Techs Soft Landing In Rough Economy

By Mel Duvall  |  Posted 2001-01-08

Techs Soft Landing In Rough Economy

A year ago people, were nervous about planes falling out of the sky, money disappearing from bank accounts and entire countries going dark from the widely feared year-2000 glitch.

As we head into 2001, people are still worried. But now attention has shifted to the state of the stock markets, a steady flow of layoff announcements in the technology sector and the possibility of a full-fledged recession.

Time for another reality check.

Like the buzz about the Y2K bug, there now seems to be too much hype about the prospect that the information technology (IT) industry will crash or the country will fall into an economic recession, according to a panel of economists, analysts and Fortune 500 chief information officers (CIOs) consulted by Interactive Week.

Certainly, the IT industry is experiencing a significant amount of pain — pain that many say it deserves. And yes, no one can say for sure that consumer fears or skyrocketing fuel costs wont ultimately stall the increasingly fragile economy. But the underlying fundamentals suggest this should be another solid year of growth for the high-tech sector as companies turn to the Internet to cut costs and become more efficient. Not a stellar year like weve gotten used to over the past four years, but a year that should infuse a healthy dose of reality back into the industry.

"Everything tends to get exaggerated in the computer industry," said Shyam Sunder, an economics professor at Yale Universitys School of Management, who specializes in e-commerce. "What we have is an industry thats used to an extremely high growth rate, so a slowdown like we seem to be experiencing looks like a crash. But I think if you look at the macro level and ask how many people are worried about their jobs at this stage of the economy . . . how many companies plan to cut back on IT spending . . . I think you would find the percentage is relatively small."

Reports coming from industry seem to back up Sunders analysis. A year-end survey of 150 chief technology officers at Fortune 1,000 companies released late last month by Morgan Stanley Dean Witter & Co. shows that companies plan to increase their IT budgets in 2001 by an average of 8 percent, most of which is targeted at moving more company systems onto the Internet. Thats a healthy increase, but a drop from the 12 percent growth in spending budgeted for 2000.

"You cant continue to do business without up-to-date information technology," said Harris Miller, who directs the Information Technology Association of America. "The projections show continued growth in the high single digits or low double digits."

Why all the fuss then? For starters, its hard to dismiss the storm clouds that appear to be gathering on the horizon. And perhaps theres something in our underlying psyche that says weve had it so good for so long now, its time for a little payback.

Payback Time


Payback Time?

The economic numbers coming in paint a mixed picture at best. The National Association of Purchasing Management reported last week that U.S. manufacturing activity fell in December to its lowest point in 10 years. It was the fourth monthly decline in a row, and steeper than economists had predicted. The Department of Commerce contributed to the chill on Dec. 21 when it said Gross Domestic Product (GDP) in the third quarter fell to 2.2 percent — the slowest rate of growth in four years. The DOC had revised its estimate at the end of November for the third quarter downward to 2.4 percent from 2.7 percent, but the actual numbers came in lower than the revised estimate. And claims for unemployment took another jump in November, reaching their highest level in four years.

The news isnt all bad, though, and this is why very few economists have been willing to say the economy is headed for a recession. Housing starts were up in November; personal income rose slightly after a small dip in October; and the consumer price index rose a modest 0.2 percent, keeping inflation in check.

More worrisome seems to be the steady barrage of layoff announcements coming out of the tech sector, debilitating energy prices and corporate profit warnings. Layoffs in the dot-com ranks have been particularly severe, with outplacement firm Challenger, Gray & Christmas reporting that job cuts rose another 19 percent from Nov. 27 to Dec. 26, hitting 10,459, compared with Novembers tally of 8,789. For the year, December 1999 to December 2000, the firm counted 41,515 job cuts in the tech sector — almost half of which came from Net companies.

"In the first six months [of 2000], all you heard about were job fairs, lavish recruiting parties and after-hours mixers where would-be entrepreneurs hoped to meet free-spending venture capitalists," said Chief Executive John Challenger. "Now, pink slip parties are the rage, where newly jobless dot-com workers commiserate, exchange résumés and talk about the good ol days — which of course were only six months ago."

The stock markets have been kept reeling by a succession of warnings of lower earnings. In recent weeks, the Nasdaq has been rocked by negative news from such bellwether stocks as Compaq Computer, Dell Computer, Gateway, Hewlett-Packard, Network Associates Inc. and even Old Faithful, Microsoft. One of the most eye-catching was a warning on Dec. 5, 2000, by Apple Computer that $600 million worth of revenue had been wiped from its projections. "It looks like were facing a broad economic slowdown that will affect many segments," Apple CEO Steve Jobs concluded at the time.

But once again, even though the warnings from PC makers appear to point to a broad decline, analysts said its not a straightforward conclusion. PC sales look "disastrous" in the U.S. in the fourth quarter, but growth in the corporate sector and in international markets remains healthy, said Roger Kay, a researcher at International Data Corp. IDC lowered its estimate for U.S. consumer PC sales in the fourth quarter from 21.2 percent year-over-year growth to 10.2 percent. However, it still expects a 19.6 percent gain in overall PC sales, thanks to a strong corporate and Asia-Pacific market. That figure is only slightly lower than IDCs original estimate.

"Home desktops are only a small piece of the market," Kay said. In contrast, corporate PC sales, which had been slow in the first part of the year, particularly as companies got through the last of their Y2K issues, began to pick up in the second half. Kay expects that momentum will increase through the first two quarters of this year as the upgrade to Windows 2000 finally kicks in.

Holiday e-commerce sales are another case of the glass being half full or half empty. Sales didnt meet the rose-colored forecasts of analysts earlier in the season, but they were still strong. According to a report by PC Data and The Goldman Sachs Group released just after Christmas, online holiday spending soared to $8.7 billion this year, a 108 percent increase over Christmas 1999. Yahoo! said order volume nearly doubled for its shopping properties, and sales for retailers that also operate brick-and-mortar stores, such as Macys and Eddie Bauer, came close to tripling.

On the other hand, several Internet-only retailers, such as eToys, warned that their revenue was not likely to meet expectations. EToys said it could run out of cash as early as March, increasing the prospect that there will be more layoffs and more failures in the dot-com sector in the weeks ahead.

Calculator Please

Calculator Please

When you add all the indicators up, what you get is a picture of an economy that still appears to be headed for modest growth. In fact, in its year-end survey of 34 leading economists, the Federal Reserve Bank of Philadelphia came to the conclusion that the economy is still expected to grow over the next two years, by 3.1 percent in 2001 and by 3.4 percent in 2002. Those forecasts are down considerably from the 5.2 percent growth rate in 2000, but 3.1 percent GDP growth is still considered healthy by most standards.

As indicated by Yales Sunder, the problem with the economy — and the technology industry in particular — is that it has been running along like a Ferrari, with no care for normal speed limits. Cruising at the posted limit now feels like heading in reverse.

On top of that, many Internet companies founded during the bubble were created on business models without clear paths to profitability. Like a pyramid scheme, the dot-coms were set up to come crashing down once normal rules of economics were applied to the sector, making a soft landing — at least on the dot-com front — a remote possibility. Also, industry stalwarts such as Cisco Systems, Dell, Intel and Nortel Networks achieved market caps that could be maintained only if revenue continued to grow at exponential rates — rates the current economic climate cannot sustain.

"Last year when I taught courses on financial analysis, I was getting looks from students like I was a dinosaur," Sunder said. "They were telling me the old economics dont apply anymore. Well guess what? The laws of gravity still do apply and were coming back down to Earth."

Those with a harsher perspective say the dot-coms not only deserved to crash, but the industry will be better off for it. "In the last five months, traditional companies have been excited to see the dot-coms getting their butts kicked," said Michael Erbschloe, vice president of research at consulting firm Computer Economics. Rather than fear these upstarts, as they may have a year ago, the so-called bricks-and-clicks are looking to learn from the dot-coms mistakes and take advantage of their tarnished records. "Theyre asking, How can we use the Web to drive traffic into stores, do some sales and build loyalty? I think theyre succeeding," he said.

Pain Before Gain

Pain Before Gain

Even if the year doesnt turn as bleak as many fear, things will likely look worse before they get better. Many dot-com companies — particularly those on the e-retailing front — were holding on through the Christmas season, hoping that strong sales would be enough to see them through another year, or through another round of financing.

Expect many of those that did poorly over the holidays, or did well but continue to operate at a loss, to give up the fight. More layoffs, failures and pink slip parties are inevitable through the first two quarters of the year.

Likewise on the business-to-business commerce front. While not dependent on holiday sales, B2B firms are facing a cash crunch of their own. Many were founded on shaky business plans that required subsequent financing rounds to eventually reach profitability. Venture financing is drying up, and the industry is poised for a wave of mergers and consolidation. While some will find buyers or partners, a great many will simply go out of business.

After the first two quarters of the year, however, the tech sector should be back on track. The transformation that is taking place throughout companies based on Internet technologies is real and will only accelerate as companies begin to achieve the first big results. Even if a downturn in the economy does come into play, many in the industry believe tech spending could come through relatively unscathed, for the simple reason that investing in new technology and Internet applications is one of the easiest ways to shave costs.

"Everybodys talking about a downturn, but IT spending doesnt go away — it gets more bottom line-focused," said Ariba CEO Keith Krach. Ariba, which supplies software to help companies automate their purchases of goods and services over the Internet, has been experiencing phenomenal growth. In its last reported quarter, sales reached $134.9 million, compared with $17.1 million for the same period a year earlier.

In an interview in late December 2000, Krach said his company had yet to feel any impact from a feared recession. Even if the economy continues to slow, Krach figures Ariba will be able to capitalize on a shift in focus to controlling costs. "If you know your revenues are slowing, then the easiest way to boost EPS [earnings per share] is to cut your costs," he said.

Netscape Communications co-founder Mark Andreessen is betting on the same game plan. Andreessen expects to push ahead with an initial public offering for his latest venture, Loudcloud, a company that builds, hosts and maintains the back-end plumbing for e-commerce sites and applications.

"All of a sudden business fundamentals matter," Andreessen said. "People were allowed to get sloppy over the last two or three years because we were in an environment where capital was basically free. Going forward, youre going to have to absolutely focus on the market you are in, because theres going to be no room for people trying to do multiple things at once. We obviously think thats going to lead to a tremendous amount of outsourcing."

Of course, no matter what the vendors think, the overall growth or lack of growth of the IT sector will largely depend on the spending plans of corporate America. On that front, Interactive Week has not been able to substantiate fears of a major slowdown.

Once again, the worst-case scenario is flat IT spending. But in most cases, corporations expect increases. They also expect to dedicate more of their IT budgets to Internet projects, which could add up to further good news for the Internet sector.

"Our IT budget has been growing modestly over the last few years, and I expect that will continue," said Procter & Gamble CIO Stephen David. P&G will be reallocating its IT resources away from such areas as Enterprise Resource Planning systems into new areas such as integrating its global supply chain with new marketplace initiatives and Web-enabling many of its internal applications. "Also, like most organizations, we seem to have an insatiable appetite for bandwidth — not only here in North America, but around the world," David said.

Michael Haas, vice president of information management and CIO at Johnson & Johnsons consumer products division, said his company will likely spend more on IT projects in 2001, not less. A big focus in the coming year will be Johnson & Johnsons participation in Transora, a huge marketplace initiative involving more than 50 of the worlds largest consumer products companies. "When I look at my plate, we have a lot of activities that will be coming up in 2001 or going into full production in 2001," Haas said. "My feeling is that 2001 will continue to be a good year for IT spending. In talking to my industry peers, everybody seems to be in a similar position."

Backing up that point, Morgan Stanley found in its annual year-end survey of CIOs and CTOs at Fortune 500 companies that just 16 percent of respondents believe they will spend less on IT projects in 2001. The majority expect IT budgets to grow an average of 8 percent. GartnerGroup also conducted a survey of 510 international companies and found that 65 percent planned to increase their IT budgets in 2001. Analyst Kurt Potter said more of that money will be dedicated to e-commerce projects —16 percent in 2001, compared with 13 percent in 2000 and 10 percent in 1999. The 16 percent forecast for e-commerce projects may be an underestimate, he added.

"IT has morphed and changed from overhead into something that generates business, increases productivity. Its not just about cost anymore," Potter said.

A more cautious tone was set by Merrill Lynch & Co., which said it found in its year-end survey of 150 CIOs that only 56 percent believed their IT budgets would rise in 2001 — by an average of 12 percent. Earlier in 2000, Merrill Lynch polled the same executives and found that 78 percent were expecting to see their IT budgets increase in 2001. The brokerage firm said fear of an economic downturn is the main culprit for the more sober outlook.

Its the Supply Chain,


Its the Supply Chain, Stupid

In terms of where the money will be spent this year, the phrase that seems to be on everyones lips is "Webification of the supply chain." The premise here is pretty simple, while the execution is immensely complicated: Corporations are beginning to use the Internet to plug directly into the operations of their suppliers and buyers, the idea being that it will eventually be possible to peer directly into the operations of all of a companys major partners to develop, manufacture and ship products to shelves in as close to real-time as possible. This involves much more than building Internet marketplaces, although that is certainly part of the picture. Its about General Motors being able to see into its dealerships to determine which vehicles are going out the door, and being able to look into the production systems of its suppliers to determine how quickly it can replace parts without stockpiling products in inventory.

The benefits of such systems for companies in sectors as far ranging as aerospace, automotive, consumer products and electronics are enormous. And the early results have been impressive enough to keep the Internet economy rolling despite the larger economic picture.

HP, for one, estimated that it saved about $70 million on its various supply chain initiatives this year, and that it could save as much as $400 million in 2001.

Beyond the supply chain, analysts and CIOs said they expect there will continue to be a big focus on customer relationship management systems and related intelligence systems to better serve customers, as well as continued investments in data warehouses to support the various e-commerce systems now being implemented.

One of the new areas to show up on the radar screen is a focus on B2E — or business-to-employee — applications. Companies are beginning to realize there are big benefits and cost savings to be gained from creating applications on corporate intranets that allow employees to access their benefits programs and operational programs such as travel and expense management.

Wild Card

Wild Card

Were willing to go out on a limb here and predict that 2001 will go down as a pretty good year for the IT community, if not a great year. And more important, the outlook beyond 2001 looks even stronger.

Of course, there are too many wild cards at play to rule out a recession, and economists warn that if consumers begin thinking and acting like theyre headed for a downturn, they might just get what they fear. If oil and gas prices stay at their current levels, the economy could also be gouged into stalling.

Even those in the IT community who are pretty bullish on the coming year said they were surprised at how quickly things headed south on the dot-com front earlier last spring.

"Anybody who says they saw the meltdown of the dot-com sector coming is a liar," P&Gs David said. "We all knew it would happen, but no one thought it would happen as quickly or a severely as it did."

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