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Downturn Tests Technology Sector's Resilience

By Peter Whoriskey
Washington Post Staff Writer
Wednesday, November 12, 2008

Technology companies often boast that they can easily weather an economic downturn because their products can help people save money. But in the ongoing global crisis, some of them are getting hammered.

Nortel Networks on Monday posted a third-quarter loss of $3.41 billion, reporting a sharp drop in sales. That news follows a report last week from Cisco Systems that its orders in October had fallen 9 percent over last year. And with executives throughout the industry bracing for trouble, the research firm IDC this week cut in half its previous global forecasts of spending on information technology.

"Everyone is expecting the worst, and when they do, they stop spending, and it just becomes a self-fulfilling prophecy," said John F. Gantz, IDC's chief research officer and senior vice president, echoing analysts' remarks about other sectors of the economy.

He said the forecast for tech spending had to be altered because of the changing forecast for the broader economy.

"Until September, most forecasts were that 2009 would be better than 2008, and then . . . boom," Gantz said. "Now 2009 will be worse, and the only question is how much of a turnaround we get in 2010."

Even so, there is some disagreement over the magnitude of the impact that the weakening economy will have on technology firms.

Many tech firms argue that they are well-suited for economic downturns because they can help their clients save money by making them more efficient. For example, companies can use videoconferencing to cut down travel costs, or buy computer systems that have reduced energy consumption.

"We're engaging in conversations with customers every day about how they can use IT to save money," said Microsoft spokeswoman Ginny Terzano.

In its most recent earnings call, the company reported that its revenue for the quarter ended Sept. 30 jumped 9 percent over last year.

"Like many other companies, we experienced deterioration in the spending environment over the last few weeks of the quarter, which has continued into October," Chief Financial Officer Chris Liddell said during the Oct. 23 call.

Andrew H. Bartels, a research analyst at Forrester Research, agreed that in an economic downturn, some firms turn to technology solutions to become more efficient.

"We've got to remember, many companies run on tech," he said. "They can cut and delay [tech spending] for a while, but not for long.

"Our forecast has been that the tech sector as a whole will continue to at least hold its own or even grow through the recession," he said. "We're not expecting to see the drop in purchases that we saw in the 2001 time frame," when the dot-com bubble burst.

Last month, Google announced a 26 percent increase in third-quarter profit, beating analysts' forecasts.

Google was able to defy the falloff in advertising revenue that comes with a downturn. Analysts said that's because many Google customers view the search advertising method as more efficient than other advertising modes and have continued to spend there.

But despite the good results thus far, the company remains wary of the financial environment.

"When I talk to other CEOs in Europe and in America, it is clear that the economic situation is so fluid, that we are all in uncharted territory," Google chief executive Eric Schmidt said during the earnings conference call.

For many tech companies, one of the most troubling aspects of the current downturn is that banks and other financial institutions -- typically some of their best customers -- have suffered. Banks and other financial institutions make up about 20 percent of all business spending for information technology.

"That core market is really in turmoil, and it probably will be for a while," said Igor Stenmark, managing director of MGI Research. "It's going to be another tough year."

He and other analysts added that it will be easier for software companies to escape the effects of the downturn than for hardware companies.

Software companies often make their money on regular expenditures on licensing and maintenance. Hardware companies, meanwhile, rely on their clients being ready to make large capital expenditures -- just the kind of spending that many companies find easy to put off during a downturn.

Complicating matters for hardware companies is that with all of the economic wreckage around, there will be lots of used computers and servers coming onto the market, cutting into sales of new technology.

"Lots and lots of used equipment will be showing up on eBay," Stenmark predicted.

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