Is optical components becoming a buyer's market?

Despite warnings that price cutting could erode the margins of high-valued optical components, analysts explain why they remain upbeat about the market's prospects.

"An organisation's gross margins ride on these new products"

Daryl Inniss, Ovum Components.

The global optical component market was down 2% in the second quarter of 2011 at US $1.55 billion, according to Ovum.

The good news is that the market research company is forecasting that modest growth will resume this quarter now that the build-up in component inventory that led to the market contraction has largely been worked through.

But Ovum is warning that there are signs that the continued weak market conditions and fierce competition could lead to sharp price declines even for newer, high-valued products. "An organisation's gross margins ride on these new products," says Daryl Inniss, practice leader, Ovum Components.

Oclaro's CEO on a recent earnings call said he was being asked for price concessions on 40Gbps products. Ovum also says the ROADM and tunable laser XFPs markets are becoming more crowded and competitive.

Inniss stresses that there is no evidence that companies are cutting prices to gain an edge but while he expects volumes will grow, intense pricing pressure should now be expected.

LightCounting points out that the slowdown in sales of optical component and modules in early 2011 has been limited to products that did very well in 2010 or which had long lead times, like wavelength-selective switches for ROADMs and 40Gbps modules. It says there is little, if any, excess inventory of components accumulated across the broader market.

"The telecom transceiver market remained steady in Q1 2011, but it declined further in Q2 mostly due to lower sales of 40Gig client-side modules," says Vladimir Kozlov, CEO of LightCounting. "We expect that by the end of this year, the telecom market segment will be strong again."

Best in a decade

The second quarter market dip follows a period where the optical components industry experienced its strongest yearly growth for a decade. The market reached US $6 billion for the year ending first quarter 2011 - a first since 2001.

So long as network expansion keeps up with traffic, we are looking at sustainable growth”  

Vladimir Kozlov, LightCounting

The six quarters of consecutive market growth up to the second quarter was due partly to the overall health of the telecom industry. The service provider industry - wireless and wireline - grew 6% year-on-year between 2Q10 and 1Q11, to reach $1.82 trillion. In turn, the equipment market, mainly telecom vendors but including the likes of Brocade, grew 15% to $41.4 billion.

Ovum attributes the 28% growth in optical components between 2Q10 and 1Q 2011 to strong growth in the fibre-to-the-x (FTTx) market as well as new revenues entering the market from datacom players. A third factor was optical equipment vendors over-ordering long lead-time items – such as ROADMs – to secure supply.

“ROADMS did grow nicely but if you look at wavelength-selective switches, it is not such a big market," says Kozlov. The market research firm says the wavelength-selective switch market was $280 million in 2010.

LightCounting says 10 Gigabit SFP+ optical transceivers was a market highlight in 2010, with volume shipments tripling. Ethernet SFP+ sales alone reached $180 million in 2010, and will grow to $250 million this year.

“The optical component market grew 36% in 2010, and in 2011 we’re projecting it will grow 7%,”says Inniss

But competition is intense. Finisar may be the market leader but only 4% market share separates the players in second through to sixth place, says Ovum. “It’s a very competitive market and there is no breakaway here,” says Inniss.

Another challenge is the emergence of the Chinese optical component players. The large-scale deployment of FTTx being undertaken by the main three Chinese operators means that there is a huge market opportunity for local optical component and module players. The Chinese market also accounts for half the all 40 Gigabit-per-second shipments, according to Infonetics Research.

“Looking at the western suppliers, everyone is reporting slowdowns and drops in the second quarter [of 2011],” says Kozlov. “Yet from the data we are getting from the Chinese optical component players, they grew 35% in 2010 and are on track for 30% growth this year.”

Another challenge is for firms to fund sufficient R&D. Share prices took a severe hit after the companies issued warnings about second-quarter sales. “The entire optical component market is depressed because of the localised correction,” says Inniss. “It will still grow but because it is so much smaller than 2010, capital markets are bashing the companies.”

Since the stock market is an important source of investment, it may take several years for the market to recover the share price levels at the start of 2011. “It won’t stop investment in technology but there is going to be real hard eyes on each decision that is made,” says Inniss.

The main challenge facing optical component players is not so much technical issues but more the requirement to continually decrease costs. This is not new but neither is it going away, says Inniss.

Positive outlook

Yet the analysts expect market growth to continue.

Inniss points to the growing role of optics for short-distance interfaces: “The I/O (input-output) bandwidth requirements are sufficiently high, whether it is the backplane or chip-to-chip connections, that the market realisation is that optics will play a role.”

Ovum also highlights consumer market developments such as the USB 3.0 interface which will drive the market for active optical cables. “It [the consumer market] is not going to happen tomorrow - meaning 2012 - but it is something that is coming and has the potential to transform the industry,” says Inniss.

“Companies such as Finisar and Avago [Technologies] are becoming more assertive in enforcing their intellectual rights,” says Kozlov. This is as a positive development that has been missing in the past: “Protecting your intellectual property ultimately helps you become profitable,” he says.

LightCounting also highlights the need for network investment to keep track with traffic growth. "So long as network expansion keeps up with traffic, we are looking at sustainable growth,” says Kozlov. See Plotting transceiver shipments versus traffic growth.

This article is based on a piece that appeared in the ECOC 2011 exhibition guide.