Finding a Silver Lining in the Tech Bust
Suddenly customers are learning to flex their muscle.
FORTUNE
Monday, October 14, 2002
By Fred Vogelstein
URL: fortune.com
THE ROAD BACK: PART 1
Tech's in a deep depression. This story is the first in a series examining what went wrong--and what tech needs to get growing again.
Talk to Richard Chu about Silicon Valley, and you can tell he's trying his hardest to be upbeat. The veteran SG Cowen technology analyst rambles on about the software projects companies are itching to start, about his firm's just- released survey showing IT spending growing again next year, and about just how hard it is to call the bottom of any economic downturn. But by the end of the conversation, it's clear he hasn't even convinced himself. "I started in 1972, and I've never seen this kind of collapse" he says.
Remember when Silicon Valley's economic woes were a source of amusement, when it felt good to watch smug 26-year-old dot-commers lose their shirts? The smirking is gone. Infotech has been in a slump for so long--two years and counting--that schadenfreude not only doesn't seem fun, it seems sadistic.
How bad is it? Prices for virtually every piece of hardware the industry sells--servers, PCs, printers, storage, routers, you name it--are falling fast. Hardware and software companies are shifting into selling consulting services, in part because no one wants to upgrade. Margins are shrinking. Revenues are evaporating. In Silicon Valley, 100,000 jobs have disappeared since 2000. And nearly 40% of all commercial real estate there is now unused. Tumbleweeds are practically rolling through.
The picture is just as grim on Wall Street. While the S&P 500 has slid about 40% over the past two years, the DJ Technology index has dropped by nearly twice as much. Stock prices for some onetime tech stars have fallen so low that many institutional investors are forbidden by their rules from owning them. At a recent $2.75 a share, Sun Microsystems is trading at $1 more than the per share value of its cash in the bank--which means investors value its $12-billion-a-year business at close to zero. Sure, the U.S. economy might still be in a recession. But in Silicon Valley, "depression," with all its worrisome connotations, may soon be the buzzword. Even Cisco CEO John Chambers, perennially one of the greatest optimists about the Valley's long-term prospects, says he's not bullish about business in the coming year. Next year? If only. Merrill Lynch analyst Steve Milunovich says economic stability might not return to high tech until 2005.
Yet there's one area of business that's benefiting from IT's woes: the users. With tech suppliers desperate for sales, CIOs are staging a revolt--call it a coup de tech. They're pitting hardware vendors against each other to drive down prices. They're stretching out the time between hardware and software upgrades. And instead of just buying whatever proprietary systems a vendor is pushing, they are forcing tech companies to adhere to more generic systems. On top of all this, they're taking steps to make sure that the power shift is permanent. "There has never been a better time to be a buyer of technology," says Merrill Lynch CTO John McKinley, the investment bank's top technologist.
The shift is momentous. For 15 years--since companies started using PCs en masse--business has been sprinting on a buy-and-upgrade treadmill. Layering on generation after generation of products has made IT infrastructures bloated and mind-numbingly complex. "Cost and complexity is our No. 1 problem," says Tony Scott, one of GM's top technology officers. "It's a hundred times what it was ten years ago." When selling was easy, tech makers had less and less incentive to coddle customers. No wonder CIOs and other buyers of technology increasingly have felt resentful and taken advantage of.
Most CIOs admit they brought some of the problems on themselves. "We were collectively not great portfolio managers," Merrill Lynch's McKinley says. A big part of the problem, he says, was just inexperience. Complex Internet-based networks, storage, and e-mail systems, after all, have only been around for five years. That's a short time to learn what configurations work best, particularly when business is booming, you're worried competitors will figure out the tech game before you, and a computer salesman is in your office with a box he says will quintuple the speed of your network. Even Merrill, which has always thought it had strict controls about how much it spent on technology, didn't start measuring tech spending as a percentage of revenues--the kind of reality check routinely applied to other big expenses like payroll--until two years ago.
These are important lessons for CIOs, especially in a period when they're seeing their budgets axed. Historically, IT spending has grown at 10% to 13% a year. Now Goldman Sachs is looking for a paltry 3% rise next year. McKinley says that to deal with his increasingly limited budget, he is working on creative ways to get more bang for his buck. The most intricate software and the fastest hardware are no longer musts. "Good enough instead of perfection" is now his mantra, he says. And more than ever he is sharing information with Merrill's competitors to develop hardware and software standards for the financial industry. Until two years ago, he and other Wall Street CIOs tried to one-up each other in technology. Now, he says, they realize everyone makes far more money if they just compete for customers and cooperate in IT. "We've learned the value of coordinated customer activism," he says.
But will these lessons stick? Won't customers get right back on the treadmill when the economy bounces back? That's not likely, analysts say, because the business has fundamentally changed. Technology, for one, is growing more standardized. Customers increasingly want software and hardware delivered not in one big package but in modular, interchangeable components that can be added and subtracted from systems in a matter of hours. Even many suppliers now believe that open systems, standards, and swappable hardware will permanently drive down how much customers pay and how often they buy. "It's like just-in-time manufacturing," says Mark Bregman, executive vice president in charge of product operations at Veritas, a $1.5-billion-a-year maker of storage software. Once companies figured out that they didn't need to hold inventory, they stopped doing it and never went back.
To anyone who's purchased a PC recently, it must seem puzzling that this power shift from vendors to customers didn't happen years ago. After all, consumers and businesses for years have reaped the benefits of price battles in the increasingly commoditized PC world. But in corporate server farms and data centers, where huge chunks of IT budgets are spent, price competition was much less fierce. The equipment sold by companies like Sun, HP, and IBM, was superfast and super-reliable, but it also ran on proprietary software that made switching vendors difficult and expensive. Now, servers loaded with Intel chips are just as fast, and Microsoft or Linux software is in many cases just as reliable.
CIOs love this--in part, no doubt, because they can be heroes. Mike Prince, the CIO at Burlington Coat Factory in Burlington, N.J., says he's been able to save so much money switching his systems to Linux--the software is free and the Intel-based hardware costs a fraction of what his old proprietary systems did--that he thinks he'll be able to cut his IT budget voluntarily in coming years. "What we can buy today far exceeds what we need to keep up," he says.
Tech suppliers like HP are already preparing for the era of the powerful customer. "The focus on reducing total cost of ownership is here to stay even when the economy recovers," says Jim Milton, head of enterprise sales for the Americas at HP. "It's why HP and Compaq merged. We saw the writing on the wall."
For those in the innovation business, like Bill Gates, Scott McNealy, Larry Ellison, and Steve Jobs, who have built companies and careers on technological breakthroughs rather than on bean counting, all this talk about cost cutting and commodity pricing must be the bitterest of pills. But innovation is not dead. In fact, it might end up being the path out of death valley.
What tech manufacturers need is the same thing that made them powerful in the first place: a new technology that corporate America believes it can't do without. That was true of the PC in the 1980s, and it was true of networking and the Internet in the 1990s.
What will that technology be? If you want the big picture, it still makes sense to listen to Cisco's Chambers. Last month, in a speech at a Bank of America conference in San Francisco, he explained that we are far from seeing the potential of all the equipment bought and advances made during the boom. For all companies' bluster about outsourcing arrangements, Net-based streamlining, and virtual supply chains, there's still much to do. Throughout corporate America, files are sitting undigitized and forms have yet to go online. Once all that becomes available on private and public webs, Chambers told his audience, it will create a fluidity of information that will profoundly change business.
If the thinkers like Chambers are right, the meaning of the word "corporation" will change. Armed with the flexibility of moving and sharing information instantaneously with whomever they choose, companies will slim down to focus on doing one thing well, say designing computer chips, and outsource everything else from payroll and accounting to manufacturing and distribution. "It will be the most fundamental change to business since the assembly line," Chambers says. "It's amazing to me how many businesspeople around the world tell me 'that's exactly where we are going to go.' "
During the boom, of course, such big-picture talk was omnipresent. Then, everyone thought the change was around the corner. Now we know it will probably be years before the technology exists to do all this easily, cheaply, and quickly. Until then, expect the tech business to be a different place: smarter customers, scrambling vendors, and slower growth. A more sober relationship for a more sober time. |
