The end of summer vacation is almost upon us, and that means one thing for many CIOs and their assistants: It's time to prepare proposals for next year's IT budget. While I wish I could predict that IT spending will sail upward, I see economic storm clouds on the horizon that could cause many companies to cap their expenditures. However, not all is lost. Keep reading and I'll give you some pointers you can use to navigate through the rough weather that could lie ahead.
As you may remember from last year's IT spending review and forecast, I predicted that some companies would rein in IT spending during the first half of this year over worries about an economic slowdown. I also predicted that many of those companies would loosen their purse strings during the second half in the belief that the slowdown was behind them. So far, that prediction is running true to course. Back in March, participants in the CIO magazine Tech Poll survey said that their IT budgets would increase by a below-average 5.1 percent over the next 12 months. When the magazine ran the same survey three months later, that number shot up to a healthy 7.2 percent. Moreover, some analyst firms are predicting that today's spending increases will persist into 2008. For instance, Forrester Group is projecting that IT spending in the United States will grow by 7 percent in 2008, up from 6 percent this year.
I hate to be the contrarian here, but I am predicting that at many or even most North American companies, spending increases for 2008 will be smaller than those handed out this year. There are sound economic reasons that 2008 will likely be a sub par year for technology spending. Since you are probably asking yourself what those reasons could be, allow me a few paragraphs to shed some light on the subject.
Financial and Business Cycles: A Quick Primer
As we all know, companies are more willing to approve IT spending increases when they expect business to be good and are less willing to do so when conditions are uncertain. What many do not know is that the business cycles that influence IT spending are closely tied to another cycle: the expansion and contraction of credit. When credit expands after a period of contraction, the economy expands, though it often takes nine months to a year before it does so. When credit starts to contract, the economy usually follows after a similar "lag period."
The reasons this occurs are fairly obvious when one thinks about it. When consumers and businesses can borrow money at favorable terms, they spend more on everything—from houses and leisure services (for consumers) to new plants and equipment (for businesses). When credit becomes tighter, consumer spending decreases and businesses cut back on capital investments.
At this moment, the financial sector is in the early stages of a worldwide credit contraction. Over the last four years, credit was expanding at a heady pace. As a result, consumers and businesses threw around ever-growing sums of easy money that drove up asset prices to unsustainable levels. Despite what the mass media simpletons and government spin doctors may tell you, this money was not just lavished on houses by subprime lenders. It was also spent on a wide range of consumer discretionary items (often in the form of home equity loans) and business investments. On the business front, for instance, credit was used to underwrite increasingly risky leveraged buyouts. To illustrate what I mean by "increasingly risky," consider the following: Back in 2003, private equity firms could buy up companies for around four times their cash flow. By the middle of this year, easy money had driven up prices for the average LBO to around 15 times cash flow.
The problem with credit bubbles is that they all end badly. One day, lenders wake up and realize that borrowers have used their money to buy assets at unreasonable prices. They also realize that those assets could easily become worth less than the value of their loans. Suddenly, perceived financial risk levels hit the ceiling, and the lenders—be they high-flying hedge funds or your community bank down the street—put the brakes on further lending and try to sell off their risky loans to someone more foolish than they are.
This month, such a wholesale reassessment of risk has been ravaging the financial industry in general and Wall Street in particular. Around the world, money is fleeing subprime mortgages, junk bonds, and other investments that are based on overly optimistic assumptions about growth rates. However, do not think that what happens on Wall Street will leave Main Street unscathed. As more financial institutions reveal that their investment portfolios are riddled with bad debts, standards for extending credit to everyone will grow tighter. That will eventually blunt consumer and business spending, though the cutbacks will not be felt fully until next year.
In short, I predict that the recession that hit housing-related industries this year will spread to other parts of the North American economy next year. Look for revenue growth to turn negative among financial firms first and then spread to many (though not all) consumer discretionary companies and firms in other cyclical industries. In these parts of the economy, most companies will rein in the growth of their IT spending over the course of next year. For a significant minority of these firms, 2008 IT spending will be flat versus 2007 or even lower than this year. Overall, I expect North American IT spending to grow somewhere between 3 percent and 5 percent in 2008.
Now for the Good News
While the looming credit crunch may crimp spending in 2008, I do not expect it to kill off the economic expansion that has been sweeping the world over the last several years. As a result of that expansion, millions of families in developing countries have joined the middle class and are demanding the kinds of lifestyles we enjoy. Millions of new businesses have also been created and are generating additional wealth. Indeed, many developing countries have enormous cash reserves that they have accumulated from years of exporting goods and services to more-developed nations. These new consumers and cash reserves will help to keep the global economy afloat while debt-ridden developed nations clean up their credit acts.
That said, how should CIOs frame up their budget proposals for the coming year? Here is what I would recommend. First, try to submit your proposal for 2008 as soon as possible before the credit crunch starts slicing into your company's sales. You will probably find it easier to get increases approved sooner rather than later. Second, have a contingency plan in place in case your company decides that it must cut your budget in the coming months. Know how you can get by with less in case you are called upon to do so. Finally, be ready to show your senior management how any IT spending increases will help to cut costs or boost revenues. The more you can demonstrate how IT can help your company navigate any rough economic waters that are ahead, the easier you will find it to get the funding that you need.