Avici Systems TSR product was launched in 1999. The company has since developed the lower capacity SSR and, most recently, the QSR. These products have been deployed into a number of carrier networks in the U.S., Europe and Asia, including that of AT&T and Qwest Communications. Having established a secure foothold in the core router market, Avici Systems is now seeking to expand its customer base, channel partners and market share.

For the latest quarter, ended December 31 2002, Avici's pro forma net loss improved to $12.6 million or $1.01 per share from $16.3 million or $1.31 per share for the fourth quarter of 2001. This 23% bottom line improvement resulted from an ongoing focus on managing expenses and the successful implementation of cost reduction measures initiated earlier in the year. Avici's cash utilization was $8.6 million for the quarter and the company finished 2002 with $125 million in cash - and no debt.

"At Avici Systems we are constantly monitoring the financial health of the company, with the aim of achieving the optimum balance between expenditure controls and investment necessary to maintain our competitive edge. We consider the reliability and scalability of our product to be key competitive advantages, and we are continuing to invest in product development to retain our leading position in the market."

As evidence of the fruits of this policy, Mr Kaufman cited the successful delivery to market of Avici's unique NSR non-stop routing solution, the first commercially available offering that delivers carrier-class 'five-nines' level of availability. Avici Systems has also developed a 10 Gbit/s line card with what is claimed as the highest port density commercially available, and the smallest footprint, highest density scalable core router, the QSR.

This focus on, and demonstrable financial commitment to continual product development and technology leadership is seen by Avici Systems as a key differentiating factor in the core routing product market sector.

Commenting on the evolution of the product portfolio, Mr Kaufman explained that the original high capacity TSR system had proved to offer more capacity than a majority of carrier customers required. A key feature of the product, from its initial development, has been carrier-class functionality such as scalability and reliability.

Responding to market demand for smaller carrier routing systems, Avici developed the scaled down SSR half-rack product, delivering lower minimum bandwidth capacity, together with smaller footprint and associated reduced operating costs. This development work has continued with the recent launch of the QSR product, the industry's smallest footprint scalable router. These smaller capacity solutions have enabled Avici Systems to compete effectively in the core router market by addressing a wider range of PoP applications.

Discussing the products, Mr Kaufman said: "Avici Systems' product portfolio provides a unique level of scalability in its market sector. From an economic perspective, our solution enables a carrier to collapse together multiple network layers at the core and aggregation level into a single cost-effective platform - a capability that has received a very positive response from carriers. When set against smaller, lower capacity, offerings from Cisco and Juniper, Avici Systems' comparable products are now very competitive."

In the fourth quarter of 2002, Avici Systems released a new version of its system software, IPriori Release 5.0. This release includes the company's NSR (Non Stop Routing) technology - claimed as an industry first - and also enhanced convergence and BGP (Border Gateway Protocol) scaling capabilities across the product range.

Avici also launched a new generation of line cards, comprising the 1-port/1-slot OC-192c card, the 1-port 10 Gbit/s Ethernet card and 4-port OC-48c card. This generation of line cards increases system capacity to a maximum of 800 Gbit/s per seven-foot rack. Mr Kaufman added that these new products and features have been launched commercially, shipped to customers and are generating revenue for Avici Systems.

Product development

Discussing ongoing product development, Mr Kaufman emphasised that great care is taken to cater to the needs of customers, noting that the recently released product capabilities have generated a very positive response:

"Avici pays very close attention to meeting customer requirements - both near-term and in the future. As I said earlier, Avici Systems strives to balance the conflicting demands of managing expenditures, to maintain a healthy balance sheet, with investing in R&D, to hold on to our leading position in the market. To judge by feedback received from the market at large, and our customers, we have successfully accomplished this to date."

Commenting on the strategy behind development of the original TSR solution, Mr Kaufman said that, at its conception during the late 1990's, the industry consensus was that bandwidth would be at a premium, based on expectations that the Internet would continue to drive massive traffic growth. At that time, data showed network traffic growing at many hundred of percent annually - growth that was projected to continue. Based on this assumption, Avici Systems set about designing a high capacity, highly scalable, core router:

"When development work began on the TSR product, demand for OC-48 and OC-192 connections was expected to climb exponentially, making a high capacity system the logical choice. Based on the available criteria, producing a smaller system did not make sense for the market we were targeting - the large IXCs."

When traffic forecast data was found to be growing at 80-100% per year vs. original assumptions of 100% per quarter, Avici Systems was able to quickly modify its product to suite the prevailing market conditions. This task was made straightforward due to the design of the TSR system, in which the unit of scalability is the line card. Therefore scaling down - as with scaling up the system was a relatively simple job.

Whilst traffic growth forecasts proved overblown, Mr Kaufman pointed out that, even in today's depressed environment, traffic continues to increase strongly.

Mr Kaufman explained that this is due to a number of factors inherent to the respective products; with the SSR and QSR systems, the small size, ease of installation and support, and lower selling price, obviate many of the factors prompting a direct sales approach. He added that the launch of the scaled down SSR and most recently the QSR have resulted in a high level of interest from potential channel partners.

On the topic of winning orders in the present market climate, Mr Kaufman commented that orders derive from offering more than simply a strong product containing innovative technology at a competitive price. A key factor can be the customer-vendor relationship, and beyond that, customer service and product support. These factors encourage adoption of a channel partner distribution model - with the increased links to potential customers providing expanded market reach and local service and support facilities. Mr Kaufman noted, however, that Avici Systems does not intend to cease direct sales activities.

Mr Kaufman acknowledged that Avici Systems lags its competitors in the area of distribution, noting that Cisco and Juniper have more effective and mature channel partner programmes. Mr Kaufman stated that, through leveraging the expanded and enhanced product portfolio, Avici Systems is now ideally equipped to address this shortcoming.

He added that global as well as regional partnerships would be sought, "at this stage Avici Systems is not committing itself to following any one path".

Avici Systems has thus far concentrated efforts on developing partnerships to address the Asia market, with companies including Itochu Techno-Science Corporation (CTC) and Nissho Electronics Corporation.

Commenting on general recent trends within the industry, Mr Kaufman said: "The trend for the telecommunications industry over the past decade has been one of separating research and manufacturing from carrier activities, for example Lucent splitting from AT&T. From the perspective of the equipment manufacturer, this policy is a good move, placing them into a larger market where they can more effectively compete. The downside is that they are now playing in a very competitive and dynamic market. This is a negative aspect of horizontal integration - far removed from that of being closeted with a captive customer. And once implemented, the transition is virtually impossible to reverse".

Mr Kaufman remarked that further piling on the pressure for the equipment vendors is the fact that the carrier space has become extremely competitive over the past few years, adding that so much profit has been taken out of the system the emphasis is now on costs above all else. For the carriers in this environment, economies of scale become paramount.

Mr Kaufman explained that the company holds a major advantage with its close and long-standing relationship with AT&T. This partnership dates from Avici's early days, and is felt to have been crucial in the development of a commercially viable product, through providing invaluable information regarding the requirements and challenges for a carrier customer. It was noted that Juniper has developed a similar relationship with UUNET.

Highlighting the benefits of this longevity, Mr Kaufman cited as first and foremost an understanding of the needs of the carrier customers, developed through a high degree of interaction with them. He added that this understanding of the market place has made Avici Systems adept at anticipating future requirements and demands from the carriers. Long-term customer relationships are viewed as a key differentiator, and competitive advantage, for Avici Systems.

Mr Kaufman noted that a majority of potential competitors had simply vanished from the core router market, adding "The core router product sector has been one of the most crowded of any in the industry in terms of companies that attempted to break into the market but ultimately failed, with perhaps ten big-name players a few years ago. IronBridge Networks, Pluris, Nortel Networks with Optera and Versalar, and Lucent with Nexabit and PacketStar, are just a few examples".

Remaining competitive

Discussing the challenges to remaining competitive, Mr Kaufman stated that Avici maintains a very close watch on developments in the router market, paying particular attention to any emerging technologies. That said, the company is confident of keeping its present position in the medium term.

Mr Kaufman outlined a number of factors underpinning this view, all of which point to an absence of up-and-coming players possessing commercially viable products. He explained that Avici Systems does not encounter any new products when engaging in trials with carriers - the competition is either Cisco or Juniper, or both.

Further bolstering this view is the fact that developing a core router system is a long and difficult process, starting with hardware design and software development, followed by an intensive validation and testing programme, before the product can be touted to the carriers, who will then conduct their own testing and certification.

Mr Kaufman added that Avici is not aware of any new companies that are more than half way through this process, although acknowledging that gaining an accurate and complete picture of the competitive landscape is extremely difficult. He reiterated that it is now two years since the TSR product was first deployed commercially.

Looking further out over the competitive landscape, Mr Kaufman remarked that barriers to entry into the core router market are now probably higher than when Avici opted to attempt it. With reference to the company's close relationship with AT&T, Mr Kaufman said that today a vendor would struggle to develop such ties, due to the depressed market. In addition, in the event that a manufacturer was able to find a carrier prepared to nurture it, that carrier would now be able to offer only drastically reduced resources - one factor being much depleted research staff.

Summing up, Mr Kaufman offered the view that Avici Systems is today in a stronger position than at any point in its history, founded on its recently enhanced product portfolio delivering carrier class scalability and proven reliability, combined with effective service and support operations.

Commenting on the European market, Mr Kaufman said that ongoing changes there, and restructuring within the major carriers, would provide an opportunity for Avici Systems. However, presently the carriers in Europe are concentrating on regrouping their operations. The U.S. carriers are seen to have progressed further with this process.

Regarding the U.S., Mr Kaufman said that the market is beginning to settle, with, for example, the first of the carriers to seek Chapter 11 bankruptcy protection now emerging as viable companies - in this tranche are carriers that include WilTel Communications. However, major players, most notably WorldCom, are yet to complete this process. It is predicted that WorldCom will surface in late 2003 - an event expected to have a substantial impact on the market as a whole.

Market share

In the fourth quarter of 2002, Avici Systems held slightly over 4% of the 10 Gbit/s router market according to data from Dell'Oro, based on vendor sales figures. Dell'Oro valued the 10 Gbit/s core router market at $157.2 million for the fourth quarter 2002, an increase from $141.5 million in the third quarter. The remainder of the market is shared between Cisco and Juniper, and no other company name beyond these three appears in published figures.

Commenting, Mr Kaufman said that this market share included systems going to carriers for resale to the enterprise market, and that it is likely that Avici Systems' share in the carrier space could be greater than 4%, noting, however, that reliable estimates for equipment deployed into carrier's own networks are not available.

When compared to Cisco and Juniper, Avici Systems is a newcomer to the industry, and this factor in some measure accounts for the low market share. As noted previously, Avici believes its products are very strong, and is witnessing increasing traction with the carriers. The company is aiming to boost market share into double digits.

The key to growing market share is seen to be the market climate in general; once carriers regain confidence, as the telecommunications market recovers, network expansion will fuel the core router market, and, it is believed Avici's share. Mr Kaufman said that Avici Systems has directed a huge amount of effort to reaching its present position, and is justifiably proud of what has been achieved. He emphasised, however, that there is no intention to now sit back and relax.

Market landscape

Describing the wider market in which Avici Systems plays, Mr Kaufman said that, as a rule, the carriers have been poor historically at predicting traffic growth, and thus infrastructure requirements. In the recent past a carrier would often build out its network based on traffic forecasts, whilst in the current environment build out is generally centred around 'hot spots' or bottlenecks in the network, based on necessity rather than predictions.

Mr Kaufman cited trans-Atlantic and trans-Pacific cities as typical hot spots in carrier's existing networks. Avici judges that current carrier customers have developed a realistic view of the market and its short-term development, tending to base decisions on near-term forecasts derived from actual traffic patterns rather than analyst forecasts.

Over the past year, cable networks in the U.S. have been showing notable traffic growth, driven mainly by rapid growth in residential broadband connections. From Avici Systems' perspective, this is beneficial, as much of this traffic is ultimately carried over AT&T's backbone network, with which company Avici has a long-standing relationship.

Traffic growth arising from this sector is expected to continue and to accelerate as take up of broadband services becomes widespread and new applications fuel demand for bandwidth. Mr Kaufman said that in the U.S., broadband service is currently the driver of traffic growth, powered by such facilities as sale and supply of music over the Internet and interactive gaming.

Longer term, mobility services are expected to represent another market that will drive traffic growth, although the type of service will be a decisive factor. For example, exchange of pictures and video via cellular phones would demand substantial network capacity, while text messaging does not. Mr Kaufman noted that, in the immediate future, Wi-Fi services are set to become a significant driver of traffic growth.

Closer to home for the equipment vendors, a transition from legacy network infrastructure to a single converged backbone is anticipated to become a major source of revenue. Mr Kaufman commented that this transition has been mooted for several years, but has failed to materialise, largely due to the carriers' focus on extending their networks in expectation of capacity demand that, finally, was not forthcoming. However, Mr Kaufman added that the shift to a converged backbone network, from multiple service-specific networks, is now very much a reality in the market, with carriers seen to be accelerating plans to implement the transition over the past six months.

Market climate

Discussing the market environment, Mr Kaufman commented that, despite the disappointing rates of traffic growth, and resulting over capacity, many carrier's infrastructure is now reaching its capacity limits, witnessed by, for example, demand for additional ports and slots, and diminishing capacity at the network edge. Mr Kaufman also pointed out that the ability of individual carriers to handle capacity demands varies considerably, arising from dramatically differing traffic growth rates from carrier to carrier, with some seeing annual growth rates of up to 300%, whilst others are experiencing under 50% growth.

As noted previously, Avici Systems sees a general market recovery and the associated increase in capital expenditure, as key to growing its market share. Mr Kaufman explained that due to the nature of Avici's product, doing so in the present conservative market, primarily through expanding the customer base, is extremely difficult:

"What capital expenditure there is by the carriers presently is largely directed towards upgrading and up-rating existing equipment, rather than to investing in entirely new platforms. Very simply, a freer market will give Avici Systems more room to manoeuvre".

Mr Kaufman said that a recovery in the telecommunications sector would be driven by a general macro-economic upturn, in tandem with the emergence of troubled carriers from restructuring programmes executed under Chapter 11. He commented that 2003 was expected to be a flat year for the industry, with a recovery and resumption of market growth in early 2004. He noted that analyst forecasts peg growth in 2004 at between 10% and 12%, "although I would be hesitant in endorsing those estimates, they concur with messages regarding network build-out that Avici Systems is receiving from carrier customers. Looking ahead, the signs are positive towards a resumption of growth in the routing sector.

Market outlook

Regarding future market requirements and product capabilities, Mr Kaufman commented on the viability of a petabit router - currently in development by Hyperchip - in view of the fact that Avici Systems has found a need to launch scaled down versions of its original high capacity TSR system.

He stated that Avici Systems could see no need for such system capability today, adding: "Carriers assess a number of criteria when selecting a core router system. Priorities now are price, size and operating costs, reliability and interoperability - petabit capacity is not something that they are interested in, and certainly not asking for. The only case where petabit capability would be of interest is where it is part of an otherwise highly attractive package, as 'future proofing'. But basically, this is not a problem demanding a solution."

Discussing possible pitfalls to a market recovery, particularly the return onto the scene of reinvigorated companies presently passing through Chapter 11 restructuring, Mr Kaufman expressed the opinion that intensifying downward pressure on bandwidth pricing will primarily serve to fuel demand for capacity, further driving down pricing, resulting in a vicious circle.

Underlying this scenario is an escalating demand from the carriers for network equipment from vendors including Avici Systems. In addition, Avici is witnessing an accelerating shift amongst carriers to integrated (IP MPLS) backbone networks, offering further opportunities for the company.

At a more detailed level of network operations, Mr Kaufman noted that carriers are seeking smaller economies of scale through, for example, siting a single router in each network POP in place of the two or more necessary in the past - a practice in tune with Avici's product strategy. He asserted that Avici Systems is fully able to facilitate new network build-out as well as enhance the capabilities and operation of deployed networks.

In conclusion, Mr Kaufman said: "I believe that carriers have returned to the purchasing practices followed prior to the Internet inspired 'bubble' - the chief concern now is return on investment. One facet of this policy is a sharp focus on actual performance delivered by products, a welcome reversal of the common, and even accepted, practice of 'hyping' new product capabilities during the boom years."