Light Reading
Customers unhappy with Cisco's optical-module markups are turning the gray market into a growth business for used-equipment dealers

Cisco Modules Pay Off – for Other Companies

Craig Matsumoto
News Analysis
Craig Matsumoto
3/14/2012
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It's well known that Cisco Systems Inc. (Nasdaq: CSCO) puts a hefty markup on optical modules, selling standardized parts at a Cisco-branded (i.e. pretty expensive) price.

That's turning optical modules into a healthy business -- not just for Cisco, but for the used-equipment vendors that can sell the same modules without the Cisco markup. Companies such as Curvature and OSI Hardware have been doing this for years, and the growth of the business has them thinking about publicizing it more overtly.

NHR is even going a step further. It's signed a deal to be a U.S. provider of certain modules from startup Menara Networks , Light Reading has learned.

That's a change, because until now, NHR and OSI have bought modules from the same vendors Cisco uses, such as Finisar Corp. (Nasdaq: FNSR). Now, NHR will have Cisco-compatible modules that it will claim are better than Cisco's. The gray market has gone legit.

Cisco's blessing
The pluggable optical interfaces on a Cisco switch or router come in a standard size and shape and run at specified speeds. All these things are defined in multiservice agreements (MSAs), which means they should be interchangeable. Among other things, that keeps the prices down.

Sometime around 2003, Cisco started putting a "quality ID" into the modules' software, and Cisco's Internetwork Operating System (IOS) was programmed to flash a warning if that identifier wasn't found. In essence, Cisco started distinguishing between the modules it bought off-the-shelf and the modules someone else bought off-the-shelf.

Customers grumbled, and it wasn't long before NHR started selling used Cisco modules. A little more than five years ago, the company went to the next obvious step, buying the MSA modules from the same suppliers Cisco uses. One software tweak applied by the distributor, and bingo -- Cisco-compatible modules.

OSI, smaller and younger (four years old, with founders from NHR), likewise got into the modules business "as soon as we saw the demand was as high as it is," says President Jordan Quivey.

Both companies' prices beat Cisco's substantially, which of course is the whole point. NHR officials say it's common for their modules to go for half the price that Cisco demands. An OSI salesperson tells Light Reading he's sold $195 SFP+ modules that Cisco would sell for $1,050.

Back in 2006, two-thirds of readers in a Light Reading poll said they'd be willing to use cheap clones of Cisco optical modules. The real-world numbers haven't gotten to that point yet -- "I would be shocked if it was over 15 or 20 percent of this market," says Mike Lodato, NHR's senior vice president of sales and marketing -- but they've continued to grow.

Even with almost no marketing effort behind its modules, "we got close to $20 million last year on that business alone," Lodato says.

OSI operates on a smaller scale -- 500 to 1,000 modules per month, one sales representative says -- but it's recognizing the attention its module sales can bring. "We're finding some clients that are only using us for our optics," Quivey says.

What's the use?
Unpopular though the markups may be, Cisco has some justification for them. Here's what Cisco had to say when queried by Light Reading for this story:

In addition to our ongoing commitment to innovation, Cisco invests significant resources, including rigorous product and system level qualification. This ensures that our optical networking technologies perform to our customers' defined environment and specifications and meet NEBS, EMI/EMC and other relevant safety and compliance standards at a system level. The performance of so called Cisco-compatible technologies has been inconsistent and unpredictable, as they do not undergo the same system-level pre-production qualification and compliance testing on Cisco platforms. Our customers find tremendous value and peace of mind knowing that their networks are guaranteed by Cisco to maintain exceptional performance and reliability.


Lodato concedes Cisco's policy can improve quality. Namely, it can weed out some counterfeit modules that have Cisco's label slapped on them.

Counterfeiting of Cisco products has become a big business -- $76 million over the span of a few years, according to a report in 2008. In fact, that was one motivation for OSI to start putting its own label on Cisco-compatible modules. "We didn't want to sell Cisco-branded optics because of the chance of counterfeit," Quivey says.

NHR and OSI use their own labels; it's clear you're not buying a Cisco module, so the chances of counterfeit are lower. Both companies offer lifetime warranties on the modules, and they're well known enough that they're not likely to drive away under cover of night.

Going rogue
NHR's deal with Menara takes the concept even further. It's one thing to buy from Cisco's own suppliers and yet another to sell parts that Cisco doesn't offer at all.

It's certainly a break for Menara, which is essentially an engineering company and one that hasn't had a foothold into Cisco. Likewise, NHR isn't exactly an optical research powerhouse.

You'll recall that Menara won a Leading Lights award back in 2008 for being able to pack an OTN chip into its 10Gbit/s DWDM transceiver. As with IP-over-DWDM (a technology Cisco offers), this eliminates a transponder from the network. (See LR Names 2008 Leading Lights Winners.)

With the Menara deal, NHR plans to get aggressive about marketing its optical modules. So far, its model has been one of "would you like fries with that?" Lodato says, with customers getting some optics thrown in with their equipment. The hope was that they'd find out the NHR optics worked just fine and come back for more.

Now NHR is going to really test the market demand for Cisco-compatible optics reaches. "We're going to actually try this year," Lodato says.

For more
Light Reading's past coverage of Cisco's optics.

— Craig Matsumoto, Managing Editor, Light Reading

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Pete Baldwin
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Pete Baldwin,
User Rank: Light Beer
12/5/2012 | 5:39:30 PM
re: Cisco Modules Pay Off – for Other Companies


Here's a possible justification for Cisco's optical markup:


At OFC/NFOEC, I caught just a minute of a panel that included Andrew Schmitt of Infonetics. I didn't put a quote in the story because this was literally 1 minute of the panel and I didn't catch the full context -- I was walking past, to another destination -- but a bit of the conversation caught my ear.


Think of it this way: Cisco is using a pay-as-you-grow model. The chassis cost is relatively low, and the "real" cost of the system gets added on as you add optics.


The same is true for line cards, so it's not an unusual model.  Does it sound more fair if it's put in those terms?


(Of course, the error message you get when using non-Cisco optics would still be a source of irritiation for customers. I think part of what they're sore about is that feeling of being railroaded into one choice, when MSA modules are supposed to allow for many choices.)

-0
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-0,
User Rank: Light Beer
12/5/2012 | 5:39:27 PM
re: Cisco Modules Pay Off – for Other Companies


I think you got it wrong. I believe the real reason is that networking industry (and Cisco as part of it) sells software cheaper than it costs and hardware at premium. Software - especially for routers - is sold either at loss or with minimal margin. Inflated hardware prices make up for that.


Vendors have hundreds (in case of big companies like Cisco - thousands) of developers working on sw and it costs tons of money. OTOH software prices in catalogue are frequently mere thousands of $. Compare price of a single licence of MS Win + Office vs price of, say, CRS-1 software. And then compare how many licences sells MS and CSCO.


This whole model is going to change (well, it is already changing). In part because innovation cycle is slowing down. This means we will be paying more for software and less for hw.


When each component sells for the price it costs grey market will loose its attractiveness. Not sure when that will happen though.


 

salam@menaranet.com
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salam@menaranet.com,
User Rank: Light Beer
12/5/2012 | 5:39:26 PM
re: Cisco Modules Pay Off – for Other Companies


Dear editor


You have mistakenly identified Menara Networks as an Israeli company. It is in fact a US company with 100% designed-in-US and madie-in-US products. Thank you for bringing this accidental editorial inaccuracy to your readers attention.


 


Salam   

Rush21120
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Rush21120,
User Rank: Light Sabre
12/5/2012 | 5:39:24 PM
re: Cisco Modules Pay Off – for Other Companies


Actually Cisco optics have their own business unit with SPA, etc, there is no such business unit as optical any more although products are optical and ethernet products have optical interfaces but optical revenue is not recogonized as part of those products or business uinit. It was created that way back in 2005-6 and still holds true.  I unsuccessfully argued in Cisco (Senior Optical Product Manager, no longer with Cisco) to allow revenue and margins for my products.  There seems to be some confusion over locking or allowing foreign SFF optics.  SFF optics have the ability to put in a specific vendor code when created by the supplier, this is what Cisco and others do to lock their systems to a specific code, in other words if you don't have the code you may not be able to use the SFF.  Some of Cisco's products allow other SFF products to work but create MA or an constant alarm message stating a mismatch.  While some Cisco products won't allow anything but Cisco coded SFF optics, which means you buy from Cisco, used market or black market clone.  I can attest to the effort needed to qualify optical SFF or discretes, its expensive; but Cisco was more than paid back within the first year to that effort.  On other note is warranty, if you don't use a correct product (I.e. Cisco) then you can void your warranty.  Additionally there is huge revenue in Cisco warranties.  Pretty good model for Cisco.

Pete Baldwin
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Pete Baldwin,
User Rank: Light Beer
12/5/2012 | 5:39:22 PM
re: Cisco Modules Pay Off – for Other Companies


Thanks for the correction, Salam. I must have gotten Menara's backstory mixed up with one of the chip companies I've talked to over the years.

Pete Baldwin
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Pete Baldwin,
User Rank: Light Beer
12/5/2012 | 5:39:21 PM
re: Cisco Modules Pay Off – for Other Companies


> I think you got it wrong. I believe the real reason is that networking industry (and Cisco as part of it) sells software cheaper than it costs and hardware at premium. Software - especially for routers - is sold either at loss or with minimal margin. Inflated hardware prices make up for that.


Could be. You're right that that model would have to change; these vendors are already thinking of themselves as software companies more so than hardware.


Pete Baldwin
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50%
Pete Baldwin,
User Rank: Light Beer
12/5/2012 | 5:39:20 PM
re: Cisco Modules Pay Off – for Other Companies


Thanks for the extra info, Rush. Yes, other companies did take advantage of the vendor lock-in code (Extreme was one) but my understanding was that they'd backed off (Extreme, in particular). It's not like I've extensively checked this, though.


Again, I think the core issue behind all this is that some customers are feeling railroaded and bullied. Which opens up these other avenues for getting the optics.

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