For the next few posts I am going to in a specific direction that I think might help people understand some overall challenges in the Communications Business and how it is evolving. Some of the impacts to consumers is indirect, but I think this background will help people have greater depth on the issues. Today, I am going to focus on the M&A spree that companies that are hardware suppliers to ISPs are on. As recent examples of this, take a look at Nokia’s purchase of Alcatel-Lucent and the partnership between Cisco and Ericsson. But this has also happened at the chip level with Broadcom, ATMEL and many others. As a background you may wish to read one of my very early posts HERE!
The fundamental problem for Hardware and Chip Makers is that there to trends against them. The first is that the major ISPs are consolidating. The second is that innovation has exited the hardware world. I will address these in order.
The ISP consolidation has been going on for a decade now. I want to talk about why this is next time, but this week just take it as a given. This creates an imbalance of power between suppliers and customers. There are fewer customers and they tend to buy in higher volume. The fewer customers means that there are fewer opportunities to win business. The higher volumes have led to extreme discounts. This means that the numbers of major suppliers needs to go down. If we spread out the business to far then the effort to design a product is done against too small of a product win. You can see this in the Aircraft Manufacture business. There are two huge suppliers that make most of the world’s commercial airliners – Boeing and Airbus. There are some niche suppliers who compete in specific geographies or in small parts of the market. But at the end of the day, there are two major suppliers. The Communications Business supports many large providers today – Cisco, Ericsson, Nokia, Huawei, ZTE, and some Japanese manufacturers are the major providers. There are some smaller players that are focused like Calix, Ciena, Juniper and Coriant. Will this list boil down to two like the Aircraft Manufacturers? Probably not. If you recall, the dot.com bubble created a huge number of Hardware and Chip start-ups in the Communications business. That bubble collapse and the subsequent consolidation has driven many of these newer companies out of existence or into being parts of larger firms.
We also have this long term lack of innovation. I remember about 10 Years ago a Venture Capitalist named Drew Lanza posted on Lightreading that he was no longer going to be a part of the Communications Business. He was attacked, but has turned out to be prophetic. The last set of real advances were in Wave Division Multiplexing and Optical Switching. Both of those technologies were put into place about 15 years ago. Since then, we have truly been refining hardware not fundamentally changing it. In addition, the cost to build hardware has gotten astronomical. The old way of competing was the development of unique Hardware Architectures that made special products. The cost to develop custom chips to support this has gone crazy and is essentially impractical at this point. This also impacts the chip makers and forces them to build things that they are sure are going to sell. All of this pushes Hardware to Standardization (as much as Virtualization is pulling it). This means that everybody has similar products. If the products are similar then how can small companies innovate? Well, there has not been a truly successful hardware start-up selling to the ISPs in a long time.
Next week, I want to talk about the ISP consolidation and the impact of the reduction of innovation.
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