Grumpy old men

by Stephen M. Hardy

On the afternoon of Feb. 25, 2008, a collection of C-level executives took their places behind a table and looked out at an audience of nearly 200 of their peers, gathered to hear the panelists� views on the market at the OSA/Lightwave Executive Forum. The panelists had several characteristics in common. They all worked for optical component and subsystem companies. They had all survived the downturn in the space that appeared to have ended conclusively last year. They had seen their companies� revenues grow in 2007, to the point where some had been profitable and others had approached that mark for the first time in years. They all seemed to expect revenues to increase this year. Most anticipated that revenues would be even better in 2009. They also shared one other trait: As a group, they were cranky as hell.

What was wrong with these people, several attendees asked me. It was almost as if the pessimism that had surrounded the space since the Internet bubble burst in 2001 had seeped into these executive�s skins.

The sense I got in listening to these panelists, as well as others during the Forum, was that optical components executives are just plain frustrated. They�ve moved their production facilities to Asia. At the same time they�ve shouldered the R&D burden their systems customers no longer wish to carry. They�ve cut costs, adopted lean manufacturing practices (or suffered while their customers similarly revamped their inventory requirements), and otherwise jettisoned every non-essential weight from their ships in order to remain buoyant, all hoping for the day the market would finally turn around.

And, lo and behold, the market did turn around in 2007. But, the executives seemed to feel, the ensuing payoff they had counted on had not materialized.

Their margins still stink. The pressure to further reduce prices remains. Wall Street shows them no respect, judging by the anemic market caps of the publicly traded among them. Those war chests they were going to amass via IPO that would enable them to be engines of consolidation? Right now, they seem too small to cover more than lunch.

What�s an executive to do? The impression I got listening to them is that they were unsure, short of continuing to find new and better ways of executing the same old strategy. Sure, consolidation in the number of companies chasing optical component dollars would help. But this market space has proven astoundingly resistant to the amount of consolidation observers inside and outside of the space agree would be beneficial. As the opinions expressed elsewhere in this issue illustrate (see �CEOs Describe Strategies for Profitability�), M&A isn�t an altruistic activity; it�s done for business reasons that make economic sense for all the parties involved.

Or, as someone else put it, mergers make the most sense when they involve two strong companies. How many strong companies do you know of in the optical components space?

Meanwhile, as the executives lamented at the Executive Forum the barriers to consolidation, at least two new component companies were preparing to make their debut on the exhibit floor.

Clearly, the way this space operates needs to change. On the one hand, new ways of reducing cost that can drive margin growth must be found, since the laws of the financial world that call for repeated quarters of profitability and growth won�t change. Perhaps technologies such as silicon photonics and polymer materials can provide a path here. On the other hand, perhaps new management strategies and business models can offer opportunities for M&A that might speed consolidation. The expansion GigOptix launched thanks to a large infusion of private funding certainly has attracted attention as that company acquires firms left and right.

However, I think component and subsystems suppliers will need assistance from their customers and their customers� customers. Mike Nishiguchi, president and CEO of ExceLight Communications, wondered during the Executive Forum why his company had to go through a long and expensive requalification process every time it wanted to replace a component with a less expensive alternative. Nishiguchi rightly pointed out that this requirement dampens innovation and penalizes suppliers for doing exactly what their customers demand: lowering costs.

And, finally, everyone in the space�those who operate in it and those who observe and comment on it�probably could benefit from a virtue that the executives I�ve described here have exhibited for several years but perhaps forgot during their time at the Executive Forum. That�s patience. The strategies necessary to improve the fortunes of optical component and subsystem companies took longer than a few months to execute. The benefits of such execution might take some time to manifest as well.

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

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