The Well-Heeled Upstart on Cisco's Tail

The campus of Huawei Technologies Co. in Shenzhen, just over the border from Hong Kong, looks like a giant construction site. In one area, the network-equipment maker is erecting a 21-story steel-and-glass tower that by mid-2003 will accommodate the company's 10,000-strong research and development staff. Across the campus stand five more buildings that will provide additional space for Huawei engineers. Another set of offices is due to open this fall. And down the road is the Hundred Herb Garden, a residential complex that includes tennis courts, a swimming pool, and three-story townhouses to accommodate 3,000 Huawei networking and software experts.

Huawei's building frenzy reflects its determination to be a world leader in switches and routers. These make up the backbone of corporate networks, as well as the Internet itself. Huawei aims to catch up quickly with industry leaders Cisco (CSCO ), Nortel (NT ), and Alcatel (ALA )--mainly by selling reliable, low-cost knockoffs of their products. But the upstart also hopes to match the big boys in innovation. And although its market share is still minuscule outside China, the mere mention of its name can raise pulse rates in Silicon Valley.

Founded in 1988 by a former officer in the People's Liberation Army, Huawei earned $578 million on $2.4 billion in sales last year. Only 10% of its business was outside China, but that number should surge to 35% in a few years, says Executive Vice-President William Xu. "Our products are high-quality and cost-effective," he crows. "This gives us an opportunity."

How big an opportunity is unclear. On the one hand, Huawei has made recent inroads in Europe, while opening sales offices in San Jose, Calif., northern Virginia, and suburban Dallas. However, it has yet to dent Cisco Systems Inc.'s market share. At a time when many router customers are interested in new features and functionality, says Michael Volpi, Cisco's senior vice-president in charge of routers, Huawei is going after the market with low prices. "That's not necessarily the smartest strategy," he says.

In the view of some analysts, though, Cisco has cause to worry. "In the current economic climate, many buyers are very constrained in their spending," says Chris Barnard, a networking analyst with IDC in Amsterdam. That already has opened doors in Europe, where Huawei's prices undercut Cisco's by as much as 40%. In 2000, Huawei teamed up with Vierling Group, a 60-year-old German tech service-and-support company that used to install and maintain mostly Siemens equipment for clients such as Deutsche Telekom (DT ). Now, Vierling is Huawei's exclusive German distributor for carrier customers, winning it deals in several German cities, including a 465-mile fiber network in Berlin.

In Britain, Huawei has made converts of distributors such as Access Network Services (ANS). One draw: Huawei's low prices let distributors make 40% profit margins on a sale, compared with just 5% to 10% on equivalent Cisco gear. What's more, the Chinese devices look and function just like Cisco's. "We were impressed by the ability of a Cisco-trained engineer to take a Huawei product out of the box and use it," says ANS Marketing Manager Richard Eglon.

The similarities aren't lost on Cisco. Huawei is "the only competitor in the world where the products are made to look like ours," gripes Gordon Astles, Cisco's Hong Kong-based president of Asia-Pacific operations. So far, Cisco hasn't publicly lambasted Huawei for any alleged patent infringement or threatened legal action. But neither has it ruled that out.

Whatever course Cisco chooses, there are good reasons not to beat up Huawei, which is well-connected in government circles. Cisco is making rapid strides in the China market and can't afford to anger its hosts. In September, Shanghai Telecom picked Cisco to help with a big expansion of its citywide broadband services. And in October, China Telecom announced plans to use Cisco routers as it expands its northern ChinaNet Internet backbone.

Huawei, for its part, denies any wrongdoing in the patent arena. "Our major products are self-developed, with self-owned intellectual property," says Xu. True, the company may be playing follow-the-leader today. But that won't always be the case, says Eglon at ANS. Considering its massive research and engineering base in China, "I expect to see an acceleration of innovation and development from them," he says. Indeed, innovation tops Huawei's agenda: It spent $342 million on research and development last year. That's just one-tenth what Cisco spent, but Huawei's budget will grow over time.

On the political front, Huawei's murky heritage could hinder its overseas push. Analysts say Huawei maintains ties to the Chinese military. Huawei denies that, as it denies reports it has done work for the Taliban and Saddam Hussein. These and other matters will become clearer if Huawei manages to stage an initial public offering, which its executives desire. Then, Huawei will see if the market believes in its bold global bid.

By Bruce Einhorn in Shenzhen, with Ben Elgin in San Mateo, Calif., and Andy Reinhardt in Paris

— With assistance by Benjamin Elgin, and Andy Reinhardt

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