Overview

Despite the big hits being dealt by investors to all segments of the telecommunications industry, we believe that over the next five years the market for dense wavelength division multiplexing (DWDM) optical systems will grow at a 28 percent compounded annual rate. Why such optimism amidst the current doom and gloom? We are making these projections with two major points in mind:

• The Internet continues growing at over 100 percent a year, regardless of conditions in the financial markets; and

• Optical equipment is the only solution that can, in the long-term, cost-effectively meet the increased demand for bandwidth in long-haul and metropolitan networks.

The phone companies are continually expanding their fiber distribution networks further and further into local neighborhoods, trying to meet the demand for data services. This capacity expansion will become even more necessary as time goes on. Long-haul networks are flooding metropolitan networks with increasing volumes of data, while access networks are being strained by the need to support demanding Web applications. However, the time division multiplexing (TDM)-based technologies used in most fiber-based metropolitan networks are too costly and inflexible to meet the growing data traffic demand.

Synchronous optical networking (SONET) and synchronous digital hierarchy (SDH) standards were set up for the transmission of TDM digital signals—usually voice traffic—over fiber in the 1980s. Using TDM, a data stream at a higher bit rate is generated by multiplexing together lower bit rate channels. High-capacity SONET/SDH systems now operate at levels up to 10 Gbit/s (OC-192), and the architecture has proved very reliable for the transport of voice services.

However, SONET does have some significant limitations. As higher bit rates are used—40 Gbit/s (OC-768) and above—physical limitations in laser sources and optical fiber impose limits on the practice of endlessly increasing the bit rate on each signal. As customers demand more services, and need to carry more data traffic, SONET has reached a point of diminishing returns.

DWDM systems, in contrast, can carry multiple data bit rates, allowing multiple channels to be carried on a single fiber. The technique quite literally uses different colors of light down the same fiber to carry different channels of information, which are then separated out at the distant end by a type of grating that identifies each distinct color. DWDM has been more successful than SONET/SDH in terms of providing the higher bit rates needed within many new optical networks. Future generations of optical networking equipment promise better and more flexible protection schemes and network management.

DWDM systems also help to maximize the capacity of installed fiber. As new service providers entered the market in the late 1990s, crews began tearing up freshly-paved roads across the United States to lay fiber, causing a significant amount of damage and disruption. Municipal governments can do little to control the timing and frequency of such buildouts, since pressure is being kept on the federal government by bandwidth-starved businesses to allow local fiber buildouts to continue. Given the expense of laying new fiber and the consequent further disruptions, service providers are receptive to new ways to minimize reconstruction of existing fiber plant.

Development of the All-Optical Network

The introduction and rapid evolution of fiber capacity has been extraordinary by any measure, and DWDM is credited with providing a major boost to total capacity over the past few years. Consider the following:

• By 1983, a single strand of fiber could carry 703 telephone conversations; by 1996, 625,000 conversations could be sent through a single strand of fiber.

• In 1996, the commercially-deployable capacity of DWDM systems was 40 Gbit/s, with 16 channels of 2.5 Gbit/s capacity. By late 1999, DWDM equipment with 96 channels at 2.5 Gbit/s was available, for a total bandwidth of 240 Gbit/s. In the first half of 2000, DWDM equipment handled 49 channels at 10 Gbit/s each, and 96 channels at 10 Gbit/s each by late 2000.

• By March 2001, French and Japanese engineers had squeezed more than 10 trillion bits per second through single optical fibers in trial situations. This capacity can handle about 150 million simultaneous telephone conversations.

Narrower channel spacing (50 GHz) via fiber Bragg gratings has helped expand total DWDM system capacity. 25 GHz systems are expected in the near future, enabling DWDM channel expansion without using channels in new bands, in which case additional amplifiers would have to be installed in much existing fiber, since much of the existing amplifier equipment can only operate within limited bandwidth ranges.

Despite this progress, and vendors’ announcements of all-optical equipment, we are nowhere near an all-optical network that lives up to the concept’s inherent potential. Technologies for redirecting light in different directions are primitive, so electronic conversion and processing of optical signals is needed at intermediate switching points. Almost all major routers and switches are still in the electronic domain, and will remain there for at least five years. This is why Ciena is still selling their electronic cross-connect, and Cisco Systems and Juniper Networks are still selling their monster electronic routers. However, frequent optical/electrical/optical (O/E/O) conversion adds substantial cost to the network, making all-optical switching and routing the industry’s Holy Grail. Though designers are attempting to reduce the number of electrical interfaces in optical networks, the total elimination of such interfaces is years away, and will require fundamental scientific breakthroughs.

Many industry participants are still debating whether all-optical network elements will scale to the sizes required by carriers, and whether the technology can be developed to manage a network in the absence of electronic interfaces. All of the optical cross-connects that have been announced are well short of the 1024 x 1024 port capacity needed by carriers (the largest on the market is currently 256 x 256). In fact, there are indications that development on key optical equipment may be slowing. In April 2001, for example, Cisco announced that it would stop making the 15900 Wavelength Router, a product gained from its 1999 acquisition of Monterey Networks. Cisco cited that the optical routing technology was still immature, and that it wanted to focus on its core businesses.

Of course, once all the technical hurdles standing in the way of all-optical network components are overcome, there is still the question of cost. Unless all the components of the all-optical network can be manufactured inexpensively, carriers will simply do without them. If deployment of optical components leads to cost savings and performance advances, the steady evolution of the optical network will continue and any difficulties inherent in the optical networking scheme will be resolved incrementally.

The Market

Insight’s forecasts for SONET/SDH equipment, DWDM equipment, and optical component subsystems are based upon two major factors:

1. Current and projected demand for bandwidth; and

2. Expected optical fiber deployments.

Bandwidth demand calculations rest primarily on Internet-connected PCs used in both businesses and homes. The rapid proliferation of Internet usage, combined with a significant movement to higher-speed access, has led to a burgeoning bandwidth demand. Response to that demand by further network capacity increases has, in turn, reduced bandwidth prices, which has helped to further feed demand.

In response to bandwidth demand, markets for hardware will grow proportionally, dampened by decreasing prices and performance improvements. Component costs will follow a track close to that of Moore’s Law, while system costs will be buoyed by enormous demand, particularly for high-end, large capacity systems. Insight believes that SONET technology will maintain a solid niche over the forecast period, in some cases being implemented in joint DWDM/SONET solutions.

Given the enormous potential revenues, equipment makers have gone through an acquisition spree. The targets are smaller manufacturers with optical products or personnel with technical expertise. Examples of major include Cisco Systems’ purchase of Cerent Corporation for $6.9 billion, Redback Networks’ purchase of Siara Systems for $4.5 billion, and Nortel Networks’ acquisition of Qtera Corporation for $3.25 billion.

However, the optical segment has not been immune from the financial chill that has swept across the telecommunications industry. Service provider customers have rescheduled or canceled orders for optical equipment in an attempt to appease investors by cutting costs. In October 2000, after key optical equipment vendors announced a shortfall in revenue, their stocks took a battering. In a week, the stock prices of Nortel Networks fell 40 percent, JDS Uniphase fell 30 percent, Ciena fell 37 percent, and Corvis fell 15 percent. For the most part, this fall has continued: Nortel’s stock has fallen from its July 2000 high of $89 to $15 by mid-April 2001, JDS’ stock has fallen from $140 to $20, Ciena’s stock price has fallen from $151 to $50, and Corvis’ stock price has fallen from $114 to $8.

The orientation of today’s global economy, the slowdown notwithstanding, is expected to remain fertile ground for high-speed communication services and the photonics industry over the forecast period. The fact remains that next-generation optical networking equipment is essential to upgrading worldwide network capacity in the long-term.

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