Having missed out on a key product shift, mighty

Nortel Networks

(NT)

is now stuck pushing air conditioners during the telecom industry's long, hard winter, observers say.

As shortfall warnings from Nortel and its suppliers

JDS Uniphase

(JDSU)

and

Corning

(GLW) - Get Report

punished the networking sector Friday, some signs pointed to a dramatic shift in optical networking product demand as the culprit. Nortel's failure to heed this shift could leave it in the same straits as rival

Lucent Technologies

(LU)

, which missed an earlier product cycle, ceding key ground to Nortel and leading the equipment maker into its current morass.

Among the patterns investors and industry observers saw emerging from Friday's networking meltdown was a rather glaring void in Nortel's nearly comprehensive product line: The company lacks an optical switch.

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With cash in short supply, phone and Net services companies have slashed jobs and trimmed costs, as many are seeking to preserve liquidity and keep creditors at bay. These equipment buyers, who sit atop the sector's cash-supply pyramid, have accordingly begun to shift their purchases away from gear that expands their networks to gear that operates new networks.

This trend was expected to play out incrementally over the coming years, but some analysts say cash constraints have hastened that move. And Nortel, with its Xros optical switch estimated to be still a couple quarters away from release, isn't exactly cashing in on the changing product cycle.

"In 2000, a lot of carrier spending went to network buildout and the addition of a lot of transport equipment," said a Wall Street analyst who currently has no ratings on these stocks and asked not to be identified. "But now they are getting far more interested in ways to operate and optimize those networks." His firm has done no underwriting for Nortel.

Passing the Baton

Last year, Nortel had surpassed Lucent as the dominant supplier of the world's optical transport gear. These are laser-based fiber optic boxes that shoot lightwaves through networks at speeds of 100 billion bits per second. These transport boxes are affectionately called OC-192 or 10-gig devices. As a possible sign that there is less demand for 10-gig equipment,

TheStreet.com

found some of these once-coveted parts in the

repossessed equipment market.

Ciena, which also makes transport products, has the market lead in optical switches and said Thursday that it expects its switch sales to exceed 10% of its sales this year. The Linthicum, Md.-based all-optical shop lists 11 customers for its CoreDirector switch, with big-spender

Level 3

(LVLT)

the most recent addition to the list.

Ciena's president and chief operating officer, Gary Smith, said the shifting winds in the industry are moving firmly at his company's back. Some analysts agreed. "Ciena and Sycamore are in pretty good shape in terms of what they offer and where the market is headed," said the unnamed Wall Street analyst.

Nortel's CEO John Roth continued to deny that Ciena was swiping market share from his company. But to support his point, Nortel held up market-share figures for the transport products. Nortel cannot gauge its optical switch market with no optical switch to offer.

A Nortel spokesman couldn't resist a parting shot at a rival upstart. "It's easy for

Ciena to show growth; they have a smaller base," the spokesman said. "They are very small, their revenues are $1 billion a year ... we make that in two weeks."

Taking a Managerial Role

Both Ciena and

Sycamore

(SCMR)

, along with closely held

Tellium

, have developed optical switches that are run by sophisticated software that serves as the brains or operating system of a network.

These switches have demonstrated an ability to manage network traffic routes and, if you believe the developers, effectively cut network operating costs by as much as 90%. The cost savings presumably come from the elimination of numerous electronic boxes and attendant devices. Optical switch fans also blow the revenue horn, saying the smarter boxes can speed up a service provider's response time, allowing it to sell capacity in lucrative short-term blocks as opposed to the traditional long lead times and long bandwidth contracts.

To be sure, the nation's sagging economy may play a larger hand in the equipment spending shifts and slowdowns. And in that sense even Ciena, which was hit less than its networking brethren Friday, remains very vulnerable.

"Ciena and Sycamore are trying to lead the way, but the question is whether the carriers are going to be able to buy anything at all," says Bill Trent, a money manager with New Jersey's employee retirement funds. "The idea that they had to keep spending to stay ahead of their competitors has gone away."

"Now," says Trent, who has positions in Ciena, Nortel, Sycamore and Lucent, "the carriers are probably not going to spend until they see the monetary advantage."