How big is big enough?

by Stephen Hardy

Last month�s announcement that Finisar and Optium have agreed to merge has created plenty of fodder for conversation. Principal among the topics under debate has been whether the creation of a new giant in the components and subsystems space will finally touch off the wave of major consolidation that analysts have long desired. Speculation began immediately over which companies would now be forced to combine and which pairings had the greatest chance for success.

But there�s another topic attendant to the deal worth considering, and that�s scale. As I just noted, the new entity will be huge�according to Ovum RHK, bigger than the optical communications business at JDSU, which has been the 800-lb. gorilla in the space since early in the Bubble Era. And according to the principals involved, bigger is definitely better. �We think this industry needs a dominant player that has all the answers for the customer,� Optium chairman and CEO Eitan Gertel told me the day the merger agreement was announced. Moreover, big systems houses like Cisco Systems and Alcatel-Lucent like to deal with big suppliers, Finisar chairman, president, and CEO Jerry Rawls added during the same conversation. �It�s very difficult for little companies to scale to satisfy the needs of these increasingly consolidated, large equipment companies,� he explained. (For more comments from Gertel and Rawls regarding their rationale behind the merger, visit the Lightwave Blog at http://www.pennwellblogs.com/lw/.)

Darryl Inniss of Ovum RHK added to the �bigger is better� drumbeat in his comments on the deal, stating, �[Optical component] vendors must use consolidation and partnerships to remain competitive.�

So is every company going to have to pump itself up to survive? We�ve heard the �one-stop shop� philosophy espoused by a large number of companies, starting with JDSU. However, as we discussed in this space about a year ago (see �A Shrink-proof Industry?� in the April 2007 edition of Lightwave, page 12), the industry has traditionally proven resistant to evolving toward component and subsystem superstores.

First and foremost, there is such a broad range of available technology (a range compounded by the multiple form factors in which each product is presented) that it�s difficult for one company to get its arms around a critical mass of technologies�not to mention more than one company. It�s expensive, for one thing, and discretionary income among component and subsystem vendors isn�t exactly plentiful these days. And it�s difficult to maintain differentiation in each product niche as one�s portfolio expands. JDSU is a fine company, but it�s not on everyone�s short list for every product on the JDSU web site. It�s not that JDSU�s products aren�t good; it�s just that a competitor with a narrower focus has a better chance of creating differentiation by optimizing the performance, cost, etc., of a smaller product line.

And that�s just taking into account the off-the-shelf products. As systems houses continue to request customized offerings, the difficulty in meeting every customer�s requirements compounds.

And then there�s the question of just how important having a broad line of products really is to systems houses. For the past two years, we�ve conducted a survey of our readers who buy transceivers and transponders and asked them about the factors that make up their purchasing decisions. In this year�s survey, �Company supplies other products to you now� ranked 12th on the list of determining factors for transceiver/transponder purchases. Thus, having a broad product line in and of itself doesn�t appear all that important. Improving performance, cutting costs, increasing reliability, stabilizing production capabilities, and reducing power requirements would appear to be more important goals.

Of course, Finisar and Optium would assert that they�ll be better able to meet such goals once their merger is complete than they could as individual companies. The question for the industry as a whole is whether the merger somehow creates enough urgency within the components and subsystems community to overcome the barriers to consolidation�and whether their deal is a model for how to get the job done. Despite the problems I�ve just enumerated, plenty of companies have expressed a desire to more closely match JDSU�s product breadth. Now that Finisar and Optium have shown that it can be done in today�s business climate, will shareholders, venture capitalists, investment banks, and other interested parties suggest to senior executives across the space that there is now �no excuse� for not finding a partner for product expansion�or at least exit strategy execution?

I think this will be the case�and the result will be some match-ups born more of desperation than insight. These combinations will feature floundering companies, lots of product overlap, and size for the sake of size (or finally getting investors some sort of payback). Big is indeed better for some. But I think we�ll find that it�s not for everyone.

Stephen M. Hardy
Editorial Director & Associate Publisher
stephenh@pennwell.com

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