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Don't pop those corks just yet
Before getting swept away by rosy economic data, look closely at sobering numbers on IT spending.
December 8, 2003: 2:42 PM EST
By Eric Hellweg, CNN/Money Contributing Columnist

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SAN FRANCISCO (CNN/Money) - You'd better duck: With all the rosy economic reports coming out in the last few weeks, champagne corks are flying at a pretty steady clip.

The stock market is up, companies such as Intel (INTC: Research, Estimates) are raising the low end of their mid-quarter guidance, and productivity is at a 20-year high. With all these positive indicators, it can't be long before tech companies start spending like gangbusters again, right?

Well ... not exactly. While no one can argue that the recent general economic data are anything but strong, recent surveys in the information technology arena show that CIOs are a little hesitant to predict that they'll be working with larger budgets next year. It looks like a case of once bitten, twice shy: The execs overspent a few years ago and are loath to be called on the carpet like that again.

Investors in the IT space shouldn't assume that because the general economy is improving, technology purchasing will pick up immediately.

Given the shell-shocked nature of the IT industry, investors should expect a little padding between good economic news and increased technology budgets. Budgets may improve next year, but we may not see it for a few months.

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I've been meeting with high-level IT executives every week for the last couple of months, and very few answer in the affirmative when I ask if their budgets are increasing next year. The vast majority speak of minute increases, and many are having to work with less.

A recent report by Steven Milunovich, a vice president at Merrill Lynch (MER: Research, Estimates), backs up my anecdotal observations with numbers. He surveyed 100 CIOs and found that budget growth slotted for 2004 had declined from 3 percent to a paltry 1 percent.

More CIOs responded that their budgets were more likely to decline. "Given investors' assumption that the economy is strengthening," Milunovich wrote, "we're surprised that slightly more CIOs said that budgets were more likely to be managed down than up."

Need more evidence? Look at what the respondents claimed were two top priorities for 2004: "Cost reduction" and "Doing more with the same dollars." Hardly a positive indicator for the business-focused sector of the IT industry.

Outsourcing is one of the few growth areas in the Merrill report, with offshore outsourcing poised to make some gains in 2004. This shouldn't come as a surprise, given that offshore outsourcing offers companies the ability to farm out application-development or help-desk functions at a significant cost savings.

The problem is that the money spent is leaving the United States, so it won't do much to boost U.S. employment or applications sales.

Of course, not all is gloomy. In fact, even a 1 percent gain is an improvement over the last three years, when budgets declined. What's more, some areas will see modest growth next year -- most notably storage. In that sector, Dell (DELL: Research, Estimates), EMC (EMC: Research, Estimates), Hewlett-Packard (HPQ: Research, Estimates) and IBM (IBM: Research, Estimates) are expected to gain the most revenue, according to respondents.

EMC Corporation
Hewlett-Packard Company

Also, IT shops in consumer-facing industries such as retail, insurance and entertainment may see budgets increase, as the consumer-led recovery wends its way into their server rooms and calls for more e-commerce capabilities.

Finally, many companies haven't updated their employees' desktops in more than three years, meaning PC makers could see continued growth as enterprises finally purchase new workstations. This is one of the key drivers behind Intel's recent gains.

Other recent studies are a little more optimistic, but with caveats. Last month Forrester Research came out with its own 2004 IT spending report, which puts the average increase in IT budgets at 1.7 percent.

However, the group believes that when IT executives factor in some of the recent positive economic news, that number could increase to as high as 4 percent -- but not until the latter half of next year.

Research firm IDC also predicts a 4 percent increase in tech spending next year. But Kevin White, an economist with the firm, says that rather than spending on "exciting" new initiatives, most companies will be replacing outdated technology and updating existing infrastructure components.

White says that for budgets to include new initiatives, companies will need to show a sustainable return to profit growth. Right now we're seeing profits start to grow sequentially, but until that momentum proves it has staying power, companies will continue to mete out tech-budget dollars with caution.

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