After over 15 years of both optical component and system suppliers struggling to generate meaningful margins in the telecom and data communications market, it may be way past time to concede that there may never be much of a positive change in the future. Actually, the nature of DWDM itself right from the beginning and before the bubble burst around the turn of the century, promised the current state of affairs. While there are a number of generic strategic options available to the present players in the space, the example of Jabil Circuit, a global supply chain management company, partnering with Optelian and acquiring AOC Technologies may represent an effective type of new ecosystem that would be most beneficial not only for optics vendors, but for technology manufacturers across the board.
In April, 1999, this writer wrote, while running Trans-Formation, Inc.: “The WDM market represents a combination of the worst attributes of 1) an emerging business with high development and manufacturing costs along with 2) the characteristics of a mature, commodity-like market with extraordinary price pressures. Consequently, profit margins for just the WDM equipment itself are likely to become unimpressive shortly for suppliers, if they are not very low or non-existent already....The catch is that while the suppliers are providing more capacity and enhanced features, they have to reduce the price at the same time to be competitive.”
The options available to the companies involved in this tough optical business tend to be rather unattractive because any kind of effective consolidation has been taken off the table. On the components side, both the Chinese government and hyperscale data center companies have continued to invest in new firms. With systems, as we partially noted in the comments section of a recent blog article, two of the major Chinese vendors, two of the principal Japanese suppliers, and two of the prominent router companies have no obvious financial or technological incentive to engage in such rationalization. (We also addressed the situation with other vendors.)
While taking a public company private removes the pressure of producing quarterly results in a cyclical market that operates on much lengthier timeframes, it does not eliminate the continuing challenge to generate adequate profits. Of course, for whatever reason, the Street has recently decided to put aside its naturally negative prejudice against the space only for one vendor in the sector, especially by what appears to be irrationally driving up the valuation of Acacia Communications to an obnoxious level since going public. Otherwise, we talked about the case of Xtera Communications, which seems to have just decided to go for an IPO out of a lack of enticing choices to exit, and let the chips fall where they may.
Our advice to Finisar was to cut back on the leading-edge development as much as possible, get the margins up to a more respectable level, and somehow try to get out – a game plan we still stand by, but it would hardly be a happy end for the most dominant componentry participant. We also expressed our concern about the potential perils in Lumentum Holdings moving upstream. While diversification into related businesses for one or more of these entities would be a possibility, there is still the risk of moving too far away from their own knitting.
So, we turn our attention to the Jabil business model. At OFC 2016, as a result of its new relationship, the CEO of Optelian had the appearance to us of being quite satisfied, and was at least partially relieved in apparently not having to struggle for survival anymore as one of still too many independent metro optical system providers.
Jabil assumes all of supplier’s manufacturing (facilitated with the purchase of AOC in China), logistics and delivery, as well as its supply of components and product management. Optelian is responsible for the rest of the business responsibilities including R&D, sales, and customer planning.
Jabil’s direct customers were asking for optical network capabilities and that is the reason for its transition to the technology. As with its other solutions, the idea is to become vertically integrated and be the single supplier for all of their needs. Within this kind of ecosystem, the costs are spread out throughout all of the offerings and industries (better absorbing the low-margin nature of optics) as greater economies of scale are achieved.
This movement by Jabil probably helps to explain why an even larger electronics production services manufacturer, Hon Hai/Foxconn Technology Group, acquired the optical module assets from Avago Technologies. (fibeReality was the first news source to report on this deal.) It seems clear that actual ownership of the technology itself is becoming more of a competitive advantage for such businesses. The very sensitive nature of the transaction’s importance to the Taiwanese company may help explain the lack of any direct publicity.
So, it would not be surprising if the industry eventually sees Flextronics International either partnering or making an acquisition to take control of its own optics assets. In fact, any of the small, independent optical transport gear suppliers, in particular, should perhaps be putting presentations together right away – and set up meetings with the giant contract manufacturer (along with maybe other similar types of players).
It will be interesting to see whether there will be smaller, more niche types of operations arise with the marrying of supply chain management entities with production plants, especially in North America, as the ability for manufacturing companies of all types of technologies increasingly struggle to remain competitive domestically. In the rare chance that the US federal government unjustly takes on the role of actually punishing firms for transferring their manufacturing operations outside of the country (in supposedly a free country), it would clearly be a mandatory requirement to find ways to more efficiently and cheaply maintain such an operation in the States.
[written by Mark Lutkowitz]