OFC: Analyst blames Cisco for unprofitable optics

ANAHEIM--“This is an era of profitless prosperity,” Andrew Schmitt, general partner of Niquist Capital, told a crowd at the Optical Fiber Communications conference.

Revenues are climbing in the optical component market, he said, but profits are not. And a “major contributor” to the problem is Cisco Systems.

Cisco buys 70% of all the optical modules in the market, Schmitt said. It then resells those modules for a hefty profit--90% gross margins--with “negligible value added,” he said. Because competing modules are not as interoperable with Cisco gear as its own modules, customer choice is limited, he said. “Cisco is forcing customers to buy modules from them at inflated prices.”

The practice has worked well for Cisco. The vendor sells 60% of the world’s Ethernet ports and 70% of all non-copper gigabit Ethernet ports. Module sales contributed about $2.1 billion to Cisco last year, Schmitt estimated—more than that reported by a handful of top component vendors combined.

Consolidation among component vendors could change the situation, giving those suppliers more pricing power to leverage against the router giant. And Schmitt believes such consolidation is in Cisco’s interest as well.

“More consolidation is needed to keep Cisco honest,” he said.

However, because investors see component vendors’ top lines climbing, and because some vendors still have a fair amount of liquidity left over from the bubble years, consolidation may take a while to occur. Ovum-RHK expects the global optical telecom component market to grow 11% year to $5.1 billion in 2011.

Cisco was not immediately available for comment.