The Survivor's Guide: Will Vendors Be Less Flexible This Year?

Amid signs that the U.S. economy is waking up from its three-year slumber, predictions abound that we'll see a modest increase in business technology spending in 2004. Some analysts and IT chiefs expect that as demand rises, discounts will fade away.

"Any CIO planning for 2004 should expect to find a less friendly market," says Gartner analyst Martin Reynolds. "Vendors will be less flexible." Vendors don't publicly disclose the size of their breaks, but heavy discounting reveals itself in an upturn, when vendors' earnings grow faster than revenue, Reynolds says.

To get a sense of just how steep the discounts have been, ask Niraj Patel, CIO of GMAC Commercial Holding Corp. in Horsham, Pa. Low interest rates have kept business brisk for the commercial lender, whose IT budget rose 10 percent in 2003, to $60 million. Yet the IT department's actual spending was 20 percent below budget at the start of the fourth quarter, Patel says.

"It's like, geez, you have some money but you can't spend it because everything's cheaper," Patel says, followed by a sinister laugh. "It's so cool!"

Patel's 200 IT professionals rolled out voice over IP and MPLS (multiprotocol label switching) this year, and they're rapidly adding Cisco 6500 switches across the enterprise to increase bandwidth. The new equipment will support video-streaming and business intelligence software projects already under way.Another source of discounted IT products has been the secondhand market, which Cisco and other vendors legitimized by promoting "authorized" refurbished equipment repossessed through their credit units. New online auction houses have helped connect sellers with buyers.

Todd Schoenfeld, IT director at Point Biomedical Corp., a developer of medical imaging equipment in San Carlos, Calif., recently bought a Compaq tape library from a bankrupt biotech firm at a liquidation auction. The item, which lists for $200,000, cost him a mere $6,000. With his venture capital-backed firm just now ramping up for its first product release after seven years in development, Schoenfeld is on the prowl for bargains to equip hundreds of new hires planned for 2004. He also keeps a close eye on eBay. At press time, he was looking for a Compaq G3 server that was no more than two years old.

Of course, used equipment comes with hidden expenses and pitfalls. For one thing, a three-month maintenance and support contract with Hewlett-Packard, which now owns Compaq, costs more than the equipment itself, Schoenfeld says. Before he bought the tape library, he checked with HP to make sure it would offer a service plan. "We didn't want to get a doorstop," he says.

Although IT vendors have been careful to devise programs that don't cannibalize their core businesses, soft demand has kept prices low on new equipment.

"Every single category--storage, computers, networking--is trending to be more cost-effective than a year or two ago," says Tony Scott, chief technology officer at General Motors, which has cut its IT budget by $1 billion, to $3 billion, since spinning off IT consulting firm EDS in 1996. In Scott's view, information security is among the only IT categories that carry a premium today.To be sure, not all companies are growing as fast as GMAC or Point Biomedical. Nor does every enterprise have the bargaining clout of GM. For the average IT buyer, deals may be fewer and farther between.

Still, IT spending won't exactly snap back overnight. Gartner, for instance, predicts a 5 percent increase in U.S. IT spending next year, excluding telecom services but including some consumer-technology categories. Gartner's Reynolds cautions that even that figure may be overly optimistic.

"We based our numbers on expectations expressed in surveys this year, which could decline as pen is put to paper" this budget season, he says. In fact, real demand proved to be as much as 30 percent weaker in the second and third quarters of 2003 than users surveyed by Gartner had projected.

IDC also projects a five percent increase in IT spending worldwide in 2004, but says its forecast is conservative. A Goldman Sachs survey of Fortune 1000 CIOs conducted in August foretells IT spending growth of 2.3 percent in 2004, down from the 3.5 percent growth predicted in June. Fifty-three percent of the 100 CIOs surveyed said they anticipated that budgets will grow, versus 25 percent who expected to cut spending.

"Rebound may be an aggressive word," says Robert Reeder, CIO of Alaska Airlines. "But anything better than what we've been going through would be an improvement. I'm not sure we'll ever see the exuberance of the '90s again."Research firm Techtel Corp. periodically surveys as many as 1,000 IT shops with 250 or more employees, asking about their expected IT spending in the next six months. Over the past two quarters ended Sept. 30, 2003, those expecting IT spending increases in the succeeding four quarters climbed nearly eight percentage points, to 28 percent, while those expecting a decrease dropped nine points, to 21 percent. Top managers were more likely to predict an increase than middle managers, which Techtel CEO Michael Kelly sees as a good sign. Middle managers, he says, "have been knocked down so many times" that it's understandable they would be more cautious in their predictions.

Some executives say they can no longer wait to deploy technology that's been on hold for the past year or two. The IT budget has been "minimal" at Puget Safety Equipment Co., a Bellingham, Wash., distributor of gas detectors, hard hats and other gear, says president Becky Eastwood. But the million-dollar firm plans to upgrade its Windows NT 4 servers to Windows Server 2003 early next year, says Eastwood, citing security concerns about NT 4.

Other companies kept IT spending constant through the downturn. The two-man IT shop at Cincinnati's Gold Medal Products, a manufacturer of popcorn makers and other concession equipment, has never had a formal budget, but usually spends a minimum of $250,000. This year, the $72 million, 350-employee company invested in a barcode inventory system. In 2004, it will deploy a Web EDI system to interact electronically with more suppliers and customers, using technology from Ohm Systems.

"We've been focusing on projects that save time," says Mike Rizzo, Gold Medal's manager of data processing. "We know we'll pay for this stuff [in productivity] in no time."

As difficult as it has been to reconcile for IT managers, the focus on cutting costs has been a healthy exercise for so many companies that overbought technology during the '90s boom years, says Techtel's Kelly. Now, he is advising clients to focus not on IT costs but on a much larger target: SG&A (selling, general and administrative) expenses, which often amount to 30 percent of revenue versus 3 percent of revenue for IT. This might mean investing more in ERP, CRM and other enterprise applications that can help eliminate administrative steps.Bayer Corp., the drug and chemical maker, is wrapping up a massive deployment of SAP ERP applications that started in 1999 with its consumer-care unit and has been extended to the company's pharmaceutical, biological, animal-health, polymers and services businesses. To offset the hefty investment, which the company would not disclose, Bayer has moved aggressively to consolidate a swarm of data centers into two, helpdesks into one and desktop support into one outsourced operation. This allows the IT budget to remain flat going into 2004, at about 2 percent of revenue, says CIO Greg Babe.

Because the SAP rollout has coincided with business-process re-engineering and restructuring--particularly within the IT organization, which now operates as a standalone service contractor to other units, with its own profit and loss--it's difficult to measure the impact of the SAP apps, Babe observes. "It's all cumulative," he says. "Businesses aren't static. You can say, 'This is where we were, this is where we are now, and things are improving,' and you can point to several concurrent projects."

Researcher Kelly acknowledges that many IT shops overspent on large ERP deployments in recent years. He advises a more surgical approach to cutting administrative costs using ERP apps, especially for companies with smaller budgets than Bayer's.

Bayer's consolidation mantra is being repeated in IT shops of all sizes as they try to organize the chaos created during the boom, when business leaders snapped up all the new technology they could find for fear of losing a competitive edge. The problem was compounded during the soft years.

"Because formal IT was given project requests and wasn't getting them done due to budget constraints, business lines got more savvy about wrapping IT projects into their own business projects," Kelly says. Such "shadow projects" used to account for about 5 percent of all IT expenses; now they account for more than 10 percent, he says. One financial services company he studied recently was spending about twice as much on IT than the formal IT budget suggested.Lessons Learned

IT executives will no doubt carry into the upturn the lessons they learned in the downturn. Patel, the CIO of GMAC Commercial Holding, says there are things you can do to save money under any economic circumstances. For example, he usually buys equipment and software near the end of the quarter, when salespeople are under pressure to meet their forecasts. This puts him in a better bargaining position.

Patel also offers his shop as a testing ground for vendors. Two years ago, Microsoft took him up on the offer during the beta rollout of Windows XP. In return for the lessons Microsoft learned, it picked up some of GMAC's deployment costs. Patel's bosses let him take such risks because, he says, he has built a track record of successful projects completed on time and under budget.

Patel is confident that his aggressive purchasing will prove to be a competitive advantage as the economy improves. "You could turn off the lights for the next two years and we'd still be ahead of the market," he says. His experience shows you can wring a lot of extra value out of vendors if your timing is right and you have credibility with management (see our special issue on building business credibility).

David Joachim is Network Computing's editor/business technology.