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Cisco's Link to Your Living Room

Cisco Systems has longdominated the market for corporate networking gear. But Victor Tsao, along with wife Janie, are intent on making the $22 billion networking giant a consumer powerhouse as well. Having founded Linksys in 1988, the pair helped pioneer the market for home routers. That led to Cisco's $500 million acquisition of the Irvine (Calif.) company in early 2003 -- and to even greater success in the years since.

Cisco (CSCO) has extended its line to include wireless routers, and Linksys has now taken a huge lead in the market for home Voice over Internet Protocol (VoIP) gear as well. Cisco doesn't break out Linksys' revenue, but analysts peg its 2004 sales at around $600 million.

That's just the start. Now, Cisco is looking to Linksys to help it develop vast new consumer markets, in part by making acquisitions to build out the Linksys product line. In April, Cisco spent $68 million to buy Sipura Technology, which had designed much of the VoIP equipment sold by the Linksys division. And on July 21, the company spent $61 million to acquire KiSS Technology, a small Copenhagen-based maker of networked DVD players and other gear.

Tsao recently spoke with BusinessWeek computer editor Peter Burrows about past successes and where he sees Linksys -- and consumer electronics in general -- headed in the future. Edited excerpts from their conversation follow:

Q: What capability does KiSS Technology give Linksys?

A: They make a box that sits in the living room. It's a DVD player and recorder but it's networked, so it can easily talk to a PC or to anything connected via the Internet. So you can use it as a platform to do a lot of things. And they have a very talented R&D team, and it's very complementary to our product line. We're very strong in data-centric products [such as wireless routers and VoIP adapters]. But voice and data have started to converge, and now entertainment is starting to converge as well.

Q: What do you mean by "entertainment is starting to converge"?

A: Four or five years ago, all the activity was just about finding ways to share a broadband connection [so multiple computers in a home could share one connection]. Starting in 2002, we began pushing WiFi really hard as the de facto wireless communications foundation for the home.

Then, last year, we began pushing very hard on the VoIP product line [so consumers could use that connection not just for surfing the Web, but also for making phone calls]. We shipped more than 2 million [VoIP devices] in just nine months, as of last August.

So data and voice is starting to converge. Now we need more applications to help consumers take advantage of the network in other ways. We believe networked entertainment is going to be the next big wave.

Q: When will this new wave of networked entertainment equipment be available for consumers to use in their homes?

A: By Christmas you'll see a lot of products, and a lot more by next year. Absolutely, it [will be a big trend] by 2007.

Q: How will the products that KiSS makes fit into this wave?

A: Today the DVD player is the most popular product in the home, next to the TV. It can be used for two purposes -- to play audio or to play movies. So if you put a hard drive into it, you essentially turn it into a PVR [personal video recorder]. It virtually becomes a TiVo (TIVO) box right away.

If you add a tuner, you can use it to [choose channels], like with cable TV. And if you have [Internet Protocol TV] and a wireless connection, it can communicate and share content with other devices -- say, another storage device somewhere in the house or another DVD player upstairs or with some other device out on the Internet.

Obviously, digital rights management comes into play [to make sure content providers get paid properly as content moves between devices]. But there are a lot of ways that can be handled.

Q: Does Cisco want to create this consumer-electronics gear itself, bearing the Linksys or Cisco logo? Or will you compete by licensing your networking technology to others?

A: We're in the very, very early stages of the market for networked entertainment devices. Most of all, we want to help grow the segment. Linksys wants to partner with the [consumer-entertainment] companies.

When you talk about networked entertainment, you're by definition talking about multiple devices from multiple vendors. That means [we have to find] ways so we all can work together and share content with each other. We're a networking company. That's our strength -- and making this complex set of products easier to use is a strength, as well. Linksys will play a major role, by partnering up with many players.

At this point, it's far too early to determine our exact role. We'll have some products. We won't do TVs, but we can license technology to TV makers to help them make connected displays. The important thing is for someone to take a leadership role. We know the digital home market will be there. As an industry, we've all been talking about this for the past four or five years. But who has these capabilities today? I don't have it in my home. My friends don't have it. So Cisco is making a stand. We want to really promote this to make it a reality.

Q: But you will get into the DVD market, by selling KiSS's networked DVD offering?

A: Yes, we'll continue to sell the product in Europe, and likely in the U.S. -- with some variations on the applications. But yes, we're going to sell this connected DVD player.

Q: How do you view Apple's role in this market? They have their own wireless-network product, the Airport Express, and many Apple (AAPL) watchers expect the company to try to take a leadership role in creating the digital living room of the future. Have you talked to them about working together to have products such as the iPod work with other devices in the home?

A: I really view Apple as a potential partner. The iPod is obviously a very good design. But at the end of the day it has to be a networked device. Linksys does most of the home-networking infrastructure for consumers. If we can partner together, we can give [consumers] such a good experience.

In the future, there are a lot of areas where we can work together. This market is huge. Let's face it: No one player can dominate the whole thing.

Q: Talk about Cisco's success in the VoIP market.

A: It's another application that we as an industry had been talking about for 10 years -- but nothing much was happening. The infrastructure in the networks wasn't that well established, and the hardware devices weren't capable of delivering the right quality of service. But then we got to the point that we could do it, so last year we started selling a lot of phone adaptors.

Q: What about dual-mode gear, so people can use phones that switch from cellular while they're out of the house onto free WiFi networks once they get into the house. Is this going to be the next big wave in consumer communications?

A: We need to see more deployments by the mobile-phone companies. Right now there are some limited trials, but it's not widespread yet. It's not a matter of yes or no. It's a matter of when. It depends on the particular carrier, the region where they operate, the country and the regulations. Once you involve the phone companies, you have those kind of constraints.

Q: How has being a part of Cisco helped Linksys?

A: When we were bought, we were relatively small. Two years later, we're still an independent division but we have the infrastructure to support a multibillion-dollar company. We've really taken advantage of Cisco's international channels and presence with resellers and its relationship with the service providers.

You go to MBA courses, and there's always talk about synergies, and about one plus one equaling three. Well, that's not always true, but in this case, one plus one has turned out to equal 2.8.

There are things you have to compromise on when you're part of a big company. We had to conform to lots of corporate guidelines and support lots of things. Let's face it: That slows you down a little bit. But by integrating the brainpower and knowledge and process improvements and taking advantage of Cisco's channels, it has been absolutely great.

Q: Will Cisco do more acquisitions?

A: Cisco has done 101 or 102 acquisitions in its history, and it's an absolutely integral part of the company's strategy.

Q: When Cisco bought Linksys, there were questions about whether a high-margin company like Cisco could make an acquisition of a low-margin company like Linksys work. Do you think you've put those questions to rest?

A: Over the past two years, this unit has proven it can be part of the Cisco system -- and the consumer brand has become an integral part of the corporate strategy. We've proven it can work.

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