Market Structure of Networking Companies (WRKoss)

Koss has a very cool chart that separates Networking vendors into tiers. Here are some key obversations he makes wrt the chart.

  • 79% of total revenues are reported by five companies
  • 96% of total revenues are reported by 11 companies
  • It is very difficult to move from tier 2 to tier 1
  • It is very difficult to move from tier 3 to tier 2 and sustain position

— iain — full post follows ————————————

Ericsson/Redback and the future of Networking Consolidation…exposing the state of denial that most companies live in…: “

The meeting
probably played out like this….

has the executive team assembled in the Board Room. Maybe a BOD member present, but most likely
the full board is not present. The BOD
has been briefed, but the final decision has yet to be made and until the
leadership team has made the final decision, they will not convene the entire BOD for
a vote until the details are completed and they are all in agreement. This is the last meeting before they go to
the full BOD for a vote. The CEO is
going through the thought process on the deal. The investment bankers are present. The CEO ticks off the positive points of the company:’

  • We have a strong customer base
  • We have exciting technology that is playing into a growth market
  • We have close to $200M in cash and manageable debt
  • We are profitable and growing
  • We are public company
  • Our stock has recovered from its worse lows from a year ago
  • We have come back from the brink, now it our time to enjoy the fruits of our labor

Then the
CEO starts to think about the negative points of the company:

  • We are small compared to our competitors
  • This is hard work
  • Our customer base is declining in overall number of customers, but growing in overall opportunity size
  • It is clear that we are under capitalized to compete in a global market as we cannot fund a significant presence in all markets
  • As our customer’s get bigger, we need to become bigger to maintain market share and we need to be much bigger to grow market share

conclusion of the discussion is to do the deal. This is my guess as to how the thought process went down for Kevin
DeNuccio and the leadership team at Redback.

Market Structure for the Networking Companies:

In my book
and on this blog (see
Part II: Six Years that Shook the World towards the bottom)
I have written
that companies are trapped in revenue
because their market(s) (i.e. customers) have settled into
an equilibrium point
. The networking
companies are prime examples of this market state. They are all waiting on an event that will
disrupt the structure of their target market and cause market share to become
dynamic. When has this happened in the

happened in the late 1990s when a host of new entrant service providers raised massive
amounts of money and built competitive networks. The new service providers were all Greenfield
and they bought networking products from companies that did not exist
years earlier. The rise of the new service
providers pressured the incumbent service providers to change their
procurement process. The large,
bureaucratic service providers, who were largely the product of state
during the Cold War years, suddenly had to go faster. They had to buy
technology faster. They had to deploy technology faster. They had to
operate faster. When the bubble popped for the telecom industry
and the dark times (i.e. 2001-2003) descended, the pressure was off the
guard. The incumbents could focus on (1)
consolidation and (2) influencing regulatory policy. Here is a chart
that I created in early
2006. I updated the chart to reflect the
closure of the Redback/Ericsson deal and I assumed the Nokia/Siemens JV
get done when the bribery investigation wraps up and few executives are
banished and fines levied.


A few
points of explanation on this chart:’

Companies are ranked by total top line revenue reported during the CY
– Yes, I
used average estimates for CY2006
– Yes, I
did my best to align reporting quarters for non CY companies
– 79% of
total revenues are reported by five companies
– 96% of
total revenues are reported by 11 companies
– It is
very difficult to move from tier 2 to tier 1
– It is
very difficult to move from tier 3 to tier 2 and sustain position

Exposing the State of Denial:

The state
of denial that some companies possess has to do with how they view their target
market. When consolidation is occurring
in your target market, it means that fewer
decision cycles
are occurring to award business to suppliers. Companies that are the size of Ericsson,
Cisco and Alcatel need large contracts to pay for their operating models. Winning a $10M deal for Alcatel is nice, but they
would rather win a bunch of $1B deals. The Tier 1 Service Providers (e.g. Verizon, at&t, Comcast) require
massive amounts of capital for suppliers to win big contracts; this it the conundrum
that the mid-tier companies (i.e. Tier 3 and 4) and startups must overcome. How does a company the size of Redback win a
$1B deal over 6 years? It does not and
that is why Redback needs to be part of Ericsson. Ericsson can win a big contract. Redback was simply under capitalized to be a
global supplier and under capitalized to fight a war with companies far larger
in size on a global scale. This is not a technology
battle – this is a resource battle. ‘

I speak
with leaders in startups, public companies, consultants and venture capitalist
everyday who want to point out to me that startups can sell to the service
provider market. I agree they can, but
it is just a matter of (1) where in the network are you trying to sell and (2)
the size of the deal. The closer you are
to the core of the revenue generating portion of the network (i.e. the more
dependent the service provider is on your product for revenues) the more
stringent the deal terms become. I have
a friend who works at a mid-tier networking company. He told me that the Tier 1 service providers
are concerned about the long term financial health of his company and they have
been around for long time, have plenty of cash and stock symbol.’

Some networking
companies will say that they are a niche supplier or they are comfortable with
the state of their target market. That
is a state of denial. The Tier 1 Service
Providers are increasingly separating themselves from the rest of the market in
terms of CAPEX. If you do not have a
part of this expenditure, you are missing out on the majority of the market. This is this reason why there has been
speculation in the business press as to whether the Redback deal will set in
motion consolidation amongst other mid-tier networking companies. For the CEOs of startups who are planning to
go public in 2007 and service providers are your target market, finding a
solution to the ‘we went public, now what?’ is something you need to have a
plan for today – not tomorrow. Being a public company means you will have
less time to be creative, see my 11.12.06 post on
creativity and public companies
.’ ‘ ‘

I think
this will be the last post for 2006…I might post something next week, but I
will be focusing my creative writing skills on my first fiction novel. Happy holidays.

always, thoughts and comments welcome, whether private or public.


(Via Technology and Geopolitics.)