Success grows hand-in-hand with irony

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Declining prices and increasing volumes bedevil and yet enrich the WDM components industry. Smaller companies are still valued for their expertise and intellectual capital, but they face increasing pressure from large-scale manufacturers. Meanwhile, the laser diode market for telecom applications grows at an average of 22% per year.

Tom Hausken

senior analyst

Strategies Unlimited

These are the best of times for the telecommunications components industry, with the market growing at a record pace and to a whole new level of consumption. Long-awaited developments, including WDM, came upon the industry so quickly that they even caught some of the most optimistic companies by surprise, bringing with them high stock values and record profits.

At the same time, however, this new phase in the industry brings unprecedented challenges and raises the stakes for competitors. While the market is expanding to allow more competitors, so too are the volumes driving down prices, squeezing out some suppliers accustomed to low-volume, high-margin business. Many suppliers that cannot simultaneously bring down their prices and increase performance will be outpaced by large-volume manufacturers that are rising to meet the challenge. At present, fortunately, these smaller players are still prized for their established capacity, intellectual property, and human resources (see "Packaging comes to the fore," p. 20).

Demanding performance

What is driving the demand? The usual answer is that the Internet-or more specifically the Web-is behind it. In this sense, the Internet is truly the "killer application" that the telecom industry has been waiting for. Without it, growth would have occurred, but more slowly, and some opportunities would have been missed entirely.

In fact, the actual traffic dedicated to Internet applications is only now approaching that of traditional circuit-switched voice traffic. If just today`s traffic and capacity mattered, the existing infrastructure could easily accommodate the new traffic over most routes, requiring only limited new installation.

What is particularly significant about Internet traffic is that it has been growing at rates of 100% or greater per year for several years. The number of computers connected to the Internet is growing at a slower rate than in the past, but is still growing at nearly 50% per year-a phenomenal rate by any measure but especially considering that there are about 100 million computers already connected!

Added to this, people are using the Internet more and are using applications that increase the traffic, such as image and audio files. Even discounting much of the hype surrounding its growth, the Internet will quickly dominate worldwide telecom traffic, pushing the existing infrastructure beyond its limits.

A fortuitous convergence of events

Moreover, the convergence of other events with the increase in demand has affected the fortunes of new and established telecom players alike. Now nearly any new player has an opportunity to take the most-profitable customers from the established carriers, who were previously untouchable.

In particular, the development of optical fiber amplifiers in the late 1980s enabled new WDM solutions. WDM, in turn, allowed for vast increases in telecom capacity at a fraction of the cost of lighting-and especially installing-additional fiber.

For example, major carriers such as AT&T and MCI WorldCom have been able to double their entire network capacity in one year using WDM technology. Once WDM equipment is installed, the cost of adding an additional WDM channel to a route is a fraction of the cost of lighting a new fiber, especially if an additional fiber must first be installed. In fact, WDM is so economical that a new service provider can install a cable with hundreds of fibers, light a few, and increase its capacity as necessary by adding WDM channels on just those few fibers. All of the remaining fibers can remain dark.

In addition to the jump in demand and the coming of WDM, the late 1990s marked a period of deregulation of telecom services around the world, including the lucrative North American and European markets. And capital has been abundant and accessible for carriers seeking to build or upgrade networks. Carriers like Global Crossing and Qwest Communications have emerged in just a few years to become major players. These new companies can jump directly to new equipment solutions, such as WDM, without the burden of paying off legacy equipment.

Leveling the playing field

Ironically, the growth in revenue to the carriers is relatively fixed and is driven by larger economic and social factors. At Strategies Unlimited, we forecast wireline telecom services growth at about 8.6% per year, worldwide (see Fig. 1). High-value-added services are growing much more quickly, however. These services include systems engineering and services other than "plain vanilla" traffic provision. New carriers and established carriers alike are targeting these services in an increasingly complex industry. It is as if the target markets have no truly established carriers, especially where the former monopolies are confronted with new types of business, such as IP services.

The effect of this convergence is to level the playing field-it is now a whole new ball game. The new carriers must build their infrastructure. The established carriers must also invest even when their networks are still relatively robust. While no carrier wishes to overinvest, overinvestment is now preferable to underinvestment. The carrier that is caught short in coming years may be left behind for good.

Laser diodes rise to the challenge

The steep growth in traffic combined with the modest revenue growth by the carriers implies that the relative price of the traffic must decline dramatically in coming years. In fact, prices have fallen drastically as a result of WDM and will continue to decline as the technology continues to increase performance at ever-lower costs (see Fig. 2).

The price of telecom capacity varies according to several factors, including the distance, type of service, available capacity, competition, regulation, and method of payment. In an ideal market, however, the price of an arbitrary unit of capacity can be expected to fall another 70% over four years.

This decline in prices is only possible because of WDM and related new technologies that enable an increase in performance even as costs decline. Since WDM emerged onto the market, leading-edge carrier systems have doubled in capacity about every 18 to 24 months.

This growth is not confined to WDM alone, however, or even to fiberoptics. We have observed that long-distance communications have increased over nine orders of magnitude since the first trans-Atlantic telegraph cable was installed. This increase amounts to a doubling of maximum data rate about every four to five years over a period of 134 years!

A key component in the WDM business is the laser diode. For every WDM channel installed, there is one laser operating on one of the ITU grid wavelengths at the terminal. Many more lasers are associated with the WDM explosion, however. For example, there may be one or more lasers in adjacent transponders to jump the demultiplexed signal from the long-haul equipment to local switching equipment. Also, additional pump lasers are needed in the optical amplifiers used in WDM systems (see "What are WDM lasers?" above).

Strategies Unlimited forecasts that the market for telecom laser diodes overall was $1.95 billion in 1999 and is expected to reach $5.4 billion by 2004, according to a new comprehensive study (see Fig. 3). The high but declining growth rate amounts to compounded growth of 22% per year over the period to 2004. These figures include all the lasers that support telecom applications, including transmitters, pump lasers, and tunable lasers of all types and data rates.

The growth in sales of laser diodes for telecom applications represents a small but growing fraction of total telecom revenues. Telecom networks now use lasers widely, and their use is still expanding from the core outward to the access network.

While the forecast is built up from a complex set of smaller and interdependent forecasts, a general observation can be made. We do not anticipate that the exceptional growth observed overall will be sustainable year over year, nor do we expect that the current investment will be sufficient to carry the industry for several years out. Rather, we view the industry as entering a new phase, where optoelectronic components play a larger part, and where replenishment will play a larger role than it has in the past.

Tom Hausken is a senior analyst at Strategies Unlimited, 201 San Antonio Circle, Ste. 205, Mountain View, CA 94040. Contact him at 650-941-3438 or thausken@strategies-u.com and www.strategies-u.com.Wdm93972 30

FIGURE 1. Worldwide wireline service revenues should grow at 8.6% per year.Wdm93972 31

FIGURE 2. Decline in price for average US long-distance capacity reflects the impact of WDM, which increases performance and lowers costs.Wdm93972 32

FIGURE 3. Telecom laser diode revenues show a high but declining growth rate equaling 22% per year over the next five years.

Packaging comes to the fore

The paradox of increased competition in the face of unprecedented demand is especially striking in the area of packaging. For years, packaging did not play a prominent role in the development of fiberoptic components, as low-volume, high-margin production allowed for expensive custom-packaging methods and low packaging yields.

Today, however, with most of the cost of WDM components in the assembly and packaging processes, high yield and automated packaging technology are the key to success in the market. And the packaging process must be coordinated with the entire device design and manufacturing process to be successful. Packaging engineers are now highly prized.

Moreover, with so much of the value invested in the package, companies eye the market for packages-and subsystems-as more desirable than selling merely chips and other subcomponents. With the increased volumes, subcomponents and even some packaged devices have become commodities, with yet more pressure to reduce costs.

Packaging automation, while serving the larger silicon industry for years, has now become essential in the new WDM components industry. Automation is the solution to many of the challenges facing suppliers, including the need to improve process control, reduce labor costs, alleviate trained labor shortages, reduce training times, and accelerate delivery of new products to the market.

What are WDM lasers?

While it seems that any company with WDM in its business plan is sure to get high values, telecom lasers are not used only for WDM. In fact, relatively few lasers are actually used to multiplex traffic together onto a single fiber. These long-haul lasers bring a high value, however, with prices at 10 to 100 times that of lasers used for shorter distances or lower data rates. Perhaps more important, the growth in WDM components is high. In 1999, the market for lasers for 10-Gbit/s functions grew more than 300%. High growth means high opportunity.

Even so, it is not always clear what is meant by the WDM market. For example, WDM equipment sometimes uses short-reach transponders to carry the signals between the long-haul WDM equipment and local SONET switches and IP routers. At OC-48 data rates, these transponders use inexpensive lasers operating at a wavelength of 1.3 µm to jump this equipment. Cisco Systems has proposed that parallel interconnects using lasers operating at 850 nm be used to perform the same task at 10 Gbit/s. The parallel links cloud the usual distinction between what is an enterprise application and what is a telecom application. Also, WDM is now being applied to nearly every application, from submarine to enterprise networks and even cable television systems.

In addition, optical amplifiers in WDM systems require more pump lasers than amplifiers before WDM, so even pump lasers can be considered to directly support WDM systems.

In the larger sense, WDM in the long-haul market can be seen as driving the overall telecom industry by enabling affordable expansion at just the right time. Viewed in this way, the entire telecom market is tied to WDM.

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