Street Signals, Wrong Signals?

Financial analysts and investors seem to have decided that networking as a sector is in trouble, but most seem to have missed the point on why that’s the case.  Yesterday, the markets sent Alcatel-Lucent down about the same 20% that Juniper fell on the day before, suggesting that they believed both companies faced identical headwinds.  In point of fact, Alcatel-Lucent’s revenue line was good but the company had higher costs, reflecting among other things expanded R&D (Juniper’s stock continued to fall yesterday, over 3%).  Today, the pundits are mostly focusing on how both companies need to “cut costs”.

If a company faces temporary outside forces that limit buyer interest, then it makes sense to cut costs while those forces are acting, and to then expand when they disappear.  The problem is that networking isn’t facing “temporary outside forces”.  Let me quote from Credit Suisse, one of the research firms that’s gotten it right:  “We expect the ongoing disconnect between revenue growth and bandwidth economics to drive an ongoing shift in carrier capex to specific projects focused on revenue generation or cost savings—such as wireless backhaul, cloud/data center build-outs, and extension of VoIP infrastructure—that will benefit certain product markets and vendors while posing challenges to others.”

We’re seeing a fundamental problem with bandwidth economics.  Bits are less profitable every year, and people want more of them.  There’s no way that’s a temporary problem; something has to give, and it’s capex.  In wireline, where margins have been thinning for a longer period and where pricing issues are most profound, operators have already lowered capex year over year.  In mobile, where profits can still be had, they’re investing.  But smartphones and tablets are converting mobile services into wireline, from a bandwidth-economics perspective.  There is no question that over time mobile will go the same way.  In fact, it’s already doing that.

To halt the slide in revenue per bit, operators would have to impose usage pricing tiers that would radically reduce incentive to consume content.  If push comes to shove, that’s what they’ll do.  To compensate for the slide, they can take steps to manage costs but most of all they can create new sources of revenue.  That’s what all this service-layer stuff is about, of course.

The three big network vendors who have done badly in their quarters, from Street perspectives, are Alcatel-Lucent, Cisco, and Juniper.  Others in the network layer like Ciena and Tellabs, have also taken a hit.  Produce bits and you don’t support profit, you only help operators provision to a new level of ROI marginalization.  In contrast, we have players who are winning, like Acme Packet who have held on to some pretty decent share prices by focusing on things that fit the more-profit-justifies-more-spending mold.  Session border control and deep packet inspection are hardly unique to them, but the big vendors are big because they have big bit-pushing gear commitments.

Alcatel-Lucent deserved a better fate from Wall Street because it was able to grow its IP business by 30% or more, which demonstrates that it was able to leverage higher-layer differentiation into the IP layer.  That’s what everyone in the IP and lower-layer networking equipment world needs to do, but in order to do it you have to get that higher-layer differentiation, and nobody seems to be taking that seriously.  So Wall Street may be right here, or it may be pre-judging.  They’re doing the latter if the vendors will get their heads out of the bitpipe and see reality.  They’re doing the former if vendors stay the course.  Ironically, the Wall Street cry to cut costs favors the wrong path, because you can’t innovate in the service layer without any R&D to innovate with.



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