Tech Comes Out Swinging

The industry's top players are spending heavily to position themselves for better times

Sitting in an overstuffed armchair in a swank 15th-floor suite in New York's Carlyle Hotel, Oracle Corp. Chief Executive Lawrence J. Ellison can't suppress a grin. The object of his glee: Oracle's shocking $5.1 billion hostile bid on June 6 for rival software maker PeopleSoft Inc. If completed, it will be the largest software merger ever. And it could reshape the $35.8 billion market for run-the-business applications, making Oracle a credible No. 2 to leader SAP. In the past, Ellison always pooh-poohed large mergers -- Oracle didn't need them, he said. But now, as the tech industry starts to turn up, Ellison sees a chance to knock off a fierce competitor and set up Oracle for the future. "The strong are getting stronger," he says. "This is a consolidating industry, and in a consolidating industry, you need scale to compete."

Oracle's move comes at a turbulent time for the technology industry. Never before have tech companies seen a downturn as long or as deep. U.S. corporations cut their spending on information technology back in 1985 and again in 1990. But the spending declines never got beyond 5% or took more than six quarters to regain their previous peaks. This time is different. Corporate tech spending plunged 15% from its peak of $453 billion in the third quarter of 2000 to its nadir in the fourth quarter of 2001, according to the Commerce Dept. And it still hasn't fully recovered -- 10 quarters later. CEOs threw up their hands in despair. A dead calm settled over Silicon Valley.

Pay attention now, though, and you can feel the air stirring. Corporate spending on information technology is inching up. Consumers are scampering out to buy new goodies, such as wireless networks for their homes and mobile phones that take photos. Market researcher IDC estimates tech spending will rise 2.3% this year after two years of decline. And tech stocks have started to run in anticipation of better times ahead. The Merrill Lynch index of the top 100 tech companies has surged 38% since a recent low in mid-February.

Given a fighting chance at recovery, companies are coming out swinging. Oracle's multibillion-dollar bid for PeopleSoft may be the most audacious haymaker. But IBM, Dell, Verizon, Nokia, and Microsoft all are making aggressive moves. These are strategic decisions: The time to strike is now, they figure, while they can still take advantage of weakened rivals. "Those that make a bold move in the downturn, and can sustain it, are positioned to come out like a rocket," says Mark P. Rice, dean of the F.W. Olin School of Business at Babson College. "Others are behind when the downturn turns."

Some of the heavyweights are going for a knockout. Dell Computer Corp. is moving far beyond its core PC business to muscle into new markets. CEO Michael S. Dell thinks his company's superefficient manufacturing techniques will allow it to grab market share in storage and networking gear. "It's pretty amazing when you unleash this [approach]," says Dell. Hewlett-Packard Co. is a prime target. Dell has stopped selling HP's printers and now sells its own. Since HP gets most of its profits from printers, Dell figures that if it drains that business of profits, HP will be too weak to put up a fight elsewhere. HP says it will hold its own through innovation.

And check out Verizon Communications (VZ ) With many rivals on the ropes, the New York company is pouring about $13 billion into capital investments this year, nearly half of what the entire local phone industry will spend. It's launching a host of brash initiatives, including a 10-year, multibillion-dollar campaign of installing lightning-quick fiber-optic cables to every one of its home and business customers. These cables allow people to carry on video-phone conversations, and watch interactive videos over the Net.

The boldest companies are hammering out strategies that could transform the industry. IBM is betting its future on a radical vision it calls on-demand computing. The idea is that it will offer computing power to corporate customers as a service, whenever they need it, with all the reliability and simplicity of electricity. CEO Samuel J. Palmisano is reshaping the entire company around the idea and spending $1.6 billion on research and development this year for on-demand products. "IBM has a history of making bold moves in unsettled times," says Palmisano. "You don't make bold moves when there's stability because you're not going to capture any great advantage."

But tech has much more at stake than getting the jump on rivals. The industry's credibility also is on the line. Tech's top brass got to be known for their hogs-at-the-trough pay packages. Meanwhile, many corporate customers have come to question the payoff of their expensive technology investments. "My message to the tech companies is: Innovate around what we need, not what your own engineers are interested in. Make your product tangibly better, and we'll pay a premium for it," says Dan McNicholl, chief information officer for General Motors Corp. North America.

Even some industry execs question whether tech can ever return to the go-go growth of the 1990s, when technology spending vaulted ahead at an average rate of 10% a year. "We think it will be more than gross domestic product growth, but not a lot more," says John G. Connors, chief financial officer at Microsoft Corp. Oracle's Ellison is more blunt. While innovation is alive and well, a tech economy built on initial public offerings and rapid-fire growth is kaput, he says. "Silicon Valley as we know it is dead. It's never coming back. The industry is mature," he says.

The gauntlet has been thrown down. Are the glory days for the technology industry gone for good? Is it just another business, like autos or steel? Only with compelling new products and ever-more-attractive prices will the industry be able to prove its value and get demand revving again.

The top companies promise they're up to the task. Japan's Sony Corp. is investing around $3 billion over the next three years on new chips for devices in the digital home of the future, enabling a fusion of computing, Web surfing, electronic games, music, and videos on easy-to-use home networks. Qualcomm Inc.'s latest chips and software already are hastening the arrival of next-generation mobile-phone services, including the ability to shoot videos with cell phones and instantly transmit them to friends or business associates.

What's at stake is not just the future of the technology industry but also the health of the U.S. economy. In the 1990s, technology was the glowing engine of economic growth. Tech's share of GDP rose from 3.2% in 1990 to 4.9% at the peak in 2000 -- and still accounts for 4.2%. Economists credit tech spending with at least one-third of the productivity gains in the second half of the 1990s. Even now, according to David A. Wyss, chief economist for Standard & Poor's, it's contributing to abnormally high productivity growth in an economic slump -- a 1.9% annual rate for the first quarter. How effectively tech companies innovate will play a role in whether the economic recovery is sluggish or swift.

Making gutsy moves during a downturn has paid huge dividends for companies in the past. According to a 2002 study of U.S. companies during the 1990-91 recession by McKinsey & Co., the companies with the strongest stock appreciation after the recession had launched major initiatives during the downturn. They did this by investing in innovations, in new manufacturing facilities, and by making smart acquisitions.

This time, tech's brawniest players are in the best position to spark new innovations and answer the industry's skeptics. The 10 richest companies hold a total of $130 billion in cash, thanks to their ability to keep racking up profits during the slump. Microsoft tops the list with a $46 billion cash hoard that's allowing it to make what it calls a "bet-the-ranch" investment in the next version of Windows even as it moves into such new markets as collaboration software. Oracle can afford to go after PeopleSoft because it has $6 billion in cash. Intel, IBM, Cisco Systems (CSCO ) HP, and Dell also are loaded with dough, each boasting $4 billion or more.

And don't forget about those deep-pocketed Finns. Nokia is putting some of its $11.4 billion in cash to work to get people jazzed about new mobile phones after a sharp slowdown in the market. It spent $3 billion on research and development in 2002, up 18% since 2000. Now it's flooding the market with an unprecedented array of new products, releasing two dozen new cell phones this year. One of them is the N-Gage, a mobile phone that doubles as a portable game console. "I'm convinced we can reach 2 billion worldwide subscribers [double today's total] by the end of the decade," says CEO Jorma Ollila.

Intel is lending a hand in shooting for that goal. The company dominates the market for PC processors. Now, it's using its financial might and manufacturing knowhow to bull its way into the faster-growing markets for wireless communications chips. CEO Craig R. Barrett figures that melding computing power with wireless chips will result in innovative new products -- say, mobile phones that can handle some PC tasks. The company will face fierce competition from Texas Instruments and Samsung Electronics. Still, after spending $15.7 billion on new chip plants since 2001, it figures it has the muscle to quickly become No. 1 or No. 2 in communications chips.

But it will take more than brute force to win over corporate buyers who have soured on technology. The challenge is to persuade them to buy more gear and software when, in many cases, they're dissatisfied with what they own. Far-flung computers and networks are too complex and expensive to install and manage.

Palmisano is overhauling IBM to win back the dispirited. He thinks the answer is to make computing simpler, to shift the burden of managing tech systems from corporate customers to experts, such as IBM. Called on-demand computing by IBM, and utility computing by others in the industry, the idea is simple: Much of this complexity can be removed by using software to better stitch together applications and computers -- and to deliver computing power to customers via the Internet. Rather than selling computers by the box, the plan is to sell computing as a service.

IBM is hardly the only company that's pursuing this strategy. HP and Sun Microsystems (SUNW ) Inc. also are vying to lead the revolution. But IBM has the most ambitious vision, with technologies that enable sick computing systems to heal themselves and that tap into grids of computers, as needed, for processing power and data-storage capacity. If this plan works out, IBM will be able to rely on a steady revenue stream and customer lock-in, just as in its mainframe glory days.

Microsoft has a very different, if equally ambitious, plan to get customers passionate about technology again. The company is pouring billions into the next version of its Windows operating system, code-named Longhorn, due in 2005. Longhorn promises significant improvements in everything from the look and feel of the software to an all-new file system that makes it much easier to store and find things in your computer. CFO Connors says Microsoft is betting its future on Longhorn. "If we're successful, it will sustain our ability to be one of the most uniquely profitable companies in the world for the foreseeable future," he says.

A handful of tech giants are trying something Microsoft mastered long ago: shaping huge segments of the industry around themselves. By providing a platform for other businesses to build on, they make their own technologies more attractive to customers. Germany's SAP, for instance, has technology that makes it easier for smaller companies to create innovative applications on top of its basic applications for managing corporate finance and manufacturing. And eBay Inc., once mainly a place for millions of amateur peddlers to sell their wares, is now letting other businesses tap directly into its commerce technology to build robust businesses on the site.

EBay's plan is to become the world's premier marketplace for millions of businesses. Already, it has 150,000 "Power Sellers," including large businesses such as Walt Disney (DIS ) Co., which hawks collectibles from its movies there. More sellers attract more buyers, which attract more sellers -- and eBay collects a fee for every transaction.

A very different tech industry is emerging -- one dominated by a handful of superior companies. Gone are the days when rising demand lifted all boats in the harbor, barges and dinghies included. Today, only wealthy companies with the most innovative technologies and the most aggressive strategies will increase their revenues and profits at healthy rates.

Many of these companies are large, but they aren't the lumbering dinosaurs of computing's past. Not only are they rich and powerful, they're determined not to be caught off guard again -- as many were by the Internet. They plan to revolutionize their own markets and technologies before somebody else does it. That's some one-two punch: money, and the will to do something profound with it.

By Steve Hamm in New York, with Steve Rosenbush in New York, Cliff Edwards in San Mateo, and bureau reports

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