 producer of networking and telecommunication equipment. Huawei, which makes routers and switches, among many other products, has become one of the biggest threats to Cisco's position as the dominant player among companies that produce the pipes that make the Internet work.

INTENSE COMPETITION. Huawei has been able to parlay its lower manufacturing and R&D costs -- as well as generous state support from Beijing -- into a commanding position in the Chinese market. Thanks in part to a joint venture with Massachusetts's 3Com (COMS), Huawei has also grown its overseas presence.

Huawei is still small compared to Cisco. Huawei sold $5 billion worth of equipment last year, while Cisco had $24.8 billion in revenue for the year ended July. But Huawei's overseas sales doubled IN 2004, to $2.2 billion, and late last year IT got a $10 billion credit line from a state-controlled bank to help Huawei boost its exports even more. On Nov. 22, Huawei announced that it had signed an agreement with Vodafone (VOD) to provide the British outfit with mobile network infrastructure.

Cisco doesn't take the Huawei threat lightly: The San Jose-based giant even sued Huawei in 2003, alleging that it stole some of Cisco's intellectual property. (The two companies later settled the case.)

MUTUAL CONCERN. ZTE hasn't gone that far, but its rivalry with Huawei is just as intense. Both have their headquarters in the southern city of Shenzhen, across the border from Hong Kong, and for years, ZTE has been struggling to emerge from the shadow of its bigger and more well-known neighbor. (ZTE's sales were $2.6 billion last year, with profits of $157 million.) ZTE doesn't make routers but it does chase after some of the same business as Huawei.

It recently won a big contract from China Telecom to provide equipment for the state-owned operator's new Internet Protocol TV service. ZTE is also trying to attract business in emerging markets in Asia, the Middle East, and Africa. For instance, on Nov. 15 the company announced that it was conducting 3G trials in Tunisia.

Since Cisco is in networking gear and ZTE has focused largely on wireless equipment, the two haven't been competing against each other. By teaming up, they can help each other achieve their common goal of stopping Huawei.

THEN -- AND NOW. Cisco could use the help in China. These days, executives at Cisco talk with excitement about the possibilities in India, where Cisco doesn't have to face any serious local competitors. It wasn't that long ago that Cisco had China largely to itself, too. In the late 1990s and early years of this decade, Cisco ruled the Chinese market, with more than 60% share for high-end equipment, says Fang Meiqin, an analyst with BDA China, a Beijing-based consulting firm.

Those days are long gone, she says. Cisco "is losing market share fast," says Fang, who estimates that the company's market share is now between 30% and 40%. One big reason is the competition from Huawei, which offers comparable equipment for about half the price. "The price gap between Cisco's products and Huawei's products is huge," she says.

Moreover, Fang says, Huawei can offer better service than Cisco. Huawei "will ask the engineers to stay around the clients' central offices, get feedback on the products and provide customers with product design based on their demands," she says. "Cisco doesn't perform as well because it has much fewer employees [in China] and its labor costs are much higher."

CISCO'S FOCUS. The ZTE deal is a key part of Cisco's strategy to take the fight to Huawei's local turf. Cisco has opened a new R&D center in Shanghai, where it now has 100 engineers doing designs not just for the local market but for Cisco products worldwide.

Cisco is a major investor in China, having put $650 million into Chinese startups such as Shanda Interactive (SNDA), the Shanghai-based online gaming outfit that was the best performing Nasdaq stock in 2004 but has struggled this year (see BW Online, 11/16/05, "China's Not-So-Jolly Gaming Giants"). Most of those investments have been through the Softbank Asia Infrastructure Fund, a direct-investment vehicle managed by Japan's Softbank and funded by Cisco.

For all of their talk about the potential of India, Cisco executives see big opportunities in China. Last week, Cisco appointed a new head of China operations, Thomas Lam, who says that demand in China isn't slowing down. "IT spending is growing at 12% to 13% a year," says Lam, who points out that Chinese customers spent $27 billion on IT products last year. "It's very, very healthy."

DOWN THE ROAD. The partnership with ZTE will include as one of its major goals the development of what people in the industry call "next generation networks" (NGN), fixed line systems that carry voice and data using Internet Protocol. Lam sees Chinese operators fueling demand for NGNs. "Eventually, the network will look like one big IP network," he says.

One problem for Cisco is that Huawei is making a big push to win NGN business, too. With the new ZTE partnership, Cisco is opening another front in the battle against its pesky Chinese rival.

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