Feb 6, 2009

“It’s not only the beginning of a new year, it’s also the end of the IT business cycle that began in 2003”

 “It’s not only the beginning of a new year, it’s also the end of the IT business cycle that began in 2003”............ The STKI Annual Market Forecast prepared for the SUMMIT 2009 (24 March) suggests that very basic structural changes, taking place in the wings of a global economic drama, will propel a new‘market order V2.0’ for the Israeli IT market.


2001-2003 were “IT depression” years.  Spending stopped, projects were canceled and excess inventory flooded the market, destroying pricing.

Why? Because IT had a long way to fall. IT spending in 2001 had fluff and fat everywhere. When the bubble burst, the fall was precipitous. IT fell from its high of 3.4 billion dollars in 2001 to less than 2.5 billion USD in 2003. At the end of this fall a new IT business cycle started, which STKI called the “market order V1.0”.

 The market order V1.0 that started in 2003 was characterized by heavy vendor consolidation as well as a market that grew from its low in 2003 to a peak of 4.3 billion USD in 2007 (over 70% growth in 4 years). During that time the IT services market moved towards consolidation in favor of larger local players (Matrix, Malam-Team, Ness, etc) and the IBM, HP, etc. (International Players). Although users of technology, between 2003 and 2008, were far more disciplined and did cut out the nonsense, IT growth was spurred by the booming Israeli economy and the new available technologies (standard servers, enterprise applications, etc.).

The economic slowdown starting in 2008 and hitting us hard in 2009 will accelerate the market transformation from market order v1.0 to market order v2.0.This market transformation of the Israeli IT market has already started, with market players preparing for a new landscape. What's different about this crisis is it's a capex (capital expenditure) crisis because it involves expenditures used to acquire or upgrade physical assets.

Today's credit crunch directly affects IT because, for many companies, technology is the No. 1 "capex" (capital expenditure) item. That means IT leaders need to pay more attention to financial metrics such as the weighted average cost of capital, or WACC. WACC measures the rate that a company is expected to pay to finance its assets (the higher the WACC, the higher the "hurdle rate" in a return-on-investment calculation, or the minimum rate of ROI that must be met to undertake a project).

The start of the new landscape is also about a negative growth rate regime, so the players need to innovate, leveraging the existing knowledge and align continuously to market opportunities. The economic slowdown will further increase and accelerate the need for Business Transformation (BT) IT Services in most Israeli Enterprises. These services include business intelligence, business process innovation, virtualization, social computing, mobile computing, Green IT, SOA, extended Internet (connecting the physical world to the digital world): all these are front and center on the agendas of large companies. Will many of these projects get cut back? Yes. But many are part of long-term company plans -- they will persist despite economic slowdowns.

Another metric getting scrutiny is payback period, not just about ROI, but what ROI can I get in the next 60 days. This will change not just what gets funded but also how you think about sequencing projects and which components you're going to launch first.

Companies will intensify their focus on goals they have pursued in the past few months but now they will break up projects into smaller components with deliverables every 3 months. They will be evaluating and possibly reducing the application portfolio by a certain percentage and eliminating redundant functionality.

Projects that show concrete cost reductions will take precedence over those that provide functional enhancements.

In market orderV2.0, the two ends of the outsourcing services market i.e. low-end services like support services and high-end services like Business Transformations (BT) services will undergo further consolidation. Low-end volume services, because of increased competition, will find margins coming down and larger players will acquire their counterparts, while at the same time accelerating their movement towards better margins and specialized Business Transformation (BT) IT Services in 2009. As the IT people who will run BT, vendors will be forced to engage in a discussion of process, customers, and operations, not only references to SOA, web services, and storage management. The client’s executive team will look at these BT vendors as legitimate partners in driving revenue, profit, and market share.

Market Order V2.0 will be an era of following dynamic strategy as any existing strategy will not remain effective for long and would need to be re-constructed. The economic slowdown will only accelerate this transformation, which would manifest itself in terms of cost savings, productivity enhancement and customer retention in the short run, giving way to new engagement and delivery models in the long run.

Technologies that can deliver near-term cost savings will remain in focus while the larger capital-intensive green investments with longer payback cycles will move down the priority list. On account of the slowdown the technologies that deliver significant cost savings such as virtualization, unified communications, open source etc. will see heightened interest and adoption by enterprises in 2009.

As the economic meltdown forces enterprises to consider new computing models that promise lower capital costs, such as cloud computing, which refers to a variety of techniques in which technology capabilities are provided as a service. Focus on reducing per-unit costs, such as cost per server, per terabyte of storage, per help desk ticket, per programmer or per line of code.

We should still investigate the economics of the cloud, including migration, transition and security costs, as well as the solvency of the vendors that offer it. Capex is not just affecting end users but also technology vendors.IT ‘Cloud Computing’ service offerings–including software as a service (SaaS), hosted delivery model will get tested and adopted on a small scale. The cloud model’s advantages of lower capital outlay and operating costs, coupled with the reassurance of more major players coming on board and building capabilities (including enabling and educating the channel), will encourage more customers at the margin to invest in cloud offerings. Enterprises which have been shying away (on account of issues of security, connectivity etc.) will be forced to re-evaluate the model. Organizations across verticals will evaluate different models with services delivered through the cloud, hosted and managed by suppliers (International IT vendors), Telecom Service Providers, Israeli System Integrators or pure hosting players.

As enterprises look at optimization technologies like virtualization, cloud computing and hosted delivery models, a key challenge will be information security. Keeping the entire data secure on the cloud while at the same time making it accessible remotely and addressing other vulnerabilities will force organizations to look at integrated security solutions. The heightened security risk perception will force enterprises to inspect Business Continuity services seriously. As a consequence, the Security Solutions space is expected to evolve and grow in 2009.

The channel space had undergone a shift during Market Order V1.0 (2003-08) with linear distribution models giving way to multiple types of channels. These multiple channels (like system integrators and ISVs) added more value to the technology adopted by the end user. Keeping the key attribute of ‘value addition’ intact newer forms of channels would emerge during Market Order V2.0, with the market transforming yet again. The key differentiator for the new channel forms will be their ‘services’ play as compared to the ‘product’ play of the past. This services play will occur around the emergence of ‘Cloud Computing’ technologies and the need for reliable hosting and delivery channels.


 “Unfortunately, generations of salespeople have been brought up with the notion that they create value by bringing in revenue…bringing in revenue means collecting value, not creating it. And that is not enough to survive in today’s competitive markets.”                              Source: McKinsey Quarterly

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