Blinded by the light

Nobody knows exactly how many optical component start-ups are out there, but it seems like a new one crops up or emerges from stealth mode every day.

There are far too many optical component companies, according to John McQuillan, president of McQuillan Ventures. “We've robbed the next several years of R&D development,” he said. “The pipeline is empty — we've funded 300% of the ideas.”

The lure for entrepreneurs has been magnified by forecasts projecting markets of billions of dollars, as well as the success of companies such as JDS Uniphase, which built itself into a $27 billion firm almost overnight.

According to RHK, for example, the total optical components market will reach $24 billion by 2004. Optical amplifiers will be almost a $4 billion market by 2003. Optical silicon is projected to be a $4.2 billion market by 2002 and a $12 billion market by 2005.

Few dispute that optical components will reach these spending levels, as service providers and systems suppliers seek to stay ahead of the bandwidth-demand curve and as intelligence is added to the optical layer of the next-generation network.

But in the near term, like the next 12 months, the picture doesn't look so rosy. That's because the slowdown in service provider spending and pullback of the capital markets has crept down to the component level and is causing vendors to face some sobering realities. Those include obtaining funding to finance the product from development through beta testing and selling systems makers on a component's cost and performance benefits.

In the long term, there are still plenty of issues to deal with, not the least of which is how to ramp volume in manufacturing through scalable designs and processes.

The optical component industry is still in a phase of tremendous experimentation, said Andy Rappaport, partner at August Capital, which has funded, among other companies, Genoa, a vendor developing a single-chip optical amplifier for dense wave division multiplexing applications.

“The downturn in the industry is the best thing for optical components,” he said. “The boom stunted innovation because everything found a market. [Now] we'll see more emphasis on innovation that is economically rational.”

That's exactly what systems makers are looking for — short and long term. “We hear a lot of talk about operational benefits — it's sort of a keyword for ‘It's more expensive.’ That's not going to fly,” said Richard Barry, chief technology officer of Sycamore Networks.

Many factors drive up the cost of optical components, including manufacturing inefficiencies and short supply. The major optical manufacturers are struggling with throughput, costs and yields, according to Gregory P. Konezny, senior analyst at U.S. Bancorp Piper Jaffray. Indeed, the making of components in many cases can hardly be considered manufacturing because it involves labor-intensive hand assembly.

Packaging also contributes to cost. According to Jeffrey Yu, principal at Crescendo Ventures, lowering the price of components will involve a new market paradigm. In the current paradigm, component makers strive for “maximum transmission capacity and reach” to the detriment of cost because in the early days fiber was a scarce resource and dominated the cost of infrastructure. In the new paradigm, however, component makers will focus on scalability and lower cost by trading off performance.

“The key now is volume production. It's no longer a curiosity shop,” said Anis Husain, chairman and chief technology officer of OMM, which develops MEMs-based optical switching products.

“We are backing multiple approaches,” said Robert Pavey, general partner of Morgenthaler Ventures. “We are going to start to see which companies get the volume behind them.”

Some systems vendors question why component start-ups aren't moving to being fabless suppliers instead of taking on the asset burden of making their own widgets. One reason is the industry still has a way to go in developing standard merchant languages, said Rick Gold, president and CEO of Genoa. “It will be quite a while until we get to foundries,” Gold said. “Companies are still adding value in the guts of the device.”

Others blame the lack of common platforms. “We need to get out of the wars of whose material is better than whose and whose process is better than whose,” McQuillan said.

While the industry is still a ways from the optical equivalent of printed circuit boards, the current environment — in which systems makers have billions of finished goods and component inventory on hand and are demanding price cuts from parts suppliers — will speed the shift to a low-cost device fabrication model as well as speed up the shakeout of component suppliers.

“This is really exciting technology, but I would worry about the business going forward,” said Robert Lucky, corporate vice president of applied research for Telcordia Technologies. “How can all these people make money?”