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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