How the Optical Transceiver Module Sales Channel is Broken

I was reminded last week as I was speaking with an optical transceiver module vendor about their data communications product, just how difficult this market is. Not only do they need to start development of the next data rate before they make ANY money on the current state-of-the-art, but most of their margin is actually taken by their equipment manufacturer customers. I've written about this before, but its time to rant about it again.

I’ve noted in the past how equipment manufacturers charge a lot more for optical modules they sell to end users than what they actually pay for them from transceiver suppliers. Considering the pains NEMs go through to “qualify” their vendors, a healthy markup in the early stages of a new product adoption can be warranted. But, I’m not so sure keeping it at more than 5x the price five years down the road can be justified. And is it sustainable? Some transceiver manufacturers sell products at gross margins in the 20-percent (or less) range, while their biggest customers (NEMs) enjoy upwards of 50-percent.

And guess what, there’s not much the suppliers can do. It is well known that Cisco, Brocade and others purchase modules as well as SFP+ direct-attach copper cables from well-known suppliers and resell them at much higher prices. And if I’m an end user, I MUST buy these from the NEM or their designate or my equipment won’t work. These devices have EEPROMs that can be programmed with what some call a “magic key” that only allow them to work with specific equipment. So the OEM now has a captive market for modules and copper cables connecting their equipment, and so they can pretty much charge what they want to and they do. If I try to use a “standard” module or cable assembly – one that is compliant to the specification – it will not work unless it has this “magic key.”

I’ve experienced this first hand when I worked in a R&D lab. I had a brand new HP ProCurve Gigabit Ethernet switch that I wanted to use for some cable testing I was doing. I had dozens of SFP modules from all of the top transceiver manufacturers, but none of them would work in the switch. I called HP and they said, “You have to buy the HP mini-GBIC.” Well, I knew that wasn’t exactly true. I didn’t really want to pay the $400+ each for four more SFPs that I didn’t need so I tried to work through my contacts at HP to get a firmware patch so I could use my existing devices. Long story short, I never did get that patch and ended up doing my testing with SMC switches instead.

Nothing much has changed since my original post about this more than three years ago except that the devices keep getting cheaper. NEMs are still gouging the end user, while squeezing their vendors'  margins. For instance, Cisco pays around $20 for a 10GBASE-SR SFP+ module from its top vendors and turns around and sells it for over $100. I'm actually surprised more module vendors haven't decided to discontinue their data communications module business in favor of some more lucrative opportunities. This model is not sustainable for the long term.

When a Standard Isn’t Exactly a Standard

I’ve noted in a couple of posts now that equipment manufacturers charge a lot more for optical modules they sell to end users than what they actually pay for them from transceiver suppliers. Considering the pains OEMs go through to “qualify” their vendors, a healthy markup in the early stages of a new product adoption can be warranted. But, I’m not so sure keeping it at more than 5x the price five years down the road can be justified. And is it sustainable? Some transceiver manufacturers sell products at gross margins in the 20-percent range, while their biggest customers (OEMs) enjoy more like 40 percent.

And guess what, there’s not much the suppliers can do. It is well known that Cisco, Brocade and others purchase modules, and now SFP+ direct-attach copper cables, from well-known suppliers and resell them at much higher prices. And if I’m an end user, I MUST buy these from OEM or their designate or my equipment won’t work. These devices have EEPROMs that can be programmed with what some call a “magic key” that only allow them to work with specific equipment. So the OEM now has a captive market for modules and copper cables going into their equipment, and so they can pretty much charge what they want to. If I try to use a “standard” module or cable assembly – one that is compliant to the specification – it will not work unless it has this “magic key.”

I’ve experienced this first hand. I had a brand new HP ProCurve Gigabit Ethernet switch that I wanted to use for some cable testing I was doing. I had dozens of SFP modules from all of the top transceiver manufacturers, but none of them would work in the switch. I called HP and they said, “You have to buy the HP mini-GBIC.” Well, I knew that wasn’t exactly true. I didn’t really want to pay the $400+ each for four more SFPs that I didn’t need so I tried to work through my contacts at HP to get a firmware patch so I could use my existing devices. Long story short, I never did get that patch and ended up doing my testing with SMC switches instead.

Prime example of when an open standard is not so open. Will data center managers be able to sustain this when they have to move equipment around and need different modules or cable assemblies? Are the OEMs thinking about the aftermarket and the fact that data center managers are used to going to distributors to get these items? And are OEMs going to continue to gouge end users and potentially cripple their suppliers?

One added note - there are at least two equipment manufacturers that I know of that support an open standard:  Blade Networks and Extreme Networks. While they will both supply the modules and cable assemblies, they don't lock out other standards-compliant parts that customers may want to use.

SFP+ Marks a Shift in Data Center Cabling

With the advent of top-or-rack (ToR) switching and SFP+ direct attach copper cables, more data centers are able to quickly implement cost-effective 10G and beyond connections. ToR designs are currently one of two configurations:

1. GigE Category cabling (CAT5e, 6, or 6A) connection to each server with a 10G SFP+ or XFP uplink to either an EoR switch or back to a switch in the main distribution area (MDA)
2. SFP direct attach cabling connection to each server with a 10G SFP+ or XFP uplink to either an EoR switch or back to a switch in the MDA

Either way, SFP and SFP+ modules and cable assemblies are starting to see huge inroads where Category cabling used to be the norm. Consequently, structured cabling companies have taken their shot at offering the copper variants of these devices. Panduit was one of the first that offered an SFP direct-attach cable for the data center, but Siemon quickly followed suit and surpassed Panduit by offering both the copper and optical versions of the assemblies as well as the parallel optics QSFP+ AOC. Others rumored of working on entering into this market are Belden and CommScope. This really marks a shift in philosophy for these companies who traditionally have stayed away from what they considered “interconnect” products. There are a couple of notable exceptions in Tyco Electronics and Molex that have both types of products, however.

So what makes these companies believe they can compete with the likes of Amphenol Interconnect, Molex and Tyco Electronics? Well, it might not be the fact that they think they can compete, but that they see some erosion of their patch cord businesses and view this as the only way to make sure the “interconnect” companies don’t get into certain customers. So, protecting their customer base by offering products they won’t necessarily make any money on – because, after all, many of them are actually private-labeled from the very companies they are trying to oust. Smart or risky? Smart, I think, because it seems to me that the future of the data center will be in short-reach copper and mid-range fiber in the form of laser-optimized multi-mode fiber (LOMF).