How dark are those clouds?

by Stephen M. Hardy

Last month in this space I outlined four areas I believe will emerge this year as important trends within the optical communications market. (See �Four Hot Topics for 2008,� in the January 2008 issue of Lightwave, page 10.) Needless to say, I expect each of these�work on high-speed communications, parallel optics, and wafer-level functional integration as well as heightened interest in the consumer electronics market�to be reflected within the conference program and the booth demonstrations this month at OFC/NFOEC in San Diego.

But another potential influence on the optical communications space has arisen since I wrote last month�s column, and it could prove the most important factor in determining how this year will turn out. And that�s the impending threat of economic recession.

As I wrote this, the indicators of an impending recession had been in place for some time, particularly in the United States. A falling real estate market, mortgage industry woes, and intimations of failing consumer confidence, among other factors, had sent stocks into a freefall. Major stock exchanges around the world followed suit, as investors indicated they had more faith in emerging markets than established ones.

A presentation a UBS Warburg analyst gave last month at the Fiber Optics Expo in Tokyo underscored the concerns on Wall Street. Citing unsettling indicators from major carriers worldwide, alleged hints from Cisco Systems that enterprise equipment demand had softened, and fears of tightened consumer spending, the analyst predicted that carriers in established markets would see revenue declines. Such declines would lead investors to demand cuts in capex, possibly causing slowdowns in purchases of optical communications equipment and reduced investments in major projects such as FTTH initiatives.

Then, just when it really looked like the sky was going to fall, a funny thing happened. U.S. stock markets suddenly picked up. AT&T, which had fed recessionary concerns when it reported it had begun dropping customers who suddenly couldn�t pay their bills, announced a 2.9% year-on-year revenue increase during its fourth quarter, including double-digit growth in broadband services as well as growth from its enterprise services. The carrier also �reaffirmed its positive outlook for 2008 and beyond,� in the words of a press release.

Put it all together, and we have the very definition of �economic uncertainty.� Against this backdrop, the optical communications community will gather at OFC/NFOEC with one eye on new technology and application developments and the other on the clouds gathering on the economic horizon. Bookham president and CEO Alain Couder, while touting the successes of his company�s most recent quarter, struck a note that we�ll likely hear repeated: �Going into the March quarter, the market environment is becoming more unpredictable due primarily to the uncertain general economic conditions,� he said. �As a result, while we remain confident in our medium- to long-term growth expectations, we are taking a conservative approach with our short-term forecast.�

Meanwhile, Craig Iwata, senior director of marketing and business operations for JDSU, recently told me that he thinks the lean business practices that many systems vendors adopted last year will continue to ripple through the optical communications industry this year�mainly because component and subsystem vendors will be forced to adopt similar practices.

Oversimplified, the systems suppliers adopted these lean practices to shorten lead times, both in terms of their own deliveries and those of their suppliers. In so doing, they had an opportunity to review their inventory procedures and requirements. Many decided they had more inventory than they really needed. That�s why the adoption of these practices put a temporary brake on the components and subsystems market.

Iwata believes that most component and subsystem vendors would do well to adopt similar strategies to better position themselves to meet their customers� newly reshaped delivery requirements. That undoubtedly means that subsystem developers will go through the same sort of inventory requirement review that set their sales back last year. That can�t be good news for their suppliers.

However, like the dip encountered last year, the effect on sales should be temporary. The optical component and subsystem space has long been compared with cottage industries, and any progress it can make toward more modern manufacturing processes that improve efficiency will strengthen the segment for the long term.

Such transitions create uncertainty, and paired with the uncertainty in the global economy as a whole, one can expect an undercurrent of mild anxiety to run through the exhibition. However, I believe the fundamentals that produced such good results for the system houses last year (and decent results for the components/subsystems companies during the last six months of 2007) remain in place. The requirements to which carriers have responded with optical technology remain important and should withstand recessionary pressures over the long term.

Short term, there may be issues. But the optical communications space has experienced�and survived�far worse.

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

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