Tech Spenders Turn Choosy
SAN FRANCISCO -- When money is tight, consumers forego hamburgers for Hamburger Helper.
But how do companies adapt?
Wall Street has spent the past few months busily cranking out reports explaining why corporations will continue spending their money buying new computers and networking gear during a recession -- or predicting the opposite.
For tech firms, whose fortunes depend on the shopping habits of corporate customers, the latest batch of earnings reports has done little to clear up the matter, with some firms thriving and others blaming sluggish sales on a weak economy.
One trend not getting as much attention, however, may be the most obvious: Rather than freezing tech spending outright, and putting new projects on ice, companies may simply be bargain-hunting.
Consider
Cisco
(CSCO) - Get Report
, the world's No.1 maker of networking equipment, which has
sounded the alarm about a slowdown in corporate spending
during its two past quarterly earnings calls, and which will provide another highly anticipated update when it reports its fiscal third-quarter results after Tuesday's market close.
Many investors have interpreted Cisco's comments as a sign that corporate wallets are snapping shut. After all, whatever happens to Cisco, which controls more than 70% of the market's routers and switches, is probably a reliable reflection of what's occurring across the market.
In fact, the answer may be more complicated.
As the dominant player in the sector, Cisco charges a sharp premium for its products. In many instances, the price for a Cisco offering can be more than double what a competitor is selling.
In flush times, corporate IT managers may not mind the price premium, finding comfort and safety in the established Cisco brand. But in a recessionary environment, value becomes more important.
Thus, many chipmakers who provide silicon for Cisco competitors (Cisco uses its own home-grown chips in much of its gear) have
cited strength in networking-equipment chip sales
, with
Broadcom
(BRCM)
,
LSI
(LSI) - Get Report
and
PMC-Sierra
(LSI) - Get Report
all reporting better-than-expected quarterly results.
"We're seeing more infrastructure build-out than we had expected." Broadcom CEO Scott McGregor told analysts during a conference call last month.
Massive pre-Olympic Games investments in China -- where Cisco faces tougher competition -- may explain some of the discrepancy.
Gartner analyst Frank Marsala believes Cisco's comments on delays in corporate technology spending are probably an accurate gauge of what's occurring across the broader market. But he notes that lower-price competitors could benefit from a weak economy.
"The point is a good one that in a softer economic time,
a corporate customer might be looking to save some cash," says Marsala.
Cost saving is already a key factor behind the popularity of virtualization software, which allows companies to pool their computer programs and files together on a smaller number of servers. Not surprisingly, the case for buying less hardware, and virtualizing more servers, becomes even more compelling in tight economic times.
To date,
VMware
(VMW) - Get Report
has been the main beneficiary of this trend -- the stock is down sharply from its 52-week high of $125.25, but at $67.58, it's still up 130% from its
August initial public offering of $29
.
But penny-pinching corporations might find even more savings potential in VMware competitors like
Microsoft
(MSFT) - Get Report
, whose virtualization product,
, is free for companies who have already paid for the Microsoft Windows license.
Bargain Hunting
Betting on companies with the cheapest widgets is not necessarily a surefire investment strategy, cautions Bill Gorman, vice president of equity research at PNC Wealth Management.
If a lower price means lower quality, then corporate customers may not bite, even in a weak economy, he notes.
"From my experience in past downturns, companies would rather either defer or just cancel
a project" rather than go with the low-cost provider, he adds.
Moreover, some low-priced technology comes from companies with too much other unsavory baggage.
Advanced Micro Devices'
(AMD) - Get Report
latest generation of server microprocessors are more or less comparable to
Intel's
(INTC) - Get Report
(Intel's currently boast a faster clock speed), yet they sell at a discount -- a fact that might well endear AMD's chips to businesses looking to save a few bucks on server purchases.
But AMD has so many other problems, including more than $5 billion in debt and a long, murky path to profitability, that the stock needs more than a rebound in demand from corporate customers. As it is, AMD's stock is down roughly 60% from its 52-week high of $16.19.
Depending on how long the economic downturn lasts, troubled tech firms as well as healthy ones will face increasing pressure to lower their prices as customers push for deeper discounts and seek to play the sellers off each other. The resulting drop in profit margins, in addition to any shifts in market share, could turn out to be the real legacy of the current economic slowdown.