Can Vendors Build Their Optical Components?
The big systems vendors are starting to consider it, some industry executives say. And as far-fetched as the idea might sound, a few of those executives are convinced that vertical integration is in the optical industry's near future.
"This is their way of trying to differentiate against somebody like Huawei Technologies Co. Ltd. ," says Paul Meissner, CEO of laser vendor Santur Corp. "Alcatel-Lucent (NYSE: ALU) and Nortel Networks Ltd. are very worried that they've leveled the playing field by spinning out this technology."
Systems vendors pinged by Light Reading say they're not interested -- but then again, the way they're handling the 100-Gbit/s product generation actually supports the idea of vertical integration. (More on that in a minute.) And no source was claiming that any big acquisitions are in the works yet.
On the surface, vertical integration will be outshouted by 100-Gbit/s products at OFC/NFOEC next week. But for years, the same question has lingered over that conference: What's it going to take to make money here? (See Optical Components: Still Too Crowded.) According to some, vertical integration is being considered as a possible answer.
The big mistake
Proponents cite two arguments supporting vertical integration. The first is that it gets cutting-edge equipment to market more quickly, with Nortel and its early 40-Gbit/s and 100-Gbit/s products being held up as an example.
But some sources believe there's a deeper unrest behind this: Systems vendors, they claim, are realizing that a world of interchangeable components, all adhering to multisource agreements (MSAs), has boiled away too many of the differences in equipment, and software doesn't make up for the shortfall.
"The systems players are seeing they're all competing on price, and they're all using the same contract manufacturers," says one components executive requesting anonymity. "All these guys have got to be talking about it."
Underlying either theory is a belief that it was a mistake for systems vendors to divest their components divisions. They point to the financial misery that followed two of the biggest moves in that trend: Nortel selling its components division to Bookham in 2002, and Alcatel Optronics to Avanex in 2003. (See Bookham Buys Nortel's Components Biz and Avanex to Buy Alcatel, Corning Units.)
"I think that the de-verticalization was an unnatural act. It was a financially driven act," says Karl May, CEO of systems vendor Vello Systems (formerly OpVista). "Our view is that vertical integration does have to return. If all the systems are based on the same underlying IP [intellectual property], how exactly do you distinguish yourself?"
But even if vertical integration is sensible -- and not everyone agrees on even that point -- it may be too late to try.
"I don't think I buy that," says Andrew Schmitt, an analyst with Infonetics Research Inc. "The toothpaste is out of the tube. People are going to have to find a way to use the building blocks that are out there."
When it works
Infinera Corp. (Nasdaq: INFN) certainly shows how vertical integration can pay off, but the company started out by developing the chip, then built the system to go around it. Most systems vendors would be doing things in the other direction.
So it's Nortel that gets cited more often as a do-it-yourself example. The company got a headstart in 40 Gbit/s and 100 Gbit/s by designing its own Coherent receivers and its own optical modules. "They've got all this electronic dispersion compensation in a series of chips that are doing an unbelieveable job, and to date, nobody's been able to mirror that," says Eve Griliches, an analyst with ACG Research .
That doesn't guarantee that Nortel wants to make more of its own modules and components, though.
"We're not interested in the head-to-toes approach," says Mike Adams, director of portfolio strategy for Nortel's Metro Ethernet Networks group, which is soon to be acquired by Ciena Corp. (NYSE: CIEN).
But he concedes that, "for those types of things where you can differentiate in the marketplace, I can see why other people are beginning to talk" about vertical integration.
That sets up a likely limit for vertical integration. Companies will do it only to the extent that they have to, Infonetics' Schmitt says.
"Somebody like Nortel right now is winning at carriers they'll be shipping to for a decade. It's very important to be first, and for this market [100 Gbit/s], to be first they had to do it themselves," Schmitt says. "It only works early in the cycle. Once what they have is no different from what they can buy outside, they'll buy from outside."
Huawei, like Nortel, built its own chips for a 100-Gbit/s coherent receiver. (See Huawei Touts End-to-End 100G.) But again, the company says it's not interested in doing everything itself.
"We only do the pieces such as the DSP [digital signal processor]. Other components we get from other vendors," Glen Fang, director of Huawei's WDM product line management, told Light Reading last month.
In the weeks since that discussion, though, multiple sources have told Light Reading that Huawei does indeed want to start an optical components division. In-house optics would certainly seem to fit Huawei's culture; the company gets some of its chips through a spun-off ASIC division called HiSilicon Technologies Co. Ltd. (Huawei could not immediately be reached for comment.)
To vertically integrate on any substantial scale would certainly fall under scrutiny, so it wouldn't be an easy decision for the big companies. "I don't know that anybody's ready to pull the trigger. We've seen them fly by, but none of them have put an offer on the table," Santur's Meissner says.
Many companies might choose not to take the plunge unless the competition does it. One or two component acquisitions "could put a real dent in the market," Griliches says. "Then we could get to a situation where everybody starts snapping up the component vendors as a defensive move."
It's unlikely the trend would start with a bang, though. It would be dramatic to see a systems vendor snap up a big components and/or subsystems player -- but Finisar, JDSU, Oclaro, and Opnext have all been beefing up via acquisitions. (See Finisar & Optium Challenge JDSU, Bookham, Avanex Tie the Knot, Oclaro Makes Its ROADM Bid, and Opnext Steps Up With StrataLight.)
"The question is: What size is the bite?" says Larry Schwerin, CEO of components vendor Capella Photonics Inc. "You could bring in a lot of stuff you don't need."
— Craig Matsumoto, West Coast Editor, Light Reading