The IT crowd crunched

Steve Ballmer's gloomy assessment of the technology sector's prospects reflects a growing realisation that it can't duck a global downturn. Stephen Foley reports

There's been something grimly symbolic about the absence of Steve Jobs and Bill Gates from this week's major tech sector expos, Macworld in San Francisco and the Consumer Electronics Show in Las Vegas.

The founders of Apple and Microsoft respectively traditionally add the final touch of stardust to these glittery events, exhibitions designed to wow audiences with the latest must-have gadgets and world-changing technological advances.

Mr Jobs, of course, is spending more time with his doctors at the moment, and Mr Gates is spending more time giving away his money, so both demurred to deputies to deliver the keynote speeches at these events. And what glum affairs they were.

Opening the CES, Steve Ballmer, Microsoft's chief executive, was the most explicit doom-monger, even as he tried to rouse the faithful. "It feels like we've entered a period of reduced expectations, a time when we may be tempted to temper our optimism and scale back our ambitions," he said. "But no matter what happens with the economy or how long this recession lasts, I believe our digital lives will only continue to get richer."

Mr Ballmer was only registering the mood that is permeating the show, and the sense that the technology sector is entering its most challenging period at least since the dot.com bust at the turn of the century.

What is fast becoming clear is that the downturn in technology spending is coming on more quickly and threatens to be much sharper than previously forecast. Whether it be individual consumers, too worried about their jobs to splash out on the next generation iPod or personal computer, or businesses, crimping costs to help navigate the recession, technology is being hit hard. And experts in the sector fear the much more competitive landscape this time out means the downturn could be more painful even than the dot.com bust.

The CES opened on Wednesday night, just as Intel shares registered a 6 per cent decline for the day, the result of its second profit warning in two months. Intel is the microchip maker whose products are the brains inside so many of the gizmos on display at the show, and it said that sales in the final three months of 2008 would be down 20 per cent from the previous quarter. Going into October, it had still been predicting growth in the traditionally strong Christmas period – but that was before the effects of September's global financial panic really began to be measured.

Then yesterday came news of lay-offs at Lenovo, the Chinese computer manufacturer which bought IBM's hardware business three years ago and is now the fourth-largest maker of PCs in the world. Until recently, demand from fast-developing emerging markets had been expected to prop up technology spending both by consumers and businesses. Not now. Lenovo will make 11 per cent of its workforce, 2,500 people, redundant and cut executive pay by more than a third.

"The actions are not easy," Bill Amelio, Lenovo's chief executive, said, "but we believe they are necessary for Lenovo to compete in today's economy."

Already, online media businesses, reliant on scarcer advertising, have seen their shares plunge and even the mighty Google has said it expects a tougher 2009. Now the tech sector downturn is expected to spread across both hardware and software, and across all regions of the world.

There were about five minutes at the peak of the dot.com boom when the wildest-eyed commentators declared technology was no longer a cyclical industry, whose fortunes ebb and flow with the economic tide. In reality, businesses have to make cuts wherever they can in a recession, and that means IT managers are under pressure like everyone else.

Robert Buckland, an equity strategist at Citigroup, explained why the IT sector is his least favourite sector this year. "The global earnings downturn is still only a quarter of the way into our forecast 50 per cent peak to trough decline. Financials have suffered most of the pain so far. We expect the other cyclicals to follow in 2009."

That said, IT spending has previously been relatively robust compared to the rest of the economy, growing faster than GDP in the good times, decelerating less during the downturns, partly because managers have been able to argue that beefing up IT can help save money in other areas, perhaps by making some costly personnel redundant. That extra value seems to be on the wane, though.

On figures from the European Information Technology Observatory, which tracks IT spending in the European Union, technology investment continued to grow at more than 2 per cent a year during the recession of the early Nineties, but this time out it is forecasting a contraction in spending of 4 per cent next year.

"Historically, investment in technology has been stronger than GDP growth, but we have seen that gap narrow," says George O'Connor, an analyst at Panmure Gordon. "Whereas IT has been synonymous with the term 'growth sector', presenting strong growth year in year out, it is possible to see technology spending going negative, and it is very easy to see price deflation throughout the sector."

Examine, for example, the options now available to a corporate IT manager under pressure to cut his budget. Traditional companies are being challenged by what Mr O'Connor calls "free or freemium" alternatives.

Free or cheap downloadable word processing and spreadsheet software – from Google, from Sun MicroSystems and others – are increasingly challenging Microsoft Office. Businesses can now even buy "netbooks", low-cost computers that can download whole open-source operating systems, bypassing the need to pay for Microsoft's Windows.

"Bluntly, why buy Microsoft products when I can download something similar for free?" asks Mr O'Connor. "There seems no reason for an IT manager to spend more now that he can get more for spending less."

Less is more: Tech sector scales back its ambitions

Fewer attendees to hear from fewer exhibitors launching fewer products. The recession is very much in evidence at the Consumer Electronics Show this year. After a boom that brought the world Wiis, iPhones and a host of other must-have gizmos, the tech industry is in a funk, and the theme at the show in 2009 is one of cautious evolution. Microsoft announced an official test launch of Windows 7 – a sort of Vista that works – in the coming days. Sony unveiled the planet's lightest 8-inch laptop. There are gimmicks galore, including a Mattel game where players try to elevate a ping-pong ball using brainwaves. But executives have scaled back product launches to reflect reduced demand, and the need to keep costs under control in case the economy stays sluggish. Even the Consumer Electronics Association forecasts that spending would rise by less than 5 per cent this year, down from 13 per cent in 2008. Hideki Komiyama, the head of Sony Ericsson, said: "We have to start analysing products where we generate higher margins and eliminate the models where we have lower margins, even if it means producing less products than planned."