Growing pains

The optical electrical components market may have seen some fast and furious growth, but adjustments are still needed

For the past 18 months, the optical electrical components market has been growing faster than weeds feasting on Miracle-Gro. Spot shortages have resulted from unprecedented demand for a variety of optical electrical components that enable equipment makers to turn out new gear for next generation optical networks.

Those shortages are giving the industry growing pains to which only Michael Jordan can relate. Worse yet, despite the recent economic slowdown, the situation is not going to change drastically, and equipment makers will continue to suffer optical electrical components procurement headaches well into the foreseeable future, according to analysts and manufacturers.

In the meantime, optical electrical components vendors are doing anything and everything they can to ease those growing pains. How successful the results of their efforts will be in the near term, and even in the long term, remains to be seen.

“Things have been a little crazy in terms of components, including things you wouldn't even expect. It's been a little like after World War II in Vienna or something like that,” says Lawrence Gasman, president of Communications Industry Researchers. “It's not quite a black market, but people who know how to get their hands on a few tunable lasers are sought after people.”

The roller coaster ride started with the initial commercialization of erbium-doped fiber amplifiers (EDFAs), says Jean-Louis Malinge, vice president and general manager of Corning's optical components division.

“For the last five years, it's been an incredible ride in terms of growth and demand. Before then, fiber was used in point-to-point architectures, and you didn't need a lot of components,” Malinge says. “The explosion started with the introduction of EDFAs, which were used to push wavelengths through the fiber without requiring them to go back into the electronic domain.”

Regardless of when the boom started, the optical components business is white-hot today and will continue to burn well into the foreseeable future. While the optical components market experienced 130% growth in 2000, recent market mushiness caused RHK to revise its forecast that the market would grow 90% this year to reflect 10% less growth this year. Things are going to pick up again by the second half of the year, says John Lively, director of optical components for RHK.

The consultancy predicts that the optical components market for dense wave division multiplexing (DWDM) will reach $9.5 billion this year and soar to $23.6 billion by 2004. Like a mother outfitting her growing child with new shoes every two months, the world's leading optical electrical components manufacturers are pouring money into costly expansions. They are engaging in strategic acquisitions to keep up with demand and to position themselves to slice out a fair share of the pie.

For example, last month Nortel Networks bought an enormous DWDM component plant from JDS Uniphase. The $2.5 billion deal of Nortel stock sticks a new feather in Nortel's cap. Just as important, it enables JDS to get approval for its pending purchase of component laser chip supplier SDL (Telephony, Feb. 12, 2001, page 14).

To date, the SDL plant, located in Zurich, Switzerland, has been supplying nearly 40% of the 980 nm pump laser market. As part of the deal, Nortel also agreed to purchase a specified number of component supplies from JDS or pay an additional $500 million if it cannot take the supplies by year end.

In an effort to quadruple its output, Lucent Technologies announced a $30 million expansion of its component manufacturing facilities last year. The move was made in response to an 83% rise in Lucent's component business 1999. Lucent also took things further in 2000 by deciding to spin off its component business into a company named Agere Systems. Lucent justified the action by revealing that 75% of its sales came from outside of Lucent.

Unfortunately, Agere was in a quiet period prior to its IPO at press time, and as a result was unable to grant an interview for this article.

But just building new plants and expanding them isn't enough. You need people to run them, too. That's especially true when manufacturing processes are in the early stages of automation (see sidebar on page 52).

“The name of the game is manufacturing scalability, and it's hard to scale easily because it's hard to double your work force,” says Peter Scovell, president and CEO of passive component start-up Zenastra.

Just the factors, ma'am

Just a mere 18 months ago, the word “optical” was Wall Street slang for “money.” Hundreds of start-up component vendors, created by brainy entrepreneurs and fueled by frenzied investors, entered the market all at once. Just as suddenly, the established equipment vendors became interested in the new components these start-ups were pulling out of their valises on sales calls.

In fact, the market's been so forward-looking and tight that optical components makers that wouldn't have made it in system vendors' doors two years ago now are being ushered right in. Even more surprising is the fact that their components are selling right off the drawing board.

“There has been such tremendous demand to increase capacity at the system level that it sort of became the most important thing. Component manufacturers would demonstrate a new component to system houses…and say, ‘Hey, isn't this cool? Should we keep on working on this technology or not?’,” Lively explains. “Demand was such that, the next day, they would get a call from the company asking to buy a couple of thousand of those things.”

For this reason, optical electrical components makers often found themselves racing to get products to market, which left them no time to develop efficient manufacturing processes. In fact, the processes they intended to use were only yielding 5% or 10%, he adds.

“It's easy to kid yourself that a miracle will happen and you will be able to go from a 10% yield to 90% in the first few months, but the reality is that things take time, so those components have tended to be in short supply for a while,” Lively notes.

While demand is likely to remain high for bleeding-edge optical electrical components, some observers believe that shortages of conventional components will dwindle by summer. Although the market for optical networking equipment isn't going into a slump, this year isn't going to be as good as last year, Gasman says. As a result, equipment vendors' penchant for double ordering components is going to end. That alone should ease things a little, he adds.

In addition, expansions and acquisitions should allow optical electrical components makers to start catching up, or just keep up with demand.

Nevertheless, shortages will continue. That's because when the shortage of one component subsides, demand for another likely will make it seem as if no ground has been gained at all. “Shortages move around and tend to occur on the latest and greatest new thing,” Lively says.

However, while some components will no longer be in short supply, some will remain hard to get.

“We started to see global capacity constraints on general discrete laser products at the end of first quarter 2000, and there's been little to no letdown yet,” says Charlotte Laurent-Ottomane, vice president of investor relations for Alcatel's Optronics Division. “As of this moment, we have no reason to believe that it is going to let down any in 2001 either.”

It's also important to note that component manufacturers are facing shortages of their own. Some crucial materials and subcomponents used to make optical electrical components are made by only one or two suppliers.

People, they need people

Another factor contributing to the optical electrical components shortage includes a lack of skilled people to design new optical components and skilled labor to assemble them. “Those kinds of shortages take even longer to go away,” Gasman says.

“Every time someone quits, you have to find and train a new person,” adds Tom Hauskin, senior analyst for Strategies Unlimited. Nortel, for example, has keenly felt labor-shortage effects at its facilities in rural parts of the U.K. where skilled labor is limited, he notes.

Optical electrical components suppliers are attacking the people problem from two sides: mergers and acquisitions, and outsourcing.

For example, Alcatel's Optronics Division, which only last year added passive components to its portfolio of active components, purchased the Gatineau, Canada-based Innovative Fibers, a maker of fiber brass gratings and gain- flattening filters. Alcatel now has six optical components plants worldwide and by the end of the year will have quadrupled its overall capacity, Laurent-Ottomane says. Alcatel is “clearly on the acquisition trail,” she adds.

Even with these increases in capacity, the company does not expect to see any “real relief” in terms of demand,” she notes. That's because channel counts and spacing density are increasing, and to increase those things, you need even more components, explains Jennifer Sproul, Alcatel Optronics' director of sales for North America.

Over the past two years, Agere/Lucent has invested $4 billion in acquisitions. Companies acquired include Ortel, a leading manufacturer of optical electrical components for the cable TV industry; Herrmann Technology, a maker of thin film filters used to make passive optical filters; and DiCon, a joint venture for passive optical electrical components.

Since JDS merged with Fitel and Uniphase in mid-1999, the firm has acquired 10 additional companies. JDS Uniphase has a four-fold strategy to increase capacity: expansion, manufacturing improvements, automation and outsourcing. Acquisitions fall under expansion.

Over the last 14 months, Corning has spent nearly $10 billion to buy about 10 companies, says Maligne. It bought Siecor for pumps and amplifiers, Net Optics for thin film filters, Intellisense for micro-electro-mechanical systems (MEMS), and Pirelli's fiber optic components division for lithium niobate modulators.

The purchases of these companies mark a “radical” change in Corning's standard operating procedure. Over its long history, the company has preferred to grow its own technology rather than buy it up, Maligne notes.

“Consolidation is a natural evolution toward higher volume, more standardization and lower-cost products. The industry has reached a point where this is now the obvious thing to do. It pushes the whole industry forward,” Hauskin says.

In addition to acquisitions, optical electrical components makers are building new plants in areas where they have reason to believe that staffing them isn't going to be a chore. JDS just opened the doors to its new 320,000 square-foot plant in Shenzhen, China. The plant is manufacturing passive components in volume, and the company plans to add actives and modules to the mix in the future. JDS Uniphase built the plant in Shenzhen to take advantage of its highly trained work force and the low-cost environment, according to Tony Muller, executive vice president and chief financial officer of JDSU.

JDSU plans to use its offshore plants to manufacture the most labor-intensive and mature products in its portfolio, Muller adds. Recently introduced products will be made in plants closest to the teams that developed them.

Shortage solutions

Automation
Expansion
Mergers and acquisitions
New facilities
Outsourcing

In 2000, Corning added three new production sites to its arsenal of plants, including a site for producing amplifiers and dispersion compensation modules in Benton, Pa. The new plant will double Corning's output of amplifiers. Corning opened a site in Monroe Park, N.Y., which began shipping couplers and viable optical attenuators in December. Corning also invested $270 million in a new plant in Nashua, N.H., to increase capacity of pump lasers.

ADC, which makes passive and active components, has six plants worldwide. It recently acquired Altitun (which makes lasers) and Ibsen (which manufactures fiber brass grating and phase mark components). The acquisitions will help ADC accomplish its goal of doubling capacity by year-end 2001, says Martin Nyman, director of the advanced photonics integration center of ADC's fiber division.

One of the developments spawned by the tight market has been customer demand for more integrated devices, Nyman adds. Customers with limited OEC expertise want ADC to deliver integrated packages such as a wavelength division multiplexer coupled with an optical isolator and a 5% tap coupler, he says.

In that component, the isolator allows light to go in one direction and not back the other way. It is used in a pump laser to keep light from reflecting back into the laser, he explains. The tap coupler allows the device to divert 5% of the light for monitoring purposes.

“Today, those functions are performed by three discrete components that take up space and have to be fused together. Putting them all in one package saves space and is of more value to amplifier manufacturers than if the parts are sold and installed separately,” Nyman adds.

The brave new future

Components that were regulars on the “out of stock” list last year include:

• 100 GHz thin film filters
• Switching chips
• 980 nm pump lasers
• Tantalum capacitors
• Couplers
• Lenses and lens assemblies
• Ferrules
• OC-192 modulators

Ferrules have been in low supply for the past couple of years. Because ferrules are a main part of every connector, the whole industry suffers when they are in short supply, says Stephen Montgomery, president of ElectroniCast.

At the high end, equipment suppliers can expect continuing shortages of components such as 40 Gb/s receivers, lasers and external modulators, says RHK's Lively.

Growth in the optical components market is likely to sway toward those components needed to build metropolitan optical networks.

During JDSU's second-quarter earnings call, JDSU executives said the company is already seeing strong growth in the metro and metro access segments of the market.

“We believe our shipments in the metro arena are going to grow five times or more in 2001 as compared to 2000 and could make up 15% to 20% of our revenues in the 2001 calendar year,” Muller said.

The effects of the economic slowdown, added capacity, increased automation, consolidation and the fact that the “caught off guard” factor has been diluted somewhat should ease the overall shortage situation to a more tolerable level in the near term this year. But the market is in such a state of flux that no one can say for sure how long the relative “lull” will last.

One thing is for sure: The new plants and expanded facilities are not going to go to waste in the long term. According to ElectroniCast, the global component market (including optical fiber) will reach $67 billion in 2005 and leap to nearly double that in 2015 — $125.6 billion. By 2025, the market will reach $214.7 billion.

“Most categories of components are still back-order limited,” says Gary Shaffer, general partner of Morgenthaler Ventures, which is funding several start-up optical electrical components vendors. “Our companies are still shipping all they can produce. But a lot of new capacity has come on line in the last six to nine months, so I expect current widespread shortages will diminish in 2001, especially at the low end of the market.”

However, Shaffer, like all the analysts consulted for this article, believes the demand for high-end, best-of-breed components will continue unabated.

“Many of these components are difficult to manufacture with high quality and in high volume,” Shaffer says. “This will increasingly favor the best suppliers. The me-too's will be left behind.”