Back to bust? High technology on course for harder times - FT.com

Summary:
The IT industry may be about to face its toughest period since the dotcom bust due to the slowdown in the economy. Corporate demand, the IT industry's main source of prosperity, will fall significantly. Instability in the financial markets, declining new hires and weakening corporate profits will result in a lowering of capital expenditure and a premium being placed on operational efficiency. This is likely to play out over the next 9 months, with tech stock, already down 19% over the last 12 months, to fall further. Other recent trends that will compound the impact of the economic slowdown are the increase in choice leading to price deflation; the rise of software as a service and virtualisation. Consumer spending and spending on advertising, an important source of revenues for many Web 2.0 startups are also in decline. The downturn, however, may be less painful than the dotcom crash. There is less overcapacity in the industry, and increasing demand from the emerging world for IT services is compensating for the slowdown in the US and UK. (Published: 14/08/08)

Notes:

• information technology industry may be about to face its toughest period since the dotcom bust
• forgotten side of the technology world: industry's main source of prosperity is the corporate customer
  
• the engine that powers Silicon Valley and the rest of the technology industry
• "flashy gadgets such as Apple's iPhone and online consumer services such as Facebook may have captured the popular imagination and created new technology fortunes, but they are not the industry's main source of prosperity"
• companies account for 60-65 per cent of the end-market for technology
• consumer technology represents only about 20-25 per cent
• governments make up the rest
• with a pronounced economic slowdown in the US and the UK, this engine has started to sputter:
1. weakening corporate profits
2. decline in new hires
   
3. instability in the financial markets
   
• these have historically all been warning signs of lower capital spending ahead
• based on the usual lag, the turmoil in credit markets of the past year virtually guarantees that corporate spending on technology will fall over the next nine months or so
• technology demand, which has been growing recently at an annualised rate of 5-6 per cent, could decline by 10 per cent
• tech stock investors
  
• investors in tech stocks are invariably drawn by the promise of superior growth
• made the sector a stock market stand-out for much of last year, as a slowing US economy made growth stocks rarer
• industry's seemingly endless hype cycle feeds this optimism
• there's always a new computing architecture about to go mainstream, a new must-have gadget, and a Next Big Thing
• optimism is often justified given the big markets that new technologies can create
  
• but: investors frequently pay dearly for that potential
• "If it doesn't work, you get your neck broke"
  
• tech stocks have fallen 19 per cent over the 12 months to the end of July
• nearly double the rate of the overall market
• operational execution at a premium
  
• "I expect the slowdown to profoundly impact Silicon Valley internet, networking and technology companies over the next 12 to 18 months"
• "Technology start-ups should already be tightening their cost controls and turning their attention to the nuts and bolts of operational efficiency."
  
• "There are still numerous long-term growth opportunities across Silicon Valley, but operational execution is at a premium and much more of a differentiator than it has been in many years."
  
• Jim Breyer, partner in VC firm Accel Partners
• recent trends in the technology industry compounding the impact of the worsening economic environment
• availability of choice -> price deflation
  
• thanks to the rise of the internet and other standards-based technologies
• made it easier for buyers to shop around
  
• many corporate buyers have come to count on these to help them continually reduce the overall size of their tech budgets
• When the 1990s tech boom reached its peak, corporate buyers were often tied to proprietary systems from single suppliers
• that is no longer the case
• result: a severe price deflation has taken hold in some corners of corporate technology
• rise of "software as a service" and virtualisation
• two of the most powerful recent technology trends that exemplify this change
  
• software as a service (SAS)
• involves shifting corporate computing tasks to online services
• e.g. using a company such as Google to provide an e-mail service
• "I don't have to buy servers, I don't have to buy storage, I don't have to do back-ups"
• many of these service companies have priced their services at rock-bottom rates
• relying on attracting large volumes of customers to spread their large fixed costs
• "We're talking about products that are one tenth the cost of things that were hawked in the last recession"
• virtualisation
• makes it possible to run several computing workloads on a single server,
• greatly reducing the number of machines that companies need to buy and maintain
• trends like these have created new markets and supported the rise of new companies
• but 1: they have also exposed those whose technologies or business models are not suited to the changing times
• e.g. Sun Microsystems
• soared in the dotcom boom as its proprietary servers became the mainstay of Web 1.0
• but has struggled to adapt to the latest generation of low-cost, standards-based machines and open-source software
• but 2: even tech companies that have been better positioned to ride this wave are starting to feel the pinch.
• due to weaker corporate demand
• companies taking a more "pragmatic" approach to their tech budget
• putting off buying new services
• not just weaker corporate demand
• consumer spending on tech, though far less significant overall and traditionally less prone to big dips, could also be hit in a wider downturn
• another big source of growth, the rapid rise in online advertising, has slowed notably this year in the face of a wider softening in consumer advertising
• after growing nearly 26 per cent in 2007, online advertising in the US, is predicted to grow by only 17.5 per cent this year and 14.5 per cent in 2009, before growth eventually pushes back above 20 per cent in 2011
• search still dominates
• people are cutting back on typical display ads
  
• this slowdown in advertising could not have come at a worse time
• many of the consumer web companies created since the dotcom crash have been avidly building an audience in the expectation that they will cash in through advertising

• downturn will not be anywhere near as painful as the one that hit the industry at the start of this decade
• late-1990s tech binge was more than a bubble in stock market valuations:
  
• it also reflected a massive bubble in tech spending
• internet euphoria
• fear that many older IT systems would not be able to handle the date shift at the turn of the millennium
  
• combined to produce a boom in corporate spending
• we don't have the overcapacity in IT systems we had going into the last downturn
• capital spending in the US has been low by historical standards for the past four years
• will cushion the blow from any fall now
• demand from emerging world growing
  
• after many years of investment, these markets are finally on the brink of becoming significant money-earners for some of the industry's biggest players.
• at its current growth rates, these "growth markets" may account for nearly 30 per cent of its revenues in five years' time
• Silicon Valley is once again turning into a place of "haves" and "have-nots"
• those start-ups that raised a comfortable cushion of cash from investors to see them through this more uncertain period and those that risk being left high and dry if business turns down