The view that the optical industry is due a shake-up has been aired periodically over the last decade. Yet the industry's structure has remained intact. Now, with the depressed state of the telecom industry, the spectre of impending restructuring is again being raised.
In Part 2, Gazettabyte asked several market research analysts - Heavy Reading's Sterling Perrin, Ovum's Daryl Inniss and Dell'Oro's Jimmy Yu - for their views.
Part II: The analysts' view
"It is just a very slow, grinding process of adjustment; I am not sure that the next five years will be any different to what we've seen"
Sterling Perrin, Heavy Reading
Larry Schwerin, CEO of ROADM subsystem player Capella Intelligent Subsystems, believes optical industry restructuring is inevitable. Optical networking analysts largely agree with Schwerin's analysis. Where they differ is that the analysts say change is already evident and that restructuring will be gradual.
"The industry has not been in good shape for many years," says Sterling Perrin, senior analyst at Heavy Reading. "The operators are the ones with the power [in the supply chain] and they seem to be doing decently but it is not a good situation for the systems players and especially for the component vendors."
Daryl Inniss, practice leader for components at Ovum, highlights the changes taking place at the optical component layer. "There is no one dominate [optical component] supplier driving the industry that you would say: This is undeniably the industry leader," says Inniss.
A typical rule of thumb for an industry in that you need the top three [firms] to own between two thirds and 80 percent of the market, says Inniss: "These are real market leaders that drive the industry; everyone else is a specialist with a niche focus."
But the absence of such dominant players should not be equated with a lack of change or that component companies don't recognise the need to adapt.
"Finisar looks more like an industry leader than we have had before, and its behaviour is that of market leader," says Inniss. Finisar is building an integrated company to become a one-stop-shop supplier, he says, as is the newly merged Oclaro-Opnext which is taking similar steps to be a vertically integrated company. Finisar acquired Israeli optical amplifier specialist RED-C Optical Networks in July 2012.
Capella's Schwerin also wonders about the long term prospects of some of the smaller system vendors. Chinese vendors Huawei and ZTE now account for 30 percent of the market, while Alcatel-Lucent is the only other major vendor with double-digit share.
The rest of the market is split among numerous optical vendors. "If you think about that, if you have 5 percent or less [optical networking] market share, that really is not a sustainable business given the [companies'] overhead expenses," says Schwerin.
However Jimmy Yu, vice president of optical transport research at Dell’Oro Group, believes there is a role for generalist and specialist systems suppliers, and that market share is not the only indicator of a company's economic health. “You have a few vendors that are healthy and have a good share of the market,” he says. “That said, when I look at some of these [smaller] vendors, I say they are better off.”
Yu cites the likes of ADVA Optical Networking and Transmode, both small players with less than 3 percent market share but they are some of the most profitable system companies with gross margins typically above 40 percent. “Do I think they are going to be around? Yes. They are both healthy and investing as needed.”
Innovation
Equipment makers are also acquiring specialist component players. Cisco Systems acquired coherent receiver specialist CoreOptics in 2010 and more recently silicon photonics player, Lightwire. Meanwhile Huawei acquired photonic integration specialist, CIP Technologies in January 2012. "This is to acquire strategic technologies, not for revenues but to differentiate and reduce the cost of their products," says Perrin.
"There is a problem with the rate of innovation coming from the component vendors," adds Inniss. This is not a failing of the component vendors as innovation has to come from the system vendors: a device will only be embraced by equipment vendors if it is needed and available in time.
Inniss also highlights the changing nature of the market where optical networking and the carriers are just one part. This includes enterprises, cloud computing and the growing importance of content service providers such as Google, Facebook and Amazon who buy components and gear. "It is a much bigger picture than just looking at optical networking," says Inniss.
"There is no one dominate [optical component] supplier driving the industry that you would say: This is undeniably the industry leader"
Daryl Inniss, Ovum
Huawei is one system vendor targeting these broader markets, from components to switches, from consumer to the data centre core. Huawei has transformed itself from a follower to a leader in certain areas, while fellow Chinese vendor ZTE is also getting stronger and gaining market share.
Moreover, a consequence of these leading system vendors is that it will fuel the emergence of Chinese optical component players. At present the Chinese optical component players are followers but Inniss expects this to change over the next 3-5 years, as it has at the system level.
Perrin also notes Huawei's huge emphasis on the enterprise and IT markets but highlights several challenges.
The content service providers may be a market but it is not as big an opportunity as traditional telecom. "It is also tricky for the systems providers to navigate as you really can't build all your product line to fit Google's specs and still expect to sell to a BT or an AT&T," says Perrin. That said, systems companies have to go after every opportunity they can because telecom has slowed globally so significantly, he says.
Inniss expects the big optical component players to start to distance themselves, although this does not mean their figures will improve significantly.
"This market is what it is - they [component players] will continue to have 35 percent gross margins and that is the ceiling," says Inniss. But if players want to improve their margins, they will have to invest and grow their presence in markets outside of telecom.
"I like the idea of a Cisco or a Huawei acquiring technology to use internally as a way to differentiate and innovate, and we are going to see more of that," says Perrin.
Thus the supply chain is changing, say the analysts, albeit in a gradual way; not the radical change that Capella's Schwerin suggests is coming.
"It is just a very slow, grinding process of adjustment; I am not sure that the next five years will be any different to what we've seen," says Perrin. "I just don't see why there is some catalyst that suggests it is going to be different to the past two years."
This is based on an article that appears in the Optical Connections magazine for ECOC 2012