European markets will see no real upturn until '03

Andrew Bartels

Giga believes IT spending in Europe showed no change (when measured in euros) between the first and second quarters of 2002, in contrast to the US and North American experience, where there was modest growth. We expect that trend to continue in the third quarter of 2002 before IT spending picks up slightly in the fourth quarter, driven largely by the seasonal pattern of higher vendor sales in the fourth fiscal quarter for leading European vendors like SAP.

As a result, we expect IT spending on hardware, software and services by European enterprises will be up just 1 percent in the second half of 2002 compared to the first half of the year, and down about 6 percent from second half 2001. European companies don’t face as much of the depressing effect of CEO-distracted-by-financial-and audit-issues as US companies do. But, they operate in a weaker economic environment (European 2002 GDP growth is projected at one percent to 1.5 percent, vs. 3.8 percent for the US) with little forward momentum in European IT spending.

European IT budgets won’t be down as much as IT spending, since continental European companies are constrained in laying off or reducing the salaries of IT staff. As a result of this forecast, we expect continued tough times for IT vendors, but also see opportunities for European IT buyers with courage to get good bargains on IT products and services.

To estimate European IT budgets and spending, Giga is increasingly relying on IT vendor revenues in the absence of the kind of official data on business investment in technology that the US Commerce Department publishes. Recent research comparing IT vendors’ North American revenues with US macroeconomic data suggests there is a reasonable correlation between these two measures gives us confidence that our IT vendor index is a good indicator of overall IT spending.

Giga’s estimates for the European revenues of 20 leading IT vendors during the past five quarters (see Table 1) show little change from first to second quarter 2002. Both quarters are down from 2001 levels, especially for network equipment and computers and peripheral equipment. We are forecasting that European revenues of computer equipment and software vendors will be fractionally lower in the third quarter, then come up a bit in the fourth quarter, reflecting

seasonal deal patterns. Any increase will be small, though, since "making do with what we have" is still a common approach. European revenues of IT services have been flat for the past year and we expect that trend to continue.

However, the mix of IT services will change, with strategic and integration consulting down and IT outsourcing and business process outsourcing growing. European revenues for network equipment vendors have been steadily declining over the past year but we expect small increases in the second half. As a result, we think European revenues of IT vendors – and IT spending by European enterprises – will be generally flat in the rest of 2002, with second half revenues just 1 percent or so higher than first half.

IT spending will have to wait until 2003. This is consistent with SoundView/Giga surveys of Giga clients at GWITF Europe in June 2002, which showed some back-loading of IT budgets into the second half, more companies reducing than increasing IT budgets since the start of the year.

We don’t yet have the data sources to estimate total European IT budgets and spending, although the European Information Technology Observatory (www.eito.com) shows promise. However, we can now start to make some estimates of trends. Table 2 (below) shows our forecasts for second half 2002 IT spending by category of IT budgets compared with the same period in 2001, and for full year 2002 vs. 2001.

Compared with 2001, we expect European spending on computers and peripheral equipment will be down 2 percent in the second half of 2002 and down 4 percent for the year. We expect software spending will be up 8 percent for the second half of 2002 and 6 percent for the year. But remember, the Sept. 11 events depressed IT spending in the second half of 2001 in Europe as well as the US. We expect spending on IT services will remain flat, if just 1 percent growth, and we expect investment in network equipment will remain below last year levels (though by lesser degrees) due to troubles in the telecom industry.

We think spending by European companies on salaries and benefits for IT staff will be up by 2 percent to 3 percent, reflecting a general 3.3 percent rise in European employee earnings, offset by some layoffs in the UK and some other European countries (although challenges in laying off staff in other continental European countries limit the scope of IT employment reductions).

Our recommendations are the same as those we provided for North American clients. For IT vendors, this analysis points to a continued difficult selling environment in Europe, with limited growth potential for the remainder of this year and no real pick-up until 2003. For European IT buyers, a mixture of caution and opportunism is warranted. Difficult times for IT vendors increase the risk of vendor failures at worst, or of cutbacks by vendors in new innovations, marginal products and service and support.

It is important to stay on top of the financial condition of key IT providers, watch for indications of problems (such as deteriorating service) and have contingency plans in place. In general, though, and apart from the telecom industry, IT vendors are not hurting so badly that the risks of vendor failures are up dramatically. Instead, IT vendors are much more likely to be willing to make deals to close business, so this is good time to buy what you need in the way of IT products and services.