Vendors express their caution the same way - "We see this as a commodity market and we aren’t commodity suppliers". I heard this statement directly from JDSU (NASDAQ:JDSU) and several other module vendors. Vendors looked self assured when they said it. Sell side analysts love to hear it.
The problem is that most of the optical component and module market will ultimately be commodities, and if a supplier isn’t building commodities they won’t be building much of anything.
Vendors communicating this message have a noble goal; they have no wish to repeat the over-investment sins of the past. In the year 2000 there were over 30 companies building optical modules; it would be a comical understatement to say the market was oversupplied. This memory triggers a flight response in incumbent module suppliers that encourages them to run from any market that looks marginally profitable or highly competitive. The FTTH market is a great example.
Unfortunately for them, any technology market that is big is also commoditized and highly competitive. The communication semiconductor company that figured this out first was Broadcom (NASDAQ:BRCM), which won’t even touch a market that isn’t $500M.
The debate about the FTTH market isn’t whether it will be big but whether it will be profitable. PON is becoming the global access technology of choice for new construction. Self quoted from FTTH in China Part I:
Consider the numbers in China alone: the massive migration of labor to urban areas is creating the biggest greenfield telecom installation opportunity in history. Three hundred million Chinese will migrate to the cities in the next 15 years -the equivalent of creating a Los Angeles/Orange County/San Diego urban each year until 2021.
Any component market this big is by definition is a commodity market. Marginal producers that cannot cover large fixed costs are unprofitable, suppliers with scale and leverage on such costs are very profitable. Therefore, only vertically integrated market share leaders have any hope of profitability. The trick is for such supplier to arrive at the market “fastest with the mostest“.
Bookham (BKHM) attempted the same strategy in higher end telecom products and met with disaster. I outlined the risks in combining vertical integration with niche products a year ago (see last paragraphs of “Bookham, China, and the Optical Component Market“). I still stand by my assessment that a vertically integrated strategy makes sense for high volume, commodity module markets.
Finisar’s decision to introduce a FTTH product brings them into direct competition with Luminent (NASDAQ:MRVC) and Fiberxon, two companies that once merged will form the biggest incumbent supplier of optical components for the FTTH market.
Luminent is a big supplier into Verizon’s B-PON deployments, and Fiberxon is an on-again/off-again supplier into NTT’s GE-PON deployments (discussion of these technologies can be found here). The biggest competition to-date for Luminent/Fiberxon has been the propensity for FTTH equipment suppliers to design and build their own modules at contract manufacturers. If (an if too big for me) the merger is successful, the resulting vertical integration will make Luminent/Fiberxon a force to be reckoned with.
The product Finisar announced is for G-PON, which Verizon will begin deploying this year as part of it’s transition from B-PON. Finisar is clearly trying to capitalize on the market breakpoint created by this transition.
Ultimately we feel GE-PON volume will outstrip G-PON volume based on our assumption it will be the technology of choice in Asia. According to Finisar, they are not betting on G-PON vs. GE-PON. They simply see G-PON as a good entry point for FTTH optics, given that few domestic suppliers exist to meet Verizon’s demand.
I believe this is only a first step, as Finisar appears to understand the importance of being the low-cost supplier (not necessarily low price) and unlike other vendors, embraces the idea of supplying commodities. This attitude will be required for success in not just the FTTH market, but the optics market in general.
Disclosure: Author is long Finisar