Is optical components becoming a buyer's market?
"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.
Chinese optical component vendors set for change
“If [Chinese optical component] companies get $100m from an IPO, they have the resources to really do things”
Vladimir Kozlov, LightCounting
The local OC players have benefitted from the prolonged growth of China’s economy, the rise of global telecom system vendors Huawei and ZTE, and the significant expansion in Chinese operators’ networks. But such domestic growth will not continue and will likely lead to a shake-up of the local OC firms.
“They [Chinese OC players] all have the same industry pitch: they all have huge capacity, they have tons of people and they are growing fast but when you research that, you uncover different approaches to doing business,” says Vladimir Kozlov, CEO at LightCounting.
The market research firm has identified several classes of OC player. There are quite a few mid-size companies that focus on niche local opportunities. “Very few of them have an ambition of becoming a global player,” says Kozlov. “They have been set up with local government support, primarily with the aim of employing local people and being involved in local telecom projects.”
But there are other players with broader ambitions and resources. Companies such as HiSense Broadband and HG Genuine, acknowledged manufacturers of electronics and consumer products, have formed OC business units recognising the growth potential of optical communications.
Another category that Western firms will do well to note, says Kozlov, is the Chinese OC players with a long history such as WTD and Accelink. “WTD is 30-years-old and grew from the Wuhan Research Institute that is also a founding body for Chinese system vendor FiberHome,” says Kozlov. WTD has been growing steadily and the pace has accelerated in the last two years. “WTD is becoming more aggressive and is gaining market share while Accelink has a successful IPO that brought in $100m,” he says.
Other companies will likely follow Accelink’s example and raise money through IPOs. But what will be interesting is whether such companies continue to focus on the Chinese market or start addressing issues such as what technologies they are missing and even make acquisitions, he says.
“A lot more companies will have access to financial markets as the regulation that limits how many companies can become public is relaxed,” says Kozlov. “If [Chinese OC] companies get [US] $100m from an IPO, they have the resources to really do things.”
“It is unlikely that Huawei will keep on growing as fast as it did over recent years and continue to take market share from Alcatel-Lucent, Ericsson and others for much longer”
Yet another Chinese OC player segment is start-ups funded by venture capitalists (VCs). One example is Innolight which has received funding from local VCs and a Western company. “VCs will push firms to be as ambitious as possible as they are after returns,” says Kozlov. Interest among the financial investment community is also growing given the rise of the stock price of the OC industry’s leading firms in the last year. Such interest will likely lead to investment and restructuring of local Chinese firms, he says.
Chinese OC vendors have been helped by the rise of the system vendors Huawei and ZTE. The Chinese equipment makers have been disruptive in adopting technology quickly while reducing their costs. But having become global players, Huawei and ZTE now face their own challenges.
“Both [system vendors] companies have caught up on the technology and the next step for them is to see whether they can become leaders in technology and stay ahead of an Alcatel-Lucent or a Ciena,” says Kozlov. “They have the ambition but can they do it?” Kozlov notes that Chinese companies are now highly active with patent applications: “Chinese firms recognise that this is how they will achieve a longer-term advantage and protect their own technologies.”
Another challenge facing the system vendors, common to many technology industries, is that no one player dominates a market. “Usually three global companies share the dominance; the same if it is a local market,” says Kozlov. “It is therefore unlikely that Huawei will keep on growing as fast as it did over recent years and continue to take market share from Alcatel-Lucent, Ericsson and others for much longer.”
This will require Huawei and ZTE to adapt to more moderate growth in future. Meanwhile North American and European system vendors have long responded to the competitive threat, moving their manufacturing to Asia Pacific - and China in particular - to benefit from reduced operating costs. For the Chinese OC vendors, yet to become global players, the chance to be as disruptive as the Chinese system vendors has gone since leading OC vendors have established local manufacturing.
Can Western companies learn from the experience of Chinese system and OC vendors? Kozlov is not so sure.
The Chinese have proved adept at learning the business and mastering new technologies. The examples of Huawei and ZTE that have disrupted the market by being as efficient as possible have proved a wake-up call for Western companies. “I don’t see anything beyond that that Western companies can learn; it is still the Chinese that are learning from Western companies,” says Kozlov. “This does not mean that the Western companies have nothing to worry about; there is plenty of room for improvement in the industry supply chain.”
Looking at the decade ahead, Kozlov expects Huawei to have a much greater penetration in the North American telecom market. “And as it [Huawei] builds up its own intellectual property, it will be better able to compete with Cisco Systems and H-P in the datacom market,” says Kozlov. And as Chinese companies get access to greater finance he also expects they will start acquiring Western firms to gain expertise and greater access to markets.