Tech's Gathering Gloom

A growing list of trends and factors suggests that 2005's initial optimism was premature. Want proof? Just look at Big Blue's latest numbers

By Jim Kerstetter

After three years on an earnings merry-go-round, you would think tech investors might have figured out the pattern: Flush from a healthy fourth quarter, most tech companies started this year with rosy forecasts. Market prognosticators piled on, said things were looking up, and then investors raced in -- only to get slammed by disappointing first-quarter results.

IBM (IBM ), the tech industry's rock-steady giant, delivered the biggest disappointment of all on Apr. 14, when it said first-quarter profits from continuing operations came to $1.41 billion, about 5% less than Wall Street's expectation. Revenues were $22.9 billion, also below what was anticipated.

But don't be too hard on Big Blue. It's not alone. The entire tech industry may be undergoing a structural shift toward cheaper computing. What required a multimillion-dollar mainframe a decade ago can now be accomplished with a server computer that costs $1,000, says Mark Stahlman, an analyst at investment bank Caris &Co. It's interesting to note that sales of IBM's so-called blade servers -- little stackable machines that can be bought as needed -- grew 70% in the last quarter, while mainframe sales shrank 16% (see BW Online, 4/18/05, "The Old IT Is Dead. Long Live the New").


  Open-source software is also giving customers a low-cost alternative to systems that once commanded top dollar. "People are clearly figuring out ways to achieve the same or greater results with less tech spending because of open-source, low-cost servers, and the high productivity of their [IT] staff," says Scott Lien, vice-president for products and technology at ePredix, a Minneapolis (Minn.) company that provides software as a service over the Internet.

The week of Apr. 18 will be telling, as tech stalwarts such as Intel (INTC ), Google (GOOG ), Yahoo (YHOO ), and SAP (SAP ) report earnings. Analysts will be watching to see if demand is slackening along with prices. So far, no clear trend is evident. On Apr. 15, market researchers at IDC said worldwide PC shipments increased 10.9% from a year ago, to 46.1 million, during the first quarter.

Certainly, some larger economic issues are in play here. IBM, business software maker Siebel Systems (SEBL ), and other tech companies that came up short in the first quarter all said they had difficulty closing deals toward the end of that period. Rising oil prices, fears of inflation, and the weak dollar probably all played their parts. And over the last few years corporate tech buyers increasingly have been delaying their purchase until the fourth quarter, when they're confident their budgets won't get slashed.


  But what exactly are they buying? The answer, increasingly, is cheaper stuff, whether its servers and PCs from Dell (DELL ) or software from Red Hat (RHAT ), which distributes a version of the Linux open-source operating system. Prices on servers have dropped 6% over the last 12 months, Smith Barney analyst Richard Gardner wrote in a report.

That deflation was one of the biggest reasons computer maker Sun Microsystems (SUNW ), which has suffered at the hands of low-cost competitors for years, missed Wall Street's first-quarter sales expectations, Gardner wrote. It's "all part of the natural evolution of a maturing industry as people figure out how to do things in a more efficient and cost-effective way," says Lien.

In that sort of deflationary market, a drop in demand, no matter how slight, can cause even healthy companies like IBM to come up short.


  What's not so clear is how far these problems extend into tech sales to consumers. Apple Computer (AAPL ) on Apr. 13 announced yet another blowout quarter, thanks mostly to sales of its iPod digital music player. But in South Korea, consumer-electronics giant Samsung reported a 52% profit drop as prices of liquid-crystal displays and computer memory chips plummeted.

If the slowdown really does extend into consumer sales, this year of high expectations could turn out to be another in a line of dreary periods for the tech industry.

With Robert D. Hof in Silicon Valley and Steve Hamm in New York

Kerstetter is Technology editor for BusinessWeek Online in Silicon Valley

Edited by Roger Franklin

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