Tech Spending and the Recession

Calculated Risk has a post on Q1 GDP, predicting it will be ugly. He uses an analogy to demonstrate how companies that make enabling technologies like computers and software will be in for tough times.

Imagine ACME widget company with a steadily growing sales volume (say 5% per year). In the first half of 2008 their sales were running at 100 widgets per year, but in the 2nd half sales fell to a 95 widget per year rate. Not too bad.

ACME's customers are telling the company that they expect to only buy 95 widgets this year, and 95 in 2010. Not good news, but still not too bad for ACME.

But this is a disaster for companies that manufacturer widget making equipment. ACME was steadily buying new widget making equipment over the years, but now they have all the equipment they need for the next two years or longer.

This could explain why Dell is being hit harder (48% profit drop last quarter) than the level of drop in the economy would suggest. Dell's sales depend on growth in other companies, and in companies upgrading equipment. In tough times, current employees can make that old computer last longer, and no hiring means no new computers, meaning no sales for Dell.

But there is one way that I think computer equipment is different from the widget machine in the example. In manufacturing, equipment is more expensive and represents more of a capital investment (and retains more value) than do computers. Have you ever heard of a company buying used computer equipment for new employees? I haven't.

And, even when those computers are sold, the software licenses generally don't come along for the ride. If a company owns a computer worth $2000 and has $2000 worth of licensed software on it (typically Windows, Office, Adobe CS4, plus more), when a company goes into bankruptcy or sells off computers they don't need, they typically (at least in my experience) wipe the machines, and don't pay that much attention to the software licenses.

On the other side, when new companies are started, they buy all new computers and all new software.

In a recession, a lot of small companies are started, and as we come out of the recession, those companies will grow, and so will the existing companies that have suspended purchasing.

If a company typically buys new computers every 2 years, but has suspended that to 3 years during the recession, it's likely that when the recession ends and they're doing well again, they'll go back to 2 years. That next year you'll see 2 years worth of sales (maybe at a lower rate because the company is now smaller, but still) in 1 year.

My expectation is that when the economy shows signs of recovering, tech companies will recover faster than the rest of the economy (although the accelerated recovery will be a bit of a bubble - hopefully companies don't think that year of pent up sales is the new run rate and scale up to that!)