High Tech Hits An Air Pocket

The computer boom fades a bit

No one is claiming that the party is over as far as computer-related spending is concerned. According to International Data Corp., U.S. shipments of personal computers in the first quarter were up a healthy 24% over the year before. Although competitive pressures have clipped the wings of some computer producers, notably Compaq Computer Corp., most are still flying high--racking up both record sales and hefty stock market valuations.

Still, as economist Robert E. Mellman of J.P. Morgan points out in a recent analysis, the computer industry's production rate has decelerated sharply from its unusually strong pace last year (chart), and semiconductor output has followed suit. Although computer and office equipment production was still rising at a healthy 29% annual rate at last count, that is actually the slowest pace since 1994. Moreover, perhaps half the rate of increase reflects improvements in processing power rather than volume gains.

Demand-side data tell a similar story. Factory orders and shipments of computers and office equipment both rose steadily from a $9 billion monthly pace (in current dollars) in early 1997 to $11.1 billion by mid-1998, but they have stayed flat ever since.

The slowdown reflects moderating gains in sales to businesses and consumers as well as overseas, reports Mellman. Growth in nominal business spending on computers and peripherals, he notes, decelerated from a 28% annual pace in the first half of last year to just 7% in the second half. Moreover, recent surveys indicate that many small and large businesses believe their Y2K-inspired spending has already peaked and will lose steam in the months ahead.

Perhaps the most ominous development is the sharp drop in the computer industry's capacity utilization. After the Asian crisis hit in late 1997, operating rates in traditional manufacturing industries turned south in a hurry, but in computer-related businesses they stayed relatively high--until recently. Since November, capacity utilization by computer- and office-equipment makers has actually fallen below that of manufacturing in general, hitting 75.7% in March, compared with the overall factory rate of 79.3%.

The bottom line is that some of the zip has gone out of the computer business. With revenues flat and operating rates falling, pressure to cut prices will grow even more intense, and profits will be harder to come by.

Mellman adds that these developments point only to a spending slowdown--and not to an outright slump. In the U.S., the need to boost productivity in a labor-scarce environment is as strong as ever. In Europe and Japan, sales of computers have surged recently despite uncertain economic outlook. The fact is that once bitten with the computer bug, consumers and businesses have proved highly susceptible to the lure of sharply falling prices and rapid technological improvements.

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