... from the front page of The Wall Street Journal, December 24, 2001 ...
The Outlook
For Tech, the Hard Part May Just Be Beginning
Among battered high-tech companies and their investors the talk is all about stability, the apparent end to a year of sharply declining sales. But the relief that conditions are no longer worsening obscures a growing concern that tech will emerge from this recession more slowly than the rest of the economy, contributing to a sluggish overall recovery.
The technology industry is suffering from a rare "triple whammy," says Stephen Levy, director of the Center for the Continuing Study of the California Economy. The U.S. recession has battered domestic demand while the global economic slowdown has stifled tech exports. And after years of breathtaking innovation, there are few new advances to motivate chief technology officers to spend precious corporate cash.
The combination has been devastating. Sales of computers, software and communications equipment began sliding last winter as most of the economy was growing. After rising at double-digit annual rates for four consecutive years, business spending on high-tech gear fell at a 20% annual rate through the first nine months of the year. By contrast, nontech business investment fell at a 2.2% annual rate.
To make matters worse, there are few tech offerings to inspire bravery. In the 1990s, a steady stream of innovation stirred waves of tech spending, including the mass adoption of personal computers, the linking of corporate computers into networks, business-process software, and the Internet. Now, most tech sectors seem to have hit an innovation trough all at once. "I don't see an obvious killer app," to stimulate spending, says Goldman Sachs hardware analyst Laura Conigliaro.
Mr. Levy thinks at least two of the three trends have to reverse for tech to begin growing again.
How difficult is that? First, nontech concerns have to regain their health, so that they will have profits to invest in tech gear. "People forget that tech is an expense," says Scott Cleland, chief executive of the Precursor Group, a Washington, D.C., research firm.
Historically, tech spending remains sluggish for more than a year after the national economy starts to recover, according to Goldman Sachs economist Jan Hatzius, who analyzed seven economic downturns since 1968.
The pattern seems likely to repeat. Precursor President Bill Whyman notes that more than one-third of tech spending comes from two industries -- financial services and communications -- that are hurting badly. The telecommunications industry's woes seem to know no end. Friday, for example, Nortel Networks Corp. slashed fourth-quarter sales projections to less than 40% of last year's levels.
Elsewhere, executives who a few years ago were scrambling to set up electronic-commerce sites and upgrade corporate networks are milking an extra year out of their PCs and deferring software projects.
Eastman Chemical Co., a Kingsport, Tenn., specialty-chemical maker, revised its tech budget twice this year, cutting expenditures by about 15%, or $20 million. Now, Chief Information Officer Roger Mowen is pruning next year's budget, delaying for a second time the purchase of software to better track customers. Mr. Mowen says the project, initially scheduled for early 2001, won't be launched before late 2002 and then perhaps only as a small pilot. Mr. Mowen's message to his troops: "If we can postpone [a project] until business conditions are better, we'd rather you postpone it."
Pip Coburn, global-technology strategist at UBS Warburg in New York, thinks nontech executives are psychologically scarred by their huge tech outlays during the late 1990s and 2000, not all of which seem to have paid off. He thinks it will take at least six months after a profits rebound before company tech managers "get brave and start asking for money."
But stronger demand alone won't rescue tech because of oversupply, a legacy of excessive investment during the tech boom. Semiconductor factories are running at 60% of capacity, the lowest level since 1975. After looking across the tech supply chain, Merrill Lynch analyst Jerry Labowitz estimates that inventories are still about 13%, or $5 billion, higher than typical for the past decade.
Idle factories and excessive inventories mean tech prices will continue falling abnormally fast, suggesting that any uptick in demand won't quickly translate into more revenue, or profit, for tech companies.
To be sure, falling tech prices often become the spark for new demand. Some economists think low interest rates, easy credit and pent-up demand will prompt companies to increase tech purchases once their own businesses stabilize, as some already are reporting.
But it is bracing to see how far tech will have to climb to reach its once-lofty perch. Tech spending would have to grow 8.5% a year for the next two years just to equal last year's levels. Mr. Whyman thinks it will take until late 2004.
A lot is riding on a tech recovery. Business investment in tech helped power the 1990s expansion and the large productivity gains that let wages grow, without much inflation. But the economy has been in recession since March, despite relatively robust consumer spending and strength in housing. Without a tech rebound, Mr. Hatzius says, "it's very hard to see what's going to be the driver for recovery next year."
-- Scott Thurm
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