Back in the days when the Internet bubble burst, the technology industry had clearly gotten ahead of itself. There were so many routers deployed and so much fiber optic cable laid that significant network capacity remained unused for years to come.
Since then supply and demand has come into closer balance and the tech industry was able to resume its winning ways though with more restraint than during the Internet bubble days.
Now we are faced with a severe recession. How well is tech positioned this time? To understand the answer, we need to consider two markets: consumer and enterprise.
The Consumer --
Electronic gadgets tend to fall into the "nice to have" category when compared to buying food for the family or making mortgage payments. As such, the consumer market can be impacted by layoffs or fear of layoffs and the desire to keep credit card debt to a minimum when the economy seems to be crumbling around you.
Where many consumers often lined up to get the latest thing, that enthusiasm may now run into headwinds. Millions of iPods and cell phones, for example, have already been sold and North American and European markets are considered saturated. If you already have a cell phone, why do you need a different one? You don't, unless you want to move up to a smart phone and are willing to begin paying your telecom company for data services above and beyond what you are already paying for voice services. Last year's PC is still good enough for the average citizen as is last year's flat screen TV or GPS device.
This leaves some of the best opportunities for growth in emerging markets. Yet, with the failure of the decoupling thesis, we now find emerging markets reducing their imports as their own economies feel the negative impacts of global recession.
Luckily, not everyone in the world is out of work; nevertheless, consumer electronics is in for a period of muddling along at best or painful contraction at worst. In order to move product, manufacturers will be forced to lower prices and endure skimpy margins. After all, much of what they produce is not actually "needed" as much as it is merely "desired".
The Enterprise --
Some tech CEOs, like Jonathan Schwartz of Sun Microsystems (JAVA), are saying that the economic crisis will prompt enterprise CIOs to experiment with new technologies with the potential to lower costs - open source software, for example. It is more likely that enterprise CIOs will get out the same old playbook that says to cancel non-essential projects, reduce headcount, outsource to India where possible and delay new equipment purchases.
The business schools all say that strong companies will invest when economic times are bad so as to come out of the bad times stronger than competitors. Certainly there are some companies that will do so but it may be harder during the current downturn because financing is so difficult to obtain. The IPO market is dead, corporate bonds and especially junk bonds are out of favor and thus must offer significantly higher yields than usual, banks are reluctant to lend, etc. Many companies that want to invest in tech in order to increase efficiencies, productivity and competitiveness will find themselves stymied by the credit markets.
Much of the installed tech base can be characterized as "good enough". Many enterprises have programs where equipment is retired when warranties end, not when the equipment is inadequate. This often means that there is constant turnover of equipment over rolling three year time periods. How many three year old PCs are underpowered considering the use they are seeing? Probably very few. We can expect to see companies stretch out the replacement cycle which will serve to depress demand in the tech sector.
On the other hand, there are always some companies that are bumping up against capacity limits due to growth, acquisitions, aging infrastructure or what have you. Others will need new equipment because they are consolidating business units and/or data centers. Many companies will need to purchase data storage since data needs don't stop just because the economy slows (EMC and NTAP could be beneficiaries). Some companies running out of bandwidth will see the need to update networks with Cisco the obvious pick but Juniper and others in the running. As I always point out, none of this stuff works without the chips inside, so companies that make semiconductors for disk drives and networking equipment could see some demand, too.
Growth might also be expected to increase the number of software licenses for enterprise applications but this will be tempered by the situations where layoffs result in unused licenses. Separately, the growth in data storage may support demand for more database software licenses.
Those companies that receive a steady stream of maintenance revenue (enterprise software companies like Oracle, Microsoft and all the lesser players) are fortunate to have a base income and should hold up well relative to companies that are in sectors that typically don't support that kind of business model.
Tech is again the victim of its own success. It has developed and sold great products with good reliability and in many cases there is just no rush to replace them.
This realization has hit certain parts of the tech supply chain more than others. The semiconductor companies have been quite forthcoming with reductions in earnings estimates and not a few layoff announcements. If these companies are predicting weak growth it is a sure bet their primary customers, the equipment and gadget manufacturers, are in the same boat.
Clearly, all the earnings estimate reductions, job losses and demand destruction in tech signal that the industry is experiencing a real slowdown. This is not a bump in the road. The fact that so many tech companies are guiding downward shows that the problems are too pervasive and are not limited to just a handful tech sub-sectors. Recovery will occur but it will take several quarters rather than several months. The new administration's stimulus plan, while friendly to tech, will mostly provide just job preservation rather than a real boost to the tech industry as a whole (read "How does the Obama stimulus plan help tech?")
As investors, though, don't give up yet. Recently we have seen reports of inventories declining in the tech supply chain (read "Remember JIT?"). While we "muddle along" through this recession one would do well to scrape along the bottom and accumulate some tech stocks. When the economy does begin to recover, tech stocks should take off explosively as companies ramp up in order to fill depleted inventories and meet pent up demand.
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