I’ve been blogging about the fact that the Internet’s pricing model has been undermining the revenue potential for “connection services”. If you can’t charge incrementally for bits, then there’s less value in investing to generate them. One thing this has meant for the industry is pressure on network equipment vendors; operators don’t want buy as much when their ROI is low. However, you can’t be a “carrier” or “operator” without bits, and many have seen the fiber vendors like Ciena as the winners in the equipment space.
Well, maybe not “winners”. Ciena reported, and while the company beat estimates in both profit and revenue, it offered what the Street characterized as a “soft” outlook. Revenues guided significantly lower than Street estimates and gross margins were also projected to be off, suggesting considerable price pressure. So what does this tell us?
First, it proves that if bits aren’t profitable, operators will do everything to reduce their cost of generating them. You can argue that the price pressure on switching and routing and network features that spawned interest in SDN and NFV were attempts to streamline infrastructure at the higher layers and so to cut costs there. The thing is, we have little operator SDN deployment at this point, no NFV deployment, and the cost pressures remain. So operators will economize where they have to, which is everywhere.
This is also why Huawei is riding high and presents such a formidable threat to the rest of the vendors in the space. As the acknowledged price leader, Huawei can expect to sell and sustain acceptable profits at price points where other vendors would see their margins trashed and their stock prices in the toilet. Huawei doesn’t have to innovate to get ahead in this game; they are ahead and all they need to do is innovate enough to prevent a competitor from gaining a feature advantage that would offset Huawei’s pricing power.
The second thing it tells us is that Ciena and the optical players haven’t done enough with things like SDN. The one thing that is absolutely true about networks is that they are built on Level 1—the physical layer—no matter what goes on above. Optics are here to stay, and that’s clearly something you can’t say confidently about the other layers. Ciena could develop an SDN vision that could build upward from the transport/physical layer and infringe on the features and capabilities of what’s above. If they were to do that they could effectively steal switching/routing market share without fielding a switch or router. That in my view is what they should have done by now, and they have not done it.
Switching and routing started off as aggregating functions. We can’t build networks by running an optical mesh between every possible communicating pair in the world. However, nobody needs to do that. Increasingly our networks are really metro star configurations where users are trying to reach not other users but service points of presence. We should be considering the question “What kind of network topology and infrastructure builds a network that carries profitable traffic?” I contend that network would be heavy on fiber and would have higher-layer gadgets that looked more like giant BRASs than like switches or routers. What other gear would be there? What functions needed above metro optical transport are needed? Those are the questions that vendors like Ciena needed to answer.
The third thing we can learn from Ciena is that you can “steal market share from operations”. There is one budget for networking, one aggregate cost of service that has to compare favorably with the aggregate price. While new service revenues (gained through “agility” for example) are always nice, the fact is that the only absolutely credible source of new infrastructure spending is a proportional reduction in operations costs. Don’t rob optical-layer, or even higher-level, Peters to pay your Paul, rob somebody outside the whole equipment framework. If we could bring about a reduction of ten billion dollars in operations and administration in networking we could increase network equipment TAM by the same amount without changing our ROI assumptions/needs a whit.
Everybody seems to have gotten somewhat interested in OSS/BSS, even major vendors like Cisco who recently invested in an operations startup. But billing systems are not going to move the ball much by themselves. To make a revolutionary change in operations cost we’re going to need a revolutionary change in operations practices. The OSS/BSS vendors are unlikely to drive this sort of change for the same reasons that network equipment vendors aren’t anxious to drive revolutionary changes in network architecture. So the network vendors should be robbing operations Peters here, and that includes Ciena. There’s found money to be found in operations, money that could help a lot of revenue and margin lines down the road. Find it.
The final thing we’re learning from Ciena is that the operators themselves are not going to drive this process forward as they should. Since the Modified Final Judgment and Telecom Act and similar “privatization” initiatives globally, operators have not only gotten out of the equipment business (Western Electric, a Bell subsidiary, used to make gear for the Bell System) but out of the habit of driving equipment details. Today, faced with a new requirement, operators tell vendors “Well, we need x, y, and z” and then stand back and hope somebody hands the items to them on the proverbial sliver platter. Obviously when those things are contrary to vendors’ own continued revenue and profit growth, they’re not falling all over themselves to do the hand-off.
Operators do not understand how to run projects to build infrastructure in a software-driven age of networking. Yes, there are some who do, but the processes they initiate to face the future are not run like software projects even though software is the expected output. And, perhaps worst of all, the projects have an implied timeline measured in years when the Investor Relations people in the operator space would tell them they don’t have years to get a new approach rolled out.
Ciena didn’t have a bad quarter but it should have, could have had a great one and didn’t. The difference between not-bad-ness and greatness isn’t that hard to bridge. Will somebody else bridge it? That should be something Ciena management fears more than just a continuation of price pressure trends that we’ve faced for years.
