IT Spending Predicted to Increase Modestly in 2005

by Timothy Prickett Morgan

Looking at the earth from outer space, you might never guess how much churn there is in the atmosphere and the ocean; everything looks relatively calm. Likewise, looking at current and projected spending on worldwide IT spending, you might not expect a lot of churn under the surface. According to some recent analysis, IT budgets are growing modestly, which should be comforting. However, the aggregate growth numbers mask the churn in subsectors of the IT economy.

At about this time every year, the eyes of CEOs, CFOs, IT managers, programmers, and the marketing and manufacturing teams of IT vendors keep a lookout for the many reports on IT spending for the current year and forecasts for the coming year. That's because they are building budgets for the coming year or are subject to the plans of those who do. In one way or another, we are all linked to the expectations for IT spending, and what happens affects us directly.

Such prognostications are a bit of a black art, and the analysts and vendors who go out on a limb and make such predictions often end up with a black eye. Ever since the dot-com bubble burst, vendors and analysts have predicted a recovery in IT spending that never quite materialized. And while the IT market has become stable, it's like the weather patterns on earth: from a distance, it doesn't look so bad, but if you look at the currents and storms more closely, you see there is a lot going on under the surface.

The churning in the IT market (which is being driven by the sluggish economy and by CEOs and CFOs, who have a much more careful eye on IT expenses) is largely what makes predictions so difficult. For instance, if large numbers of companies decide to shift some of their maintenance and help desk support to an outsourced, offshore model, that has tremendous implications for IT. Or if companies figure that 64-bit Linux or Windows is suddenly good enough for most of their work, and they abandon Unix and proprietary platforms, there can be big swings in spending. If the economy worsens, that changes things, too. There is little doubt in anyone's mind that the rush to the X86 platform has been accelerated by the worldwide recession and lingering slow growth we have experienced for about five years now.

This year, Forrester Research went ahead of the pack and called the 2005 IT market in North America way back in early September, saying that spending on IT products and services in 2005 in that region will be up 7 percent over 2004 spending levels. (You can read our full coverage of Forrester's predictions in the September 7 edition of this newsletter.) Forrester was relatively optimistic, saying that IT spending would grow at about the same rate (a little faster than the growth rate for the U.S. economy) between 2006 and 2008. Forrester is expecting a relative boom in hardware spending as companies move to new architectures (such as X86 servers, cheaper Unix boxes, and new form factors such as blade servers), while software spending will be relatively sluggish. Forrester may have cased the worldwide IT market for 2005, but it has not said anything publicly about what it expects just yet.

IDC has released its most recent projections for worldwide IT spending (see "IDC Makes Its IT Prognostications for 2005"), but Gartner has not. At this time last year, Gartner was saying that IT spending would be up about 1.6 percent in 2004, with a moderate acceleration in 2005 and 2006. IDC was expecting IT spending worldwide to grow about 5 percent in 2004, with growth also accelerating to 6.5 percent in 2004, 6.8 percent in 2006, and slumping a bit to 6.4 percent in 2007.

Brokerage house Goldman Sachs, which took a lot of the darlings of the dot-com era public and has a huge interest in tracking the IT market for its investment clients, just did a survey of 100 CIOs and found that they expect their 2004 spending levels to be up by 3 to 4 percent. These same CIOs, when surveyed early in this year, had been expecting essentially flat IT budgets for 2004. When asked about how 2005 was shaping up, the CIOs polled in August and then again this month seem to be getting more optimistic about budgets. In August, the average rate of IT spending growth across those polled was 1.9 percent, and, more recently, that number rose to 2.5 percent.

The analysts at Goldman Sachs concluded that even though spending expectations are on the rise, they have consistently risen at the end of most years for the following year. In other words, this doesn't necessarily mean spending is going to take off. "The resulting 2% to 4% growth range is still unimpressive for a so-called recovery year," Goldman Sachs said in a lengthy report. The analysts also pointed out that there is a huge gap between growth expectations from the street (by which Goldman Sachs means Wall Street consensus on aggregate revenue growth for IT vendors) and the survey data. The average revenue forecast for growth for the big IT players is now 9.4 percent, compared with CIO spending targets at 2.5 percent. To be fair, the CIO budgets include personnel, maintenance, and a lot of other factors. This would seem to indicate that the big IT vendors are going to be getting a bigger share of the IT budget pie. When all is said and done, Goldman Sachs estimated that, overall, worldwide IT spending will be up 3 to 5 percent in 2005.

Goldman Sachs tends to be pessimistic about IT spending growth (but is more optimistic than usual), and the projections from Forrester are the most optimistic numbers I have seen in a long while. The analysts at META Group threw a little cold water on the idea of IT growth at the level that Forrester is projecting, saying that they expected a 3 to 4 percent increase in IT spending in 2004 and only 4 to 5 percent growth in 2005. But the META analysts also went a little bit further in explaining the whole idea of microclimates in spending in the IT world.

For the past decade, META has been putting together a database called the Worldwide IT Trends & Benchmark database. This database not only tracks IT spending in 32 different categories in all the major geographies and industries around the world but also provides a means for IT managers to track how well they are doing against their peers in their industry and geography, and the best of the lot across all industries and geographies.

Howard Rubin, senior vice president at META, gave a presentation last week on the spending trends for 2004 and 2005, and said that there is still a global IT recession (by which he means a time of contraction) and that it will still be holding down the market in 2004. He said that some people were forecasting IT spending growth in the range of 9 to 15 percent for 2005. "We just don't see this," he said. "IT spending is lukewarm, but maybe lukewarm is the new steady state. You almost can't do big IT trends any more. There are what we call IT spending microclimates. Some places are hot; some are not." Of the 32 different areas in spending that META tracks, only two are projected to be allocated more funds in 2005: security and Web application development. In all of the other areas (all kinds of hardware, software, and services), the trend is flat or down. And, according to META's research, what's hot or cold changes according to industry and geography. It's not even a matter of saying wireless is hot, ERP is not. "The lack of certainty in the worldwide economy is creating an El Nino in IT spending," Rubin said.

Rubin says that big companies with more than $1 billion in sales are keeping their IT spending flat, as they have been doing in the past couple of years, and those with $10 billion or more in sales are still acting as if we are in an economic recession and are still cutting back on spending. For 2005, META says that companies with $10 billion or more in sales will spend about 1 percent more on their total IT spending, while companies with more than $1 billion and less than $10 billion in sales would spend about 3 percent more. Companies with between $100 million and $1 billion in sales will see IT spending rise by 7 percent, according to META, while companies with under $100 million in sales will see their budgets rise by 23 percent. While those growth figures are stunning for small and midsized businesses, remember that the big companies consume a very large portion of the total $1 trillion or so in IT hardware, software, and services each year. At large companies, after a decade of decentralization, IT managers are involved in massive server and application consolidation efforts so they can simplify their infrastructure and cut even more costs.

On the personnel front, META says that there has been a slight increase in spending on application development in 2004. Perhaps as significant, a quarter of all big businesses ($1 billion or more in sales) have outsourced some functions, and many have outsourced more than one. META says that one in six IT workers is either a contractor or an offshore laborer, and that the savings companies have generated from using outside workers is what they are plowing back into the IT budgets to work on new application development projects.