Lawsuit puts spotlight on Huawei

On Jan. 23, Cisco Systems Inc. filed suit against Huawei Technologies Co. Ltd., alleging that the Chinese company had unlawfully copied its input/output supervisor (IOS) software, including source code, and infringed upon at least five Cisco patents.

The legal battle kicked off with that suit, which also implicates two Huawei subsidiaries in the U.S., Huawei America Inc. and FutureWei Technologies Inc., has put the spotlight on Huawei, one of China’s top networking and telecommunication equipment vendors and a growing threat to equipment vendors like Cisco.

On Monday, Huawei filed an opposition brief in the case, saying Cisco’s call for a preliminary injunction against Huawei was unwarranted, but acknowledging that some copying had occurred: In 1999, a Huawei employee obtained from a third party some of the source code at issue in the lawsuit, which another Huawei employee used in development work, the company acknowledged.

The Chinese network equipment maker is investigating the case, is removing products based on the contentious source code from the U.S. market, and is redesigning all the product elements in question, Huawei said in a statement. It rejected a number of Cisco’s allegations, and reiterated its belief that Cisco’s real goal is to reduce competition by blocking Huawei’s participation in the U.S. market.

Cisco representatives were not immediately available for comment on Huawei’s latest statements regarding the case.

Founded in 1988, privately owned Huawei is one of China’s most aggressive high-tech companies, with a product range that spans fixed-network telecommunication equipment, mobile telecommunication equipment, optical networking equipment and data communications products.

“In China, they are seen as a company that is very different from the typical bureaucratic culture,” said Bertrand Bidaud, vice president of telecommunications at Gartner Group Advisory (S) Pte. Ltd., in Singapore. “They also have a very strong focus on technology and marketing.”

“They are pushing exports and they have some ambitious plans,” he added.

Last year, international sales accounted for around 20 per cent of Huawei’s revenue, the company said. The company’s two largest international markets are Thailand and Russia, which each accounted for more than US$100 million in sales during 2002, it said.

As part of its plans to broaden international sales, Huawei entered the North American market in the second quarter of last year and has been primarily focused there on selling routers, switches, mobile wireless infrastructure, videoconferencing equipment, and optical network gear, said a U.S.-based spokeswoman for the company who asked that her name not to be used.

Huawei seems to have just got started with its North American plans when Cisco first raised concerns about alleged intellectual property violations in December. At that point, Huawei had shipped about 640 routers and switches to the U.S., most of which were given or sold to potential customers for testing and demonstration, the spokeswoman said.

Huawei’s expansion plans may be overly ambitious, particularly in its efforts to build a broad product line that extends from basic networking gear to high-end optical equipment.

“They are trying to cover the whole spectrum of telecommunication equipment,” Bidaud said. “I’m not sure it’s the right thing to do but they think it is.”

To support its product plans, Huawei has placed a heavy emphasis on research and development (R&D), with 46 per cent of its 22,000-person workforce and at least 10 per cent of its annual sales revenue allocated to R&D-related activities, according to the company.

Huawei spent US$342 million, out of revenue of US$2.4 billion, on R&D in 2001, putting the company far ahead of Legend Group Ltd., China’s top computer-maker and one of the country’s best known tech companies. Legend, by comparison, spent US$15.2 million, or 0.6 per cent of its revenue, on R&D during its 2001 fiscal year.

Huawei has also signed partnerships with a range of overseas companies, ranging from joint software development efforts with Microsoft Corp. to the development of third-generation (3G) mobile technology and services with NEC Corp. Most recently, Huawei established a joint venture with 3Com Corp. to build enterprise networking equipment.

But joint ventures and outspending other Chinese tech companies may not be enough for Huawei to keep pace with foreign networking rivals. Cisco spent US$3.8 billion on R&D during its 2001 fiscal year, more than 10 times the amount spent by Huawei.

“If you look at how much they invest in R&D in dollar terms, it’s much less than companies like Cisco and Nortel (Networks Ltd.),” Bidaud said, noting that Huawei’s focus on building a broad product line means that the company’s R&D dollars are spread thinly.

Unable to keep pace with its foreign rivals on spending to develop new technologies, the greatest threat that Huawei presents to companies like Cisco is its ability to offer networking gear at cut-rate prices. “The threat (Huawei presents) is the threat of commodity,” Bidaud said.

“Cisco is taking a big premium on every piece of equipment that it sells and the market value of Cisco’s stock is based on this premium,” he said. “The worst scenario for Cisco is that some segment of their market becomes price-competitive, when competition becomes based on price and not value.”

In China, Huawei has used lower prices to dominate some sectors of the telecommunication equipment market, Bidaud said, citing central office switches as one market where the company has a leading position.

Cisco is well aware of the threat that Huawei presents. Speaking at a financial conference in January, Cisco President and Chief Executive Officer John Chambers acknowledged that Huawei, along with Dell Computer Corp., poses a threat to the company’s dominance of traditional network equipment markets.

The legal contest currently unfolding between Cisco and Huawei is one indication of the seriousness of the threat that is posed by the Chinese equipment maker. “It is an indication of the fact that Huawei is perceived as a threat and when Huawei is more mature they are going to compete in more markets,” Bidaud said.