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Optical Survivors – John Dexheimer, Lightwave Advisors

January 21, 2002

5 Min Read
Optical Survivors

After a year of declines in capital spending (capex) and a lingering hangover from the inventory bubble of 2000, everyone is now worried about more capital spending declines by U.S Carriers in 2002.

As conventional wisdom has it, the dominant portion of capital spending will belong to the incumbent telecom carriers. The big question is whether capex returns to 1999 levels in 2003, 2004, or 2005. In the more optimistic scenario, players such as Global Crossing Ltd. (NYSE: GX), Level 3 Communications Inc. (Nasdaq: LVLT), Qwest Communications International Inc. (NYSE: Q), SBC Communications Inc. (NYSE: SBC), Sprint Corp. (NYSE: FON), Verizon Communications Inc. (NYSE: VZ), and WorldCom Inc. (Nasdaq: WCOM) will all open up their labs again and award every system startup contracts. But this all sounds as likely as a World Series victory by the Boston Red Sox.

Red Sox fans and others dealing in hard realities – and facing up to the massive failures of the Telecom Act – argue that the incumbents are the only game in town for the next few years.

Many players are using this new “reversion to the incumbents” trend to employ the old “FUD” (Fear, Uncertainty, Doubt) strategy. FUD, which emerged during IBM Corp. (NYSE: IBM) mainframe days, is a strategy of intimidating customers by assuring them your startup competition is going out of business. This strategy was the one initially employed to keep the minicomputer and ”toy” PCs from ever being used in the corporate world.

This occurred to me, when, recently, the CEO of Tellabs Inc. (Nasdaq: TLAB; Frankfurt: BTLA) played the FUD card in addressing an investor group in New York. Telecom equipment would soon be supplied by only a handful of systems firms, he said. [Ed. note: Ironically enough, though bad-mouthing purchases from startups, Tellabs just forked over $355 in cash to buy one – see Tellabs Cops Ocular.]

In such a climate, next-generation technology is being pushed out in time, forecasts for demand have dropped, and Ethernet and MPLS have yet to be telecom “hardened”. In the incumbent world, Sonet, Telcordia compliance, and Osmine still rule. FUD is what they want. It’s comfortable. The fact that the wonderful world of Osmine-based equipment is difficult to manage and not delivering what customers want doesn’t matter. It keeps incumbents happy. We might as well bring back batch processing and slide rules as well.

Is this our destiny?

Well, such a dismal outlook discounts several grounds for optimism. For one, few analysts have commented on the size and role of non-U.S. carriers. While North America may be the dominant corporate location for equipment and component vendors, the end-market (those with the capital budgets) is much broader. If we want to understand the drivers of customer needs and the timing of turns in sector demand, we need to take a global perspective and look outside that handful of U.S. carriers.

A December report by J.P. Morgan & Co. includes some very interesting data. Thirty-two of the 50 largest carriers in the world are from outside North America. Seven of the top 10 are outside the U.S. If you look at the market capitalization of the top 10 carriers, 68 percent comes from outside the U.S. Economic indicators all support the view that substantial growth will come for equipment vendors outside the U.S. market. Most importantly, direction will also come from these markets: Direction in performance requirements, direction in pricing, direction in architectures, and direction in the need for meeting archaic specs and standards – all this may be very different than that to which the cozy little U.S. incumbent club has grown accustomed.

FUD is comfortable, in some circles, but fundamentally uneconomic. Just as the perceived “non-mainstream” and foreign users in computing in the 80s broke open the floodgates of low-cost, distributed computing, a similar evolution may likely be led from outside the U.S. incumbents' cabal in terms of carrier investment. After all, foreign deployments of ISDN, DSL, broadband video, and mobile services have all outpaced those in the United States. For the optical systems industry to right its direction, we need to incorporate the needs of the largest markets.

Thankfully, some U.S. organizations like the Optical Internetworking Forum (OIF) and Optoelectronics Industry Development Association (OIDA) recognize the need to change. OIDA has an initiative aimed at achieving cost reduction targets of 25 to 30 percent in carrier neworks, as suggested by the consulting firm McKinsey & Co. New design methodologies, automated manufacturing, automated testing, integration methodologies, and changes in the Telcordia processes and standards are all necessary and are being addressed to move the industry forward.

Beyond praying and hoping that 2002 is better than 2001, what’s the call to action? One is to get active in industry-wide initiatives and evolving standards. The other is to engage in change. As the mainframe computer vendors of the early 80s learned the hard way, ignoring a known big customer segment, playing the game of FUD with your existing customers, and not focusing on the supply chain is a recipe for disaster.

It’s time to look globally. Startups need to look for distribution and strategic partnerships. Mergers to gain scale and breadth may be the best option for the majority of small component players. But it’s do or die. Death is assured if you are waiting for a U.S. incumbent to wake up.

See the world and enjoy the pursuit of matchmaking in 2002!

John Dexheimer is President of Lightwave Advisors Inc. He has helped optics firms raise over $800 million of equity investments, helped found two firms, and is a limited partner in three VC funds. He is on the boards of several optics firms and acts as a consultant. In his prior life as an investment banker he led the IPO of Uniphase in 1993 and managed the equity research organization of a brokerage firm.

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