IBM technology buy means big things to Cisco

Cisco and IBM have been bitter rivals for years in the SNA-to-IP internetwork and migration wars. Cisco concocted a way for SNA accounts to replace expensive, high-margin IBM front-end processors (FEP) with channel-attached routers. IBM was resolute in its attempts to maintain SNA account control, even going so far as to claim it would "eat its young" before giving ground to Cisco.

IBM must be bloated, because Cisco now claims to own at least 75% of the SNA/IP internetworking market. In August, IBM finally conceded such and handed over a plateful of its young to Cisco.

The companies hammered out a $2 billion deal that essentially shutters IBM's Networking Hardware Division in Raleigh, N.C., and pushes NHD router and switch customers into the waiting and welcoming arms of Cisco. Cisco will purchase all of NHD's routing and switching intellectual property.

IBM, meanwhile, will offer global service and support of Cisco gear, and Cisco will purchase more IBM technology and resources over the next five years. IBM will continue to develop, sell and support SNA FEPs and software, Token-Ring gear and Ethernet adapters.

With a monopoly on the SNA/IP internetworking market and IBM an also-ran in LAN routing and switching - IBM had less than 1% of the switched Ethernet market in 1998, compared with Cisco's 44%, according to The Dell'Oro Group - what value could Cisco possibly derive from the $2 billion deal with IBM?

Plenty.

"Even in the SNA-to-IP market, we do have 80% market share, but we believe the market's only been penetrated by about 20% worldwide," says Selby Wellman, senior vice president of Cisco's Interworks business division. "This is worth billions to both companies, and that's just one good reason why right there."

Analysts say the deal also eliminates Cisco's only competition in the SNA-to-IP internetworking market.

"What Cisco gets out of it is that it greatly reduces its sales cycle because it doesn't have to fight IBM anymore," says Dave Passmore, research director at NetReference in Sterling, Va. "That in itself should help it accelerate revenue and reduce sales resources to take IBM out."

The service and support aspect of the deal is nothing to sneeze at either. IBM Global Services is a multibillion dollar business. Having that as a backup can only help Cisco win over more huge IBM network accounts.

"It seems to make IBM a Cisco service provider now," says George Young, vice president at investment firm Morgan Stanley in New York, a joint Cisco/IBM account.

"IBM has the'feet on the street' to participate in the deployment and operation" of networks, Wellman says. "It has 130,000 employees in 60 countries, so partnering with IBM Global Services is really a home run for us."

It's a home run because Cisco did not and will not invest in a service and support infrastructure on the scale of IBM Global Services. Cisco chooses to partner for these requirements, as evidenced by this arrangement with IBM, and by its $1 billion investment in IT consultant KPMG.

On the surface, the billion-dollar investments in both integration giants would seem to create the potential for conflict. But Wellman says the overlap between IBM Global Services and KPMG will be minimal because KPMG focuses on consultation and design; IBM Global Services emphasizes deployment and operation.

Cisco finds value in IBM's routing and switching intellectual property as well, even though Cisco's IOS routing code is the de facto standard in IP and multiprotocol internetworking. Once Cisco becomes fluent in the intricacies of IBM's routing and switching code, it will be easier to write hooks into IOS and migrate NHD customers over to Cisco's gear.

"As you embark upon a migration plan for those customers, the odds are you're going to encounter some things on how they run their network that they would also like to have on their Cisco gear," Wellman says. Network management hooks into IBM's Tivoli Management Environment is one specific gain from the acquisition of IBM's routing and switching source code, Wellman adds.

Cisco also acquires hundreds of patents by purchasing the NHD technology, Wellman says. This intellectual property is key for Cisco as it looks to increase its patent portfolio to better defend itself against any potential legal wrangling with other companies.

"We don't use our patents in an offensive mode like some companies do," Wellman says. "When those companies come after us . . . the broader our patent portfolio, the easier it is to settle the whole issue."

Cisco also has the option of acquiring other IBM technology over the next five years, but the real appeal of this aspect of the deal is IBM's chip manufacturing operations. Cisco designs its own Application Specific Integrated Circuits, but IBM could spin them out quickly and in high volumes, which would mean lower production costs and faster time to market for Cisco products.

"IBM has a world-class foundry for producing the chips," Wellman says. "An awful lot of that $2 billion is going to be made up of us buying those chips from their foundry that we designed."

Analysts say Cisco and IBM will also collaborate on developing mainframe channel protocols for the channel interface processor (CIP) on Cisco routers. Before this arrangement, IBM would keep channel protocol technology a moving target for Cisco. "IBM was changing [the protocols] every six months and forcing Cisco to play catch-up," Passmore says.

The opportunity for Cisco and IBM to now collaborate on this development instead of compete is viewed positively by some joint Cisco/IBM shops. Some say the collaboration - or concession - began months before the $2 billion arrangement.

"I sensed over the last several months, as we began planning our FEP-to-CIP migration, IBM seemed to be totally on board with it," says Charles Sokolski, senior vice president at financial services giant AXA Financial in New York. "Over the last two months or so, IBM was really facilitating it. They were very encouraging."

But now this $2 billion deal makes it official, and there's more collaboration to come.

"When you form a strategic alliance like this, your competitive barriers no longer exist," Wellman says. "This opens up all kinds of doors. You're going to see IBM and Cisco working jointly in a lot of development areas around the world in e-business. There's a lot we can do between servers, software and networking software to make things work better and smoother."

Some examples include management of Cisco gear from the Tivoli product, developing IP stacks for the mainframe and defining interfaces between IBM's System/390 Open Systems Adapter and Gigabit Ethernet, Wellman says.