Cisco learns from MS mistakes

The No. 2 technology company plays by the rules to avoid antitrust woes.

SAN JOSE, Calif. -- Cisco Systems Inc. is the world's second-most-valuable technology company. It boasts a 62 percent market share for its core product. It aggressively acquires emerging technologies and grafts them into its flagship products. And its market power is so great that three of its most entrenched rivals have surrendered in the past year.

So how has Cisco (csco) avoided the antitrust problems that have brought Microsoft Corp. to the brink of a breakup? Part of the answer lies in the dynamic market for Internet switching equipment, where well-funded startups emerge regularly to challenge one or another outpost of Cisco's empire. But Cisco's carefully choreographed conduct also deserves much of the credit.

Where Microsoft (msft) seemed to ignore or bully antitrust regulators, Cisco has schmoozed them. Where Microsoft executives left a detailed e-mail trail of potentially incriminating anticompetitive remarks, Cisco has instructed every salesperson and marketer to avoid inflammatory language -- citing Microsoft as an unfortunate example -- and to be careful when writing, on paper or computer.

Cisco's generally clean record demonstrates how it and other high-tech giants have quietly applied lessons from the Microsoft case to stay out of regulatory hot water. Despite a dominant position in database software and price changes that sometimes rankle customers, for example, Oracle Corp. has steered clear of antitrust difficulties. Ditto for America Online Inc., which has six times as many subscribers as the next-largest paid Internet service provider and, by some estimates, signs up half of all newcomers to the Net.

Even before the Microsoft case, Intel Corp. was tutoring its executives and sales staff in the vagaries of antitrust law, starting in 1987, when the chip maker declined to license the design of a new microprocessor to a key rival. Intel (intc) has been sued by competitors and by the Federal Trade Commission but has escaped with only minor sanctions. William Baer, a Washington attorney who was head of the FTC's Bureau of Competition during the Intel lawsuit, said the company's compliance program lessened its exposure to antitrust complaints.

Antitrust compliance is "embedded in our culture," said an Intel spokesman. "It colors everything we do.

Cisco has had its own brushes with federal regulators. The FTC investigated 1997 discussions of potential partnerships between Cisco and rivals Lucent Technologies Inc. and Nortel Networks Corp. And the agency took a longer-than-usual look last year before signing off on a complicated deal in which IBM Corp. effectively quit the computer-networking business in exchange for payments from Cisco.

Like Intel, Cisco has so far avoided any serious fallout from these inquiries. One big reason lies in Washington, D.C., where Cisco opened an office in 1997 while still a relatively obscure maker of high-tech gear with $6 billion in yearly sales. Its public lobbying has focused on familiar Silicon Valley goals, such as making it harder for disgruntled shareholders to sue companies whose stocks have fallen and preserving merger-friendly accounting rules.

Ciscos (csco) But antitrust issues are an integral part of the Washington, D.C., office's job. The lobbyists report to Daniel Scheinman, Cisco's senior vice president for legal and government affairs. The Microsoft case, he said, furthered his and Cisco CEO John Chambers' "belief that we were right to invest resources in Washington."

Unlike Microsoft officials, Scheinman goes out of his way to woo regulators. "They are very smart people," Scheinman said of the lawyers in the antitrust division of the Justice Department.

Cisco executives seize on every opportunity to explain themselves to federal decision makers. Following an introduction, Chambers chatted with Justice Department antitrust division chief Joel Klein at the White House correspondents' dinner earlier this year. At a university symposium last month at the Portola Valley, Calif., estate of real-estate mogul Walter Shorenstein, Chambers and Treasury Secretary Lawrence Summers talked one-on-one almost continuously through a 90-minute dinner, hardly acknowledging the other diners at their table. Just Wednesday, House Minority Leader Richard Gephardt stopped by Cisco's headquarters here in San Jose to chat with Chambers about education.

"I'd be shocked and extremely disappointed if [antitrust] were to be an issue for Cisco," Chambers said. His pitch to the nation's policy makers: "If I'm ever doing anything wrong, let's just talk about it, and I'll fix it."

Cisco is in regular contact with regulators at both the FTC and the Justice Department, since each of its acquisitions must undergo at least a nominal review. Scheinman said Cisco uses these opportunities to "educate" them about its business. Michelangelo Volpi, Cisco's top deal maker, and Charles Giancarlo, the Cisco vice president in charge of sales to small businesses, have made presentations to regulators on Cisco's competitive landscape.

Scheinman said that regulators frequently consult Cisco executives on other mergers. For example, he said Cisco executives have talked with regulators about JDS Uniphase Corp.'s pending plan to acquire E-Tek Dynamics Inc., another maker of the fiber-optic components used by Cisco and others. Cisco even offered advice on Lucent's (lu) acquisition last year of Ascend Communications Inc.

Cisco's main legal training tool for its salespeople is a 12-minute presentation delivered over the company's internal Web site. "Here's a list of the real no-no's of the antitrust laws, laws that can get our company in hot water," a deep-voiced narrator intones, as warnings against bid-rigging, price-fixing or collusion with competitors appear on the screen.

The presentation refers, both directly and indirectly, to Microsoft at several points. Avoid "guerrilla marketing language" such as "kill the competition," "dominate the market" and "own the market," the narrator said. And lest viewers forget how phrases like these can fall into regulators' hands, he warns that "e-mail, notebooks and hard disks can be looked at by lawyers." Instead, the narrator urges Cisco salespeople to offer customers an "end-to-end solution" of Cisco equipment, using one of Chambers's favorite phrases.

"Of course we're going to market it as if we're a one-stop shop for everything," Scheinman said. And Cisco will compete with rivals on price, but "we aren't giving anything away. We wouldn't have the margins we do if we were giving it away," he said.

At other points, the references to Microsoft are more direct. The narrator said that companies "with a bottleneck monopoly" have special responsibilities under the law, for instance, "a company whose operating system has become very popular." And the presentation concludes with a long excerpt from one of the most incriminating e-mails that surfaced in the Microsoft trial, the Dec. 20, 1996, one by Microsoft Senior Vice President James Allchin urging colleagues to "leverage Windows" more by including Microsoft's Internet browser as "an integrated solution."

Chambers said the presentation's reference to the special responsibility of monopolists doesn't mean Cisco considers itself a monopoly. Rather, it is a reminder to Cisco veterans that the rules have changed as the company has grown. "When you are a cute 30-pound chimpanzee, what people would consider fun or acceptable behavior in your house is not acceptable when you are a couple-of-hundred-pound gorilla," Chambers said. "To underestimate that would be a mistake."

These days, Intel includes antitrust training as part of its annual sales conference. The company said the specifics of that training are confidential under its attorney-client privilege, but a spokesman said that in general it involves briefings on the current state of antitrust law, including any recent changes and updates on pending cases that might set new precedents.

Intel managers are briefed on issues such as when certain sales behavior might be viewed as illegal product tying -- one of the government's main complaints in the Microsoft case. Top executives get an annual "report card" on Intel's antitrust status and more frequent updates on specific problems.

It isn't illegal to have a monopoly; what does violate the law is using monopoly power to crush those that threaten that position. "You're allowed to succeed," said Washington antitrust attorney Marc Schildkraut. A company gets into trouble, he said, when it displays "exclusionary conduct not justified by some pro-competitive effect."

Beyond market share, regulators considering an antitrust case typically look at whether competitors are complaining and at how hard it is for rivals to enter a market. "If you stay big because you continue to offer better value and better pricing," said Baer, the former FTC official, "then the antitrust laws ought to stay out of there."

Cisco has vanquished its traditional competitors. 3Com Corp., IBM and Lucent have stopped, or will soon stop, selling computer networks to large companies. In their place, however, are upstarts such as Redback Networks Inc., Juniper Networks Inc. and Foundry Networks Inc., with rapidly growing sales and multibillion-dollar market values.

The newcomers voice few complaints. Cisco plays hardball, they say, but it plays by the rules. "They are a tough competitor, but they are beatable," said George Prodan, vice president of marketing at Extreme Networks Inc., Santa Clara, Calif., which went public last year, selling gear that competes with some of Cisco's. Extreme is on track to top $200 million in sales in the fiscal year ending in June. "A lot of those were Cisco shops," Prodan said of Extreme's customers.

Even more rivals are on the way. Venture capitalists invested $4.3 billion last year in roughly 200 communications-equipment startups, according to VentureOne, a San Francisco market researcher.

AOL (aol) said it, too, faces competition from upstarts, notably free Internet providers such as NetZero Inc. and Juno Online Services Inc., which have grown quickly by eliminating monthly access fees. "Every consumer everyday can switch off AOL and go to a competitor," said George Vradenburg, AOL's senior vice president for global and strategic public policy.

Cisco also claims it is unlike Microsoft because its products must conform to open standards published by industry groups for how Internet switching machines talk to each other. By contrast, Microsoft controls virtually all the programming code for Windows and the instructions that allow other programs to talk to Windows -- control that the government argues it has used illegally to hurt competitors. "We don't have a secret sauce," said Scheinman, Cisco's top lawyer.

Well, at least not as strong a sauce as Microsoft's: In fact, Cisco does add some of its own software to the industry standards that keeps customers coming back for more.

Cisco promotes this software of its own with the claim that the Cisco-owned code ensures that Cisco's machines work better when they talk to each other, rather than with machines made by rivals. And, because of its dominant market position, Cisco's Internet Operating System has become the lingua franca of the Internet. Cisco's 62 percent market share for the Internet switches known as routers dwarfs its competitors'. Lucent is second, with 5 percent of the router market, according to market researcher Cahner's In-Stat, Newton, Mass.

Cisco's software is so crucial to the operation of the Internet that rivals must track the bugs in the code, for fear of disruption to their machines. "If you're going to be in a network dominated by Cisco routers, your router needs to operate in a particular way," said John Ryan, chief analyst at market researcher RHK Inc., South San Francisco, Calif.

Cisco's proprietary code has enough of an edge that some competitors tout their compatibility with it. Scott Kriens, CEO of Juniper Networks, frequently said that his company's biggest cachet is that it makes the only routers for the core of the Internet that have been proved to communicate effectively with Cisco's. Juniper began selling its routers in late 1998 and quickly grabbed 15 percent of the market, according to RHK.

Cisco counters that the Cisco-owned portion of the software built into its products is too tiny to constitute any edge meriting antitrust scrutiny. Cisco's Scheinman said that 99 percent of IOS is based on open standards. "I can count the exceptions on one hand," he said.

Anne Marie Squeo and David P. Hamilton contributed to this article.