Economy Slow down & impact on IT: Gartner Oct 2008

Dataquest Alert: IT Market Forecast Worst-Case - Scenario, October 2008

Gartner's worst-case scenario for global IT spending in 2008 and 2009 assumes worldwide government efforts to revive the economy are too late, and Europe and the U.S. will slip into recession. Under this scenario, worldwide IT market growth drops from 8.9% to 7.3% in 2008 and from 5.8% to 2.3% in 2009.

WHAT YOU NEED TO KNOW -

The recent turmoil in global financial markets could cause a sharper slowdown in economic growth than previously forecast. However, because IT spending was healthy during the first two quarters of 2008, IT market growth for calendar year 2008 will be only moderately affected by even a significant slowdown in spending in the fourth quarter. The unfolding economic downturn could have a much more marked negative impact on corporate and consumer spending on IT in 2009.

FINDINGS: TOP-LINE RESULTS

Gartner's worst-case analysis assumes that the current credit crisis triggers a full recession in the U.S. and Europe, and that government remediation attempts are insufficient to prevent a turndown. This recession will hobble economic activity into 2009, leading to a slowdown in IT spending growth.Software and telecom services both reflect run rate spending that is difficult to curtail. Annual
maintenance software fees must be paid and vendors have been unilaterally increasing prices.Telecom services are also essential and dwarf the hardware component of the telecoms industry.So, these two segments suffer less in a downturn. External services can have an element of discretionary spending to them and some can be swiftly cut or suspended if the need arises.Hardware purchases can often be deferred. This is particularly true of the PC industry, whereboth consumers and businesses can delay purchasing new equipment, or buy less expensive equipment.Through August 2008, IT markets remained robust but recent dramatic events in the financial
sector are bound to have a negative impact in coming quarters. In a worst-case scenario, a sharp slowdown in the IT market in 4Q08 could cause annual growth to be reduced from 8.9% to 7.3% this year, while spreading global economic problems in 2009 could reduce IT market growth from 5.8% to 2.3% next year.

High-level worst-case scenario assumptions are as follows:

• We expect discretionary IT spending to be cut or delayed. For example, hardware replacement cycles would likely be extended, operating system and business applications software not upgraded, and many longer-term development projects put on
hold.
• However, essential operational IT spending focused on business process efficiency and cost reduction will likely be preserved.
• Furthermore, businesses will be reluctant to slash capital spending on critical infrastructure projects and strategic investments in technology migration.
• Many businesses will still have the resources to invest in IT to retain customers and gain competitive advantage; wherever those resources exist, business management recognizes that a downturn represents a key opportunity to gain market share in their
industry or geography.
• We believe the developed economies (especially the U.S. and Western Europe), which represent the vast majority of the global market, will be worst affected, but emerging regions will not be immune.Segment-specific worst-case scenario assumptions are as follows.

Computing Hardware -

In our most recent IT Market Databook, Gartner had a forecast for 6.5% growth of Computing Hardware in 2008, 3.8% in 2009 and a CAGR of 3.6% through 2012. Gartner believes that the worst-case scenario is that Computing Hardware will grow by only 5.5% in 2008, -4.1% in 2009 and by a CAGR of 3.4% through 2012.

In the worst-case scenario:
• 2008 year to date has been reasonably strong and the bulk of the hardware forecasts already contain actual market share data for the first half of the year. Therefore, we believe our 2008 number is reasonably close, there is little leeway for adjustment and
have made only slight revisions.
• The credit crunch comes at a time when professional replacement activity is expected to be rising. This worst-case scenario has more delayed replacements as companies hold off on IT budgets. However, replacement activity cannot be delayed indefinitely,particularly for mobile PCs that are inherently less sturdy.
• The most dramatic effect on hardware spend is seen in finance in 2009 across all regions. The finance segment is extremely dependent on IT, so although finance spending remains lower than in the base scenario, spend does recover to 2008 levels over the forecast period.
• We expect retail and manufacturing IT spend to be affected by falling consumer spending, this will take longer to take hold and to spread. Public finances are expected to suffer in 2009 and 2010 and lead to reduced spend in most regions.
• Western Europe and the U.S. are the most affected regions, however all regions are affected. 2009 has the largest modification for all regions because the effect on the finance sector should spread very rapidly.

Software -

In our most recent IT Market Databook, Gartner had a forecast of 14.9% growth for Software in 2008, 9.5% in 2009 and a CAGR of 10.0% through 2012. Gartner believes that the worst-case scenario is that Software will grow by only 13.5% in 2008, 8.6% in 2009 and by a CAGR of 9.4% through 2012.

The software industry experienced unprecedented growth in the late 1990s, leading to an exaggerated, although short-lived, downturn in 2001. Many of the factors in place during that time period do not exist now, which leads us to believe that the any economic slowdown or recession that materializes in the U.S. and other markets around the globe in 2008 and 2009 as a result of the financial crisis will not have as dramatic an effect on software spending compared to other IT markets. While it is prudent to remain cautious on software spending in a contracting economy, several factors outlined here lead us to conclude that a downturn will be shallow and that the
recovery is likely to materialize in 2010 for the following reasons:
• Given that software maintenance and support represents about 70% of forecast software spending, this leaves only 30% of the software market exposed to volatility as a result of the financial crisis and a potential economic downturn.
• A significant portion of software revenue are recurring, that is, maintenance, and are generally not subject to price negotiations or price declines once instituted (actually most maintenance contracts have an imbedded "cost of living" price increase and this year major vendors actually raised prices) and are often considered nondiscretionary.
• In the emerging markets, software is a much lower proportion of global revenue, when compared to other sectors of IT. Software derives 20% or less of revenue from emerging markets.
• On a relative basis, software is relatively price inelastic. For example, cheaper database management systems (DBMS) do not generally stimulate more sales of DBMS.

Therefore, in the worst-case scenario:
• Although software investment is not likely to decline dramatically, extended macroeconomic weakness will adversely affect software spending's upward trend, and growth will slow. We do not believe that any market is inherently immune to a softening in demand; however, the magnitude of a downturn will vary, affecting software markets and vendors differently.

IT Services -

In our current forecast and most recent IT Market Databook, Gartner forecasts 11.3% growth for IT Services in 2008, 6.5% in 2009 and a CAGR of 7.8% through 2012. In our new worst-case scenario, IT Services would grow by only 8.5% in 2008, -0.2% in 2009 and by a CAGR of 5.6% through 2012. The 2008 decline in the U.S. dollar in 2008 is a significant part of the story:expressed in constant currency, the current forecast is for 5.3% growth in 2008, which would translate to 3.4% growth in the worst-case scenario for 2008.
Results for the first half of 2008 have been strong, and expected results for the third quarter are consistent with the current forecast. However, in a worst-case scenario, there is room for a significant downturn in 4Q08 (to 95% of our expectations overall), which would result in the worstcase outcome: 8.5% growth in 2008.

In the worst-case scenario, we are assuming the first-year (2008) impact is moderate and that the primary downturn is in 2009.
In a severe downturn, outsourcing would be affected the least; these services represent multiyear contracts that often provide the IT that runs businesses. Consulting and system integration would suffer the most, as many of these services are associated with discretionary spending. Product support services resist, but are not immune to downturns. Because the financial crisis is global, our worst-case scenario hits all regions at the same time,except for Asia/Pacific where countries generally enjoy better reserves and balance of trade so have therefore more discretion for managing financial industries and stimulating economies.Spending by the financial industry is approximately one quarter of the IT services market andwould particularly be expected to reduce IT services spending even in a best-case scenario.However, even in the worst case, that impact will be moderate, both because some of this spending is mandatory for keeping businesses running, and because significant new opportunities have presented themselves for selling solutions to requirements created by the current financial crisis, including opportunities created by government intervention, similar to past experience where regulations such as the Sarbanes-Oxley Act created substantial and ongoing opportunity for IT-enabled services.

Telecommunications-

In our most recent IT Market Databook, Gartner had a forecast of 7.7% growth for Telecom (services and equipment) in 2008, 5.6% in 2009 and a CAGR of 5.4% through 2012. Gartner believes that the worst-case scenario is that Telecom will grow by only 6.5% in 2008, 3.9% in 2009 and by a CAGR of 4.8% through 2012.

In the worst-case scenario:
• Gartner believes the early effects on global Mobile Terminal and Enterprise Networking markets are already being felt in 2008. Services and Infrastructure will follow in 2009.Mobile Terminal and Enterprise Networking will show stability in 2010 and strength in 2011 and 2012, while Services and Infrastructure recover more slowly.
• Carrier infrastructure markets will do slightly worse in 2008 and somewhat worse in 2009. The recovery will be slow with North America and Western Europe hardest hit (although North America will recover faster). Carriers in the midst of long-term projects to increase productivity will continue investment because to abandon it would impact customer management. Increased need for back-office solutions to mitigate the high cost of legacy could actually drive investment.
• Enterprise Networking will be negatively affected as non-crucial upgrades are put off and small businesses are hit. Areas most heavily affected will stabilize in 2010 and rebound in 2011 to 2012.
• Mobile Devices unit volumes are likely to be lower than previously forecast. Consumers will seek to buy or continue with lower-end models for a time.
• Mobile Services remain quite resilient and we anticipate emerging market growth and the stability of developed market contract plans to continue. The market is largely driven by consumers, who seem inclined to seek other areas of the budget to cut. Even subscriber growth will be largely unaffected, at least in emerging markets. Service expansion will suffer in selected markets (such as teens hoping to get their first cell phone this holiday season).

• Consumer Fixed Services are being forecast for further reductions, although voice is already declining. Mobile substitution in developed markets (and pre-substitution in emerging ones) could accelerate: balanced against that is the strength of prepaid bundles in mature countries. Basic service charges are not likely to decline, but customers could seek to trim back on calling, and there could be increased reliance on voice over Internet Protocol, especially in the international sector.
• Enterprise fixed services will be hurt by losses in small or midsize business; remote office closures, on the other hand will drive home-office usage. Contract lengths mitigate sudden losses, and carriers will benefit if businesses increase sourcing to low-cost locations outside the country.
• North American and Western European markets will be the hardest hit, especially in the infrastructure and Enterprise Services markets, as carriers delay 4G and WiMAX-type roll-outs, and small and medium businesses close. Expect North America to recover earlier: we also do not see strong negative effects for Japan.
• The Middle East and Africa, Latin America, and developing markets in Asia/Pacific will continue to grow Mobile and Consumer Fixed Services, seeking to cut other spending in preference. Some increased substitution of fixed lines will happen in mature telecom markets, but this sector is already in decline.
• Eastern Europe, influenced by instability in Russia and strong ties to Western Europe,will be more heavily affected.

Conclusions and Recommendations

While planning agile responses for changing conditions is essential in any environment, current market conditions are in a state of uncertainty unprecedented for generations. This worst case forecast scenario provides Gartner's guidance on the degree of downturn for which we recommend that clients develop worst-case contingency plans. Specific recommendations for technology and service providers will be provided in upcoming documents specific to each market; stay tuned on gartner.com for these updates.