Lumentum: Be Careful What You Wish For

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Who could blame Lumentum Holdings for finding it desirable to move upstream in offering something close to full optical systems in order to generate higher margins? In some respects, the time to do so is somewhat optimal given the ex-JDSU’s historic position, particularly on the telecom side of the house. However, the level of competition that now exists, particularly with the hyperscale operators (including the growing amount of vertical integration by these companies) could make the move problematic for Lumentum. So, the amount of foreseeable opportunity for the firm could theoretically be greatest in supplying the service providers. However, while optimistically, there may be greenfield metro deployments with disaggregated elements supported by SDN, we maintain our strong reservations about the entire scheme of white boxes and Open Line Systems (OLS) involving public transport.

JDSU had an impressive track record as a component technology company (going back to JDS Optics starting about 35 years ago), and has actually shipped complete passive systems to the “RBOC/Bell” companies in the past. Of course, if the questionable “Open ROADM” vision by AT&T were to be realized, for example, either the carrier itself or a third-party systems integrator could facilitate direct purchases of equipment from Lumentum without the need to go through an OEM.

Nonetheless, although five-nines reliability may not perhaps be as critical to AT&T as it was 20 years earlier, the complexity, and potential impossibility involved in ensuring adequate upgrades, bug fixes, etc. along with the concomitant continual insurance of compatibility amongst all of these types of gear from several suppliers for a single system that would be a part of the infrastructure for an extremely long period of time is at best a nightmarish proposition. Thus, the ultimate result could be heads rolling at the network planning level at AT&T.

In effect, with its current thinking, Lumentum would actually adopt a subsystem strategy, which always looked good on paper, particularly for newcomers, years before OLS was even an idea. The concept involved being high enough up on the food chain to be fairly profitable and the solutions would be advanced enough to engage in a push/pull with the network operators in order for them to influence their vendors to adopt them, while avoiding the operational and other headaches including costly standardization requirements in selling to them directly. The strategy tended to fail because these were the elements in which the system vendors differentiated themselves, resulting in much of their profits.

Assuming for the sake of argument that white boxes at the optical layer take off in public networks, the stakes would actually be higher than in the past for full system players in that there would be a battle for shrinking revenue and margins in offering such subsystems and other piece-parts. So, it goes without saying that there would be deep resentment about Lumentum directly competing with its buyers in encroaching close to the system level. In addition, the following statement may not necessarily sway these customers to its side: “[S]elling pizza boxes does not make Lumentum a systems vendor.” In fact, if Lumentum truly does make this leap, the vendor might be forced to divest its component business.

In short, the chance for an increasing number of competitors, including its direct componentry rivals along with the ferocious nature of these interactions make Lumentum’s current game plan a risky one, albeit based a great deal on hypothetical situations. Actually, one may wonder whether the manufacturer fully realizes the pitfalls with service providers moving in this “open” direction, and its current strategy may actually be a way of testing the waters of becoming a full optical system vendor.

JDSU itself benefited by moving beyond components in getting into test equipment and other higher-margin producing businesses. While there would obviously be a whole slew of additional challenges in moving totally upstream, it does not necessarily have to engage in a war for the most leading edge technology focused on by the largest competitors, but possibly look for ways to make improvements on mature solutions and/or target particular types of customers with specialized needs, which might be ignored by the bigger players, such as in catering to tier II service providers.