It was only a year ago that the Internet was fueling "infinite" demand for services, spurring a massive move to beef up fiber-optic networking. But the demise of the dot-com industry started a chain reaction throughout the technology sector that could culminate in the worst year ever for semiconductors, with revenues declining as much as 25 percent from 2000 levels.

That's the result of networking equipment vendors working through their own problems-Cisco Systems Inc. in May wrote off $2.2 billion in inventories, and Nortel Networks predicted losses of $19 billion in its second quarter, due in part to write-downs on the value of acquisitions. And equipment vendors are suffering because so much of their customer base-dot-coms and competitive local-exchange carriers (CLECs) in particular-is either dead or in hibernation.

Nearly all pundits and analysts were blind-sided by the downfall. But some say it wasn't that hard to predict.

"Everybody who was looking at either their stock price or their business forecast and found the numbers were too good to believe, they should have said there was a problem there. In 27 years, every time I've seen a downturn, it's usually been preceded by, 'God, the numbers look so good,' " said Craig Barrett, Intel Corp.'s chief executive.

That scenario played perfectly in digital subscriber line (DSL) access, a technology kicked in the by the collapse of overambitious CLECs with unrealistic business plans. DSL could recover as early as this winter, but only after a serious rethinking of business models, analysts said at DSLCon in April.

Whether pockets of growth exist, and how strong they are, remains to be seen; most experts expect the slump to worsen. Research firm The Dell'Oro Group had originally expected 2001 service-provider purchases to decline by 8 percent from 2000 levels, but it now appears that figure will be closer to 18 percent, president Tam Dell'Oro said.

Multiple angles
Recovery won't be a simple matter, either, because of the complexity of the slump.

"The general problem is multifaceted-one is the drying up of the capital carriers were using to buy equipment," said Russell McGuire, chief strategist for telecom consultancy Telechoice (Tulsa, Okla.).

Another is the gray market arising from companies rethinking their network buildouts or failing altogether, resulting in a glut of barely used equipment being sold at bargain prices, through venues such as eBay or outright e-mail spam.

That's hurting the sales of new equipment. "Carriers can buy the same equipment for pennies on the dollar. Sometimes it's in the box, never used," McGuire said.

Another problem lies in the ratio called construction work in progress (CWIP), which is used in financial reports to indicate assets purchased but not yet used. They aren't generating revenue and can't be marked down for depreciation. For most carriers, CWIP is "a much bigger number than it should be," nearly 40 percent in some cases, McGuire said.

"[Carriers] bought more equipment than they needed, and before they put the first generation in service, they said, 'Let's go to the next generation," McGuire said. "It's a big surplus they haven't deployed. Either they're going to deploy it, or they'll sell it for pennies on the dollar."

It all adds up to a sheer cliff in spending, and most analysts tracking the OEM markets say that things aren't likely to improve soon. Tepid equipment spending will last "at least through the end of this year," McGuire said. "We don't see an end in sight."

Smiles, everyone!
Still, many vendors remain optimistic that theirs is the niche where carrier spending remains healthy. Officials at terabit router firm Avici Systems Inc., for example, claim the slump gives carriers motivation to retool their networks for better efficiency. "They're very much interested in starting to migrate the various networks to an MPLS and IP infrastructure," said Esmerelda Swartz, director of strategic marketing at Avici.

Michael Zadikian, chief executive of Metera Networks Inc., echoed other startup executives by noting how the pressure is even greater for older companies. "One of the worst places you could be [during a slump] is in the public markets, where you always have to meet next quarter's numbers," Zadikian said.

An opposite argument says that the slump-along with the proliferation of one-product startups-will favor the more established companies over the newbies.

"There are about 40 or so companies playing musical chairs with about four chairs," said Patrick Nettles, chairman of equipment provider Ciena Corp. "This is a very common phenomenon [in American business]. It's going to lead to consolidation, and having the scale and the ability to ship a broad range of products during this time I think is serving us very well."

Indeed, Ciena's suffering has been mild compared with others. Nettles said it's because the company chose its customers carefully, turning away those that didn't seem stable. "Of course, it's always tough to turn down business. But we did turn some down. Being disciplined is something we learned a lot about, going through adversity at other times, and we try to maintain that discipline," Nettles said.

Discipline was lacking during the comms frenzy, and Barrett linked that factor to an overall lack of maturity in the networking industry.

"If you look at Dell or Compaq or Gateway or IBM or just about anybody [in PCs], you see pretty good supply-line management and not a lot of inventory write-offs," Barrett said. "If you look at the networking industry, you see there's a degree of maturity difference in terms of supply-line management and such. That's a learning which is translatable from industry to industry, and it's a basic part of the business model-how you do supply-line management, inventory control, how you forecast what the customer wants."

Compounding the problem was the fact that many startups had no contingency plan for bad times. "A lot of companies founded during the good years, they don't have the 'culture' to weather a slump," said Hyeon Lee, chief executive of Coree Networks Inc., which along with Metera is part of the four-company Iris Group. "A lot of sins were forgiven in the go-go years."

Though not as devastated as others in the industry, semiconductor makers are getting their share of the misery. Dataquest analysts inaugurated this year's Design Automation Conference by predicting the chip industry's revenues will drop 25 percent this year. Recovery won't come until mid-2002, Dataquest analyst Bryan Lewis said.

The effects extend even to the manufacturing sector-foundry United Microelectronics Corp. was driven into the red for its second fiscal quarter due to increased dependence on communications revenue. The news sparked speculation that rival Taiwan Semiconductor Manufacturing Co., though still posting profits, might take its share of lumps as well.

Some chip makers have claimed the worst is over. In particular, PMC-Sierra Inc. gave analysts cause for cheer in April when chief executive Bob Bailey announced that the slump would end in the fourth quarter, at least for his company.

But the good news was short-lived. Business levels in May were a "disappointment," according to semiconductor analyst Eric Chen of J.P.

Morgan Securities Inc. Underlying demand remained low in the spring, and Chen said revenues are likely to continue sinking at least through the September quarter for companies such as PMC-Sierra, Vitesse Semiconductor Corp. and Applied Micro Circuits Corp., all of whom sell products ultimately targeted at carrier networks.

For the most part, analysts and executives aren't yet willing to say when things will get better. "I don't know one person who predicted when it was going to start. Therefore, everybody has established his or her credentials-don't believe anyone who tells you when it's going to end. It will end, that's all we know," Barrett said.

In fact, Barrett pointed out some signs that the carnage isn't over.

"Cisco wrote off $2.2 billion worth of inventory-that's a pretty healthy inventory write-off. Cell phone guys have seen their phenomenal year-by-year growth crash around their ears-there's an inventory correction there too. We're still in that correction period," he said.

"The real lesson to be learned-and this is as close as I get to having a 'Barrett's Law'-is: When the numbers are too good to believe, don't."

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