The Future of Fiber To The Home in China, Part Three

Includes: CHA, NTT
by: Andrew Schmitt

Contrary to popular belief, both government and business in China do not function through rigid top-down execution of initiatives. China is a confederation of provinces and townships with varying amount of influence, and each is slowly coerced into following a high level dictum through social engineering mechanisms foreign to most western businesses.

There is an excellent chapter in the book One Billion Customers (Wall St. Journal Press) that provides the story behind the PHS ‘Handyphone’ system and how it gained popularity contrary to the desires and dictations of Beijing. With PHS, there were striking technical and economic advantages that overwhelmed the states desire for central planning.

Aside from the reams of marketing material available, the G-PON protocol has no dramatic technical or economic advantages over GE-PON. There are indeed some rogue states within China that have deployed G-PON in limited amounts, these are well highlighted in Flexlight press releases.

We believe China Telecom (NYSE:CHA), as well as other Chinese actors, are motivated by these following factors to choose GE-PON. They transcend technical specifications and matter most to the selection process.

1. Component Availability - There are at least seven silicon vendors who have announced GE-PON chipsets but only four for G-PON chipsets. More importantly, there is only one G-PON chipset that is perceived as market available.

This is incredibly important as Chinese vendors are well known for not entering a particular market until a robust supply chain exists. Multiple sources for components allow them to use their large volumes to play vendors against each other and drive radical cost reduction. Huawei is particularly good at this, and since no secrets exist in China, the Huawei price becomes the China price.

Optical component vendors have already endured this pricing bloodbath, and the relatively few optical specification differences between the two technologies should not affect China’s standard selection. ADVANTAGE: GE-PON

2. Cost - Contrary to the marketing materials pushed by G-PON vendors, a GE-PON system is cheaper than a G-PON system. You will see charts showing that at a certain bandwidth per user and certain number of subscribers per link G-PON gets cheaper, but in reality none of these matters - the startup costs for GE-PON are cheaper today. This is due to the fact that there will be several million GE-PON nodes deployed this year, and virtually zero G-PON nodes deployed.

The relative low cost of labor in China, and the resulting high percentage of costs assigned to equipment makes hardware pricing a greater issue than in the west. The lower startup costs of GE-PON make it a clear winner in China as a result.

Also, in the components business, volume is as important a cost lever as technology. Fixed costs (R&D, Qualification, Fab Capex) tend to dominate therefore the incremental cost of another component decreases as volumes increase. GE-PON will have much higher volumes for the forseeable future, and therefore lower structural costs. ADVANTAGE: GE-PON

3. Maturity - NTT (NYSE:NTT) has deployed millions of GE-PON nodes and trailblazed through innumerable technical challenges. Verizon is only now beginning a similar effort with B-PON. G-PON has yet to encounter any problems because it hasn’t been deployed yet at all.

This is compounded by the lack of proven G-PON interoperability among vendors. Telcordia is holding its very first G-PON interoperability event in 2006, while GE-PON has underwent informal interoperability testing in NTT labs for several years. The presence of a single large customer, NTT, introduced an informal interoperability requirement that forced the marketplace to quickly converge GE-PON requirements. ADVANTAGE: GE-PON

4. Flexibility - The IEEE 802.3ah spec is relatively lightweight, with many of the features written as optional add-ons. GE-PON equipment initializes communication by negotiating with the known standard, then begins to query connected devices on their capability to support addendum requirements. GE-PON chipset vendors are accustomed to making modifications and in many cases have designed their architectures around such flexibility. Implementations can be custom but still meet the specification. The ITU spec does not allow for such flexibility, and it turns out that flexibility is something China Telecom is looking for. ADVANTAGE: GE-PON

These four factors could apply to the decision of any telecom actor, not just a Chinese one. At this time it is unlikely that the large American and European telcos will use anything but the ITU B-PON and G-PON standard. It also appears virtually certain that China will choose GE-PON based on the structural economic advantages it brings to the table.

However, the most compelling evidence that China will select GE-PON is based on the actions of its largest carrier. There is a quiet and coordinated effort by China Telecom to enhance the IEEE GE-PON specification to meet the needs of their network, something informally referred to as C-PON. This effort and the companies involved will be examined in Part IV of the series.

See Part 1 and Part 2 of this series.