As the pendulum swings

Almost two decades ago, the optical communications business was dominated by companies with strong research labs that actually invented the intellectual property that made their systems work. But in all maturing industries, as the market grows, the ecosystem splits into smaller segments. In this case, optical component companies sprang up, offering value-add to smaller systems companies that maybe did not have the breadth or depth to master the electro-optics piece of the equation. After all, dealing with fiber splicing, S-parameters, diode pumping, or thermo-electric cooling was esoteric stuff back then. At first, it was subsystems, with engineers leaving to form design houses that delivered linecards or large modules (fiber amplifiers, transponders, multiplexers). Gradually the subsystems market subdivided into even smaller elements, eventually reaching the point that TOSAs, ROSAs, DFB lasers, isolators, etc., were all just a phone call away.

With the advent of the GBIC came the start of the pluggable optic revolution, and a long line of standard form factors developed through cooperative multiple source agreements (SFP, XFP, QSFP, etc). Now, not only did optical communication system builders not need to understand the optics, they could completely remove them from their systems altogether. Since their systems were comparison shopped using the metric of dollars/port, this sleight-of-hand allowed them to completely remove optical costs from their systems’ cost per port rollup as well. A key cost of their systems was (and is still today) hidden from end customers.

Along with the pluggable optics revolution came the rise of large optical transceiver powerhouses. Those optical component companies that jumped on the pluggable transceiver bandwagon quickly grew, while those that stuck to their elemental component roots stumbled, either scrambling to buy available pluggable startups or fading into oblivion. With such a simple business model that promised easy profits, pluggable transceiver companies sprang up everywhere. And business cycles being what they are, the number of suppliers eventually outnumbered the number of customers.

Fast forward to today, and we are in the middle of a consolidation of optical component suppliers. For example, Bookham and Avanex, themselves an amalgam of smaller companies, merged to form Oclaro, which will soon merge with Opnext. The ecosystem that fragmented into many segments is recombining into fewer companies that offer a wider range of products.

Basic business theory suggests there eventually will be only a few dominant players. And as the optical component suppliers grow even larger, they begin to face the same challenges that made system houses turn to them for optics in the first place, such as shareholders to please. They risk long-term strategic thinking and internal innovation gradually giving way to quarterly bean counting and external IP acquisition. Some have even quietly begun offering to OEM complete optical communication systems. Why not -- they now have all the pieces anyway.

But is there more to what is happening than meets the eye? Perhaps we are actually returning to the days of vertically integrated optical communication giants from whence we came. It seems almost unfathomable, yet there are signs everywhere. One large communication system company has consistently messaged that they do not want to be in the optical component business. After all, when you are used to margins over 60%, why would you want to enter a business with single-digit margins? Yet, over the last couple years this company has been consistently buying up optical technology companies (see “  and “Cisco to acquire CMOS silicon photonics firm Lightwire”), and other large system vendors have quickly followed suit. Perhaps this is a necessary defensive reaction to the rise of state-backed communication behemoths around the world.

Or, perhaps this new reality reflects the advancement of pluggable optics to the point where supporting them is once again so complex that only large companies with technical depth can be successful. Anyone who has tried to mass produce a 10GBASE-LRM compliant XFI bus understands the difficulty; the OIF’s latest interface bus will support data rates up to and including 56 Gbps. Just the receiver in the industry-standard 100G interface requires a level of computation power that would have given a supercomputer bragging rights just a few years ago (see “OIF approves 100G coherent receiver implementation agreement”). The industry’s move to variable QAM rates to support the next speed steps only makes matters worse.

And so the pendulum swings. As with all businesses, there are cycles. Arguably, the big push over a decade ago to break up vertically integrated companies into a complex supply chain might have been a bit overblown. The optical supply chain fragmented into too many small vendors without sustainable business models.  And now as the race toward consolidation and vertical integration appears to be picking up speed, we risk overdoing it again. Having too few optical vendors will risk the innovation and price competition that comes with a diverse supply base.