Optics vendor profitability depends on new strategy

Ovum Demand from Google and Huawei resonated throughout the 36th European Conference and Exhibition on Optical Communications (ECOC) held 19–23 September 2010 in Turin, Italy. Optical component suppliers expressed both hope for these new opportunities and fear of large customer concentration.
 
Recent robust demand has helped suppliers post profitable returns. However, in a recent report Ovum finds sustaining profitability hinges on suppliers’ ability to deliver a new business strategy.
 
Suppliers scramble to meet demand; customers want more and faster
 
Tension between optical component suppliers and their customers was bubbling below the surface at ECOC 2010. Conversations with component suppliers indicated they are running all out to meet demand. Yet system vendors expressed concern that the component vendors are not mature or nimble enough to meet today’s surging demand or manage through the down times.
 
Meanwhile, the public announcements painted the picture of orderly, evolutionary technical and product advance. New components and modules that support transmission at 10Gbps and above and that support agility at the optical layer could be found throughout.
 
Rise of a new industry gorilla, but how much will it spend?
 
The clash between Google and Finisar in the 40Gbps and 100Gbps Systems Market Focus session was a public display of customer and supplier frustration. Google is a unique service provider because it purchases optical components and builds some of its own equipment.

Its request for a non-standard product put its needs at odds with the industry as a whole. It believes today’s industry standard 100GbE product (100GBase-LR4) is too expensive, too big, and too power hungry, and that the roadmap to the next-generation product is too long for use in its networks. Optical component market-leading Finisar is shipping this product.
 
 
Google has taken to the bully pulpit, perhaps betting on its large market cap (over $150 billion) and high profile to drive industry support. What’s disappointing is that Google did not participate in the IEEE standardization process, the basis for today’s transceivers. Moreover, while Google’s voice is heard industry-wide, we estimate its typical annual optical component expenditure at less than $50 million. Huawei, in contrast, likely accounts for more than ten times that.
 
Rest assured that a component supplier will make what Google wants; Santur is the leading candidate. Also note that this is unlikely to be the last time the optical communications industry has heard from Google.
 
Huawei’s dominance reverberated throughout
 
Although Huawei’s status as an industry giant has been clear for some time, at ECOC we recognized just what this means to the optical component suppliers.
 
We did not speak to Huawei at ECOC, nor did it make any announcement, but its presence was felt throughout. Its demand forecast was a common subject for numerous component vendors, particularly for 40Gbps parts. Its large purchase and forecast volumes cause suppliers to question the sustainability of the deployments and the wisdom of investing in capital expenditure to meet one customer’s demand.
 
Given Huawei’s leadership of the optical networking market (25% share) and its share growth across a range of infrastructure segments, past history suggests that one must take the forecasts seriously. The long-term challenge is that by serving Huawei a supplier may get into a monopsony situation and be left with little margin.
 
 
Serve customers and build a sustainable business
 
Overall, at ECOC we verified high demand for optical components. Google and Huawei appear to be making supplier demands that may not fit with the rest of the market, but these do represent growth opportunities. Yet we worry that these opportunities may run counter to suppliers’ goals of sustained profitability.
 
Suppliers are pleased now, as their businesses are profitable and the market outlook is for continued growth. But analysis in our recent report “In search of sustainable profitability for optical component vendors” shows that component vendors have cut the very things, namely R&D and capacity that they now need to meet market demands. This observation points to the need for new business strategies if these suppliers are to be profitable in lean times and successful during booms.

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