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My-Optic Markets
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
October 26th, 2001


By Brent Holliday
Greenstone Venture Partners

" I can see clearly now,
The rain is gone...
It's gonna be a bright, bright
Bright sunshiny day "
Johnny Nash, I Can See Clearly Now

In defiance of Bin Laden, I sat strapped in my seat in an A319 headed for Boston. After a quick check around to figure out if I could take any of the men on the flight armed with only a Globe and Mail, I relaxed and thought about the business at hand. Trade shows and conferences had been decimated since 9/11. Most had last second cancellations. A lot had very disappointed attendees and financially ruined show organizers. Everyone was wondering if business was really this bad or if everyone was just scared.

In Cambridge, MA on October 24th and 25th, I am proud to tell you that an industry that has taken an absolute pounding in 2001 stood up and said, "We are doing business." The last place you would expect to see an SRO crowd would be from the optical components and networking sector. But there we all were, VCs, analysts and entrepreneurs standing shoulder to shoulder in a shaky coalition of faith. Faith in a market rebound sometime before the end of 2003. Please. Pretty please.

Exactly one year ago, you could have said, "I have an optical bagel company" and you would have raised $30M. Now, after the tremendous slides of JDS, Nortel and the rest, the amount of new money going into this sector is pretty close to bagel. Last year, the entrepreneurs screamed that they had the biggest, fastest and most optical (least electronic) devices for the brave new unlimited bandwidth world. This year, the entrepreneurs murmured about cheapest, easiest to manufacture and most likely to sell into existing networks. To quote the show organizer, "Boring is exciting this year".

Pity poor Ryan Hankin & Kent (RHK). They were ridiculed in every presentation because the obligatory slide of optical network and component market size and growth is always from RHK predictions. Every CEO cut the predictions for 2002 to 2005 by RHK in half. Some even suggested no growth for the next 3 years in overall market size. Here's a little secret about the optical business going forward: it will be cyclical. Maybe RHK will look at the boom and bust cycles of the semiconductor business over the last 25 years and learn something about predictions.

Even in these uncertain economic times, even with the predictions of dire demand for the next two years at least, I like this sector a lot. I've said it before, photonics and optical networks are where it is at for the next 25 years. Look at where we are today (this comparison paraphrased from the head of the MIT Microphotonics Lab):

To send a DVD movie (7.5 Gigabytes = 60 Gigabits) from Boston to Hollywood:

· On a 56K modem
17,857 minutes = 300 hours = 12.5 days

· Cable modem (1MB)
1,000 minutes = 16.6 hours = 0.7 days

· FedEx
600 minutes = 10 hours = 0.4 days

· HDSL (8 MB)
125 minutes = 2 hours = 0.08 days

· OC-12 (622 MB) avg metro speed
1.5 minutes = 0.03 hours

· OC-192 (10 GB) avg core speed
6 seconds

Since none of the final three speeds are available to your home or your office yet, FedEx is competitive with available bandwidth for the end user. Would you really wait 10 hours for an on-demand service? Sure, you could stream it and/or compress it to reduce time. But that reduces quality. Here's another way to look at it. You have the ability to throw bits of data around inside your PC at hundreds and hundreds of MB per second. But you can't accept or release any data anywhere near that fast. This is our current situation after hundreds of billions of dollars were spent upgrading data networks in the past 6 years.

The point is that we still have a long way to go, both in a technology sense and in a market sense, in order to have seamless bandwidth between the ends of the Internet. Let's talk about the market first:

Any observer of the rise and fall of the optical networking sector would think that the market simply overheated and cooled, catching people like JDS, PMC-Sierra and our new favourite corporate punching bag, Nortel, a bit off-guard. But there was much more to it.

Back in 1970, Corning invented fiber. By 1982, they had proven that the technology could be implemented in telecom networks. In the twelve years in between, they realized that fiber alone did not make a network. It needed amplifiers, connectors and interfaces to existing infrastructure. In 1984, after two years of trials, MCI, an upstart telecom company taking on the giant AT&T, rolled out 500 miles of fiber between Chicago and St. Louis. Two things to note: 1) The market required an entire system, not a single invention. 2) The incumbent carrier did not rush to try out the new technology. It was the new guy that innovated.

The 1999-2000 boom in the sector was caused by greed. Too many entrepreneurs and too many investors thought that everyone could make money in a new competitive environment. The rapid decompression of the sector was caused by obstinance and economics. The obstinant incumbent telcos tried as best they could to block any upstart from getting their enterprise and residential customers. They succeeded. The economics of the last mile to the home or to the business didn't work. It would be prohibitively expensive to lay fiber to the home. The slow roll out of high speed cable or DSL and the expense to the end user kept demand low. The result is that FedEx is faster still today.

During the boom, demand soared for optical gear to make the networks faster. In the optical networking business, components, switches and systems were sold for very high speed systems that made the core faster. It was a low volume, high margin business. The metro area and residential markets were not hot markets even though they would drive volumes of optical gear through the roof. The reason they were not hot was that the incumbents were harder to dislodge and the volume would likely bring prices down. Running new fiber across the country was easier. With demand sky high and prices high in the core, component companies like JDS Uniphase hired thousands of workers. Seastar Optics in Victoria sold to SDL and then to JDS. It was one of a dozen sweatshops in the empire of people using microscopes, wearing hair nets, bonding fiber the width of a human hair to components. No one stopped and asked where all of this was going. If you could sell an amplifier to Nortel for US$3000, and it took $200 in parts and 1.5 hours of a well-paid assembler plus overhead, you were making a killing. And JDS was making a killing. Any MBA student will tell you that high labour costs of assembly leads to big problems when demand slows and prices drop. The world of optical gear remains today a very labour intensive, un-automated business.

Back to the markets. If the optical network is to ever be high speed through the metro area to the enterprise or to your living room, clearly the costs of optical gear cannot be US$3000 per amplifier. The new markets require low cost networks. The last mile requires low cost parts. It also requires a motivated incumbent because most of the competitive carriers that contributed to the boom are gone. Here is a dilemma for Telus and the other incumbents: How do they justify putting a broadband fiber connection to your home when they are already getting $40 a month with a 40 yr old twisted pair of copper? This is called the unbundling of broadband problem. With a fat data pipe, they could supply voice over IP, Internet access at high speeds and all of the enhanced services that they already sell you today like voice mail. But are you going to pay them $200 a month because it's faster and has more services? Why would they go through the expense of putting it in then?

So the technology needs to get smaller, cheaper, more easily manufactured (automated) and still be faster. That's the first problem facing the photonics/optical industry. But that's a problem that entrepreneurs and scientists love. They can innovate and look for new methods and processes to drive down costs of manufacture and assembly to exploit the large un-fulfilled market. But problem number two is tougher. That large un-fulfilled market has only one point of distribution and service: the incumbent carriers. And they are not yet motivated to spend the dough. They need to see the economics better. They have a nice fat stream of money now and they want to sit tight for a while.

Our valiant entrepreneurs at Optical Portfolio are soldiering onward. Their bravado is definitely more muted compared to last year. They use new phrases like "if we don't have any revenue, our cash lasts until well into 2003" to counter arguments that the markets will be slow to pick up. Most component vendors are talking about other nearer term markets like military, medical and displays for their innovative new devices. Two Vancouver companies, that are still in development, but have innovative, novel devices and technology are Galian Photonics and JGKB Photonics. Both came out of UBC Electrical Engineering department and both received very favourable responses among the world's leading innovators here. But both are a long way from a big company as the market sorts out when the cycle starts back up again.

Letters From Last Time -

Hi Brent,

Enjoyed your article. The concept or relative degrees of "friction" at different locations is excellent.

The real question is what we can all do to reduce the "friction" in Vancouver. Perhaps a topic for your next article?

Bruce Tattrie
Campney & Murphy

I would love to write about solutions for "friction" but I feel that it is something that only improves by experience and learning. I hope that my articles help a bit in reducing friction by parlaying a lot of what I am learning into a useful and entertaining story. In order to "get it" you have to be willing to say to yourself that you don't have all the answers and you need to keep trying to be better. You have to see how it is done right and bring that back to what you are doing. Being insular is the worst thing you can do. Get out and learn.

Thanks for the support.


Once again bang on Brent. Add to that note that a contributor to Vancouver's friction is the continued lack of "smart" money. Smart money comes from investors who "get it".

Much too often, a good part of the local investment community is focussed on the "get in get out " aspect of their investment versus owning part of what will grow to a very big company.

Smart local money has good ties with US funding which will help the great local companies grow.

Reg Nordman
Rocket Builders

Awww shucks Reg. You really know how to make a VC feel good. Thanks for the addition to my story on "friction". It would have sounded a bit self-serving for me to say it.

Brent,

Thanks for another insightful and well written essay. This one really struck a chord because SPC is one of those infrastructure suppliers that grease the launchpad for companies to become truly great world class companies. I love the analogy of turkeys flying in a hurricane. I always argued that in times when demand exceeds supply significantly, even the worst software company can survive.

But in lean times, only those that have control over their development/business processes and are able to maintain decent quality will survive. This may be the reason for our recent success. We finished last FY (July 2001) with a 62% revenue increase over the previous year. Our product and service business is still doing well despite of a bloodbath in the market.

Keep up the stories, thanks,

Wolfgang Strigel
Software Productivity Centre

Congratulations Wolfgang! The SPC does "get it" and you are absolutely right: No software company will be world-class without proper processes in development and management. Keep up the good work.

What Do You Think? Talk Back To Brent Holliday

 



Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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