3 Network Equipment Suppliers Respond to a Changing Industry Landscape

The world's accelerating appetite for broadband capacity is applying enormous pressure on the broadband providers to upgrade and expand their networks. The network equipment suppliers, in turn, are challenged to each provide something unique to avoid the commoditization, and subsequent loss of profitability, of their products as happened to PC manufacturers a decade ago.

Three of these suppliers, Infinera , Ciena , and Alcatel-Lucent , are implementing unique strategies to distinguish themselves in the new competitive landscape. The outlook for each of their stocks is intimately tied to the success of their chosen strategy.

Infinera's hardware strategy
Infinera was founded specifically to be, in the words of former CFO Ita Brennan at the 2013 Citi Global conference, the "technology leader around intelligent transport networks." Superior hardware, however, is more expensive; yet this conflicts with their customers' price sensitivity that is driven by their massive capital demands.

To address that, Infinera develops and deploys hardware that greatly reduces the operational cost of the network resulting in lower life-cycle costs. Networking hardware is a serious hog of real-estate, power, and air conditioning equipment; and can require lots of expensive maintenance and reconfiguring. Infinera presented a chart at the recent Goldman Sachs conference comparing a single small device, their 500G photonic integrated circuit, to their competitors' myriad of devices and cables required to achieve the same capability. Fewer, smaller, higher-performance parts translate into lower operating costs.

Ciena's software strategy
Ciena has adopted a different strategy, one that emphasizes software and services. The industry's rapid evolution is more than just hardware, as CEO Gary Smith pointed out in their latest quarterly conference call (emphasis added):

All of our customers... are looking to leverage an open ecosystem of the virtualized resources to enable the real time analytics and network agility required to deliver on-demand business models... [our architecture] is all about transforming capacity into on-demand capability.

To achieve this Ciena is focusing on deploying best-in-class network control and analysis software. If done effectively it will provide customer "stickiness," an unwillingness of customers to switch suppliers because the network software becomes integrated into their processes, skills, and training. To illustrate with a domestic example, you wouldn't hesitate to switch hot-water heater brands; but you are likely very resistant to changing smartphone brands because its software is thoroughly integrated into your daily life.

To ensure a timely arrival at this goal, Ciena has recently partnered with two companies with networking software expertise. The first was Swedish-based Ericsson with whom it is developing SDN (software defined networking) control software; while the second is a recent announcement with California-based Brocade which also fields SDN software. Smith emphasized the strategy later in the conference call, "In the second half we will be introducing new application software and an entirely new product platform targeting opportunities that expand our addressable market ..."

Alcatel-Lucent's transformation strategy
Alcatel-Lucent is unenviably saddled with a large legacy telephonics business that is bleeding copious red ink. Last summer they took the bull by the horns and announced "The Shift Plan" to turn around the company and make it competitive in the modern broadband networking industry. The plan specifies that most of its capital will be committed "to reposition Alcatel-Lucent from a telecommunications equipment generalist to an industrial specialist in IP Networking and Ultra-Broadband Access ..." If successful, this will make the company again competitive with the likes of Ciena and Infinera, as well as with larger, more diversified suppliers such as Cisco.

Though implementation specifics are few, the company plans to spend 85% of its 2015 research & development (R&D) funding in the new technologies. To give perspective to this, in 2013 they spent €2.3 billion on R&D. That is a huge investment; greater than all of Ciena's $2.1 billion in sales last year, or of Infinera's $0.5 billion in sales. Much of that will be allocated to the company's Bell Labs, once a crown jewel of American innovation. Time will soon tell if it can summon the magic of its past.

Investor's takeaway
By pursuing different strategies these three companies can continue to provide differentiated products at premium pricing, thus avoiding the perils of cutthroat price slashing which erodes profitability and can even endanger their viability. In return, customers can choose among diverse products to suit their requirements. It is possible that all three of these suppliers can win and their stocks rise handsomely to reward investors.

Keep an eye on the results of each company's unique strategy to see if they are achieving their objectives. One investment approach is to take a stake in each, gradually adding to those companies which make progress against their strategy.

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The article 3 Network Equipment Suppliers Respond to a Changing Industry Landscape originally appeared on Fool.com.

Erik Eason owns shares of Infinera. The Motley Fool recommends Cisco Systems and Infinera. The Motley Fool owns shares of Infinera. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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