Budgets down, prices plummet

10 February 2006

It's the best market ever for technology buyers. Budgets may be down, but prices have dropped even further.

JP Rangaswami is CIO of investment bank Dresdner Kleinwort Wasserstein. He controls a $1.5 billion IT budget, one of the largest in Europe. However, Rangaswami wants to reduce that budget by 5% every year for the next five years. In 2002,

Software

Throughout the IT industry downturn, software vendors continue to boast new customers, or at least new deals from existing customers. Yet at the same time, the revenues that these companies derive from software licences themselves are actually shrinking.

According to Bill Clough, director of European software research at IDC, many of the major application vendors have been forced to change their payment terms and make their licensing deals more flexible. Some offer additional application modules for the same unit price, while others offer additional services, for example, 500 'free' hours of consultant time.

"You can track what the standard unit price is. They've tried to keep that as stable as possible, but their revenue figures show otherwise," says Clough. "This drop in price is much easier to see in hardware, where technology cycles dictate that you get more power for less money over a period of time. In software, vendors are no longer just selling products, they're selling modules, maintenance and interfaces to other packages - in other words 'solutions', so it's very difficult to track."

Faced with shrinking budgets and increased competition just to get deals, some software vendors have slashed their software licence prices by as much as half. Typical prices for application integration software suites have tumbled from $750,000 in 2000 to $350,000 today, says John Senor, the head of iWay, the integration software arm of business intelligence tools vendor Information Builders. By the end of 2003, they will be down to $150,000, he predicts.

he called all of his IT contractors into a room and asked them if they could do the same amount of work for less money. Every single one agreed.

IT decision-makers like Rangaswami are in a tremendous position of power. IT budgets remain flat or in some cases have even been reduced from their levels of 18 months ago, yet the market for technology has been squeezed to such an extent that many areas of IT investment - whether hardware, software or services - have experienced a dramatic fall in price. For those organisations that are willing to continue investing in technology, this new cost baseline has created an extraordinary opportunity.

"It's the best market ever for technology buyers," says Michael Fleischer, CEO of analyst group Gartner. "We need to make the most of the current situation - we're looking at pricing and terms now that will disappear in the next 12 to 24 months." The sort of terms Fleischer is talking about make for interesting reading. The CIO of one major telecommunications provider in the UK says that he has seen a 60% decrease in the fees the company pays to major IT consultancies - a consultant that used to cost £5,000 a week now costs £2,000. Meanwhile, a number of the enterprise software vendors offer deep discounts on software licences, in some cases as much as 60% or 70% (see box).

Colin Saunders, IT director of UK bakery Warburtons has been on the receiving end of these kinds of deals, particularly from vendors he has dealt with in the past. These vendors realise his budget is squeezed, but don't want to lose a longstanding customer. "Sometimes [these deals] have been incentives to stop us looking around [for alternative suppliers] and sometimes they're just to stimulate our thinking and bring projects forward. We have also been offered fantastic deals on software licences and have bought and banked some just because we were approaching our year-end," he explains.

Bargain hunt

This bargain hunt mentality is in stark contrast to two or three years ago, when IT spending was growing substantially faster than the rest of the global economy, and many technology consultants were paid highly inflated fees. "What's happened is that the vendors used to have massive power because there was such a demand for technology. They've lost that leverage so lots of products and services have been forced into commoditisation," says Howard Rubin, vice president of research at analyst company Meta Group. "Companies used to need the newest technology to run their systems. Now there's so much excess capacity that the demand's not there anymore." Furthermore, adds Rubin, technology replacement cycles have increased. Companies are refreshing desktop systems every four or five years instead of three, while server replacement cycles are as long as seven years.

Faced with this abrupt slowdown in spending and technology refresh, vendors are becoming ever more creative in how they win deals. In consultancy, many of the big names now hire out consultants at cost - so a full-time consultant may be earning $100,000 a year, but the company is hiring him or her out to clients at $50 an hour instead of the $200 that consultant used to command. In software, some companies are offering finance deals either directly or through their value added resellers (VARs). German enterprise resource planning software giant SAP, for example, has a scheme that enables VARs to secure bank loans so they can offer 'buy now, pay later' deals to customers.

Finally, a number of recruitment agencies that hire out developers and support staff now offer risk sharing deals - if a project is not completed by an agreed time to an agreed standard, the agency will absorb any additional costs. This avoids 'maverick spend' on contractors or paying inflated overtime rates.

Buyer power

Technology buyers, at the same time, are in a better position to negotiate than ever. Michael Whitby, sourcing director at news organisation Reuters, for example, was able to negotiate a 20% reduction in contractor rates based on

Application development and support

Development and support costs - particularly for contractors - have plunged dramatically.

Reed Technology Group, an IT recruitment consultancy, reports that hourly rates for many contractors have fallen by half. Even by 'downward negotiating' rates with existing staff - based on the going rate for similar skills - customers can cut their staffing costs by between 25% and 40%.

The calibre of the people that organisations can get for those rates has also changed - for the better. "Around £20 an hour wouldn't have got you a basic support person a couple of years ago. Now it will get you an experienced engineer with a full knowledge of network topology. You can get design assignments for support rates," explains Phil Redding, regional business director at Reed.

For permanent staff, the salaries of senior staff have fallen the most. Many senior software developers, previously commanding an annual salary of £70,000, can now only expect £50,000, adds Redding.

IT directors themselves are not immune to falling staff costs - the average salary for an IT director based in London has slipped from £82,500 in 2001 to £77,000 in 2002, according to recruitment company Harvey Nash.

"general market awareness of a softening or reduction in rates". Other organisations, like Dresdner Kleinwort Wasserstein, are 'downward negotiating' rates with existing staff.

These cost reductions are not limited to home turf, either. Many organisations are looking at offshore outsourcing in a bid to reduce their cost base even further. Jim Davis, IT director of Thames Water, says his company has trimmed 20% of its application support and maintenance budget by farming these functions out to Indian outsourcing company Wipro. Anothercompany, Venda (which has licensed and now sells the technology that underpinned the defunct boo.com online shopping portal), has outsourced all of its front-end application development work to a contractor group in Vietnam, creating savings of 50%.

However, despite this shift in power structure between suppliers and buyers, the act of forcing through dramatic changes to a company's technology infrastructure or skills base may prove risky. Any organisation could place an advertisement in the classified section of a technology magazine and recruit the same number of staff they have in place now but at a vastly reduced rate, says Phil Redding, regional business director at Reed Technology Group, an IT recruitment consultancy, "but the disruption and risk in hiring new contractors would mean you'd spend your savings just in the exercise".

Given the level of savings some IT managers have already made, this risk may prove worth taking. But where does the money go? In most cases, straight back into the business. "We don't spend more money in IT just because we have managed within budget," insists Jon Marchant, an IT director at credit card company Capital One. "If we are able to execute our strategy more efficiently, any savings made go back into a central pot for the business as a whole to decide on." Roy Perry, acting CIO of US-based disk storage vendor StorageTek agrees: "It's difficult to justify any major spend in the current environment," he says.

Without doubt, the victims of the new cost baseline are the vendors themselves. Howard Rubin of the Meta Group points out that 2002 was the first year in thirty years of the technology industry that absolute dollar spend on IT went down as well as IT spend as a percentage of overall company revenues. "The situation is problematic because people remember what the prices used to be. Any vendor that starts to raise prices can only do this if demand truly exceeds supply - that's the only way they'd be able to justify it," he says.

In the meantime, technology buyers can make the most of the reset cost base and ensure they are well prepared for when the tables turn again.

Services and consultancy

There were some huge services deals announced in 2002, but on the whole, it was a year characterised by lay-offs, consolidation and shrinking contracts in IT services and consultancy. Thousands of consulting and systems integration professionals were made redundant as customers cut back on IT spending.

The result, according to analyst group AMR Research: consultancy rates at the seven largest IT services and consultancy companies fell by as much as 50%. Hourly rates for enterprise software consultancy at AMR's 'global seven - IBM Global Services, EDS, Accenture, Computer Sciences Corp, Cap Gemini Ernst &Young, Deloitte Consulting and KPMG Consulting - fell from a high of almost $400 an hour in mid-2001 to just over $200 an hour in 2002. These rates will crash even further in 2003, predicts AMR, to just over $100 an hour.

This trend was mirrored in Europe - and specifically the UK. Services industry watcher Richard Holway of Ovum Holway Group says that many of the larger services companies in the UK are re-quoting at 15% to 25% below their current prices when they go in to renegotiate contracts. "You'd be surprised by the number of suppliers that will do any deal, rather than no deal at all," he observes.

Hardware

Hardware prices have been affected by two key trends, according to Howard Rubin of research company Meta Group.

First, prices fall steadily as technology becomes more commoditised - an effect of the so-called Moore's Law. This a trend that has been exacerbated by the economic downturn. In mid-2002, for example, both IBM and Sun Microsystems slashed their server prices by as much as 40% in a bid to stimulate a market that still has much over-capacity.

Second, as hardware vendors attempt to manage fluctuating demand, they are offering all kinds of variable pricing arrangements. IBM customers, for example, can acquire one of its zSeries mainframes on a 'pay as you go' basis, increasing its capacity, functionality and performance at any time during the lease, but with little upfront cost. Increasingly, such deals are part of a wider, flexible outsourcing programme.

Storage hardware prices have also plummeted. The price of storage on a 'dollar per gigabyte' basis has halved from around $12 in 2000 to $5 or $6 in 2002, according to research from the University of California at Berkeley.

Information Age: News, analysis & insight for IT & business leaders