BRIEFING: NETWORKS
Routers: central theme of the next buildout
Today router companies have seen their sales evaporate, even though Internet traffic continues to grow at a torrid pace.
By David Lipschultz
April 5, 2002

It wasn't long ago that companies producing routers were considered not only Internet pioneers, but also Wall Street's technology darlings. Years of rampant growth in Internet data traffic made it abundantly clear that carriers needed ways to route loads of data reliably and precisely over an aged phone network built for another purpose: voice. Hence, routers came to be in high demand, and the companies selling them corralled some of the largest market caps in the technology sector.

But how rapidly markets change. Today, router companies, like Juniper Networks, Extreme Networks, and even Cisco Systems, have seen sales evaporate, leaving many observers contemplating their fate, despite the fact that Internet traffic continues to grow at a torrid pace.

Still laden with surplus equipment they acquired in an aggressive IT infrastructure buildout during boom times, many companies and carriers have stopped buying the latest networking gear. That dramatic drop in spending has had an effect on carriers in particular, which, in addition to staggering under truckloads of inventory and suffering from deteriorating capital-expenditure budgets, are now trying to recover from huge levels of debt and slowing revenue. Therefore, businesses and carriers are purchasing only equipment that immediately pays for itself, says Stephen Kamman, a director of the telecom equity research group at the investment bank CIBC World Markets. "A carrier gets requests for more T3 lines, so it goes out and buys more T3 [lines]," Mr. Kamman says. "Nowadays, there's no thinking about the return on investment five years out."

The communications-equipment market is still grim, especially for routers located on the periphery of the Internet backbone--those that serve the enterprise market or private companies using simpler routers for local area networks. But many industry observers, including Mr. Kamman, say there is one bright spot ahead; core routers, the complex boxes that carriers use to move traffic at the center of a network, soon could be in high demand again.

Traffic Report
Despite the recession, Internet traffic still appears to be doubling every year. That means that before long, carriers are likely to reach a point when their networks are bottlenecked, forcing them once more to pull out their checkbooks to build additional capacity (to the cheers of router vendors). Internet pioneer Lawrence Roberts, who is also the founder and chief technology officer of the router startup Caspian Networks, surveyed 19 carriers and concluded that that point will be reached sometime during fourth quarter 2002. By then, most of the carriers will be at 40 percent capacity, Mr. Roberts says, which is the point at which they have to purchase more equipment. "With that kind of capacity, they won't be able to support their networks without investing in more core routers," he says.

Consequently, substantial growth in the core-router market is likely, starting at the end of this year (see "Core Value," facing page). By 2005, Mr. Kamman says, the market should double to $4.8 billion, from $2.4 billion in 2001. The enterprise market, however, isn't likely to make out nearly as well, because demand for edge routers is stagnant.

With billions of dollars at stake, the question is what company is likely to grab the core-router business? Cisco once had a near monopoly on the router market, both at the edge and the core. Then, after the company missed a critical development cycle for faster equipment, Juniper quickly entered the scene with a high-performance core router and grabbed a substantial share of the market. Now analysts say Cisco has regained some of its losses and is once more holding a majority share. Still, the market for the next generation of routers seems to be up for grabs.

Typically, a carrier that wants to add more capacity must buy a new router from either Juniper or Cisco to accommodate data traffic. And because there is a limited number of ports on each router, expansion is an expensive proposition. "Core routers currently can't deliver the performance necessary to keep up with the exponential growth at the core of the Internet," says Mr. Kamman.