Hardware: Computers Get Their Groove Back

>>Big companies are spending again, eager to update antiquated systems
>>PCs and peripherals are heating up -- but server profits will be squeezed

No event foreshadowed the slowdown in the U.S. economy like the sudden swan dive in PC sales in late 2000. So you can forgive economists a bit of exuberance now that computer demand is perking up. In the third quarter of 2003, rising corporate profits and growing confidence helped lift PC shipments 15.7%, the biggest increase since 2000. "The key missing ingredient was confidence," says Economy.com Inc.'s Mark M. Zandi. "CIOs, CFOs, and CEOs have got their groove back."

If nothing else, they're back on the dance floor. After three straight years of declines, including a 2.9% drop in 2003, worldwide spending on hardware will rise a sturdy 4.8% in 2004, to $348.8 billion, according to market researcher IDC. The ripple effects should feel especially groovy: Increased computer sales will make up 17% of U.S. economic growth during the year, and information-technology investments overall, including software and services, will generate 80% of the expected rise in productivity from 2002 to 2010, according to Economy.com. "Stronger hardware spending is one of the most therapeutic things that can happen to an economy," says Zandi.

This rebound is about as overdue as a flu shot in January. During the downturn, businesses stretched tech equipment as thin as they could, cut their info-tech budgets, and spent only when it was absolutely necessary. Now, with technology prices at unprecedentedly low levels, 40% of small and midsize companies plan to increase their spending on computer infrastructure during 2004, compared with 30% in 2002, while only 8% will cut their budgets, down from 15% two years ago, according to research firm Yankee Group.

Large corporations, meanwhile, are being lured into spending more in part by the opportunity to try out emerging technologies such as Wi-Fi networking and Voice-over-Internet phone systems. Two out of three say they'll boost IT spending during 2004, up from 36% in 2003, according to a November survey of CFOs by research boutique Sanford C. Bernstein & Co. Says Dell (DELL ) Inc. Chief Executive Michael S. Dell: "They are getting a lot more interested in making upgrades. As these machines get older and older, the users become restless."

Ready to Spend

The most restless element may be the major financial-services companies that slashed big technology purchases when stocks tanked. Some now project double-digit spending increases, says Goldman, Sachs & Co. (GS ) analyst Laura Conigliaro. That's welcome news, because the financial sector accounts for 20% of total IT purchases and typically presages demand elsewhere. Gregor S. Bailar, CIO at banking behemoth Capital One Financial Corp. (COF ) has already replaced his entire base of PCs and e-mail servers. Now he's expanding Capital One's huge data-storage capacity by about 20%. "We wanted to be there when the market came back," he says.

Nowhere has demand been weaker than in the PC sector. Now, many companies can't wait to replace computers that have grown costly to maintain and can't support Windows XP, the latest Microsoft Corp. (MSFT ) operating system. "They're getting a little long in the tooth," says Scripps Health CIO Jean Balgrosky, who is replacing more than half of her company's 5,000 PCs over the next two years and adding about 1,000 tablet PCs for hospital staffers this year. She's eager to deploy more powerful machines running the latest antivirus and security software and capable of connecting to the Internet without a tether. Overall, in PCs, the hottest buys are notebooks. Shipments of portable PCs will jump 26% in 2004, while overall PC unit sales will surge 11.4%, to 169.9 million, according to IDC. Falling prices, however, mean revenues won't keep pace. Total spending on all PCs will rise just 4%, to $182 billion.

As PC sales rebound, so will spending on peripherals, which are hotter than they've been in years. Sales should rise 13.8%, to $75 billion, led by handheld e-mail devices, thin and sexy flat-panel monitors, and multifunction color printers. And it's not just consumers snapping up these products. Big companies are replacing their copiers and printers with networked workhorses that can handle both tasks, cutting costs by as much as 30%, according to Gartner Inc. "It's one of the last bastions of savings," says Gartner analyst Peter Grant.

Elsewhere, falling prices will put a damper on overall revenue growth. In the server market, giants such as IBM (IBM ) and Hewlett-Packard Corp. (HPQ ) are promoting futuristic visions of delivering computer power in the same way as the electric company delivers kilowatts. Yet customers are still broadly focused on containing costs by buying inexpensive machines in dribs and drabs. One reason for that, says HP CEO Carleton S. Fiorina, is that customers increasingly know what they can live without. "They understand it better, from the CEO on down," Fiorina says. IDC believes server sales will rise just 3.5% in 2004, to $51 billion, with growth in machines running the free Linux operating system far outpacing more expensive Unix boxes -- by 41% to 1%. As for all-important storage gear, falling prices will hold spending to $24.8 billion, just 1.7% over last year.

The good news is, computer makers are better equipped to deal with price-sensitive buyers than they were three years ago. Every company has tightened its belt, meaning any improvement in revenue will improve profitability. And many companies have undergone the corporate equivalent of Extreme Makeover, broadening their product lines through alliances, acquisitions, and increased research and development. If they can keep customers confident, the dancing might last all year.

By Andrew Park in Dallas

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