Shedding Darwin on Light

Shedding Darwin on Light -- Stephen Saunders

February 15, 2001

6 Min Read
Shedding Darwin on Light

Let's face it: The last four or five months have been brutal for the opticalnetworking industry. The problems began with concerns about the slowdown oncarriers' capital spending, and were followed by a Nasdaq annihilation thatsaw the share price of many of the public optical players fall by 50 percentor more -- a lot more, in the case of companies like Corvis Corp. (Nasdaq: CORV), Foundry Networks Inc. (Nasdaq: FDRY), Lucent Technologies Inc. (NYSE: LU),Redback Networks Inc. (Nasdaq: RBAK, and Sycamore Networks Inc. (Nasdaq: SCMR).

Unfortunately, the optical industry's problems aren't over yet. LikeBiblical plagues, there are more woes on the way.

The next curse to strike the optical networking industry will be an almightywinnowing amongst the startup community.

Pruning is inevitable given the "if it moves, fund it" attitude tooptical investing taken by the venture capital community last year. LightReading maintains a global directory of every company (public and private)involved in the optical networking industry -- from fiber infrastructureservice providers, to systems vendors, to components manufacturers. Thereare now over six hundred companies on the list (605, to be exact). We alsomaintain a separate registry of companies that are still in "stealth mode,"which means they aren't at the point where they are ready to start talkingpublicly about their products. That list now totals 168.

That's too many, obviously. In fact, the shakeout has already claimed one ofits first IP system vendor victims: Ironbridge, which shut its doors at theend of last month (see IronBridge Has Fallen Down). IPHighway Inc. and Point Reyes Networks Inc. look setto follow Ironbridge into systems vendor Gehenna (see Shutdowns Send Dark Message).

They won't be the last. Many optical startups are already having troublefinding further investment, and some are having to settle for unpublicizeddown rounds, where a company takes money at a lower valuation than at itsprevious round -- the thin end of the shakeout wedge.

How bad could things get? Vinod Khosla, the legendary optical networkinginvestor, said recently that he thought that 95 percent of startups wouldultimately wither on the vine (see Khosla: Optical Market's Still Huge).

There are several problems with Vinny's apocalyptic prophecy. First, it's agigantic over-exaggeration. The real number is a lot lower: 50 percent,maybe. And most of those companies won't crumble into dust -- they'll beacquired. (For a more realistic taste of what's to come, considerantecedents such as the LAN switch or high-speed router markets).

Further, this kind of doom and gloom doesn't actually do much tohelp service providers and investors work out where they should be puttingtheir money. The fact is that the optical shakeout will affect the threedifferent categories of startups (service providers, component plays, andsystems houses) to different extents, and at different times.

Here's a brief Light Reading prognosis for each of those areas:

Service providers were the first to exhibit marks of the Beast. Aduronet,Digital Broadband, NorthPoint Communications, and GST Telecommunicationshave already gone bankrupt. Global TeleSystems Inc. (GTS) (NYSE/Frankfurt: GTS) and ICG Communications Inc. (Nasdaq/Neuer Markt: ICGX) are both looking a bit leprous. E.spire (Nasdaq: ESPI) and Urban Media Inc. are also said to be having problems. And lots of the pan-European backboneoperators are teetering on the brink of financial ruination.

In the longrun, consolidation is likely to be the order of the day. The big serviceproviders (especially the IXCs) will get bigger. Most of the smaller players(especially data-only players without voice revenues from an establishedcustomer base) will be acquired, or simply fade into the æther.

Of course, problems in the service provider community will inevitably affect the systems vendors, who are next in line to feel the pain. But, again, notall companies in this market are as susceptible to the shakeout miasma.Clearly, the metro market is overcrowded, with startups like Alidian Networks Inc., Astral Point Communications Inc., and Mayan Networks Inc. still struggling to establish a toehold against larger public companies(many of which have themselves bought startups in order to competeeffectively in this realm).

Another subset of the systems market that is sounding alarm bells is theall-optical switching tribe -- as typified by Calient Networks Inc., Ilotron Ltd., Luxcore Networks Inc., Nayna Networks Inc.

These players have capturedthe imagination of the investment community. (Hey, "all optical" must begood, right?) But the reality is that the market for these products isstill developing. And even when it does arrive (in a couple of years' time)it will still represent a tiny proportion of the overall market for opticalequipment. Expect all-optical casualties.

Components companies have so far been relatively immune to the malaise. That's about to change. I strongly believe that the attrition ratein this area will eventually surpass that of service providers and systemsstartups combined.

The reason is that there are currently no standards -- or even a consensusof opinion -- over which type of component technology to use in developing the next-gen optical kit. For example, there are more than half a dozenapproaches to building all optical switch fabrics alone -- including arraysof tiny tilting mirrors, liquid crystals, bubbles, holograms, and thermo-and acousto-optics (see Optical Switching Fabric).

This lack of standards makes life hard for component startups. They don'thave the bulk to force their proprietary approach on systems vendors. And inthe current climate, the systems vendors would rather buy from largercomponent manufacturers in any event, since there's less chance of themgoing under. A vicious circle.

The irony is that life for these companies will be even worse when standardsdo arrive. If the history of networking tells us anything, it's thatso many diverse approaches will not survive, and that eventuallyone technology will win out. (The networking industry loves a consensus, evenif it takes it a long time to reach it -- just look at Ethernet or IP.) Atthat point, components startups that invested in other than the chosen approach will be denied admission to the Promised Land.

If it all sounds a bit depressing, that's because it is. However, it's alsoimportant to remember that there's also an upside to any industry shakeout.In the long term this natural wastage will have a positive affect on theoptical networking industry.

Think Darwin, with a Nietzsche chaser.

The weak will perish in the desert. The strong willenter the Empyrean -- and prosper to an outrageous degree. The one thing that isn't indoubt is the size of the optical market opportunity, which boggles theimagination. All in all, a good thing for both service providers andinvestors -- at least, those that back the right players and the righttechnologies.

This raises another obvious question: Which areas are still hot? Automatedsubsystem manufacturing is one example. It's a "happening scene" for tworeasons: First, it enables systems vendors to shorten the time to market and reduce development costs. Second, there aren't a lot ofstartups in this area. Axsun Technologies is one of them; Cenix Inc., another.

2001 is also set to be the year of Jubilee for optical storage area networks (SANs).Why? On the one hand, a wave of demand for SAN equipment is comingfrom corporate users -- folk who desperately need to consolidate theirstorage requirements and are used to spending big bucks on communications.

On the other hand, this is a technology that uses whole wavelengths -- whichis a big attraction for carriers, because it translates into generatingrevenues quickly. It means they can just plunk in some DWDM gear and awaythey go. They're not faced with having to install edge switches and thelike to support and bill for lower bandwidth, lower-value services.

How long will these Pearly Gates stay open? Until VCs start clogging them later this year. A shakeout follows in late 2002.

-- Stephen Saunders, US editor, Light Reading

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