It’s important that people get a sense of exactly how upside down the optical module business is.
Finisar (NASDAQ:FNSR) and Avago sell short reach modules in large volumes to Cisco for $25, netting out around $5 in gross profit on each module sold. Cisco then resells this module (which has been pre-packaged and labeled for Cisco by Finisar/Avago) for $150 to $300, depending on the customer. Cisco has added no value to the product yet extracts a gross profit 25-50x greater. This is the power of the Cisco monopsony.
Is there anything wrong with this? No. It’s a brilliant business for Cisco, and makes paying $2.00 for a cup of coffee seem like a great deal. However, it does not represent a return on invested R&D, and high margin businesses with low barriers to entry like this cannot last indefinitely. The next Michael Dell may sell optical modules.
Suppliers of lower-end commodity modules (the market Cisco controls) will find it difficult to realize higher margins on incremental revenue until the Cisco monopsony is broken. I believe this monopsony can only be broken through further consolidation and vertical integration of high volume module suppliers.
I’ve completed a report that investigates this business in detail. More details about the report can be found here.
“Perhaps the sentiments contained in the following pages are not yet sufficiently fashionable to procure them general favor; a long habit of not thinking a thing wrong, gives it superficial appearance of being right, and raises at first a formidable outcry in defense of custom. But the tumult soon subsides. Time makes more converts than reason.”
Common Sense, 1776
Lightreading is running a poll to gather feedback. Vote here.