Imagine that Apple had folded in the mid-1990s, as some predicted at the time. Perhaps music downloads would still be a hassle, smartphones a novelty and tablet computers two inches thick. But one thing would certainly be different: the information-technology industry would now lack a leading light.
Thanks to record sales of its recently upgraded iPhones, on October 20 Apple surprised analysts by revealing excellent quarterly results. It was almost alone among the big technology firms in doing so. Most others reporting in recent weeks seem to be in something of a funk: profits have fallen at Google as well as IBM, SAP and VMWare. Does this mark the start of a downturn for the tech industry?
In some cases the reasons are specific to the companies. IBM seems to have done more financial engineering than the real kind in recent years. Since 2000 it has spent over $100 billion on buying back its own shares. It has shed less-profitable assets but now lacks a big fast-growing business to drive growth (its bet on artificial intelligence, called Watson, has yet to take off, for instance). The earnings of VMWare, a company that makes corporate software, dropped because of charges related to a recent acquisition.
The gloomy economic climate is also playing a role. The strong dollar does not help: it shrinks the foreign revenues of American IT firms. Companies tend to cut spending on IT when times are tough. Ginni Rometty, IBM’s chief executive, noted there had been a “marked slowdown in September in client buying behavior.”
Some firms are having to grapple with shifts that are affecting the whole industry. One is cloud computing, geek-speak for digital services delivered over the internet. SAP, another corporate-software company, is seeing more of its business moving into the cloud, for instance. That requires big investments in data centers and yields lower margins, at least for the time being.
Another trend is that consumers are spending more time on mobile devices. This, among other things, has hit Google, which is selling more advertisements on smaller screens, where rates are lower, whereas growth in more lucrative ones on bigger devices has slowed. For other firms this shift has been good news: Yahoo, a struggling online conglomerate, joined Apple in exceeding analysts’ expectations in large part because of a notable increase in mobile-advertising sales, which accounted for 17% of its revenue of $1.1 billion in the past quarter.
More fundamentally, however, the IT industry is rapidly maturing, with overall annual revenue growth reaching only 3%, says Sebastian DiGrande of Boston Consulting Group. Although some parts, such as cloud computing and all things mobile, are expanding rapidly, the biggest sectors, including most hardware, business software and IT services, are growing slowly or even shrinking And these are dominated by big technology firms such as HP and IBM.
This “bifurcation,” in the words of DiGrande, will lead to a big restructuring of the industry. HP’s recent decision to break itself up was merely the opening shot. Like HP, some firms are trying to become more focused. Others will shed businesses that have become commoditized; along with its quarterly results, IBM announced that it will pay Globalfoundries, a contract chipmaker, to take its semiconductor business off its hands. Others will try to buy firms in fast-growing sectors; last month SAP bought Concur, which offers web-based travel and expense-management software, for $8.3 billion.
The recent disappointing results are another harbinger of an unbundling and rebuilding of the IT industry. How the sector’s new landscape will look at the end of the process is hard to tell. Who would have imagined that Apple and IBM, once bitter enemies, would one day form an alliance, as they did recently to develop mobile applications for Apple’s iPhones and iPads? If that pair can work together almost anything seems possible.
© The Economist Newspaper Limited, London (October 25, 2014)
Featured image: Thinkstock