Thursday, 14 August 2008

GDP, inflation, IT services growth and all that

I’ve had some very interesting responses to my footnote to the Logica piece yesterday where I explained that GDP was a real growth number which excluded the effects of inflation. Therefore, if you compare this to SITS growth, you should exclude inflation in the comparison here too.

To answer some of the points:

1 – We've had high inflation and recessions before
Obviously a lot of HotViews readers are either young or have short memories. Unfortunately I can remember 1976 when inflation reached 24%. GDP growth that year was ‘only’ 2.8%. SITS growth was 32% but ‘only’ 8% in real terms. In 1980, we had a real recession. GDP fell 2.1%. Inflation was an equally mind-boggling 17%. But SITS managed a 10% growth in real terms as we all got hyped up about micro computers and the impending launch of the IBM PC.

2 – Will headline growth rate go negative?
I think what CEOs are most worried about is, as one said in an email, “a sudden nosedive in the absolute size of the IT services market a la 2002 and whether we will start to decline in absolute terms in revenue putting intolerable pressure on margin”.

Since I started in IT, I have only known one year when the headline SITS growth turned negative – that was 2002. We got very close to it 1971-1973 and 1991-1992 but it never turned negative.

Currently I am NOT forecasting a decline at the headline level in 2009. Indeed I am forecasting a 2% headline growth in UK SITS. But that equates to a decline of 2% in real terms as I explained yesterday.

The problem is that when you are playing with such low figures as this, margins can still be eroded which is why cost control (which inevitably means wage control) is key. Moving more work offshore is one solution but I would caution that wage inflation is currently very high in India too.

3 - Recession in Euroland
Today, it was announced that Europe's GDP shrank 0.2% in Q2, after growing 0.7% in Q1. The German economy, Europe's largest, contracted for the first time in almost four years and France also fell by 0.3%.

"We expect the euro zone to move into an outright recession,'" said Ian Stannard of BNP Paribas. "We see a multi-year euro downtrend now developing”.

It would be incredible if the UK avoided recession if mainland Europe is suffering like this. I’ve only lived through three recessions in my working life – 1974/75, 1980/81 and 1991. As I have said above, the UK SITS sector avoided recession in those years. Firstly, because it was very small in the early years and was not ‘significant’ in the economy. Secondly, there were major tech drivers – the launch of the PC - in the early 1980s which meant that IT grew despite the economic downturn.

Now things are very different. Tech is ‘core’ and ‘significant’ to the economy. If you include all of tech – SITS, hardware, consumer tech and telecomms (fixed and mobile) – it’s c10% of UK GDP. SITS alone is c4% of GDP. If there is a general economic downturn, SITS will be affected and growth is bound to slow. However, if it offers customers real savings, it might well avoid outright recession.

4 – Anywhere to hide?
I think today’s news from the Euro zone indicates that there isn’t going to be a ‘safe haven’ anywhere in the Western World – not the UK, not the USA, not mainland Europe. So, although when Andy Green says (as he did on the Radio 4’s Today programme) that one of Logica’s strengths is that it only gets 20% of its revenues from the UK (true) it is also significantly exposed to France and Germany (both currently recording GDP declines)

Conclusion

If I can offer just one lesson learnt from previous downturns, it is that our industry always seems to ‘Live in Denial’ when faced with a slowdown. “It will not affect IT”, “It will be short-lived”, “Let’s wait until the end of the month, quarter, year before we take any cost-cutting action”.

UK SITS is facing a downturn. I think you should prepare for no growth in 2009. That means not taking on extra office space, big capital expenditure, lots of new staff etc. Look at ways of reducing your main staff costs. Layoffs are not the only solution. More flexible working (3 days rather than 5), voluntary salary cuts, more performance-related pay. Obviously contractors can be viewed in two ways. Why pay a contractor if you have permanent staff on the bench? Contractors can be very useful in avoiding permanent staff recruitment – but in today’s environment negotiate hard. Ask your existing contractors for a 25% fee rate cut or will go out for re-tender.

Tough times requires tough actions.

1 comment:

Ya-Habibi said...

Richard, I understand that inflation has a major role in the headline growth, but I think Andy Green has exactly the same view as many of us who believe that there will be recession in the near future (maybe towards the end of this year). What is your view on this? Do you think companies like Logica will benefit from negative GDP?