Will the IT market fold?

The hot debate of the moment rages: will there be a massive collapse in the IT sector? Some share prices are falling drastically, others are holding up. Then there is the Y2K factor. Never before has there been such uncertainty as to what exactly the impact will be, with predictions ranging from "catastrophic" to "mildly sensational" to "just plain mild". The impact of Y2K on the IT sector may be slightly different to that on other sectors, as we will see.

I believe there is significant justification to maintain a strong belief in the long-term future of the IT industry from a 'business fundamentals` point of view.

So this column has to do with the forces, short- and long-term, influencing the IT market and industry, and some scenarios. I will then stick my long neck out and say which scenario I would put my money on - and maybe even how much money I would be prepared to stake!

This one is probably easier to deal with than the short-term outlook, and perhaps less contentious. I believe there is significant justification to maintain a strong belief in the long-term future of the IT industry from a "business fundamentals" point of view. In the long-term, these fundamentals will also drive the share prices, but in the short-term we will of course see major fluctuations.

The current wave of technology innovation is more of a long-term tidal rise (think of the melting of the polar ice-caps), than the previous growth spurt between 1994 and 1996, when everyone was changing to 32-bit operating systems (read Windows) and client-server architecture. The current long-term swell is driven by the building of the "Wired Marketplace", in which an order of magnitude growth will take place in the number of individuals who use information technology - including consumers in households. This may sound like hype, but it is also a key part of the reality that will drive the growth in the IT market for the next 10 years or more. Along with the wired consumer comes the growth in business applications, including electronic business and all that goes with it.

The short-term outlook for the IT sector is much harder to predict, particularly in respect of share prices, which are driven mainly by sentiment. Let`s look at the business fundamentals first, and build some scenarios. First let`s consider the driving forces, and the factors influencing them.

The key factors driving IT industry growth in the short-term include:

• perceived need to spend;
• ability to spend, and
• the difference between the two, which may be called "pent-up demand".

Perceived need to spend is, in turn, influenced by:

• the long-term growth drivers already discussed, which BMI-T`s research shows are clearly in place in the minds of South African IT decision-makers; and
• short-term factors such as the Y2K bug, and the need to do something prior to 1 January to avoid the pain - this factor will stimulate short-term spending, and has in fact already had a major impact on growth in 1998, and to a lesser extent, in 1999.

Ability to spend may be retarded by:

• FUD - fear, uncertainty and doubt!
• "Indigestion".
• Economic conditions.

The FUD factor related to Y2K has a negative effect on spending this year, and a positive effect next year, but how soon next year is the big question. It relates to users holding back on any new major system purchases this year, preferring to wait and see if anyone else who has the same software or hardware has major problems come 2000.

By "indigestion" I refer to companies` inability to absorb new technology, either because it requires process re-engineering or change management (eg e-commerce and customer relationship management), or because of pre-occupation with short-term problem solving (eg Y2K again). Here again Y2K has a negative short-term impact and a positive swing again next year, once the pill has been swallowed and pent-up demand for new applications is once again released.

Economic conditions are harder to predict, simply because no one can really predict the severity of the Y2K impact on the economy in general - local and global. There are two factors to consider here - the real impact of Y2K on the market (which itself is uncertain), and investor sentiment, based on fear of an economic meltdown. Sentiment is a major wildcard in this regard, since it alone could be the major driver of a recession in late 1999 and early 2000, regardless of the realities.

Assuming the economy will be impacted by Y2K, there is likely to be a stronger impact on developing countries as a result of lower preparedness. Again sentiment plays a major role, since developing countries (including SA) could be faced by a severe net capital outflow in the months ahead. This would force interest rates back up, and further inhibit our ability to grow the economy.

What this all boils down to is a net negative impact on the ability to spend, including some impact on IT spending and hence IT companies` revenue growth. However, bear in mind that IT is seen to be a critical part of infrastructure, and is becoming more resilient to such short-term influences on spending growth than in the past.

Let`s look at some scenarios.

The first scenario takes the view that the negative growth forces outweigh the positive ones during the remainder of 1999. This results in only a slightly negative growth in IT spending in real terms in the second half of the year. This view takes into consideration the safe assumption that spending on most services categories would remain positive, and services currently make up a significant chunk of the total IT market. Even if real growth were to be slightly negative, the net growth in spending in nominal rand terms would still be flat to slightly positive, once inflation is added back.

Come 2000, according to Scenario A, pent-up demand is released, and spending bounces back to higher than average growth rates to compensate.

Under this scenario the positive forces outweigh the negative forces in 1999, and spending continues to grow in real terms in most IT categories. There is still some pent-up demand in respect of projects that were deferred into 2000 as a result of pre-occupation with the Y2K problem, and this results in some additional growth next year, albeit not as much of a bounce back as in Scenario A.

The good news is that we can live with the worst case scenario. The bad news is that the above all has to do with the business fundamentals, and share prices may still gyrate wildly as a result of negative sentiment. Which says that while some speculators may do well, others will read the market wrongly and get horribly burned. If you are not a speculator, you would do well to remain invested in a well-rounded portfolio of IT shares, with the longer-term fundamentals being firmly in place, no matter which of the two scenarios you choose to believe.

Which scenario would I put money on? Being an eternal optimist, I think on balance I would choose Scenario B. But it is a bit of a close call.

Which scenario would you pick or would you like to suggest a third one? Write to me at brian@bmi-t.co.za. It would be good to hear from you.