Surprise--The Tech Industry Is Cyclical

Meltdown redux: 1985 was bad, but this time more industries are affected and more capital is at stake

It's a frightening picture, all right. Hordes of brash high-tech startups, all intent on grabbing a 20% share of vast emerging markets, getting massacred, their dreams crashing back to earth. Even the most respected tech companies are being forced to lay off staffers and slash spending as earnings fall miles short of analysts' projections. The press is stuffed with scary "end of history" articles about the death of the tech revolution. Venture capitalists, who just months before were throwing around money like so much birdseed, are nowhere to be found.

Sound familiar? All this happened back in 1985, in what was then the biggest tech meltdown ever. Yes, as the world has again learned painfully, tech can be a very cyclical business. That's why 1985 is worth remembering, if for no other reason than because "what happened then was exactly what is happening now," says Bill Coleman, CEO of software maker BEA Systems Inc. (BEAS ) and a survivor of the '85 shakeout.

For the millions of investors, dot-commers, and tech entrepreneurs who have experienced only the boom of the past 10 years, the wave of bad news and plunging stock prices must seem a cruel twist of fate. In recent years, technology came to be seen as a sector that boasted almost limitless growth; many believed it was divorced from the realities of the business cycle.

But 1985 offers a reminder that stretches of tech prosperity have always been sandwiched between deep, painful valleys. Thanks to the cash pumped into everything from fiber-optic parts to huge computers in recent years, this could be the deepest valley yet. "It's the worst ever in terms of severity and swiftness of decline," says long-term venture capitalist C. Richard Kramlich, who co-founded New Enterprise Associates in 1978.

At that, Kramlich is more optimistic than many. While he expects some recovery by mid 2002, a growing number of tech insiders say that the next cyclical upturn could be a staggering two years away. Indeed, the problems of 1985 are starting to look like a picnic by comparison. Far more capital is at stake, and the current downturn is far broader.

A WIDER SWATH. Back then, most bloodshed centered on the PC. There were 30 PC cloners and more than 70 diskdrive companies, many of which vanished when supplies ran ahead of demand. Software shops and contract manufacturers also got hit when IT spending dipped from around 15% in the early 1980s to 7% in 1985 and 1986. The chip business also tanked, as share-hungry Japanese rivals forced U.S. stalwarts such as Intel Corp. (INTC ) and Motorola Inc. (MOT ) out of core markets like memory chips.

This time, the slowdown is hitting a wider swath of industries. Rather than just PCs, this slowdown is hitting everything net-related, from chips to dot-coms, to networking to telecom. This drop has so far been far more stomach-churning, in part because the over-investment boom of recent years looks far greater than in 1985. Worse, it propped up not only too many tech suppliers but also too many technology buyers, such as Web hosters, dot-coms, and broadband-service providers. The easy sales this created for the likes of Oracle (ORCL ), Cisco (CSCO ), EMC (EMC ), and Sun Microsystems (SUNW ) have now vanished.

Back in 1985, the deadly combo of slumping demand and excess capacity set off fierce price wars as rivals fought to retain market share. Today, the stage seems set for the same battles. Take computer servers. With customers deferring all but the most critical e-business projects, top names like Dell (DELL ), Hewlett-Packard (HWP ), and Compaq (CPQ ) are slashing prices. Just as many computer makers disappeared after the 1985 slump and networking upstarts vanished in the Asian financial crisis of 1998, a bloody wave of consolidation is likely on its way, especially for makers of corporate software. Says Craig Conway, CEO of PeopleSoft Inc. (PSFT ): "The number of members in this country club might get a lot smaller."

WHEN TO BRAKE? For companies in Silicon Valley, Texas, and other tech havens, failing to see that real downturns can happen in tech is exacting a heavy toll. Even giants such as Lucent, Hewlett-Packard, and Cisco Systems were late to roll back cushy financing deals for customers--including New Economy startups that had iffy business plans from the start. "The best companies can throttle up really fast," says G. Dan Hutcheson, president of market researcher VLSI Research Inc. Braking is far harder. "If you brake too late, you crash," he says. "If you brake too early, everyone passes you."

Still, for all of today's carnage, don't forget another tech truth lost during the upswing: Downturns in this entrepreneurial sector often set the stage for new tech booms. Laid-off or underemployed engineers and software writers go to work on their own ideas. That's what happened in 1985. Giants such as Cisco got their start in that slump and were soon setting growth records. And Microsoft (MSFT ), Adobe Systems (ADBE ), and Oracle all had blockbuster initial public offerings in 1986. Says Kramlich: "Some of the best companies are founded during lean times because there's good discipline."

So even if this slump sinks to new lows, keep in mind that it may also bring long-term benefits. "Just think what the last two years have done for all those twentysomething [entrepreneurs]," says Paul Saffo, director of Institute for the Future. "They've been through business cycles that took most of us two decades to experience--and their whole careers are still in front of them. The moment the money frees up, they'll be making more businesses." Still, it may be a long, painful wait before they get that chance.

By Peter Burrows, with Jim Kerstetter and Linda Himelstein in Silicon Valley

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