Suppliers are dropping their rates and cutting profit margins to the bone, in a bid to survive the after-effects of the post-y2k downturn and dotcom collapse, research by a leading firm of analysts reveals.
With only a slow recovery likely in 2003, IT directors can look forward to cut-throat competition among suppliers that will keep prices low for some time to come, Ovum Holway's Industry Trends 2002 survey shows.
Its findings dash hopes of a recovery this year in the IT market, which has been predicted by other recent surveys.
"There has never been a better time to negotiate a good deal with suppliers. Certainly from a services point of view, demand has gone down, fee rates have gone down and margins have gone down. The suppliers are really hurting, which means that users are in the strongest position to write a good deal," said research manager Anthony Miller.
The Ovum Holway report shows that operating margins for the IT supplier industry have plummeted from 7.2% in 1998 into negative figures this year. Although margins are expected to become positive again in 2003 they will never recover to the levels of the 1990s.
This added pressure is forcing some suppliers to cut margins below commercially acceptable levels. Many are likely to go out of business, or be forced to merge to survive, creating new risks for IT directors.
"Users need to take an inventory of their IT suppliers and prioritise them in terms of mission criticality. It could turn out that the weak link in the chain is some small software company that they cannot manage without," said Miller.
Escrow agreements, which provide customers with access to the source code and the complete software documentation if suppliers do go under, will become increasingly important as conditions for suppliers continue to be difficult.
Despite the opportunities for good deals, there are also dangers. Driving prices down too far could be counterproductive, said David Rippon, chairman of the Elite group of IT directors.
"You might get one good deal but at the expense of support later on. If you are talking about a small supplier that is struggling to keep its head above water, the last thing you want to do is push them under," Rippon said.
Many IT departments are likely to switch to the larger suppliers, despite facing higher charges, rather than risk placing work with smaller companies that may be financially less secure.
The downturn is largely the result of a sharp fall in spending on new IT projects, following the excesses of y2k and the dotcom boom. IT departments are finding their budgets under pressure and company boards are less willing to believe suppliers' claims.
They will only invest in systems that generate clear cost savings. They are saying make do and mend, said Miller.
IT spending has adjusted to a new level and will not increase significantly in the coming years. "The days of champagne and caviar are well and truly over - now it's time for the bubble and squeak," said Miller.
Rise and fall of the UK IT supplier industry
1998: y2k and the dotcom frenzy push spending by IT users to an all-time high
2000: Suppliers spend £16bn buying e-consultancies at inflated prices. Stock market valuations of the sector rocket to £88bn. Eight suppliers are listed on the FTSE indexes
2001: The number of IT suppliers listed on the London Stock Exchange reaches a record peak of 38 before the dotcom bubble bursts. IT users rein in their spending. Suppliers start cutting jobs and spending on take-overs falls by half
2002: The stock market valuation of the IT sector plummets by 84% to £14bn. Only two suppliers are left on the FTSE indexes. The number listed on the London Stock Exchange falls from 38 to 28
2003: Signs of a slow recovery in IT spending are expected but the heights of the late 1990s will not be seen again.