More product, less filling

This week will mark the third SuperComm since the telecommunications industry hit the skids in late 2000. As we head down to Atlanta this week, we wonder whether the number of companies at the conference will still seem to far exceed the opportunity that now exists in the market. For three years, we've all been going to these events and most conversations with colleagues and acquaintances quickly turn to some comment about the excessive number of presenters at the show. Everybody has a real sense of the problem, but few seem to be willing to do much about it. Much of the focus is on the startups, but even if they were all wiped away, there is not enough product differentiation in the market today to support the bloated number of companies selling virtually every class of equipment.

The frustration of people in our business is, how do you push companies to do what you believe they must without insulting their ability to manage their business? We'll take one simple example: the optical-transceiver market. A quick scan of the industry can easily uncover more than 30 companies that say they address or plan to address this market. Some provide a broad range of products and others address some carve-out where they think they have particular competence. Some of the distinctions between these subsets of the market are striking today, but over time, most are unsustainable business differentiators.

Back at OFC in March, several companies told us that the slowness of the market was forcing them to move into adjacent subsets of that market, for example, a short-reach datacom transceiver player moving into telecom products or a broad-line short-reach-module supplier stretching into intermediate-reach products. Somehow, they believed that what they do today that was going to translate into a competitive advantage in the new market and fuel their growth. In a few instances, you might convince us that this business strategy is correct, but the vast majority of the time, what ensues is a competitive morass that will ultimately leave just a few companies standing.

Even when we convince these companies that this strategy is potentially unhealthy, most of them assume they will be among the survivors. But can they possibly believe that or is there something else that conditions them to move down this fateful path? We think it is the latter, namely, a fear of the loss of jobs, friends, or maybe a fear of change. This strategy may do more long-term damage than facing up to what needs to be done and the accompanying short-term negatives associated with it.

Many of us have seen the companies we work for or with slash staffing at least in half over the past few years. The first 20% was generally fairly easy, because the business boom forced managements to accept employees that were less spectacular than they might otherwise have liked to hire. Each subsequent cut became more challenging, but somehow we managed. The deeper cuts were more debilitating to the companies and often to the personal relationships between those surviving and those departing. Even though these cuts may have had nothing to do with individual performance, painful judgments were made that often damage relationships. Further cuts will cause even greater pain.

If managements were more willing to face the reality of their business conditions and instead focused on finding the best consolidation partners, they might increase the odds of corporate survival and ultimately preserve more jobs. Certainly, a merger of similar businesses forces the elimination of redundant positions, but those employees were likely to have been let go without a merger. The right merger would allow companies to focus on a more productive future sooner. For the employees able to keep their job in the aftermath, there would be one less competitor and thus a healthier business for the combined company.

It is remarkable how few companies have been willing to make a move of this nature over the past year or so. We've had a couple of desperation exits from the optical-component business by debt-burdened equipment companies. Sycamore Networks exited the DWDM transport equipment business and ONI Systems sold to Ciena. There is not much to talk about after that.

The time has come for company managements to survey the competitive landscape and make a reasonable assessment of their chance to build a valuable business for shareholders and employees. That assessment must look beyond just having a pot of cash that can ensure survival. Having enough money to last has never been what American business and having public shareholders are all about. High in the mix is fruitful employment and profits, both of which are of course closely linked.

We may have focused on the transceiver market, because there are clearly way too many companies hinging their future on that market, but we certainly do not mean to stop there. There are still too many long-haul and metro transmission suppliers. Will the market support the current number of companies claiming to supply optical switches? We don't think so.

The problems aren't limited to optical product lines. We've been surprised with the number of cable infrastructure startups, despite a shrinking pool of customers and business conditions that have already produced consolidation among the established suppliers. Even a market as mature as wireless infrastructure probably has one too many suppliers, and the list goes on. These problems are past due for resolution. ..

Kevin Slocum is managing director in investment banking at SoundView Technology Group (Greenwich, CT). He has more than 20 years of financial industry experience, including institutional equity research sales and analysis, and has been named to the Wall Street Journal's prestigious "Home Run Hitter" list two consecutive years. He can be reached at 203-321-7200 or kslocum@soundview.com.

Important information about SoundView's conflicts can be found at www.soundview.com/Research/ConflictDisclosure.

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