Tuesday, January 29, 2013

Could the cloud talk get (even) more loud?

Why the cloud will gain traction with business faster than you think.

Try this question: What’s the single largest capital expenditure item for companies? Buildings? Plant and machinery?  The answer will surprise most people: It’s Information Technology !

This is evident from the US Census Bureau's 2008 Annual Capital Expenditures Survey released March 2010, which shows that US companies spent $233 Billion on “Information Processing equipment” (a category that includes capitalized software, computers and peripherals, and communication equipment) out of a total capital expenditure of $1.33 Trillion. I verified (as you can too) that this was the largest single item, other large items being transportation equipment ($185 Bil), buildings ($164 Bil), and industrial equipment ($152 Bil).

What has driven this surprising development?

Duly surprised by this unexpected discovery, I set out to figure out why this is so. A few moments’ reflection, however, suffices to show that this fact need not sound as outlandish as it does at first blush. Over the past several decades, most forms of corporate capital expenditure have moved to “subscription-based” models such as leasing:

-          Land and buildings have long been leased or rented as a less-capital intensive alternative to purchase;
-          Heavy machinery and transportation equipment are also increasingly being leased. For example, airlines today rarely buy aircraft, preferring to lease them instead.

To be sure, IT too has begun to be subscription-based in the past few years but this trend has not yet penetrated deeply. Hence IT has emerged “by default” as the single largest capital expenditure (Capex) for companies.

This development is potentially disruptive for the IT services industry

As the single largest capex item, IT will attract increasing attention from cost-conscious CFOs in every company. As outlined above, they have become accustomed to reducing up-front costs on most other capital items thru “subscription-based” models such as leasing. Thus, pressure for reducing capex on IT will mount *, accelerating the move towards subscription-based IT models such as cloud computing, utility computing and SaaS.

As corporate IT increasingly moves into the cloud, big brands will seek larger chunks of the cloud pie, including thru alliances / acquisitions of IT services players. This trend is already visible and, driven by the above, is likely to accelerate in coming years. As large branded players gain a stranglehold, standalone players in the corporate IT market may run a risk of being marginalized. To derisk, IT services players must start combining with a leading global technology brand thru alliances / joint venture (preferably by starting subsidiaries dedicated to provision of cloud services).

The best IT services companies will thus position themselves to capitalize strongly on the immense opportunities that cloud-based computing will present as it takes off. The rest? They’ll be among the majority who’ll get “consolidated” away over the next 5-6 years, as I wrote in my last post. As for who falls into which category, time will tell.

* Thus far, the primary means of IT cost saving has been via Outsourcing / Offshoring. However these savings were essentially confined to the services stack. Now subscription-based  IT is available across the entire IT stack -  hardware, software and services.
Also while IT outsourcing has been available for some years, its attraction was limited as it did not change the fundamental cost structure of corporate IT.  Now subscription-based IT sharply reduces cost structure for many reasons including multi-tenancy. 

Sunday, January 27, 2013

Sow easy money, reap a crisis

Stock markets and asset prices are surging again. Should we exult?

All over the world, stock markets and asset prices in general have begun to boom again. Stock markets in the US, Western Europe and Asia have hit multi-year highs. The last time this happened was during the 2002-2008 period and, as I predicted (quite accurately, as it turned out) in August 2005 and again in March 2007, that boom was a harbinger of a big bust - what we now call the financial crisis of September 2008.

Given how clear the signals of the crisis were, it's disappointing that astonishingly few pundits foresaw it. (Few foresaw the ensuing recovery too, but that's a different story). What should make us sit up now is that similar signals have begun to emerge all over again, in the form of booming asset prices. This boom largely owes itself to the loose and expansionary monetary policies followed by most of the world's large central banks, in a well-meaning effort to help their respective economies climb out of the recession. An unintended, although entirely foreseeable, consequence of this easy policy is that, like a tide that raises all boats, it has steadily been raising asset prices all over the world. When there's too much cheap money sloshing around, guess what - it ends up going into various assets including stocks and property. pumping up those asset values. 

While booming stockmarkets and asset prices are quite fun while they last, they have an uncomfortable habit of running out at some stage, as happened with the financial crisis of 2008. And since we've learnt precious few lessons from that crisis, the picnic this time too is likely to end badly. So all the easy monetary policy that's being sown now may just reap a crisis down the road. 

How will the technology industry fare?

The low interest rates and easy credit of the past few years have made corporations quite inattentive to cost control, and this happy situation will continue for some time. Business performance has been - and will continue - on the upswing. But when the inflexion point (see above) occurs - most likely within the next 5-6 years, the technology industry will not be immune. The most robust companies will of course pull through - IBM for one. Amazon will continue its disruptive charge and emerge as one of the technology leaders. Others such as HP and Dell will end up on the other side of this disruption, and will almost certainly lose their independent existence over the next few years. Many middle-of-the-road companies such as Google, Sony, Samsung, SAP, Oracle, Apple and Facebook will probably survive but will be unlikely to be considered industry leaders 5-8 years hence. As for the IT services industry, which will be affected not just by this financial phenomenon but also the relentless march of cloud computing that has significant potential to dent its business, several waves of consolidation will be likely to leave just a handful - perhaps 5 or 6 - players of a multi-billion-dollar scale. 

And so the cycle of creative destruction will march ahead relentlessly, as it should. 

Updates May 28th-30th 2013: 

Sure enough, markets around the world have continued their upward surge since Jan 27th (when the above piece was written). In the brief space of 4 months, the Dow Jones Industrial Average, NASDAQ 100 and the S&P index have risen about 10-12%, most European indices by about 8-10%, and the Japanese Nikkei has soared by a whopping 45%. US home prices (as measured by the Case-Schiller Index) vaulted by a staggering 11% in the last one year. As noted, all these rises in asset prices are unsurprising - they're driven by continued loose expansionary monetary policies, particularly by the US Fed. 
Consumer confidence has hit a 5-year high - a result of booming asset prices creating a 'wealth effect'. 

Good sense however does appear to be asserting itself. Recently experts have begun a steady chorus, saying that the US Federal Reserve’s QE policy needs relooking. QE’s inflationary impact on asset prices (and the fact that it wasn’t really necessary in the first place !) have begun to be recognized, and QE is almost certain to be wound down long before the promised 2014 date. In fact, a mere mention by Dr. Ben Bernanke on May 22nd that QE may be relooked at was enough to send markets reeling across the world by 1-7% in a single day. So over the next few months, as QE is wound down, one can expect to see stock and asset markets lose some of their froth. While it’s somewhat heartening that people do realize that QE is boosting asset prices (and that its withdrawal will reverse this boost), these events also go to reinforce my old point that lucid, clearheaded thinking is at a premium in our society !