Current State of the Photonics Industry. M. J. Schabel

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1 Current State of the Photonics Industry M. J. Schabel

2 Outline Caveats Economic Indicators for the photonics industry Economic Indicators for photonics suppliers Major disconnect between the two perspectives A look at root causes Key Recommendations

3 Economic Indicators for the Photonics Industry $7,000 Total Sales of Laser Diodes (MM USD) $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 Telecom Diodes Other Entertainment and Display Image Recording Medical Solid State Laser Pumping Optical Data Storage Laser Diode Industry is growing. Growth led by telecom and optical storage Trend suggests a $5.6B market by 2010

4 Economic Indicators for Communication Laser Diodes Addressable Market (MM USD) $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $- Optical Networking Equipment Telecom and Datacom (all discretes and modules) % 35% 30% 25% 20% 15% 10% 5% 0% Percent Optical Components to Equipment Excellent correlation between service provider spending on optical equipment and optical components. Note total service provider revenues ~ $1.2T in 2005 (9% CAGR), and capital spending at $190M in % year over year growth projected for optical components. - FTTH = 11% CAGR - PON = 23% CAGR Trend suggests a doubling of the current TAM by 2010.

5 Summary of Economic Industry Indicators Photonics industry stabilized in 2002 after the internet bubble burst. Growth occurring in all segments, including telecom and datacom photonic components. Communication optical components experiencing 15% 20% average CAGR. Volume growing 40% yr/yr ASP dropping 20% yr/yr Bottom Line: INDUSTRY LOOKS GOOD! BUT this is only ½ of the story

6 Economic Indicators for Photonic Suppliers $600 $(600) Quarterly Revenue (MM USD) $500 $400 $300 $200 $100 Company A Company B $(500) $(400) $(300) $(200) $(100) Quarterly Net Income (MM USD) Suppliers in the photonics industry continue to post losses. - While top-line is growing - While the industry is growing Net income losses are running 20% 40% of revenue $- 5/24/ /10/2002 6/28/2003 1/14/2004 8/1/2004 2/17/2005 9/5/2005 $- Why are suppliers losing money when the industry stabilized three years ago?

7 Summary of Possible Root Causes 1. Market conditions prevent suppliers from reaching economies of scale. Too many suppliers Too many design variations 2. High fixed costs for the photonics industry Manufacturing infrastructure Test gear Reliability and quality programs

8 Economies of Scale (Fuchs and Kirchain) Regardless of technology or location, economies of scale are reached only at threshold volumes: EML Lasers: 30,000 units/year $12 6 TO Can Packages: 200,000 units/year 2.5Gb/s TOSAs: 100,000 units/year 1M 4M devices shipped in ) Changing Paths: The Impact of Manufacturing Off-shore on Technology Development Incentives in the Optoelectronics industry (Fuchs and Kirchain) [2005 Annual Academy of Management Conference in Honolulu] 2) Process Based Cost Modeling of Photonics Manufacture: The Cost Competitiveness of Monolithic Integration of a 1550nm DFB Laser and an Electro-Absorptive Modulator on an InP Platform (Fuchs, Bruce, Ram, and Kirchain) [submitted to the Journal of Lightwave Technology] 3) R. V. Steele, "Diode-Laser market grows at a slower rate", Laser Focus World, 41(2), p. 69, Average Sales Price (100's USD) $10 5 $8 4 $6 3 $4 2 $2 1 $ Shipped Units (millions)

9 How many suppliers are there? Public Companies Agilent Technologies Alliance Fiber Optic Products Inc. Avanex Corp. Bookham Technology plc ExceLight Communications Inc. Finisar Corp. Fujitsu Quantum Devices Ltd. Fitel Infineon Technologies AG JDS Uniphase Corp. NEC Corp. NTT Electronics Corp. Oki Optical Components Inc. Oplink Communications Inc. Optical Communications Products Inc. Stratos Lightwave Inc. TriQuint Semiconductor Inc 39 companies in greater than 6 optical technologies Private Companies Accelink Technologies Co. Ltd. AOC Technologies Inc. DiCon Fiberoptics Inc. Fiberxon Inc. FOCI Fiber Optic Communications Inc. Gould Fiber Optics Hopecom Optic Communications Co. Ltd. Koncent Communication Inc. LuminentOIC Inc. Northlight Optronics AB O-Net Communications Ltd. OpNext Inc. Primanex Corp. Santec Corp. Senko Advanced Components Inc. Shanghai Dare Optoelectronic Communications Co. Ltd. Shenzhen Hi-Optel Technology Co. Ltd. Shenzhen Photon Technology Co. Ltd. SK Opto-Electronics Inc. Sun Telecommunication Co. Ltd. Wuhan Telecommunication Devices Co. Wuxi Zhongxing Optoelectronics Technologies Co. Ltd. Heavy Reading Analyst Report Recall, < 4M total units shipped in unique companies Current companies Technology with supporting products Amplifiers 73 Attenuators 90 Detectors 60 Fiber 55 Lasers 99 Modulators 54 Wavelength Mux 110 Dispersion Compensators 34 Optical Switches 84 Transceivers 74 Lightreading Business Index 401 unique companies Current companies Technology with supporting products Dispersion Management 17 Fibers and Cables 109 Fiber Switches 33 Communication Lasers 69 Optical Amplifiers 56 Passive Optical Devices 217 Optical Cross Connects 42 Optical Transmitters and Receivers 123 OFC 2005 Exhibition

10 Supplier s Market Share Market Share of leading photonics suppliers in 2003 R. Rubenstein, RHK, "Components in a Changing Telecom Landscape," EPIC 2003 Workshop on Rebuilding the Optical Telecommunications Industry, Rimini, Italy, November 2003 Rough Numbers: 1M of any single unit shipped 100,000 threshold for economies of scale 10 suppliers can reach economies of scale. Summary: photonics industry is over-subscribed.

11 How Many Technology Variants? Technical Category Specification Application A SAN, LAN, WAN/MAN Bit Rate (Gb/s) B 0.155, 0.622, 1.0, 2.5, 10 Wavelength (nm) 850, 1310, 1550 Reach C SR, IR-1, IR-2, LR Form Factor SFF, SFP, GBIC, XFP, MSA D, Other E Optical Transceiver Variants < 4.25 Gbps 10 Gbps Discrete devices Tunable & DWDM Parallel Optics modules GBIC 300 pin XMD ITLA Pop-4 SFF 200 pin 24-pin Hot-pluggable IBPAK SFP XGP SFP DWDM Quadlink QSFP XenPak Snap 12 X2 Xpak XFP Rough Numbers: M. J. Speerschneider, "Technology and Policy Drivers for Standardization: Consequences for the Optical Components Industry," MS Thesis in Materials Science and Engineering. Boston: MIT, M total units shipped 100,000 threshold for economies of scale by a single supplier 10 different transceiver solutions can be supported

12 Key Recommendation #1 Standards Unification at Optical Physical Layer Going forward, the awareness of functional similarities at the optical physical layer between multiple market segments should prevent unnecessary differences in the respective specifications and standards. One way to assure that this does not occur in the future is for each of the standards bodies to agree to relegate future definitions of optical specifications to one industry body. In this case, ITU, Telecordia, IEEE, OIF, and FibreChannel would all outsource their optics specifications to a single industry body who can drive can drive convergence between the standards.

13 Key Recommendation #2 Standards for physical attributes of optical devices Clearly, Multi-sourced agreements are important for the communications industry. Going forward, to avoid competition between multi-sourced agreements, it is worth considering that a standards body, perhaps the single industry-level optics standards body proposed above, handles such matters. This would be a departure from previous domain of influence that standards bodies maintained, namely concerning themselves only around physical layer interoperability. However, it is clear that based on past behaviors in the industry, an expansion of the standard s bodies responsibilities may be warranted. This approach will succeed only with the unilateral support of the equipment providers. Moreover, the industry-msa standards group should take every precaution to maintain free competition in the marketplace, leverage technical innovations, and manage MSA evolution in a responsible manner.

14 Key Recommendation #3 Use outsourcing and off-shoring to encourage industry consolidation and economies of scale As optics components providers migrate to a fabless model, they should take every opportunity to merge their design teams with other companies, to provide wide product breadth, and to simultaneously reduce the number of competitors in the field. In addition, as the companies become fabless, they should seek out manufacturing partners that truly provide economies of scale based on volume from additional customers.

15 Key Recommendation #4 Develop an automation strategy for manufacturing multi-market photonic components The next step in reducing labor-content, after migration to low-labor cost regions of the world, is to begin automating the manufacturing process. Optical component manufacturing is far from automated today, likely due to the fact that individual companies are not able to reach manufacturing economies of scale. Consolidation of the supply base and manufacturing base for optical components provides a key opportunity to implement a manufacturing automation strategy. Towards that end, it would be beneficial to include the collective needs of the optoelectronic industry (optical storage, automotive, lighting, etc.) to further extend the advantages of researching and developing an automated manufacturing platform.

16 Key Recommendation #5 R&D investments in the photonics industry need to be rationalized by the industry-level affordability Research and Development investments (whether internal to a supplier or company, funded by grant agencies, or through private/venture funds) should be rationalized according to industry level affordability. This responsibility lies with the granting organizations. With those funds, it is important to fund a balance of the industry s needs for next generation solutions. Industry roadmaps are excellent vehicles for elucidating the range of needs, and should be referenced for investment purposes.

17 Key Recommendation #6 Develop a general industry-wide economics-technology tradeoff model for use in making technology and standards decisions An industry-wide general full-stream economics model needs to be built to help the industry make technology tradeoff assessments. The tool, in theory, can be used within standards for deciding upon next generation optical physical layer specifications and physical attributes. Moreover, the tool can be used for deciding on appropriation of investments by government granting agencies, as well as internal and external funding organizations. System Dynamics modeling techniques may suffice as one general framework.

18 Summary Industry-level economic indicators are positive. Supplier-level economic indicators are negative. Possible root causes include: too many suppliers and too many technical variants can t achieve economies of scale. Key Recommendations (near term) Unify the optical specification committees (commodity behavior). Use off-shoring and outsourcing to initiate market consolidation Develop a manufacturing automation strategy to bridge adjacent markets. Develop an economic/technology tradeoff model. Balance R&D with affordability and against an industry roadmap Any others???