IT growth builds to a peak

2004 is set to be the most prosperous for the UK IT industry since the end of the Y2K boom, with user spend projected to rise 9% above the 2003 level. But enjoy it while it lasts, as growth in spending is expected to drop back to the more modest levels of 4-5% in 2005 and subsequent years as users seek value for money from IT

IT spending will rise this year by its highest margin since Y2K. But cash in now, as 2005 may see that rise cut in half. We analyse the Computer Weekly IT Expenditure Report.

This year is set to be the most prosperous for the UK IT industry since the end of the Y2K boom, with user spend projected to rise 9% above the 2003 level. Enjoy it while it lasts - users are set to cut growth in spending back to the more modest levels of 4% to 5% in 2005 and subsequent years, and are generally much more determined to obtain value for money from IT than in the past.

The Computer Weekly IT Expenditure Report, produced by Kew Associates, is forecasting that user spend in the UK this year will total £71.7bn, a bigger increase on last year's £65.8bn than was expected six months ago. This increase has coincided with, and is probably largely a result of, a boom in the national economy. GDP rose well in excess of 3% in the first half of 2004 for the first time in four years.

The increase in IT spend is larger than over the past four years, and is more than double that recorded in 2003 and 2002. Nonetheless, we are nowhere near the double-digit growth of the late 1990s, and are unlikely to be for the foreseeable future.

"Mid-2004 looks likely to be the peak," says Kris Wicka, managing director of Kew Associates. He says user IT expenditure has shown a strong correlation with the national economy since the survey started 10 years ago, but adds, "GDP is currently at 3.7%, but is projected to fall to 3.3% in the second half of 2004, and then further down to 2.6% next year."

Another reason for taking a cautious view of the future is that the increase in IT spend is smaller relative to GDP than it has been in the past. Until the third quarter of 2002, national IT spend grew typically about three and a half times faster than GDP.

But "something happened two years ago," says Wicka. The ratio between the increase in IT spend and the increase in GDP fell to 2:1 in the third quarter of 2002, and has remained at this lower level ever since.

That is now eight consecutive quarters, which suggests some kind of permanent sea change in the economy. If so, no one has been able to identify exactly what caused it. Wicka himself has no explanation, and says his enquiries at the Treasury and the Office of National Statistics have drawn a blank.

The straightforward meaning of this rather esoteric statistical change is that organisations are having to spend less on IT to achieve the same growth rates. Progress requires less investment in IT than it did.

This is true at both macroeconomic and microeconomic levels. The ratio between total IT spend and GDP shows that the UK economy as a whole is obtaining growth for a smaller outlay on IT. This is graphically illustrated in the annual growth by quarter graphs.

Exactly the same graphical picture emerges if you compare IT spend with productivity per company, and with profitability per company. Organisations are individually achieving a given rate of growth for a smaller IT outlay, as well as collectively. As Wicka says, "Companies have become more profitable without the need for a proportionate increase in IT outlay."

However, there is no such change in pattern when UK IT spending growth is compared with job growth. According to Wicka, "There is no hiccup from mid-2002 as seen before. The pattern suggests that, for the economy as a whole, IT does not destroy jobs."

Despite the overall growth in IT expenditure, there is plenty of anecdotal evidence to suggest the purse strings are still kept fairly tight in many organisations. One respondent to the Computer Weekly survey, who works in an engineering company, says, "Money is allocated on a 'need to buy' basis - it is reluctantly given."

Another, working in a services company, says, "We need to make a large investment in a site-wide hardware and software upgrade, but are unable to commit the funds."

The number of organisations where life has got easier is much smaller. One respondent who works for a financial institution says, "Cost reduction has been prevalent over the past two years. There is less pressure now and a backlog of projects needs to be overcome."

This response was untypical. Growth occurs because organisations feel they need to spend the money, not because they want to.

The report shows that actual IT expenditure growth in the UK was 4.7% in the first three months of 2004, and then rose sharply to 6.6% in the second quarter. The second quarter growth was fuelled by small and medium-sized enterprises with less than 500 employees. They increased expenditure by more than twice as much as larger concerns in the second quarter, 9.7% against 4.8%.

Spending by smaller companies is more erratic than larger companies, and the differential in the first quarter was much smaller (5.2% against 4.6%). According to Wicka, "A current feature of the SME market is the quarterly cycle of accelerating and decelerating growths. This is now in its third year."

Large companies have increased their growth in expenditure in each of the past four quarters, and the 4.8% figure recorded in the second quarter is the highest since the third quarter of 2001.

The boom area for IT spending is services. Users will be shelling out £24bn this year, 19% more than in 2003. Services include many different areas of expenditure. Online information services are the biggest growth area, with expenditure up by more than a quarter on last year. Outsourcing also remains a boom area, with expenditure up by 21%.

Users are investing in getting the most out of their staff, with the outlay on training and education up by 25%. That compares with an increase in expenditure on staff salaries of just 6%. Organisations are looking to get as much as possible out of the staff they have before recruiting more.

Expenditure on software has also shown a healthy rise - by 8.5% to £9.6bn. Outlay has risen most on development tools (11%) and custom software (10%), suggesting again that users are concentrating on exploiting what they have more fully before investing in new infrastructure.

Hardware remains a larger expenditure element than software at £13.8bn, but the annual spend has actually declined for the fourth year in succession. This is down to spending less on desktop and laptop PCs. Spending on servers of all types has increased, with non-PC, non-Unix servers showing the biggest growth rate - up by 6%.

The biggest growth this year has been in the public sector, where spending has risen 14.3% to £12.8bn. Two factors have combined to bring this about: the acceleration in healthcare spending via the national programme for IT in the NHS, and the drive to make local government services available electronically.

The NHS project is sufficiently large to make an impact on the overall UK picture. According to Wicka, "It accounts for just over 2% of the 9% overall growth: it would have been 6.6% without it."

In the private sector, services companies are continuing to increase their investment in IT. The projected growth rate of 8.9% for 2004 will lift the total spending of the sector to £45.4bn. Manufacturing and construction companies are lagging behind, with growth this year projected to be less than 5%.

What do users feel they are getting out of all this investment? Increased productivity is the biggest payback in the services and public sectors, and all sectors also see improved quality as a major payback.

Among the grouses respondents mention in the survey, the commonest are "the whims of Bill Gates", as one respondent puts it. One finance user says, "Microsoft changes stuff too often." Another is more specific, "More employees means more PCs, but 95% could make do with Win95 and Office 95 - but we cannot get these. It is unnecessarily increasing our costs for no increase in productivity."

One respondent tries to avoid these increased costs, "Microsoft's 'lock-in' licensing fees are pushing us down the open-source route," he says.

How the report was produced

Information about 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.

The autumn 2004 edition of the Computer Weekly UK IT Expenditure Report was produced by Kew Associates.

Read more on IT governance