Microsoft And Cisco: Can They Still Be Pals?

They need each other, but in the race toward networked computing, each is out to be top dog

In recent years, Cisco CEO John Chambers and Microsoft CEO Steve Ballmer have met each quarter to discuss ways for the tech titans to work together--and work through areas where they compete. But this "co-opetition" relationship is increasingly tilting more toward competition.

At stake is which company will be best positioned to cash in on a critical technological shift toward networked computing. The clash was, in retrospect, inevitable: Cisco Systems Inc. (CSCO ) built its router empire by correctly envisioning a world in which all manner of digital traffic, from songs to sophisticated corporate business applications, would be doled out over the Internet rather than being trapped in stand-alone devices such as the PC.

Now that Cisco has sold most of the routers that make up the foundation of this network, the action is moving to the services that run on it. That's why Microsoft Corp. (MSFT ) is racing to make its PC programs more network-centric--and why, with far more experience and brand awareness for selling consumer and business software, it represents a threat to Cisco's hegemony.

The two have a similar view of the future. They agree that networked software will help users pull down information with the device of their choosing and let them share it in ever more useful ways. The moment an inventory management program spots a parts shortage, the network could send alerts to whichever device is specified, be it PC, cell phone, or whatever. Then it could arrange a Web conference with the supplier.

How that happens is where Cisco and Microsoft diverge. Cisco thinks the key is to build most of these smarts into the network itself. That way, all programs and devices can work together, securely and glitch-free, based on one set of rules. This could make Cisco the reigning "platform" player, positioned as IBM (IBM ) was in the mainframe era or Microsoft when PCs were king.

Microsoft executives believe the priority is still the programs people use to actually get things done. So they are introducing innovations to let key applications, such as the Office productivity suite, make better use of the Net. And they're counting on their experience in building software that's easy to use. "[Cisco's] strength tends to be on the hardware side of things," says Jeffrey S. Raikes, president of Microsoft's Business Div.

The clearest lines of battle involve how to get digital devices to work in sync--particularly the office phone. Cisco sees a $10 billion opportunity in software that, for starters, would cause a speaker phone to turn on the moment a user launched a Web conference, without having to dial a separate call-in number. Cisco has grabbed 24% market share in office phone systems, with Internet technology that enables free calling over computer networks. That means 12 million Cisco phones are able to use its Unified Communications software. "Microsoft has given us a three-year lead," said Chambers at a conference in April. "And we've never lost a game when we've had a three-year lead."

Chambers sounded even more feisty after reporting the latest quarter, in which profits rose 34%. In an obvious dig at Microsoft, he says: "When we do move into new markets, we don't take five years to make a profit. That's a difference from our peers."

Still, Cisco must prove that it can sell products to actual business users, not just the network administrators who support them. It has taken some surprising steps in that direction. Last year it unveiled "telepresence" systems, $300,000 videoconferencing rooms outfitted with banks of video screens and high-end audio devices. And on Mar. 15, Cisco shocked competitors by buying Web-conferencing leader WebEx Communications Inc. (WEBX ) for $3.2 billion.

That puts it in direct competition with Microsoft, which is No.2 with its Live Meeting service. Microsoft's big push will come in June when it begins producing a host of products, including Microsoft Office Communicator 2007.

Despite the jockeying, this battle isn't likely to get as nasty as, say, Apple vs. Microsoft. Cisco and Microsoft still need to cooperate in plenty of areas--in part because their customers demand it. Also, Cisco wants to be in the running for huge contracts to outfit new data centers being built by Microsoft. Says Cisco Chief Development Officer Charles H. Giancarlo: "Ninety percent of our businesses are very synergistic. We've been very clear with them [about areas where they'll compete], and they've been very clear with us."

By Peter Burrows and Jay Greene

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