Vertical Integration and the Early Days in the Optics Industry

This week we have an exciting guest blog post from Dr. Julie Sheridan Eng, Finisar’s VP of Transceiver Engineering. Julie has been in the Optical Communications business for over 20 years, almost from the time of the first fiber optics deployments. From my conversations with Julie, she has certainly seen lots of change in the optical communications component vendor supply base. This week I asked her to join us on Lightspeed to talk about those early days and Finisar’s decision to begin designing and manufacturing subcomponents of our products in-house rather than outsource, a strategy known as “vertical integration.”

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In the early days, almost all the R&D in the optics industry was handled in the component divisions of the big systems houses like AT&T, Alcatel, Nortel and Lucent. Eventually, most of those system companies spun out or sold their optical components divisions. After some time, we saw the components themselves migrate from discrete, like lasers and detectors, to integrated solutions like transceivers and transponders.

Around the bubble time, the industry saw many optical component start-ups whose business model was to buy optical components and IC’s, and integrate them into transceivers and transponders to be sold to system manufacturers. What you may also remember is that that very few of them survived. One reason for this is that while it’s not hard to make a product based on all purchased components, it is almost insurmountable to use that strategy to follow a cost curve. If all the content is purchased, all you can do is eliminate components and push your vendors for cost reductions. If another company has a similar design and manufacturing capability, but has the components in-house, you can never build a product that is cost-competitive to theirs.

This is why Finisar and many of the other surviving optical components vendors today have embraced a “vertically integrated strategy” where critical elements such as lasers, detectors, and optical sub-assemblies are designed and manufactured in-house. Finisar is somewhat unique in that we have a world class internal Integrated Circuit design team. When I first arrived at Finisar about 6 years ago, I thought “we’re an optics house, why do we have IC design?” But you only had to look at the numbers to see that it makes sense. At Finisar, we evaluate all the opportunities and prioritize them based on return on investment. Going through this process we are able to decide which opto-chips, packages, and IC’s make sense to create internally. For those components that don’t make the top of our priority list (or for which we don’t have a specific expertise), we work with external suppliers. Over time, we have built a technology portfolio of opto-chips, optical packaging and integrated circuits that I think rivals anyone in the optics industry.

But this is a strategy that only works with volume. That is, there is a fixed cost associated with having in-house opto-chip or optical packaging design and manufacturing, or in-house IC design. If volume is low, that fixed cost will outweigh the savings gained by designing or making these parts internally compared to buying them from someone else. At Finisar, we have approximately 36% of the world’s transceiver volume, so it’s a strategy that makes sense for us.