Where does intellectual property end and contract manufacturing begin?

TRENDS

By KATHLEEN RICHARDS

The optical boom in the last few years is creating a new business model that OEMs may or may not embrace. As demand in components and subsystems outpaces supply, companies such as JDS Uniphase, Nortel Networks, Sycamore Networks, and ONI Systems are outsourcing some manufacturing to contract manufacturers. But outside of fiber and cable, where manufacturing processes are already in place, the early going has been challenging for both sides.

Most agree a move toward contract manufacturing is needed. While the optical communications industry is exploding, an infrastructure that supports volume manufacturing is not really in place and a lack of standardization is impeding automation processes. "If the economy had not gotten poor, the industry would have collapsed under its own weight, because you can't sustain 80% growth in a manual mode," observes Dave Krohn, managing partner of Light Wave Venture Consulting (Hamden, CT).

While the electronics in optical equipment has been outsourced for years, traditional electronics contract manufacturers such as Celestica, SCI Systems, Jabil Circuit, Flextronics International, and Solectron are all working in optoelectronics to varying degrees, from board assembly and testing to the production and testing of optical modules. Contract manufacturers focused entirely on optical component and subsystem manufacturing such as Fabrinet and Iphotonics have also begun to emerge.

"Outsourcing is being experimented with on all levels-components, subsystems, and systems-although it's really the components and the modules where there is the most experimentation going on," says Robert Norberg, senior analyst of electronic manufacturing services (EMSs) companies at JP Morgan H&Q (Minneapolis). The EMSs need to under stand this business early, says Norberg, even though "right now, the dollar opportunity is a rounding error."

OEMs use outsourcing for different reasons. Some startups' business plans outsource all manufacturing; other companies that already have their own manufacturing in-house may adopt a two-tiered model, with some internal and some external. These companies look for an outsourcing partner that can lower costs on a per-unit basis, guarantee supply, and allow the OEMs to focus more on core competencies such as research and development. Several OEMs outsource the electronics portion of their products, then do the optical integration in-house or in specialty shops.

Today, it is common for EMSs to work on board assemblies, for example, an optical component like a transmitter or a receiver on a board. A step up from that are board assemblies with fiber on the board, which involves some fiber management. The next level is board assemblies, with multiple components, both passive and active interconnected with fiber and typically some degree of fusion splicing.

"The largest share in our business and I believe in the EMS space today when you talk about optical manufacturing still centers around what I would call the traditional EMS space, which is in the area of board assembly work," says Bob Bradshaw, president of SCI Systems (Huntsville, AL). "But with that comes some very critical capability in the area of optical fusion and how you actually test and configure that board assembly, which is quite complex compared to some of the other non-optical capabilities."

Module assembly is the big differentiator. While photonics contract manufacturers such as Iphotonics specialize in module assembly, it is still out of reach for many EMSs. Celestica, currently working with a customer on module production is one of the exceptions.

"When you get to the module assembly, it is very manual in nature and you have to understand fiber management, splicing, and different test skills," explains Pete Tomaiuolo, manager of the optronics technology group at Celestica (Toronto). "You're now talking about a product that's got 30 or 40 splices and different types of fiber...so the complexity is much higher. It's not just the assembly, if you have to debug, it is very difficult in optical assembly, because contrary to electronics, you can't probe points to find the problem. These skills take time to develop. Some of us have developed them sooner than others, so it has not reached critical mass yet."

Module assembly also involves investment in new equipment and processes. "While it's a relatively immature industry, and there are not a lot of standards in terms of the size and shape of the products," says Tomaiuolo, "it's tough to automate things like that. It's going to take a while for standards to develop to allow more automation to be added to module production." Currently, Celestica is working with 20 optical companies in the areas of boards, modules, and systems.

Other contract manufacturers work in specialty areas. Electronics contract manufacturer PemStar (Rochester, MN) is building component, module, and system-level assemblies largely in the optical data storage area for customers such as IBM (PemStar was a spinoff in 1994), ONI Systems, Qlogic, and Dataplay. About 10% of the company's revenue last year came from optical component-level or system-level manufacturing, according to Steve Petracca, vice president of business development.

Many OEMs want to expedite time-to-market and benefit from the economies offered by contract manufacturers, but safeguard their proprietary technologies from mass production. "People want to outsource, but they don't want to give away any proprietary technologies, so you're kind of caught in a Catch-22; I see a lot of business plans where you keep the core technology home and you farm out anything that is not core to you," says Krohn. "This has been a major barrier to widespread use of contract manufacturers. Somehow this has got to be addressed, as we move forward and there is not a good solution right now."

"Intellectual property [IP] is not as much of a concern with some of the newer companies," says Tomaiuolo. "We've worked with Sycamore for a couple of years, IP for them at least from a manufacturing perspective isn't really a key issue. With the older vertically integrated-type companies, a company like a Nortel or a JDS Uniphase, it becomes a big issue, because there is a lot of IP sensitivity surrounding the manufacturing process."

Progress is being made, according to the EMSs interviewed; OEMs that six to 12 months ago were not convinced of the new outsourcing model are now struggling with how much to outsource.

More in Earnings Statements