Software Is the Future of Broadband Network Profits

The industry is shifting from who can provide the fastest hardware to who can provide the most dynamical control over content delivery. That control will be exercised through software, and the profits will accrue there.

Jul 9, 2014 at 3:35PM

Behind all the fanfare over the ongoing broadband upgrade cycle from the so-called 10G to the 100G data-transport hardware, a quieter software revolution is taking place. Gary Smith, CEO of Ciena (NYSE:CIEN), stated in its latest conference call that "...a major market shift is just beginning toward an on-demand model that's better suited to [rapidly] changing end user behavior... [It] is a fundamental market changer and, as we said before, there will be new winners and losers." 

He was talking about Software Defined Networking, or SDN, which is a sweeping overhaul of how the entire Internet will be organized and operated. Ciena's competitors, including Infinera (NASDAQ:INFN), Alcatel-Lucent (NYSE:ALU), and Cisco (NASDAQ:CSCO), also see this shift away from providing the fastest or cheapest hardware to providing the most dynamical control over content delivery. Each company is responding in its own unique way.

How software trumps hardware
If history is any guide, the hardware of this industry will gradually become a commodity while the pricing power and resulting profit margins will migrate toward the software. Software achieves this advantage by offering unique and readily updateable services that become so thoroughly integrated into a user's processes that the user can't afford to change vendors even if they wanted to (think Microsoft Windows on PCs).

Most investors, however, still have their focus on the current hardware upgrade cycle from 10G to 100G. I believe this is a misguided focus. The future profits will be in a new generation of software that can automatically monitor, control, and adapt a provider's services to rapid changes in customer resource usage over minutes or even seconds, as well as respond robustly to the relentless introduction of novel applications and service requirements. 

Such capability isn't just nice to have, it is urgently needed as the services demanded today by an escalating number and diversity of users is already dismantling the ability of service providers to respond profitably. They need the new software-driven architecture, and they're willing to pay handsomely for it because their costs under the current architecture are escalating beyond their ability to bear. 

The competitors reshape themselves
Ciena has repeatedly made clear, in earnings calls and analyst presentations, its new emphasis on software to meet the new demands. It has forged a partnership with Ericsson to develop SDN control software, and it recently announced a partnership with Brocade "to enable on-demand provisioning for both computing and network resources across data centers." It intends to provide best-in-class SDN software for the new architecture based on the new industry-standard protocols called OpenFlow.

Infinera, with its emphasis on best-in-class hardware, is approaching the changes differently. It is currently more focused on the lower software levels embedded within their hardware to promote the convergence of the data transport layer with the switching layer, and ultimately with the router layer. At the Citi Global Conference in February, however, Infinera's CEO, Tom Fallon, intimated plans to enter the SDN software market as well: "The next step here can be some sort of transport SDN solutions." 

After a long struggle, Alcatel-Lucent is actively striving to regain its relevance in the industry's future. A recent announcement that it will launch a "new portfolio of operations support systems... via a totally new approach to automating a service provider's operations" indicates it plans to compete for the new SDN business. The CEO's new Shift Plan is providing ample resources to become just such a contender.

Cisco is taking a defensive tack in an effort to stave off the coming erosion of its very large router business. One step, which I contend is a strategic error, is the introduction of proprietary software protocols named OpFlex in lieu of OpenFlow. Though it is trying to get OpFlex accepted into the industry standard, it is an obvious attempt to put its own ecosystem at a distinct advantage, so the industry is likely to resist.

How this unruly competition will play out remains unclear, but one thing seems sure: The future of broadband networking will be ruled by those who implement the most capable SDN software using the new open standards. Ciena is one of the first out of the gate, and it intends to take a commanding lead, making now an excellent time for investors to take a closer look.

Leaked: Apple's next smart device (warning, it may shock you)
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Erik Eason owns shares of Apple and Infinera. The Motley Fool recommends Apple, Cisco Systems, and Infinera. The Motley Fool owns shares of Apple and 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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