Daryl Inniss reflects on a career in market research
Daryl Inniss
Rocky beginnings
I jumped ship in 2001 joining RHK, a market research firm, knowing nothing about the craft. I had been a technical manager and loved research and development, but work was 500 miles from my family and the weekly commute was gruelling.
Back then, the telecom market was crashing and I believed my job was at risk. Moving to a small market research firm could hardly be described as good planning, but it turned out to be a godsend.
I had no idea what I was getting into and my first months did not help. My mother passed away within a month of joining and I was absent for half of my first 40 days. But my boss was very supportive. Meanwhile, work consisted of unintelligible, endless conference calls. And while in this daze, September 11th occurred.
The first report - getting the job done
Completing my first market research report helped ground me in the art. I wrote about optical dispersion compensators. After interviewing many companies, I wrote a long and complicated piece, an exercise that I found difficult. I also struggled with who would read the report and what would be done with the data.
The report aimed to explain technical issues simply and included a market forecast. Completing it proved hard because there was always more information to include, a better explanation, and better forecast data to be gathered.
I felt unsatisfied but the report received kudos. Internally I was told that I was the second or third analyst to tackle that topic and the first to complete the work. And an optical company complimented me on the report. But I felt dissatisfied and wished I had done better. I wanted to understand the subject more, wished I could provide clearer, simpler explanations and also provide a better forecast.
Nonetheless, I learned the importance of completing assignments as they can go on forever.
A market researcher's role
An analyst tries to identify market opportunities and winning strategies. Looking at new products, for example, the goal is to explain what they are, why they are being introduced, who will use them, their value, and the competitive landscape. The issues must be explained to novices and experts alike. The technical novice may get a glimpse of what the technology means and how it works, while a technical expert may understand the ecosystem more deeply.
An analyst must strive to prepare simple messages that are steeped in facts. You need to have a story—say why something is happening and explain it in the context of the bigger picture.
Forecasts, market share, rankings, prices and volumes are all important. Everyone loves numbers. But the story underpinning the numbers is far more important and most people do not take the time to determine the causes behind the numbers.
Where is the industry going?
I have spent the last 15 years analysing the optical components market. Sustainable profitability is the biggest topic, and consolidation is viewed as providing the best approach. Notwithstanding the mergers and acquisitions, the market is fragmented, margins remain low, and there is still no evidence of true consolidation.
Independent of all the change, optical component suppliers post gross margins below 40 percent and most are below 30 percent while semiconductor companies are routinely above 50 percent. There is a force keeping the industry stuck at this level, in part because there is little product differentiation.
Forecasts, market share, rankings, prices and volumes are all important. Everyone loves numbers. But the story underpinning the numbers is far more important
Avago Technologies’ divestiture of its optical module business to Foxxconn Interconnect Technology Group points to one high-margin path. Discrete components—particularly lasers and modulators, and to a lesser extent photodiodes and receivers - command higher margins. Vendors can offer differentiated products at this level. Total revenues are lower so the challenge is to win enough business to fill the factory because these are fixed-cost, intensive businesses.
Subsystems offer another high-margin path, particularly for vertically-integrated companies. Here vendors are challenged with a long time-to-market, requiring a strong design team to support customer requests. Also business can be lumpy because solutions are customer-specific.
Acacia Communications' coherent 100 gigabit transponders is an example solution that has the basis to win broad-based business and high margins. The products offer a one-stop-shop solution including optics, electronics, and software. Acacia is developing silicon photonics so it controls most of the bill of materials, keeping down product cost. And its solution is differentiated in that it helps customers get their products to market while achieving a high level of performance.
Market research: even more important now
The communications industry is going through extensive change making market research more important than ever. The Web 2.0 companies are the new optical communication mindshare leaders, driving technology and business practices.
Simultaneously China is the biggest consumer of optical gear, both for long-haul and access networks. Optical component suppliers need to understand how to compete in this new environment. What are the new rules? How are they evolving? How can companies best position themselves to win more business?
Just like when I started, I ask how can a market researcher help component companies navigate this new world. No doubt, this is a challenge, but market researchers provide the collective market voice. They are the market mirror that shows the beauty spots and the warts. They are given license to say what everyone is thinking. They can raise market consciousness so participants may act fearlessly.
But market researchers need to understand the story from top to bottom—end customer to suppliers. They must communicate well which includes not only delivering the story but also being humble, admitting mistakes, keeping sources and information confidential, and taking corrective actions.
This is indeed a challenge and I feel honoured to have had the opportunity to participate. I could not have done the job without the help of wonderful people from all over the world. Their generosity, warmth, and kindness made all the difference. At bottom, it is these relationships that mattered as we tried to help each other navigate.
Biography
Dr. Daryl Inniss is Director, New Business Development at OFS Fitel, the designer, manufacturer and provider of optical fibre, fibre optic cable, connectivity, fibre-to-the-subscriber and specialty photonics products.
He was formerly Components Practice Leader at market research firm Ovum and RHK. Daryl was Technical Manager at JDSU and Lucent Technologies, Bell Laboratories, and started his career as a Member of the Technical Staff, AT&T Bell Labs.
Has the restructuring of the optical industry already started?
The view that consolidation in the optical networking industry is needed is not new. For a decade, ever since the end of the optical boom in 2001, consolidation has been called for and has been expected. And while the many optical startups funded then have long exited or been acquired, the optical industry continues to support numerous optical networking and component generalist and specialists.
Given the state of the telecom market, is a more fundamental industry restructuring finally on its way?
"The business model of the communication sector needs to change, and change in a relatively short order"
Larry Schwerin, CEO of Capella Intelligent Subsystems
Larry Schwerin, CEO of Capella Intelligent Subsystems, believes change is inevitable. He argues that the industry supply chain will change, especially as firms become more vertically integrated.
"This is not to say that the market and demand are not there," says Schwerin, but the industry is stuck with a decade-old structure yet the market has changed.
Optical market dynamics
Schwerin starts his argument by highlighting certain fundamental drivers. IP traffic continues to grow at over 30% a year, while the nature of the traffic is changing, especially with cloud computing and as users generate more digital media content.
“The current rate of bandwidth growth coupled with the rate of CapEx spend, the gap is widening and the revenue-per-bit is dropping,” he says. “Some argue that bandwidth growth will slow down as operators charge [users] more, but to date this hasn't been seen.”
These trends are welcome for the optical companies, says Schwerin, as operators adopt lower layer, optical switching as a cheaper alternative to IP routing. “The number of [wavelength-selective] switches per node is growing quite dramatically," he says. "We are now seeing deployments with, on average, 6-8 switches per node and people are projecting as many as 20 as people start deploying colourless, directionless, contentionless-based switching."
But such demand is coupled with fierce competition among numerous players at each layer of the optical industry's supply chain.
"Some 80% of the optics used by system vendors are bought. How do you differentiate on features above and beyond what you are buying?"
Supply chain
The annual global operator market for wireless and wireline equipment is valued at US $250bn, says Schwerin, using market research and financial analyst firms' data.
The global optical networking equipment market is $15bn. The Chinese vendors Huawei and ZTE now account for 30% of the market, while Alcatel-Lucent is the only other major vendor with double-digit share. The rest of the market is split among numerous optical vendors. "If you think about that, if you have 5% or less [optical networking] market share, that really is not a sustainable business given the [companies'] overhead expenses," says Schwerin.
The global optical component market is valued at $5bn. It is likely larger, anything up to $8bn, argues Schwerin, because of the Chinese optical companies supplying Huawei and ZTE.
"You have a $5-8bn market selling products into $15bn, and then the $15bn is trying to repurpose that material and resell it to the carriers - is that really what is going on?" says Schwerin. To this vendor hierarchy is added contract manufacturers, with different players serving the component and the system vendors.
The slim profits operators are making on their services is forcing them to place significant pricing pressure on the system companies that already face fierce competition. Meanwhile, the optical component and contract manufacturers are also trying to make money in this environment.
Looking at gross margin data from Morgan Stanley, Schwerin says that the system vendors' figures range from 35% for the low end to 40% at the high end. "What the figures highlight is a lack of differentiation," he says. "And, in part, it is because they are buying all the same technology."
Schwerin says that some 80% of the optics used by system vendors are bought. "How do you differentiate on features above and beyond what you are buying?"
The optical components vendors' gross margins of a year ago were 30%. More recent data shows these figures are down, with the only segment showing a rise being optical sub-systems.
What next?
Schwerin says one way to improve the health of the industry is greater vertical integration. How this will be done - which players get consumed and how - will only become clear in the next 2-3 years but he is confident it will happen. "There are just too many layers of the ecosystem and it is just too fragmented," he says.
Operator mergers and slower spending put pressure on vendors at each layer of the supply chain, inducing revenue stalls. "These swings seems to be more and more violent," says Schwerin. "It is difficult for companies to maintain themselves in these cycles, let alone innovate."
Schwerin highlights Cisco System's acquisition of silicon photonics start-up, Lightwire, earlier this year, as an example of a system vendor embracing vertical integration while also acquiring innovation. Another example is Huawei's acquisition of optical integration specialist, CIP Technologies.
"The business model of the communication sector needs to change, and change in a relatively short order," says Schwerin, who believes it has already started. He cites the merger between the two large optical component vendors, Oclaro and Opnext, and expects a similar deal among the system vendors: "One of those 5 percenters will be absorbed."
As the market further consolidates, and as system companies drive fundamental technologies, the components' market will start to shrink. "It is then like a chain reaction; it forces itself," he says.
Schwerin's take is that rather than continue with the existing optical component and contract manufacturing model, what is more likely is that what will be supplied will be basic optical components. Differentiation will be driven by the system vendors.
Optical components: The six billion dollar industry
The service provider industry, including wireless and wireline players, is up 6% year-on-year (2Q10 to 1Q11) to reach US $1.82 trillion, according to Ovum. The equipment market, mainly telecom vendors but also the likes of Brocade, has also shown strong growth - up 15% - to reach revenues of over $41.4 billion. But the most striking growth has occurred in the optical components market, up 28%, to achieve revenues of over $6 billion, says the market research firm.
Source: Ovum
“This is the first time optical components has exceeded six billion since 2001,” says Daryl Inniss, practice leader, Ovum Components. Moreover, the optical component industry growth has continued over six consecutive quarters with the growth being more than 25% for the past four quarters. “None of the other [two] segments have performed in this way,” says Inniss.
Ovum cites three factors accounting for the growth. Fibre-to-the-x (FTTx) is experiencing strong growth while revenues have entered the market from datacom players from the start of 2010. “The [optical] component recovery was led by datacom,” says Inniss. “We speculate that some of that money came from the Googles, Facebooks and Yahoos!.” A third factor accounting for growth has been optical equipment vendors ordering more long lead-time items than needed – such as ROADMs – to secure supply.
Source: Ovum
The second chart above shows the different market segments normalised since the start of 1999. Shown are the capex spending for optical networking, optical networking equipment revenues, optical components and FTTx equipment spending.
Optical networking spending is some 3.5x that of the components. FTTx equipment revenues are lower than the optical component industry’s and is therefore multiplied by 2.25, while capex is 9.2x that of optical equipment. The peak revenue in 2001 is the optical component revenues during the optical boom.
Several points can be drawn from the normalised chart:
- The strong recent growth in FTTx is the result of the booming Chinese market.
- From 2003 to 2008, the overall market showed steady growth, as illustrated by the best-fit line.
- From 2003 to 2008, capex and optical networking revenues were in line, while two thirds of the optical component revenues were due to this telecom spending.
- From 2010 onwards, components deviated from these two other segments due to the datacom spending from new players and the strong growth in FTTx.
- Once the market crashed in early 2009, optical components, networking and capex all fell. FTTx recovered after only one quarter and was followed by optical components. Optical networking and capex, meanwhile, have still not fully recovered when compared with the underlying growth line.
Ten years gone: Optical components after the boom
Average gross margin by industry. Source: LightCounting
The biggest change in the last decade has been the way optics is perceived. That is the view of Vladimir Kozlov, boss of optical transceiver market research firm, LightCounting. “In 2000, optics was set to change the world,” he says. “The intelligent optical network would do all the work for the carrier; nothing would be done electrically.”
The boom of 1999-2000 saw hundreds of start-ups enter the market. Ten years on and a handful only remain; none changed the industry dramatically.
“The worse is definitely behind us”
Vladimir Kozlov, LightCounting
Kozlov cites tunable lasers as an example. In 2000, the CEO of one start-up claimed the market for tunable lasers would grow to US$1 billion. Today the tunable laser market is worth several tens of millions. “It [the tunable laser] is a useful product that is selling but expectation didn’t match reality,” says Kozlov.
Another example is planar lightwave circuits used to make devices such as arrayed waveguide gratings used to multiplex and demultiplex wavelengths. “Intel was the biggest cheerleader,” says Kozlov. “Did planar lightwave circuits change the industry? No, but it is a useful technology.”
Where significant progress has been made is in the reliability, compactness and cost reduction of optical components. High-end lasers with complex control electronics have been replaced by small, single-chip devices that have minimal associated circuitry, says Kozlov.
Pragmatism not euphoria
The biggest surprise for Kozlov has been how many companies have survived the extremely tough market conditions. “There were almost no sales in 2001 and the market didn’t recover till 2004,” he says. Companies latched on to niche markets outside telecom to get by while many of the start-ups survived on their funding before folding, merging or being acquired by larger players.
“The leading companies such as Finisar, Excelight (now merged with Eudyna to form Sumitomo Electric Device Innovations), Avago Technologies and Opnext were also leading companies 10 years ago,” said Kozlov, who adds Oclaro, created with the merger of Bookham and Avanex.
The market has experienced hiccups since 2004 such as the dip of 2008-2009. “The worse is definitely behind us,” says Kozlov. Many vendors have a good vision as to what to do and plan accordingly. He notes companies are maintaining resources to be well placed to respond to rapid increases in demand. And profitability is rising sharply after the belt-tightening of 2008-09. “Whoever gets in first makes the profit,” says Kozlov. “That is what happened in 1999, although that was an extreme.”
Transceiver vendors and gross margins
Another notable development of the last decade has been the advent of optical transceivers. In the late 1990s system vendors such as Alcatel, Fujitsu, Marconi, NEC and Nortel designed their own optical systems before divesting their optical component arms. Optical component companies exploited the opportunity by developing optical transceivers to sell to the systems vendors.
LightCounting forecasts that the global optical transceiver market will total $2.2 billion in 2010, yet Kozlov still has doubts about the optical transceiver vendors’ business model. “Optical transceiver vendors still have to prove they are profitable and viable, that they are a real layer in the food chain.”
Comparing the gross margin performance of the industry layers that make up the telecom industry, optical transceiver vendors are last (see chart at the top of the page). Gross margin is an efficiency measure as to how well a vendor turns what they manufacture into income. Companies such as Cisco Systems have impressive gross margins of 75%. “You have to own a market, to have something unique to maintain such a margin,” says Kozlov.
Cisco has a unique position and to a degree so do semiconductors players which have gross margins twice those of the transceiver vendors. Contract manufacturers, however, have even lower margins than the 25% achieved by the transceiver vendors, adds Kozlov, but they benefit from large manufacturing volumes.
The main challenge for transceiver vendors is differentiating their products. There is also fierce competition across product segments. “A gross margin of 25% is not the end of the world as long as there are sufficient volumes,” says Kozlov. “And of course 25% in China is a lot – local [optical transceiver] vendors don’t think twice about entering the market.”
Kozlov says there are now between 20-30 Chinese optical transceiver vendors. “Some two thirds are benefiting from government funding but a third are building laser manufacturing and making transceivers, are real, and are here to stay.”
Bandwidth drives components
LightCounting collects quarterly shipment data from leading optical transceiver vendors worldwide. It also forecasts market demand based on a traffic model. Kozlov stresses the importance of the adoption of broadband schemes such as fibre-to-the-x (FTTx) as a traffic driver and ultimately transceiver sales.
A small change in the bandwidth utilisation of the access network has a huge impact on the network core. The advent of a killer application or the emergence of devices such as the iPhone and iPad that change user habits and drive access network utilisation from 2% to 5% would have a marked impact on operators’ networks. “This would require a significant upgrade and would result in a very nice bubble,” says Kozlov.
Utilised bandwidth (terabits-per-second). Scenario 2 with the higher utilisation in the access network quickly impacts core network capacity. Source: LightCounting
Another effect LightCounting has noted is that the total transceiver capacity is not keeping pace with growth in network traffic. This discrepancy is caused by operators running their networks more efficiently, explains Kozlov. Collapsing the number of platforms when operators adopt newer, more integrated systems is removing interfaces from the network.
LightCounting does not see operators’ traffic data such that Kozlov can’t know to what degrees operators are running their networks closer to capacity but given the rapid clip in traffic growth this is not a sustainable policy and hence does not explain this overall trend.
The next decade
Kozlov expects the next decade to continue like recent years with optical component companies being conservative and pragmatic. He is optimistic about optics’ adoption in the data centre as interface speeds move to 10Gbps and above, pushing copper to its limit. He also believes active optical cables are here to stay, while photonic integration will play an increasingly important role over time.
Kozlov also believes another bubble could occur especially if there is a need for more bandwidth at the network edge that will with a knock-on effect on the core.
But what gives him most optimism is that he simply doesn’t know. “We were all really wrong 10 years ago, maybe we will be again.”
- Lightwave July 2010: Interview with Vladimir Kozlov. "Can the optical transceiver industry sustain double-digit growth?