Microsoft has no shortage of rivals. There's IBM (IBM ) in corporate software, Sony (SNE ) in computer games, Apple (AAPL ) in digital music, plus Google (GOOG ) and Yahoo (YHOO )! on the Web. But more and more, Microsoft (MSFT ) is coming up against a new competitor: Cisco Systems (CSCO ).
Cisco? Talk to the companies and, rather than describing a rivalry, they'll list the many ways in which they're collaborating. They've worked together on such products as small-business call centers and set-top boxes. But there's rising competition on other fronts where growth is expected to be brisk, namely security software and Internet telephone technology. So while the two companies compete only in pockets today, researcher Gartner Inc. (IT ) thinks the overlap will grow to markets worth $20 billion in six years. "You have two Goliaths that need to find bigger pieces of new spending, and they're going to bump heads," says JMP Securities LLC analyst Sam Wilson. "It could get nasty."
What's at the root of the increasingly complex relationship between Microsoft, the world's largest software maker, and Cisco, the No. 1 maker of computer networking gear? It's the shift in the tech industry's center of gravity -- from the PC, where Microsoft has ruled, to the network, where Cisco is dominant. As more computing tasks are handled online, from Web searches to downloading movies, Cisco CEO John Chambers is focusing on infusing networks with the smarts that typically have been the province of Microsoft-style applications. "Cisco's strategy has been to move intelligence to the core of the network," says 3Com Corp. (COMS ) CEO Bruce Claflin. "Microsoft wants the intelligence to be in [PCs and other devices], at the edge of the network."
Consider some of the new areas Cisco is wading into: On Nov. 14 the company announced an initiative aimed at small and midsize companies. It's called Linksys One, after Cisco's unit that specializes in home-networking gear. Now, Cisco will sell routers that come preconfigured to offer basic networking as well as phone, video, and related applications. By combining all those features in one box, Cisco could potentially grab share in markets Microsoft is targeting as well, such as Net phone systems and security. Cisco has dubbed this market an "emerging technology," which it defines as one that has the potential to be a billion-dollar business for the company.
A second initiative, announced in June, creates smarter networks that simplify and speed up corporate computing tasks. For example, a network could be programmed to notify the head of sales the moment a customer places a $1 million-plus order, or to automatically send out a "thank you" form letter. The software also lets different applications talk to each other more easily -- say, to ensure that a purchase order flows from the online store through various back-office applications. "Networking is moving from a way to connect things to a way to enhance productivity," says Cisco Senior Vice-President Jayshree Ullal.
Microsoft is by no means standing still. As part of Chairman William H. Gates III's push to deliver software over the Internet, the company announced in October that it will create two families of Web services -- Windows Live and Office Live -- as online counterparts to its Windows and Office software franchises. Microsoft also has been pouring money into software that would let Windows users work together over a network. "It's a very strategic area for us, and the investments we're making are similar, if not greater, than the investments we made around Office," says Zig Serafin, general manager for real-time collaboration at Microsoft.
The big question is whether the two companies will butt heads or partner up. "They're infringing on each other's territory in a variety of ways," says Simon Khalaf, CEO of Vernier Networks Inc., a network security company that competes with Cisco and partners with Microsoft. "If they can work together, it would be great for the industry. If there's war, it's going to be ugly."
The companies are striving to collaborate when they can. On Nov. 10, Cisco and Microsoft announced that they will support a standard designed to make Internet phone calling and video services work inside corporate firewalls with fewer glitches.
The companies will also have a joint marketing arrangement to make it easy for smaller companies to integrate some Microsoft business applications with Cisco networks. "There's always overlap, especially when you look at an industry that evolves as fast as this one," says Microsoft's Serafin.
Cisco Senior Vice-President Dan Scheinman says the companies are collaborating on a range of other fronts, such as creating new "presence-based" applications that let workers get only the data they need in a given location -- say, on the factory floor. "In spite of a lot of analyst commentary, I've seen more meat to our collaboration in the last few years," says Scheinman. "Microsoft is dealing with the impact of the Internet revolution. Our hope and our goal is to work with them, to create opportunity for both of us."
Wishful thinking? Many observers believe so. This isn't the first time the companies have been on a collision course. Back in 2002, Microsoft launched its own line of wireless home routers. Two years later it exited the market amid escalating competition from Linksys, a division Cisco bought in 2003. That retreat was quickly forgotten. The same may not be true for the conflicts to come.
By Peter Burrows and Olga Kharif