A Downside to the "Cisco Standard"

As networking's dominant player, its technology tends to be the industry yardstick. An enviable position? Maybe not

By Peter Burrows

In tech circles, Cisco Systems has managed to maintain a reputation as tech's squeaky-clean monopolist. While Intel (INTC ) and Microsoft (MSFT ) have faced plenty of lawsuits and antitrust probes, there has been hardly a whiff of controversy surrounding the size and dominance of the networking giant.

Now, it seems Cisco (CSCO ) has found itself embroiled in a controversy related to its clout -- possibly, through no fault of its own. The company has never been more dominant. It enjoys a 60%-plus share in the market for routers and switches, the basic building blocks that direct traffic over digital networks. As a result, some government buyers are standardizing on Cisco gear, even before Cisco has bid for the business.


  That's what seems to have happened in Cisco's hometown of San Jose, Calif. According to city officials, members of the city's information technology staff improperly required that all bids to wire a new City Hall use only Cisco gear. These staffers allegedly even allowed Cisco to have a role in defining the project and the bid package. Says San Jose Mayor Ron Gonzalez: "It's clear enough to me that the level of involvement between city staff and Cisco was not appropriate." Cisco executives were not available for comment, but a spokesperson says an internal investigation showed no evidence of inappropriate actions by the company.

Analyst Sam Wilson of JMP Securities says Cisco's name also has found its way into controversies in other locales. In Atlanta, the public grade-school system is investigating whether it overspent on equipment purchased with funds from the federal E-rate program, which levies a tax on phone bills to connect classrooms to the Internet. According to a May article in the Atlanta Journal-Constitution, much of the unneeded gear found sitting in a warehouse was from Cisco -- including 24 Catalyst 6500 switches, which cost more than $50,000 a piece.

Wilson also sites Alaska's June 23 decision to terminate a $100 million contract with Alaska Communications Systems to deploy 20,000 Internet-style Cisco phones in locations around the state within a year. As in the Atlanta and San Jose incidents, Cisco is just a supplier to a contractor hired to deploy these networks. But Wilson says there's an appearance of undue influence by Cisco. "Eight months before the contract was terminated, Cisco's Anchorage account manager was quoted as saying: 'We were instrumental in helping the state and ACS understand that the technology is, indeed, ready,'" Wilson wrote in an Aug. 6 report.


  What does it all mean for Cisco? Wilson, who has a market perform rating on the stock, fears that publicity about these incidents could cause public sector buyers to think twice before rubber-stamping Cisco as their networking provider.

Memories still linger of California's decision to cancel a $95 million software project with Oracle (ORCL ) in July, 2002. In that case, Oracle was criticized for using aggressive sales tactics to convince state negotiators to pay $41 million more than would have been the case had they negotiated on the open market.

So far, there's been no major fallout for Oracle, and Cisco will surely remain the top provider of networking gear to government buyers. Still, Cisco could lose some business if those buyers no longer feel safe in automatically choosing Cisco as their top networking supplier. That's especially true because much of Cisco's strategy is to sell itself as a soup-to-nuts provider that can deliver a "Cisco Powered Network" made up of its gear working together seamlessly. If the San Jose scandal worsens, buyers may begin driving a harder bargain when Cisco sales reps come around the next time. "It used to be that you never got fired for buying Cisco -- until San Jose's city auditor came around," says JMP's Wilson.


  So far, there's no evidence that Cisco did anything improper. A spokeswoman for Atlanta Public Schools says no one has accused Cisco of wrongdoing. And Stan Herrera, director of Alaska's Information Technology Group, says Cisco wasn't the cause of the problems with the state's big contract. In fact, he says Cisco has been instrumental in helping a new contractor get the project back on track. While only 239 phones at five sites had been deployed by the first contractor, those are now being administered by the new contractor, which will soon resume the broader roll-out. "Using Cisco's best practices, we were able to bring the five sites up with no problem. It's stable and robust and it's working fine," says Herrera, who says that Cisco is still the main supplier under the contract.

In San Jose, city officials are focusing on possible wrongdoing by the city's own tech staffers, not Cisco employees. According to San Jose officials, the scandal began in January, 2003. That's when staffers decided to designate that Cisco gear be used for a state-of-the-art network for the new City Hall, a closely watched $388 million project. This was because the city had standardized on Cisco gear years before, so sticking with the company would reduce the need for new training and help the city keep support costs low, the staffers reasoned.

Trouble is, municipal codes prohibit the city from standardizing on any one supplier, says city auditor Gerald Silva. This was especially true because much of the equipment was not for traditional Cisco products, but for so-called Voice-over-Internet-Protocol (VoIP) gear that enables phone calls to be made over the Web at a fraction of the cost of traditional phone networks. This is a potentially huge new market, one where rivals such as Nortel (NT ) and Avaya (AV ) hope to best Cisco, now the leader.

Also, the city tech staffers allegedly requested Cisco's help in designing the proposed network, giving Cisco a leg up. In the end, the bill of materials included 18,000 pieces of Cisco gear, according to the San Jose Mercury News, which uncovered the irregular bidding process.


  This all stems from an $8 million contract the city of San Jose awarded to Unisys (UIS ), the big mainframe-maker that has now become a computer services company. When telecom giant SBC Communications (SBC ), another contender, complained about problems with the bidding process, the city council began an investigation to see if Unisys had received unfair advantages. In the process of looking into SBC's allegations about Unisys, the San Jose City Council also grew concerned about Cisco's role in the process. While San Jose Chief Information Officer Wandzia Grycz publicly declared that Cisco had no role in defining the proposed network, a long list of e-mails and other material led the city to decide that the government's dealings with Cisco were inappropriate.

San Jose city officials decided to cancel the Unisys contract. It will put the work back out to bid -- with no stipulation that the gear must come from Cisco. A final report on the flap is expected Aug. 9. While city auditor Silva won't say whether Grycz or anyone else will be fired or reprimanded, he says it's doubtful that Cisco will come under fire. Rather, he commends Cisco for providing dozens of e-mails between the company and city tech staffers. "It's unfortunate that they're getting some bad press," says Silva. "Had it not been for their openness and willingness to share information, we couldn't have done this investigation the way we did. I was extremely impressed with their integrity."

Mayor Gonzalez also denies any connection to political contributions from Cisco executives totaling $13,000 to his campaigns since he was elected in 1998. While Cisco is a hometown company and a major political force, Gonzalez insists he had no involvement with the contract -- and that he's not in the pocket of any of tech's local powerhouses.


  He says John Chambers, Cisco's CEO, personally appealed to him earlier this summer to change the zoning on some Cisco commercial property that Cisco had purchased but never developed. Instead, Cisco wanted the land to be rezoned, so it could be used for the still-booming residential market. When Gonzalez refused the request, Chambers accepted the answer and let it drop, says Gonzalez. "Sometimes Cisco gets what they want [with me], and sometimes they don't," he says.

So what's it all mean? Certainly, Cisco's dominance is in no danger. Even Gonzalez says the winning bid will likely include some Cisco gear -- simply because the company is such a major player. But if more controversies like the one in San Jose pop up, Cisco may have to do some hard thinking about the extra responsibilities that come with its dominance. "There's an industry joke that goes: How many Cisco salesmen does it take to make a sales call?" says Wilson, the JMP analyst. Answer: "One to meet with you, one to bring the donuts, one to schmooze your secretary, and two to meet with your boss."

In most cases, that's just good old-fashioned capitalism. But when a company is so dominant that government buyers start giving it business it hasn't even bid for, Cisco may have to find ways to hold itself to a different standard -- or risk losing that rep as tech's squeaky clean monopolist.

Burrows is BusinessWeek's computer editor

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