Cautious growth as economy slows

Last year saw the first significant growth in user IT spend since the turn of the millennium, according to the Computer Weekly IT Expenditure Report, produced by Kew Associates. But this looks likely to prove a false dawn. The rate of growth slackened off sharply in the last quarter and is projected to reach little more than half the 2004 level this year.

The situation today is exactly as we forecast it would be six months ago. In our analysis of the last report, we wrote that "This year is set to be the most prosperous for the UK IT industry since the end of the Y2K boom", and so it turned out to be.

This prediction did not require either rocket science or the clairvoyant skills of Nostradamus. There has been a close correlation between the rate of growth in user IT spend and the rate of national economic growth since the Expenditure Report started 11 years ago. UK gross domestic product (GDP) growth peaked at 3.5% in the middle of 2004 and has fallen since. This was forecast by both government analysts and independent experts and the consensus has proved correct.

Total annual spend on IT in 2004 came to £73bn, up 8.6% on the previous year. This was nearly twice the level of growth noted in 2003. The total was distorted by the massive NHS national programme for IT, but even without that the growth rate was 6%. At the same time, GDP rose well in excess of 3% in the first half of 2004 for the first time in four years.

The major growth in IT expenditure came in the middle of 2004, peaking during the third quarter. By the end of the year growth had slowed to 5.4%. Growth in IT expenditure is projected to rise by smaller amounts for the foreseeable future. Kew Associates is forecasting a rise of 5.3% over the whole of this year, about the same as that recorded in the last quarter of 2004. The company then expects growth to fall to 3.9% in 2006, in line with the Treasury forecast for a 0.5% fall in GDP in that year.

Many in the industry would prefer a sustained level of relatively moderate growth to a sudden short-term surge followed by a cut in spending. As Kris Wicka, managing director of Kew Associates, says, "Like the economy, user IT expenditure has had a record period of sustained growth. Over the coming few years it looks like more of the same. You will notice when it stops, so make the most of it."

Comments from those surveyed during the preparation of the report underline the correlation between business growth and IT expenditure. A business services company executive wrote, "The increase in IT expenditure reflects company growth this year. Next year there will be less dynamic growth." A less well-placed retailing respondent wrote, "This year's expenditure has been on necessities only. Next year I am hoping to be able to spend more on the niceties."

Across the board, after two years of low growth following the Y2K boom, 2004 proved a mini-boom year and is likely to be followed by two years of unspectacular growth. The increase enjoyed this year will not lead on to a return to the double-digit growth days of the late 1990s - we are unlikely to get back there for many years, if at all.

This is widely recognised. There is no sense of wellbeing among the organisations surveyed, or even of cautious optimism. Some are investing in new projects, but many organisations are still suffering from managements whose mindset is mired in the depths of recession.

One manufacturing company respondent wrote that the "directors' vision is to provide the cheapest IT service possible". Another reflected, "Cost reduction is uppermost in most things we do." A retailer noted a "reluctance to spend at all", and a local government official found that "as the costs fall there is increasing pressure to get more for less".

The rate of expenditure growth fell most sharply in the last quarter for large organisations, those with in excess of 500 employees. Expenditure on IT among these companies grew by 3.7% in the last quarter, just half the amount of the preceding three months. That slump reverses a trend of gradually increasing growth which had lasted for 18 months.

The rate of growth among smaller organisations was 8.5% in the fourth quarter, up from 8.1% in the third quarter, but still below the 9.7% of the second quarter. This ebb and flow in the rate of IT spend of small and medium-sized firms has been a consistent trend for the past three years .

Breaking down the overall spend by sectors shows that all types of organisation increased their IT expenditure in the last quarter by more or less the same amount. In the public sector growth was 5%, in services 5.7% and in production industries 5.1%.

The figure for the public sector, which fell from 8.8% in the third quarter, excludes the NHS national programme for IT: if it is included, growth in this sector would have been about 20% in the past three months. It was 15% over 2004 as a whole once the effect of this massive project was included.

The NHS project has a one-off effect on the numbers as the spending rises to a peak. For this reason, growth in this sector is projected to be much lower over the next two years - 5.3% in 2005 and just 2.7% in 2006.

The services sector is the biggest, accounting for about two-thirds of all IT expenditure. There is no change to the picture if the total is broken down into smaller components: all the major sub-groups within this sector also saw a slackening off of growth.

Over 2004 as a whole, growth in the services sector was just under 8%, taking the total spend to £50bn. It is projected to fall to under 6% this year and down to 4% in 2006.

In the production industries, the decline has brought an end an 18-month period during which growth has consistently risen. Growth was lowest in this sector over 2004 at just under 5% and is expected to shrink to about 3.5% both this year and next.

Production industries have been the most conservative. "IT is geared to support and maintain rather than develop," was a typical response from a manufacturing company respondent. Another believed "use of IT has now reached saturation".

A construction industry respondent wrote, "The industry is slow to use new technology and if it gets put on site, it gets stolen," adding ruefully, "In five years we may have a laptop on site connected to the internet."

Within IT budgets across all industries, outsourcing continued to prove very popular, with growth reaching 27%. This was closely followed by education and training, which was up by 25%, and online information services, which was up 21%.

Expenditure on actual IT equipment and software grew by much smaller amounts, if at all - expenditure on desktop and laptop PCs and data comms equipment declined.

Much expenditure on new hardware is considered unnecessary. Replacing Microsoft NT4 systems was a job being carried out by many organisations, but this was to get the systems up to date, rather than because of any perceived business benefit.

For example, one manufacturing company executive wrote of his grievance at "having to spend to keep up with software/hardware being unnecessarily developed". Another felt "Windows upgrades create more problems than they resolve".

A business services company respondent wrote that most new hardware costs were "incurred because of obsolescence rather than expansion", and an education sector response was, "We have to keep spending extortionate amounts of money on ever-changing hardware and software just to remain competitive."

One manufacturing company respondent was not merely groaning and bearing it, saying his company "will try to move from Microsoft to Linux for security reasons". But there are some still left who orient their prayer mats towards Redmond. A retailing respondent wrote that his firm's main system improvements were moving away from Unix to Windows "for increased flexibility".

Kew Associates' broad-brush IT expenditure categories conceal the real identity of many of the driving forces behind new IT investment. Compliance with government and other legislation is moving rapidly to the top of the agenda to judge from the anecdotal evidence.

One manufacturing company summarised the responses of many with the pithy comment, "Compliance issues drive specific investments." The US Sarbanes-Oxley legis-lation was specifically mentioned as a major driver by several respondents.

All the government respondents, national and local, emphasised the need to comply with e-government initiatives.

New projects listed by respondents included all the usual suspects: enterprise resource planning, customer relationship management and supply chain management, IT and voice convergence, mobile computing, web-based services and, perhaps more than any other, security and disaster recovery.

Storage area networks and other storage issues also feature, but less than one might expect, though doubtless many such developments are covered by the catch-all phrase "upgrading infrastructure".

But those organisations which have detailed project-oriented future investment plans were at least matched if not outnumbered by those that do not. One business services company respondent wrote that IT expenditure was driven by "necessity - if it breaks, fix it - if it runs out, get more".

Staffing was causing no significant cost concerns at all and was barely mentioned in the individual responses. The construction company respondent who wrote saying the organisation's major focus was on "staff training and retention" was a lone voice. For the record, overall expenditure on staff rose 6% during 2004. The average expenditure per IT staff member employed was £87,500.



How the report was produced

Information on total IT spending is collected annually from more than 60,000 UK IT budget holders on Computer Weekly's circulation list. This is supplemented by more detailed IT spending information from more than 5,500 budget holders surveyed each year.

Additional information is sourced from the Office of National Statistics and the Treasury. The Cambridge Econometrics model of the UK economy is used to forecast growth variations between industry sectors.



How to buy the report

The spring 2005 edition of the Computer Weekly UK IT Expenditure Report, produced by Kew Associates, is available this month for £2,500. For more information, e-mail Georgina Tucker.

georgina.tucker@rbi.co.uk