COM D. Kraus, B. Hafner, S. Blood, D. Neil, J. Lassman, B. Tratz-Ryan, J. Snyder, F. Fabricius, E. Steman

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1 D. Kraus, B. Hafner, S. Blood, D. Neil, J. Lassman, B. Tratz-Ryan, J. Snyder, F. Fabricius, E. Steman Research Note 25 July 2003 Commentary Vendor Rating Siemens: Focus on ICN Business Unit Siemens AG is a strong and stable vendor, but financial, technical and marketing challenges continue to hamper the performance of its Information and Communications Networks business unit. We rate Siemens AG a "positive" overall. Its Information and Communications Networks (ICN) business unit performance is lagging due to financial, technical and marketing challenges. Long term, ICN will likely continue to be a stable player in carrier and enterprise telecommunications (see Table 1). Table 1 Detailed Rating Initiative Rating Viability Corporate (Siemens AG) Strategy Positive ICN Strategy Promising Corporate (Siemens AG) Financial Positive ICN Marketing Caution ICN Organization Caution Products/Services/Technologies Products/Services ICN Enterprise Communications Solutions Caution ICN Carrier Network Solutions Promising Soarian Medical Products Positive Technology ICN Products Promising Soarian Medical Products Positive Pricing ICN Products Promising Soarian Medical Products Promising Customer Service/Product Support ICN Sales/Distribution Promising Soarian Medical Products Positive ICN Support Services Positive Source: Gartner Research (July 2003) Gartner 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 Siemens Viability Siemens AG is a true industrial conglomerate, competing worldwide in a variety of technologies, predominantly in electronics and electrical engineering. Siemens' product diversity includes power generation and transport facilities, light bulbs, IT telecommunications equipment, healthcare technologies and washing machines. Although Siemens AG is considered a single entity in the "Strategy" and "Financial" sections of this research, the remainder of the research focuses on Siemens' ICN business unit. We evaluate Siemens' healthcare offering (Soarian) in separate research (see "Vendor Rating: Siemens Moves Into the Future With Soarian"). Siemens AG Strategy (Positive) The company's diversification allows it to mitigate many of the risks faced by companies that are dependent on one technology segment. Siemens has launched SiemensOne, an initiative geared toward providing business solutions to multiple Siemens' business units and operational groupings. Although this program holds great potential for serving strategic accounts, it only addresses the largest customers. ICN Strategy (Promising) Faced with a downturn in the telecommunications equipment market, ICN's strategy in 2002 was heavily influenced by its need to reduce expenses and show progress toward a return to profitability. This is more a survival tactic than a long-term strategy. Having weathered significant program cuts, ICN appears to have emerged with a stronger focus on the convergence of voice and data networks and the applications that leverage these networks. ICN's emerging product strategies, including application offerings and system management environments that span enterprise and carrier networks, and a portfolio of next-generation carrier platforms provide early evidence of this focus. This represents a significant step forward for ICN, although delivery on the vision will remain a challenge. ICN is strengthening its customer orientation, but it remains to be seen if it can sustain increases in sales. ICN's longer-term goal of being recognized as an innovator and captor of market share will require a significant "mind shift" by ICN staff as well as customers. ICN's focus on deriving revenue from its installed base in key Western European markets, rather than driving new sales, may meet near-term cost-cutting requirements but won't position ICN as a leader as the economy recovers. Siemens AG Financial (Positive) Siemens AG increased net income by 24.3 percent and earnings per share (EPS) by 23.7 percent in its fiscal year ended 30 September In the ensuing six months, net income and EPS declined 40.1 percent and 40.5 percent, respectively. The company continues to tightly manage its costs. Despite a recent mercurial financial performance, Siemens AG is a strong, wellfunded and viable company, and will likely remain so for the near future. ICN posted a total sales decline of 25.1 percent and an earnings loss of 697 euros in fiscal 2002, by far the worst-performing business unit within Siemens AG (see Table 2). Sales and earnings continued to decline through March ICN's enterprise networks division posted a solid profit in FY02, compared to a net loss in the prior year. Most of this revenue appears to have been generated by services, rather than products. If ICN continues to show poor performance, its parent division, Siemens Information and Communications (I&C), could divert its investments toward profitable business units. 25 July

3 Table 2 Selected Financial Results Year Ended 30 September Change (in millions of euros) EBIT* 19.7% (691) (861) EBIT margin (7.2)% (6.7)% Total Sales (25.1)% 9,647 12,882 New Orders (31.2)% 8,697 12,639 * EBIT = Earnings before financing interest, income taxes and certain onetime items Source: Siemens AG (December 2002) ICN Marketing (Caution) ICN faces challenges in the marketing arena. Avaya, for example, has begun marketing campaigns targeting next-generation applications and solutions awareness, while Cisco Systems maintains the "lion's share" of awareness among IT decision makers. Siemens has traditionally been low-key in marketing its ICN solutions, and will need to make a significant shift in its marketing practices for ICN to gain market share and to be seen as an innovator. It is questionable whether ICN has the budget to compete for "mind share" in light of its ongoing fiscal austerity efforts. Recent marketing efforts in North America have improved awareness for ICN. ICN Organization (Caution) In FY02, the ICN business unit generated revenue of 9.6 billion euros (representing 11.6 percent of Siemens AG's operational sales). In FY02, Siemens Information and Communications Mobile generated 11 billion euros in sales (13.3 percent of Siemens AG's operational sales) and Siemens Business Services generated sales of 5.8 billion euros (6.9 percent of Siemens AG's operational sales). Both units, like ICN, are part of the I&C group. I&C is one of six operational business groups at Siemens AG. The other operational groups are automation and controls, power, transportation, medical and lighting. There are a total of 13 business units within these groups. This diversification offers limited stability for ICN, because Siemens AG can absorb some near-term losses while waiting for the global telecom market to rebound. It also means that Siemens AG could reduce or discard the business unit if the economic rebound is significantly delayed or is less robust. During the past two years, ICN has completed a number of reorganizations and consolidations to help streamline operations and reduce costs. As of 31 December 2002, approximately 30 percent of ICN's staff was terminated. Although this streamlining should eventually result in a more cohesive and nimble organization, such moves are expected to have disruptive effects within ICN in the near term as projects and project teams realign. Further downsizing and reorganization are expected. Products/Services/Technologies ICN Enterprise Communications Solutions (Caution) ICN holds the No. 2 market share position for worldwide enterprise telephony shipments, although its position is being eroded in key markets. Like many enterprise telephony vendors, ICN is focusing its development on next-generation IP-based solutions, and intends virtually all new telephony systems sales to be IP-enabled. ICN's recently announced ComScendo software provides call processing and feature capabilities across all of ICN's IP Telephony platforms. The user interface, system features and networking functionality are the same for some, but not all, of these platforms. However, in most standard configurations, this should not limit user capabilities at remote sites and feature transparency across the network. 25 July

4 ICN offers a smooth upgrade from its time division multiplexing (TDM)-based HiCom 300 PBX to its IPbased HiPath It has not yet delivered a cost-effective migration path for its installed base of 9751 in North America and its popular Realitis telephone systems in the United Kingdom. This is a potentially serious shortcoming it exposes the installed base to further market share erosion due to poaching from competitive offerings, particularly because the 9751 and Realitis systems represent a significant portion of ICN's corporate customer base. ICN recently announced OpenScape, a real-time communications software suite that provides presencebased conferencing and multimedia capabilities, addressing one of IP Telephony's hotter operational differentiators: enhanced collaboration tools. Developing user demand and channel readiness for this early adopter technology will be challenging. Additional enterprise applications include mobility and personal productivity tools, and unified messaging applications that, when combined with OpenScape, provide many of the tools for a unified communications offering. These applications address markets that have been slow to develop. ICN's plans to acquire Cycos, the original equipment manufacturer it uses for its unified messaging product, will give ICN greater control over product development. ICN's call center offering provides a serviceable application platform for call centers with basic to moderate call routing and computer-telephony integration complexity needs. As IP Telephony enables application software to operate independently from the switching platform, ICN can expect competition to increasingly target its installed base. ICN Carrier Network Solutions (Promising) ICN has a globally strong installed base of TDM EWSD circuit-switched carrier network equipment. ICN is building its next-generation infrastructure strategy on voice over IP (VoIP) and broadband access. Its VoIP solution encompasses Softswitch and media gateway technologies, offering carriers a stepping-stone approach to converge TDM to asynchronous transfer mode and IP networks. In North America, ICN faces strong competition from incumbent vendors, but has a chance to increase its presence due to market volatility. Siemens also launched the "we surpass" partner program, which encourages the development of open interface applications. ICN's broadband access offering is based on its array of xdsl customer premises equipment (CPE) and central office (CO) products, its narrowband and broadband integrated multiservice platform, as well as its integrated voice, data and multimedia platform. ICN has a strong presence in Europe with its DSL offering. It has gained presence in the North American market with its acquisition of Efficient Networks. Dramatic price declines for xdsl CPE and CO ports continue to challenge ICN's margins, threatening the profitability of this part of its broadband access strategy. ICN was among the top five Synchronous Digital Hierarchy (SDH) suppliers in Western Europe and worldwide in It is offering next-generation dense wave division multiplexer and SDH solutions to replace and extend the previous Siemens SDH solutions. ICN has been hit by the dramatic downturn in the optical transmission market, and is trying to increase revenue and market share via new product offerings, focused to reduce carrier Opex. Despite SDH's dismal market performance, ICN's large installed base and next-generation carrier products and service offerings should enable the business unit to strengthen its position when the market rebounds. ICN Technology (Promising) ICN's enterprise and carrier communication systems and software are technically sound and continue to show signs of improvement. Advancements in standardizing its user interface and system management software across IP Telephony platforms and early developments in its collaboration tools offering show promising vision. This is an indication that ICN may yet shed its reputation for offering solid, albeit not highly innovative, products and marketing. 25 July

5 ICN Pricing (Promising) ICN leverages its strong brand recognition in Western Europe to command premium pricing for products and services. In North America, its offerings typically fall into "middle of the pack" pricing. As price competition gets steeper for hardware and software, service revenue will continue to deliver a greater percentage of margin to ICN. Customer Service/Product Support ICN Sales/Distribution (Promising) ICN sells primarily through its direct sales force to large enterprises and carriers. This is an expensive approach, particularly in addressing the needs of branch offices of large enterprises. ICN uses direct and indirect channels to reach small and midsize businesses. Indirect channel partners include systems integrators, value-added resellers, distributors and carriers requiring varying levels of sales and support involvement from ICN. Direct account involvement is helpful in building and nurturing an indirect sales channel, but ICN will need to build a channel that is largely self-sufficient to maximize long-term profitability. To address the small office/home office market, ICN sells primarily through indirect channels, with limited direct sales via the company's Web site. Low-cost fulfillment style channels are key to addressing this typically lower-margin product category. ICN Support Services (Positive) Services range from basic system installation and maintenance to complete network and application outsourcing, to high-end systems integration and applications consulting (for example, call centers). Despite experiencing a 12 percent reduction in staff during 2002, the organization continues to provide a high-quality portfolio of on-site and remote services, directly or through channel partnerships. ICN's sales and support strengths are primarily in large, multinational accounts and in Western Europe. ICN is generally regarded as a second-tier player in North America, and is not seen as growing its presence in this important market. Recommended Reading and Related Research "Vendor Rating: Siemens Moves Into the Future With Soarian" "North American Enterprise Telephony Magic Quadrant 2002" "2002 EMEA Corporate Enterprise Telephony Magic Quadrant" "Unified Communications Magic Quadrant 1H03" "EMEA Contact Center Infrastructure Magic Quadrant 2002" "Siemens Realitis DX: Preparing Customers for New World" "Siemens HiPath ProCenter Suites" "Siemens HiPath Xpressions V3.0" "Siemens Phon Systems" 25 July

6 "Siemens HiPath 3000 Communications Servers" "Siemens HiPath 4000" "What the Juniper/Siemens Deal Says About Networking" "Worldwide Media Gateways" "Western Europe: Central Office Switching, " "Worldwide PBX/KTS, IP-Enabled PBX/KTS, and IP-PBX Market Share and Forecast, 2002" "Call Centers: Western Europe, " "North American Call Center Market Share and Forecast, " Bottom Line: Gartner rates Siemens AG as "positive" overall, due to the company's continued ability to generate positive net income in a climate of global business uncertainty. Siemens' Information and Communications Networks business unit provides telecommunications networks, applications and services to enterprise and carrier customers. ICN's performance is receiving significant scrutiny from Siemens AG. ICN is demonstrating a slow turnaround on key financial metrics, but continues to face difficulties in positioning itself for growth in a challenging global economy. ICN benefits from a large installed base that represents a potentially significant revenue stream in upgrades from traditional circuitswitched to IP-based networks, platforms and applications. ICN must prove it can deliver on its strategy to maintain and improve its market position. 25 July