Crunch time for the IT industry

This time it’s different for IT.

Rich Murphy is the former chief financial officer for IT at Deutsche Bank, and this is not the first time he’s seen IT wrestle painfully with recessionary pressures. Coming into this downturn though, he argues, the set of issues surrounding IT investment is a lot more complicated than in any previous time.

“The natural reaction of companies as you go in to a recession is to do whatever they need to in order to reduce expenses. And historically, one of the easiest things to attack from an expenses point of view is IT.”

But those tempted to go down that route have clearly not fully grasped what has been happening to IT’s role within business over this decade, he suggests.

“The world has changed. IT has become a catalyst for productivity, a catalyst for driving costs down in other areas of the company, a catalyst for growth in terms of new product innovation. And I think this time companies really have to step back before they make the decision to cut their IT investment and understand how they are going to deal with that critical contribution.”

The smart companies are going to deal with the short-term pain but continue a long-term approach to investment in IT, says Murphy, who currently boasts the title of ‘executive in residence’ at project management software company PlanView. “They are going to protect their IT spend and try to cut costs in other areas.”

Calls for measured judgement aside, the fact is that IT spending in the UK and elsewhere in Europe is about to crash. To deal with that – and somehow still provide business with the critical services it now expects – IT executives are going to have to find huge efficiencies in their existing IT set-ups, killing unnecessary projects, freezing or trimming staff levels, severely limiting the use of outside consultants and searching out and applying technologies and services that can take cost out of the operations.

In many cases, with cash in short supply, they will have to rethink some of the ways that IT purchases are currently financed and delivered to the business, swapping classic upfront capital expenditure on hardware and software licences for operating expense-based equipment leases, pay-as-you-go software subscriptions and all manner of outsourced services.

And those moves – of dramatically curtail-ed spending and reduced capital purchasing – will have a profound impact on the IT industry itself. Not only will they accelerate the move to IT-as-a-service, embodied in managed services and hosting, software-as-a-service (SaaS) and cloud computing, they will force painful restructuring at many industry companies, including large-scale lay-offs, reduced R&D spend and even more frenetic industry-wide consolidation.

Today, as Steve Kendall-Smith, UK MD of Fujitsu Siemens Computers points out, that all translates into an atmosphere of deep uncertainty among IT executives and vendors alike. And analysts and market researchers are not offering much clarity on how things stand.

Almost weekly canvassing of IT decision-makers by researchers seems to produce inconclusive and contradictory results.

Since September, analyst estimates for IT spending growth for 2009 have oscillating from over 6% (Forrester Research) to -2% to -3% (Gartner and TechMarketView).

Indeed, despite feedback from 400 and then 800 CIOs, Gartner’s worst-case scenario of just a few weeks ago (growth of 2.3%) is now its best-case scenario.

Take courage

Aside from the dramatic changes in the economic outlook, one of the reasons analysts are struggling to fix on hard numbers for forthcoming budget cuts is because businesses are still struggling with the difficult and complex decision of where to wield the knife and where to continue to invest in IT.

“The productivity gains that companies have made in this decade have come through technology advancement, and that comes through your IT spend,” says Murphy. ”Businesses need to really understand their IT expenses and what they can and cannot do in terms of savings. IT is now so critical to growth, to innovation, to competitiveness, that companies who cut it injudiciously are going to effectively cause themselves to ave a much longer and more difficult recovery period – if they don’t end up going out of business.”

What is abundantly clear is that there is going to be a major re-prioritisation of IT spend within most organisations. And a vital role for senior IT executives will be to resist cuts that will harm the business in the longer term.

Speaking at last month’s Gartner conference in Cannes, the chief information officer of tyre company Pirelli called on his peers to guide business leaders away from making draconian cuts in IT spending.

Dario Scagliotti said that there is no obvious way of taking 15% or more out of IT operating expenses. So IT executives need to understand the strategic goals of their company, and convey the role IT plays in sustaining these.

That is something Gartner analysts echo. “IT leaders must have the courage to make long-term decisions during the economic crisis and look beyond the immediate threat towards the future,” says analyst Whit Andrews. “The world has changed, and your role as an IT leader must change as well.”

Historically, most of those cuts would have been targeted at the 20% to 40% of IT spend that is typically channeled towards new investment. But, while only projects that will generate clear business value should be retained, that orientation needs to be revers-ed, with the main focus on taking costs out of the 60% to 80% spent on day-to-day IT.

“You need to make sure you are as efficient as hell on operational IT and ruthlessly prioritise the investments focuses,” counsels Murphy. “If all you do is cut the projects that represent the 20% to 40%, just think of what you have done for the long-term health of your company,” he says.

That opens up opportunity for the judicious application of technologies and services that can extract cost from the operational side. And vendors have been rushing to portray their offerings as cost-cutters – some with justification, others without.

High on the list are technologies such as virtualisation software, which has already proved its value in terms of server consolidation and utilisation levels; software asset management tools, which ensure companies are not paying for software licences that are no longer used; voice-over-IP, for taking telecoms costs down by channeling calls over standard computing networks; and more efficient data centre cooling systems and ‘green’ servers that draw significantly less electrical power.

Flight to services

However, companies need to do much more than throw technology at technology costs.

“Changing the cost structure of IT has abruptly become a business imperative for many CIOs,” says Gartner.

Some of its analysts are predicting the impact of the recession on IT will be major structural changes within the IT department and the industry as organisations try to shift capital expenditure on IT to operating expenditure.

There will be an accelerated move toward variable-cost models for IT, says Gartner. That will be enabled by the fact that many of these models – whether hosting, managed services or SaaS – have now reached long-awaited levels of maturity and cost-efficiency. Just ask the management at some of the big IT hosting companies. Telecity, for example, is in the process of building out three new data centres. And with demand still exceeding supply in that market, its group financial controller, Brad Petzer, says it has no plans to slow their roll out.

That is just one aspect of a larger movement to outsourced IT. “The traditional acquisition model of buying hardware and software, and depreciating it over time, does not allow organisations to quickly shift IT investments, or cut costs rapidly,” says Barbara Gomolski of Gartner.

Today, IT spending is heavily weighed by fixed costs with almost two-thirds of the average IT budget fixed, says Gartner. IT outsourcing is the most well-known way to move fixed costs to variable costs, but it is not the only technique organisations will employ in the coming years.

Gartner analysts say they expect some organisations to come up with new models, such as joint ventures and shared data centres as a means to reduce the fixed costs associated with IT.

But if this predicted shift from in-house IT to service-based IT gains pace, the implications for the industry are huge.

The first hit of the recession is already evident among hardware vendors. Many IT organisations have put a freeze on buying any new equipment, with the assumption they are not going to grow and with the mindset that they need to make much better use of their existing assets. That has shown up in the form of profit warnings from the likes of Intel, where sales estimates have been cut by 15%.

The impact on software companies will come later, says Gartner analyst Peter Sondergaard. Aside from lower demand, their greatest challenge will be to embrace the move to SaaS. That has huge implications for their revenue line, with any shift to subscription-based software pricing precipitating a fall in revenues – albeit temporary.

Companies such as Oracle and SAP have moved cautiously to follow the example of SaaS market leader, but the recession will put pressure on them to accelerate the availability of offerings in this area. Such IT services have also proved intrinsically less profitable than software licensing, and that is another issue the major software companies will have to face.

As that suggests, plans CIOs and IT directors are currently making for 2009 IT spending will have a profound influence on the structure of the industry and on the IT organisation. As Rich Murphy observes: “Companies have this very difficult balancing act as they assess what they want to continue to invest in IT in order to grow their innovation versus how much they don’t invest in order to save the bottom line.”

Further reading

The evolution of the CIO
The IT leader of tomorrow must have the skills to manage collaboration, innovation and change

Return on technology
The economics of IT value creation. A research report from Information Age, in association with KPMG

David Cliff

David Cliff is managing director of Houghton le Spring-based Gedanken, a company specialising in coaching-based support and personal development. Cliff is an experienced trainer, manager and therapist,...

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