Corporate Tech Spending Helped Set Stage for Slump

The blame for the horrific plunge in technology stocks over the last year can be laid partly at the door of companies such as 21st Century Insurance.

The Woodland Hills-based firm spent the last three years developing a Web site and a pair of sophisticated telephone call centers-- and, in the process, boosted its spending on technology equipment by a heaping 30% to 40% annually.

But with those projects largely finished and no new ones taking their place, 21st Century says tech spending will be flat to slightly lower this year.

“We’ll continue to invest, but we won’t have to make the very large investments that we’ve made in the past years,” said Mike Farrell, the firm’s chief information officer.

That sentiment, multiplied across thousands of U.S. businesses, goes a long way toward explaining why the technology industry has fallen on hard times--and why the economy overall has stumbled.

After several years of feverishly pouring money into everything from e-mail systems to Y2K upgrades, many U.S. companies have suddenly reined in their tech spending to a degree that was unthinkable just a year ago.

Spending has slowed for a variety of reasons, including the completion of big projects, the demise of free-spending dot-com firms and the evolution of more powerful, longer-lasting technology.

But another factor in recent months has been the weakened economy itself and its cascading effects. Companies that were content to spend when their earnings were rising now are frantically canceling tech-equipment orders to slash costs.

In a bad economy, “nothing is indispensable, not even new technology,” said Allen Sinai, chief global economist at Decision Economics Inc. in New York.

That realization also has blasted one of the pillars of “new-economy” thinking--the idea that demand for Silicon Valley’s products would be limitless, regardless of what happened in the “old economy.”

By some estimates, corporate tech outlays surged as much as 25% last year from 1999. But surveys indicate such spending might rise only 5% to 10% this year.

And a growing chorus of analysts say spending might even drop from last year’s levels.

The trend is critical because, just as the economy is a key to tech spending, the reverse is equally true. In fact, corporate tech expenditures, which topped $530 billion last year, have been a major source of economic growth in recent years.

Corporate Spending on Tech Doubles

Corporate tech outlays now account for 5.7% of U.S. gross domestic product, almost double the 3% they reflected in 1990, said Tobias Levkovich, a stock strategist at Salomon Smith Barney. Because GDP is far higher now, that increase represents a huge surge in dollars spent.

More important, corporate tech expenditures accounted for as much as 30% of GDP growth in the last four years, said Stephen Roach, chief economist at brokerage Morgan Stanley Dean Witter.

Roach argues that many companies got caught up in the initial hype over the Internet. Amid an economic boom, companies “lost any sense of discipline” in their tech buying, shelling out for such things as flat-screen computer monitors that did little to boost the bottom line, Roach said.

The danger is that, just as with boom-and-bust cycles in other economic sectors such as California real estate in the early 1990s, the “overhang” from excessive tech spending could leave a lasting cloud, he fears.

“The sea change in [technology] demand could be sufficient, in and of itself, to take the economy into recession,” Roach said.

Other economists are more upbeat, saying the tech spending slowdown is only temporary.

Companies still are under pressure to boost efficiency, and they will spend more aggressively on such things as wireless technology once the economy rebounds, some analysts say.

“All the appeal of information technology is still going to be there,” said Prudential Securities chief economist Richard Rippe.

Still, the spending falloff thus far is exposing what may be one of the greatest fallacies of the now-defrocked new economy.

Until late last year, there was widespread belief that companies would continually boost tech spending because they couldn’t afford not to. Major bricks-and-mortar firms feared that if they didn’t spend furiously on technology they’d look like corporate Luddites that were at risk of falling behind techno-savvy dot-com upstarts.

The pressure to improve profit, and the belief that technology was the key to higher worker productivity, also drove spending.

In previous economic downturns, it was common for companies to defer costly capital-spending projects. And technology had been notoriously boom and bust throughout its history, gyrating according to the economy and to product cycles.

But Wall Street’s expectations last year for a continued surge in tech companies’ earnings were based on the assumption that tech spending would defy history.

Indeed, when the Federal Reserve began raising interest rates in 1999, some market analysts told investors to buy tech stocks precisely because they thought the pattern had changed and tech would be immune to any economic softening.

Anyone who listened is hurting today, with the tech-dominated Nasdaq composite index down a stunning 60% from its peak a year ago.

Fall of Dot-Coms Eases Pressure to Upgrade

Tech shares have plunged as scores of companies have warned of disappointing sales and earnings this year. In a measure of how confounded many tech giants have been by the rapid retrenchment in corporate spending, firms such as fiber-optics equipment leader JDS Uniphase and communications chip maker Broadcom have issued multiple profit warnings within weeks of each other.

Cisco Systems, the premier supplier of computer networking equipment, shocked Wall Street last week by warning that its orders continue to fall and that it will cut 8,000 jobs.

“No one can tell me what capital spending will be for the next four quarters,” a downbeat John Chambers, Cisco’s chief executive, told an investor conference Tuesday.

But for as big a role as it has played, the softening economy only partially explains the throttling back of tech expenditures.

The late-1990s spending explosion was driven in part by older companies’ fear of being surpassed by profligate young dot-coms that had raised billions in cash from investors. Now that many dot-coms have collapsed, old-line companies feel less pressure to launch a raft of new tech projects.

“They were spending on investment technology out of fear that that’s what they had to do just to continue in existence,” said John Mueller, chief economist at Lehrman Bell Mueller Cannon, a Washington-area economic think tank. “Now they’ve seen that the sky is not falling in on them and that . . . they don’t have to keep throwing money at [technology] at the rate they had been a year ago.”

Mattel Inc. is a case in point.

Pressured by Internet-based rivals such as EToys, traditional toy makers felt compelled to spend aggressively on technology, said Joe Eckroth, Mattel’s chief information officer. Mattel, for example, built Web sites devoted to popular toys such as Barbie and Hot Wheels, even though they didn’t directly help sales.

The sites stoke children’s interest in Mattel products. But because the firm is barred legally from selling to children over the Internet, customers can’t place orders there.

Mattel developed parallel sites where parents could buy toys online. But those sites didn’t live up to the company’s expectations, Eckroth said, and Mattel is now paring them back in favor of steering potential customers to traditional toy stores and other retailers.

“Everybody was really scared that ‘If I don’t get on the [Internet] bandwagon, I’m going to get my lunch eaten,’ ” Eckroth said. “The sigh of relief is that these guys have imploded on themselves.”

After ramping up tech spending by 6% to 8% annually over the last few, Mattel’s expenditures will be flat this year, Eckroth said.

Other companies are cutting back simply because of the economy.

Executive-search firm Korn/Ferry International had been raising tech outlays 5% to 7% a year, said Dan Demeter, the firm’s chief information officer. But spending is now being held flat, and Demeter recently canceled a few orders for such things as software.

“We’re cutting things we decided aren’t really important,” Demeter said. “There is some slowdown in the economy, [and] like everybody else we want to contribute to the bottom line.”

Two factors are making it easier for firms to justify slower tech spending.

First, the spending boom of 1995-99 was fueled in part by concern over the Year 2000 computer bug--the prospect that companies’ operations would be disrupted if computers misread 2000 as 1900.

Rather than making bare-minimum upgrades, many companies spent heavily on next-generation computer systems. But with that work complete, companies don’t need to keep spending at such a furious pace. Likewise, many companies already have rolled out Web sites.

Add to that the fact that computers are more powerful than ever. Just like consumers, some businesses don’t feel bound to replace hardware and software as frequently as in the past.

“We’re buying a lot more horsepower for the same dollars,” said John Morgan, executive vice president of operations at Occidental Petroleum Corp.

Many companies want to figure out what they’ve gotten for the money they’ve already spent.

“People are saying, ‘Let’s make sure we’re getting value for what we’re doing,’ ” Morgan said.

That’s not to suggest that companies aren’t still spending on technology. Although visible projects such as Web sites largely have been tackled, many companies say they’re turning their efforts to nuts-and-bolts projects that are critical to improving efficiency. And existing systems always need upgrades.

At 21st Century, Web developers initially geared the Web site so that California auto-insurance customers could do things such as pay bills and file claims online. Now the company is working to expand services to customers in other states and those buying other types of insurance.

The economic slowdown has a silver lining of sorts for firms that are still buying equipment: A glut of supply has given them the upper hand in driving hard bargains.

Korn/Ferry’s Demeter, for example, is negotiating to buy some software, and the seller’s asking price now is “nowhere near what is was” when discussions began, he said.

“The price just keeps going down and down,” Demeter said.

That trend may prove widespread, especially in sectors such as telecommunications, where a huge number of competitors have emerged since the mid-1990s.

“Whenever supply and demand get out of balance, it tends to be a buyer’s market,” said Robert Ray, a telecom analyst at Moody’s Investors Service in New York. “The real question is: How many buyers are there?”

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Tech Boom Slows Down

Corporate spending on technology equipment began to rocket in the mid-1990s, and growth in spending last year topped 25%. But growth this year is expected to fall sharply as companies complete tech projects and as the weaker economy discourages major outlays.

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Annual growth in private-sector dollars spent on information-processing equipment

and software

2000: 25.4%

Sources: Bureau of Economic Analysis, Prudential Securities

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