Skip to main content

Who needs tech in a recession?

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.

Conclusion --

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.

Disclosure: none

Comments

Anonymous said…
I enjoyed your article. I think the crisis will lead to fundamental changes in the technology industry with a focus on low-cost, scalable solutions. Companies and governments will continue to invest in tech, but will look to maximize a much smaller budget.

For example, my company, NComputing, offers a thin client solution that offers up to 31 users to access simultaneously a $500 PC for prices as low as $70/seat (not including the monitor, keyboard, and mouse). In addition, the access devices offer up to 99% lower power consumption compared to a PC.

We've sold over a million units and are seeing tremendous growth in both mature and emerging markets, and segments such as education.

I believe technologies like these our counter-cyclical given the low-cost entry point that delivers a full multi-media computing experience.

Mark Beckford
VP of Global Business Development
http://www.ncomputing.com
Mark,

Solutions that reduce costs for enterprises will still find favor as long as they are not too difficult or expensive to implement. Virtualization is another example.

Popular posts from this blog

Brazil - in a bubble or on a roll?

A couple of years ago, no one recognized the real estate bubble even though it was under everyone's nose. Now, analysts and bloggers are seeing bubbles everywhere they look. One of them, they say is in Brazil whose Bovespa stock market index has doubled in the last 12 months. Does the bubble accusation hold water? I don't think so and here are 7 reasons why Brazil is by no means a bubble economy: Exports have held up over the past year thanks to demand from China for Brazil's soya exports and iron ore. This was helped by the the Brazilian government's drive to improve trade links with Asia and Africa. Export diversification, spurred by a more active trade policy and increased focus on "south-south" trade under current president Lula, helped mitigate the decline in demand from OECD (Organization for Economic Co-operation and Development) countries A "sensible" economic framework has been in place since the 1990's. This has included inflation

Thursday Bounce: Trend Busters, Swing Signals and Trend Leaders for July 9, 2009

This is a quick post to announce that we have published Thursday's Trend Leaders, Swing Signals and Trend Busters at Alert HQ . All are based on daily data. Today we have the following: 72 Swing Signals -- A couple of days ago we had 35 signals, today we have twice as many. Happily, we now have 65 BUY signals, a mere 4 SELL Signals plus 3 Strong BUYs. Whoo-hoo! 56 Trend Leaders , all in strong up-trends according to Aroon, MACD and DMI. There are 18 new stocks that made today's list and 60 that fell off Tuesday's list. 48 Trend Busters of which 5 are BUY signals and 43 are SELL signals The view from Alert HQ -- Talk about mixed signals. If you look at our Swing Signals list you would think the market was in the middle of a big bounce. BUY signals are swamping the SELL signals and we even have a few Strong BUYs. Yes, there's a good sprinkling of tech stocks and tech ETFs but the distribution is pretty broad-based with a good number of different sectors represented, eve

Unlock Stock Market Profits - Key #1

This is the first in an ongoing series of articles where I discuss what I feel are keys to successful investing. It is based on a post that provides a summary of the ten keys that individual investors should use to identify profitable stock trades. ( Click here to read the original post ) There are two basic steps to investing. First, you need to find stocks that seem to have some potential. Then you have to determine whether these stocks are actually good investments. There are many stocks that at first glance look interesting, but further research reveals that there are too many negatives to warrant taking a position. This first post in the series starts at the beginning: getting good investment ideas. Key #1: If something special is happening to a stock, it will be reflected in some kind of unusual activity in the markets. As individual investors, we will never be the first to know; however, unusual activity can be an early sign that allows us to follow the Wall Street professional