Profits squeezed in tech sector

IT companies are presently having no problem growing revenues, judging by the cross-section that published their financial results in April 2008. But are they spending too much money in doing so?

One company that appears to have overshot the mark is SAP. The German applications giant grew revenues for the first quarter of its financial year by 14% to 2.46 billion ($3.69 billion), but operating income fell 18% compared with the same period a year earlier, down to 359 million.

That profitability dip has raised questions about the company’s most strategically significant project currently under way – its game-changing foray into the software-as-a-service world.

In order to reign in costs, SAP has decided to cut the development budget of its forthcoming Business ByDesign on-demand applications suite by d100 million. That will delay the release of the product by at least one year (it was originally slated for late 2008), and makes the company’s stated aim of attracting 10,000 users and $1 billion in sales with Business ByDesign by 2010 an impossibility.

But SAP’s attempt to please investors by prioritising profit over revenue did not meet with the approval of analysts, who see Business ByDesign as a strategic part of the company’s product set in future.

“We are disappointed about the negative outlook for the new mid-market product, Business ByDesign,” wrote Oliver Finger, an analyst for German investment bank DZ Bank. “Although we do not assume that this will have a major impact on the projected figures, it creates a very bad sentiment for this important product.”

Spending spree

Another company that has spent money as enthusiastically as it has earned it is information infrastructure provider EMC.

Revenues for the first quarter of the financial year were $3.47 billion, up 17% from the same quarter of the previous year. Most of this was derived from its infrastructure division, which includes the storage, content management and security businesses, where revenues grew by 12% to reach $2.71 billion for the quarter.

But some of EMC’s success must also be attributed to VMware, the virtualisation market leader in which EMC still owns an 86% stake and whose own financial results are published separately. VMware’s first-quarter revenues totalled $438 million, an impressive 69% increase since the same quarter last year. Software licence revenue grew by 73% to reach $294 million and services revenue by 62% to reach $144 million.

But profit at the parent company dropped by 14% year on year to $268.8 million, down from $312.6 million. A large part of this dip was accounted for by EMC’s healthy appetite for acquisitions: it is still paying for recent purchases such as Berkeley Data Systems and Voyence.

Even discounting these acquisition costs, it appears to be costing EMC more money to make money than in the recent past. But the company is still resisting what many observers consider to be the most obvious way to pay all its bills, and more. “Right now, we have absolutely, positively no plans to spin off VMware,” CEO Joe Tucci insisted on an analyst call following the results.

One technology vendor bucking the trend of profit pressure is security software maker Symantec. Revenues for the fourth quarter of its financial year were up 13% year-on-year to $1.54 billion. Of that figure, an impressive $186 million was net profit – more than three times the $61 million earned in the same period a year earlier.

This marked improvement in margins represents the pay-off from a cost-cutting initiative instigated at the start of 2007. Symantec pledged to save $200 million a year through measures including a 5% reduction in ‘headcount costs’.

As its current set of financial results demonstrates, Symantec’s cost-efficiency drive did not impair revenue growth. This is a feat that many technology vendors will need to replicate in the coming year.

A year’s grace

Elsewhere, the Indian IT industry breathed a sigh of relief – albeit temporary – in April 2008 when the country’s government announced that the generous tax breaks allotted to those companies that belong to the Software Technology Parks of India (STPI) scheme – which include most well-known names – will be extended by one year.

The so-called ‘sunset clause’, which sees the return of normal export taxation for IT companies following 17 years of ‘special treatment’ (including zero-rate corporation tax on software service exports), was due to come into force in March 2009. But finance minister Palaniappan Chidambaram has pledged to extend the tax holiday by 12 months following intensive pressure from the Indian IT industry body Nasscom – although it originally pushed for a ten-year delay.

From the perspective of the Indian companies, the timing of the sunset clause is far from ideal – the margins of Indian IT services companies are already under pressure from the plummeting dollar, and no-one is certain what impact the predicted US recession will have on offshore outsourcing providers.

That said, the big-name companies appear to be in good shape to absorb any tax hike. Infosys, for example, reported fourth-quarter revenues of $1.13 billion this week, up 32% compared with the same quarter in the previous financial year, while Tata Consultancy Services (TCS) took quarterly revenues of $1.52 billion, up 28% from the same period in the previous year.

Further reading

SAP rethinks software SAP’s on-demand applications offering, Business ByDesign, may turn the company into a mass market vendor

EMC buys a presence in European consulting Conchango purchase continues storage giant’s reinvention

Currency commotion The escalating value of the rupee is beginning to damage the Indian IT services industry’s revenues

Pete Swabey

Pete Swabey

Pete was Editor of Information Age and head of technology research for Vitesse Media plc from 2005 to 2013, before moving on to be Senior Editor and then Editorial Director at The Economist Intelligence...

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