Changing the numbers game

March 1, 2002
Researching the researchers

Market reports missed the downturn. Can they help you survive until the recovery?


Independent market researchers play a role in almost every industry, identifying and analyzing market opportunities, sizing up the players, and forecasting market potential. How this data is digested and used by industry participants depends on the company. But after the optical-networking boom of 1999 and 2000 went bust in 2001, seemingly without warning, many fiber-optics companies are taking a harder look at market research and the assumptions behind the data. At the same time, at least some researchers are reviewing their methodologies to figure out what went wrong.

Reigning in the bulls
While each market-research firm attempts to provide a unique viewpoint through its in-house expertise, the basics of market research come down to asking a lot of people a lot of questions. ElectroniCast Corp. (San Mateo, CA) uses what it calls a "bottom-up" approach, in which the firm starts with low-level details and builds up from there. Background market research focuses on the amount of each type of fiber-optic component, part, or device used in each application the firm wishes to study and the prices paid for these devices. That forms the base year data for market projections. ElectroniCast analysts then forecast the growth rates in component use in each application, along with price trends, and apply all that to derive long-term forecasts at the lowest application levels. The analysts' usage growth-rate forecasts depend heavily on analysis of overall end-user trends toward broadband equipment usage and economic payback, says the company. Since ElectroniCast studies a wide variety of components, it can use its other reports as cross checks for predictions in new studies.

The key to making such forecasts accurate is keeping in touch with market players such as engineers at manufacturers, their suppliers, and their customers. The hope is that interviewing these sources will enable the firm to detect changes in market direction.

Not all hopes are realized, however. Certainly, as the financial squeeze in telecommunications accelerated and network deployment stalled in 2001, several market-research companies issued revisions to their fiber-optic technology forecasts. Even so, most analysts clearly did not foresee what was happening in the market until it was too late.

"If you look at the economics in general and look at the telecom industry and at the computing industry, what you're finding is that every industry is having difficulty forecasting what is going on in their marketplace-and that's been going on for a year right now," says Marc Litvinoff, CEO of RHK (South San Francisco), a market-research and consulting firm that focuses on public telecom networking worldwide. "I believe that has more to do with the fundamentals of the way businesses are changing and the way that people are consuming things. So what we are finding in forecasting is that we have to do more of an education job with our own clients to explain to them that our job with forecasting is to bring them as close to the answer as we possibly can. But there are things that occur that are unpredictable. Even we within RHK can't predict everything that is going to happen in the telecom marketplace. We think we have a great handle on what goes on, but with things like Sept. 11 or that the Federal Reserve is going to drop or raise interest rates five or six times, no matter how good you are at forecasting, you will never get those things right.
An unsustainable $49-billion bubble in service-provider capital expenditures in 1999-2000 burst in 2001-02. The recovery will depend on the speed and form that consolidation takes in the industry over the next 12 to 18 months, according to RHK.

"Now with that said, at every juncture in the road, it is our obligation to our clients to look at our forecasting process and to learn from our mistakes and from our industry's mistakes, and that's what we've spent the last six to 10 months doing as part of our normal process," Litvinoff adds. "Hopefully, what will come out of this is a stronger ability to forecast as we move forward."

KMI Corp. (Providence), a research firm owned by PennWell Corp. (publishers of Lightwave)and known for its analysis of the global fiber, component, and systems markets, had already begun to review its procedures before the downturn-and not because they were concerned about being too optimistic.

"Over the years, the market tended to outperform our forecasts," says Richard Mack, KMI's vice president and general manager. "The one exception to that was what happened in 2001, when we were trying to look at some new ways of forecasting to take that into account. So we've spent a lot of time this year looking at how we do our forecasts, why we thought the market would grow, why it did grow, and why it stopped growing. A lot of people did the same exercise. That's why you see a lot of work on capital expenditure and where it came from and the role of the financial community in telecom markets and in manufacturers and how that's changed over a period of years.

"In the past, we were looking at construction plans and what the carriers said," Mack continues. "And now we've said, 'Okay, let's go back and look at where the money was coming from, and how much they were spending, and whether that was commensurate with their revenue streams, and if not, why not?' In the past 18 months, I think everybody has had to dive into a lot more detail on financial issues and market factors to understand why the market was growing at a high rate and then stopped. If we succeed at understanding what happened in the past 18 months, then theoretically we [market researchers] should be smarter going forward."

Like KMI, several market researchers are starting to take a much closer look at service providers' capital-expenditure plans and whether these companies have the financing to back those plans up. Communications Industry Researchers (CIR) released a "capex" report earlier this year that examines the economics of service providers and what it means for future expenditures. RHK launched a Telecom Economics program in 2001 that models the financial information of about 100 service providers in North America. The goal of the program is to try to better understand the financial dynamics historically and during the spending recovery (see Figure).

Making sense of the data
Market-research reports typically define a market opportunity, discuss the companies in that market, their respective technologies and market shares if applicable, and market trends such as standards or how emerging technologies may eventually fit into the picture. The reports also offer forecasts showing expected market growth and the unit and revenue potential of the technologies over a five-year period. A company can buy a one-time report, attend a researcher's conference, or become a client and benefit from ongoing market analysis, discussions with the analysts, customized research, and consulting services.

Most technology companies use such independent market research and they buy reports from more than one market researcher-which ones depends on the respective firms' perceived areas of expertise. But few companies, if any, are comfortable relying on these resources exclusively.

"Market research is a good first step. It provides a macroeconomic overview both in product opportunity and geographic opportunity," says Bob Shine, director of marketing at components company WaveSplitter Technologies (Fremont, CA). "You might know that China is a great opportunity, but how do you get into Huawei Technologies or one of the other companies over there? You have to drill down a little bit more and that is not something the market researcher is going to tell you: Huawei needs X product with Y features at this price. Market researchers are good at giving a broader overview, but on a specific product area, they're not telling you what specs you need to differentiate on and what pricing you have to meet based on competitive pressure. There is still a lot of research that you have to do yourself.

"You also have to verify market research through multiple external sources and to try to understand the assumptions of the different groups, since each one has a different slant," says Shine. "You need to back it up with your own customer conversations."

In-house strategists
Larger equipment companies such as Corning Inc. and Agere Systems often employ an in-house team of market strategists, whose primary job is to study markets and apply that information to the company's business plans. These companies typically use outside market research for verification of their own data and to see if the market researchers are identifying any trends or developments the internal team may have missed.

"We use external firms to crosscheck our own internal market research," confirms Michaela Iery, a spokeswoman for Corning (Corning, NY). "We also internally work to reconcile conflicting analyses." The only change in strategy this year is that Corning will purchase fewer reports-opting not to buy research that the company considers less valuable-primarily due to budgetary constraints.

"It's often difficult for us to get the specific information that we want sliced the way that we want," says Mike Peppler, a strategic marketing manager for the systems architecture division of Agere (Allentown, PA). "We usually end up doing some reworking of the data in the report. We apply our own thought processes and assumptions to get to a particular product level or to look at a market in a particular manner. And it may just be that we tend to be in a component-level business and many of the market researchers concentrate on a higher level: the systems level."

Even at startups, where employees often must wear many hats, considerable effort is put into cross-referencing market data and understanding the assumptions behind independent research. That is perhaps even more critical at smaller companies than it is for larger entities that may be able to absorb a few misfires.

"You really can't outsource your thinking on the market," observes Doug Ranahan, director of business development at core optical systems startup Ceyba in Ottawa, Ontario. Ceyba, founded in May 2000 as Solinet Systems, is expecting to debut its first product in the first half of this year. "You have to get independent market research to challenge your assumptions and fill in the gaps where you may not have full visibility-new geographic areas, for instance. We use it to gauge the size of the market and we use it as an input into our business plan, but we haven't taken it at face value. When you are dealing with market-research information, the key thing isn't the size of the market or that type of information; you really have to understand the assumptions behind it, and you really have to find out whether you agree with those assumptions or have a more pessimistic or optimistic view in a particular area." Each market-research firm has its strengths and weaknesses, he adds, and knowing them is essential for choosing which data to believe and which to discard.

Direct approach
But market research is no replacement for direct contact with the market, asserts Ranahan. "We do our primary research with our customers so that we can really understand their needs and how to address those needs. We also talk with suppliers, but that's a two-way street. We have an ongoing dialogue about volume, when we see a market emerging, where we see demand going. We've seen an increased importance put on that type of communication all the way up the value chain since the capital spending reduction of 2000. I think that there is a greater industry awareness that those feedback mechanisms were probably inadequate before," he says.

In addition to gaining insight into industry trends, companies also can use market research as a mirror that reflects how their potential customers-and how analysts, in the role of impartial observers-perceive them. But that is an area ripe for abuse, as market-research firms are sometimes faced with a dilemma: How do you report negative information about a client and still retain its business?

There are ways to deal with a negative analyst report without compromising your relationship with a market-research firm or the value of that firm's research, say industry sources. "If what you're reading is contrary to what your own beliefs are and you want some understanding of how the firm arrived at that information, you might want to call them and talk to them," says Agere's Peppler. "On the other hand, you also need to be careful that you don't influence their research too much. After all, in many cases, you are paying them healthy sums for this research, and you don't just want to read back what you've told someone."

"There are definitely things when you reposition your company that they may lag on," says WaveSplitter's Shine. "There is kind of a fine line. You can try and influence them, but then they are not independent. They have to protect their independence and call a spade a spade even if a company doesn't like it."

Following the money
Market-research firms aren't the only observers of the optical communications space. As optical company after optical company went public in the late 1990s and 2000, financial analysts started to pay close attention to the fiber-optics sector.

The large, publicly held telecom companies, of course, were already on their rosters. And though a few prominent telecom analysts were recommending their companies' stocks even as their values plummeted, the financial community by and large pointed to the sector's ailing balance sheets first.

This fact hasn't been lost on optical communications companies. "The one thing that I've learned in the last year is that the financial analysts provide a good overview," notes Shine. "That's again a place where you have to be careful because they are underwriting and raising money for companies and they want to make their stock prices rise. But what I think was lacking two years ago was kind of [information on] the money flow, and the banks do a very good job of following the money."

"I tune into financial reports for a couple of reasons," says Ceyba's Ranahan. "One is to see if there is any competitive information-deals, what a competitor might be doing. The other part is really getting a better understanding of some of our customers' major spending plans and the macro conditions that are affecting their buying decisions. That's been quite important, because what I saw was that a lot of the financial institutions seemed to be ahead of the industry market forecasters in terms of capital spending and the direction that was headed. I think some of the market researchers have corrected that and are paying a lot more attention to the financial side that governs the market demand."

Braving the new world
Independent market researchers certainly took their licks last year. Forecasts were revised-sometimes more than once. And the recovery was always a quarter or two away. Going forward, what should companies realistically expect from market research and how can spending money on it in a down market be justified?

"The industry is not simply the same as it was, but smaller," says Dr. John Ryan, principal and chief analyst at RHK. "It is restructuring-the question is how? So for our vendor clients who are in the component business, a lot of the support that we are able to provide them is around understanding how their position in the food chain may be shifting. For some companies, the support can become quite specific. This company has this technology set, these parameters about it-money, sales channels, etc.-what is the opportunity that they go after?"

Helping clients-particularly service providers and systems-level vendors-understand the global market is another area of focus for RHK. North America, which once represented 60% of global optical transport spending, now accounts for about 35%. Quite a few companies, therefore, need to come up with a plan to address different regions or channels in the global market.

Strategic support is another service. "Quite a few of our clients have come to realize that the easy IPO ain't going to happen," says Ryan. "Okay, so what's the plan? They've got this set of technologies, this set of skill sets. Who would be the best company to acquire them and why? Just helping them think through that is of great value."

Independent market research will continue to play a vital role in the optical-networking industry, particularly now as many companies face a tougher business climate. "Based on the conversations that we have, the people that we sell our stuff to are very sophisticated and information-hungry," says KMI's Mack. "They are willing to probe at why we say the things that we do for the most part. So I think that, just like any other business, you have to have an ongoing dialogue with your customers about their needs, and I think that everybody is doing that."

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