IT Value Chain Analysis - Where are the Profits Heading?
Q309 IT Vendor Operating Income Rebounds Broadly in Most Sectors Q409 to Fall Short of Q42007 Peak
Q209 IT Vendor Operating Income was -7% vs. Q308 - better than the Q2 comparison (-15%), but -3% less than predicted. Most product segments did better than expected, with Comm HW and MPU doing the best vs. expectation. Software and Services were lighter than predicted.
Q409 income will beat Q408 by +10% - on the back of cost cutting (revenues will be about the same). Q110 income will be +19% greater than the disastrous Q109. But at some point we need some revenue growth to sustain the profit recovery.
Value Migration is still accelerating in Consumer Devices. The Services bump we saw in early 2009 declined in Q3, and appears to be regressing towards the mean. The Software decline was a function of Oracle's Q1 results, but gives one pause. Pay close attention to their Dec 16 report (especially the New Applications Software line) to get a picture of how Software is doing. There are broader implications of these numbers: New Apps correlates with new project and services spending so it will be an important early predictor of Services spending trends (as will Accenture's report on Dec 17).
Q209 IT Vendor Operating Income Rebounds on Back of Software Expect a Q409 Rebound Close to Q42007 Peak
Q209 IT Vendor Operating Income was -16% vs. Q208 - but it was higher than predicted. Most product segments did better than expected, with Software doing the best vs. expectation.
Q309 will trail Q308 by -5%, which is a marked improvement to the Q2 comparison. Expect Q409 operating income to increase by 12% over Q408. Layoffs and other cost-cutting appears to have done the trick. The removal of Sun, Nortel, and Bearingpoint from the calculations (well...it works for the DJIA folks) also has helped present a slightly more positive income picture.
While Wall Street will love the coming improvements in profit, its still not clear when revenue/spending growth will show up. Early Q3 revenue reports still present a weak picture. IBM's Q3 report will be a key indicator of the way the wind is blowing on spending.
Q109 IT Vendor Operating Income Dives to 2006 Levels But Expect a Q409 Rebound Close to Q42007 Peak
Its no surprise that Q109's IT Vendor Operating Income dipped to early 2007 levels. The model expects a rapid recovery to near peak levels by Q409. Watch this indicator to see just how robust this recovery will be.
IT Value Chain Analysis - Where are the Profits Heading?
Summary of Six Years of Data
IT Industry Value Continues Migration to Software, Mobility, and the Internet
IT Services Reviving (2001 Redux?)
Hardware (Across the Board) Losing Value Share
The IT Industry has experienced waves of value creation over the decades from mainframes to mid-range systems to PCs to software to the Internet.Its vital for technology vendors to plan where to focus their investments and partnerships over time – “skating to where the puck will be”.
There are a number of potential ways to measure “value” in the value chain – one being the amount of profit each component realizes from the market (basically the marketplace’s vote on what’s valuable enough to pay a premium for).
The graphic above captures the recent value migration trend vs. a view of the past 5 years. The size of the circles reflects the relative size (in revenue) of the sector.
Value Migration in 2008
In 2008, we saw an acceleration of the long term value migration towards Consumer Devices (basically handhelds) and the Web. RIM and Apple are the leaders in this sector. On the other hand, Servers & Storage value decelerated dramatically in 2008 - perhaps a function of virtualization and a late 2008 capital spending pullback. PCs and Comm Equipment maintained their steady declining value positions in 2008.
Software hit a bump in 2008 after 5 years of steady value growth. IT Services continued its steady pace of value growth in 2008. Business Services long term value growth has been low and steady - but popped up in 2008. Printers maintained its historically low value growth into 2008.
The 2008 data underscores the underlying value migration trend towards widespread mobility and connection. Infrastructure value continues to drag. Software and IT Services continue to hold value share.
Expect these trend to continue into 2009. So far in 2009, Servers &Storage have been noticably weak (and will get weaker with the Sun acquisition), with Consumer Devices looking stronger (positive RIM and iPhone results). Competitors should review their portfolios to ensure they are positioned to capture their share of the evolving high value sectors of the IT industry while reducing their dependence on lower value segments.
Ralph Finos Consulting Approach to IT Value Migration Tracking
The approach proposed by Ralph Finos Consulting is to track the profits earned by leading IT industry suppliers representing different IT industry product and services sectors.We elected to track operating income as the best measure of the value of the technology or service itself.Tracking multiple companies in the aggregate within a technology sector will balance the effects of excellent, average, and poor performers.The key measure is the gain or loss of share of overall operating income for the technology industry captured by each product or service segment vs. the other product and service segments in the model.
For the purposes of this analysis, we’ve selected Operating Income as the measure of “Value”. We’ve elected to focus on North American – based companies to avoid currency and local business issues.Given that all major IT industry technologies and services are developed and marketed by major North American-based companies – and that nearly all the acknowledged global leaders are based in the region, we believe this is probably a decent proxy for value capture and migration for the worldwide market at large.
The approach is to establish a representative sample of leading vendors in each of the technology sectors that make up the value chain.We simply record the quarterly Operating Income for each vendor which becomes (after weighting) the value measure for each technology. The trends can be forecasted to provide a view of what's coming next.
While the structure of the Hardware, Software, and Services’ industries are all different – one can monitor the gains and losses of each segment vs. the other segments to gauge where the value appears to be migrating.So, every technology can be gaining (or losing) in income – but some will be gaining (or losing) more at the expense (or for the benefit of others).The growth or decline in therelative share of the income pie is what we’re looking at.
One can argue that with the category assignments, choice of vendors, the operating income metric – but its our belief that the trend lines point us to a better understanding of value migration.We’ll be reporting the data every quarter – with a forecast of share.
There are many obvious challenges to such an approach – successful execution in financial management, technology development, partners and channel strategy, target markets, and many other strategic and execution considerations.Moreover, the measurement process itself is challenged by weighing the impact of mergers and acquisitions, currency fluctuations, and different vendor product and service definitions (as well as financial reporting structures), among other factors.Over a long period of time, the technology/service market can become moribund and a vendor or category could disappear – or be transformed within some other segment.
The measurement of value migration is a process of estimation, at best. However, this analysis can reveal important trends on the most important financial metric that can serve as a marker for Executives and Strategy Planners who are looking over the horizon at “What’s Next?”
Examples of the Companies in the model are listed below.
Examples of Companies by Category
2003 The Value Migration model is based on Quarterly operating margin data from ~100 companies and business units in the IT market. Combined they account for ~$750B in annual revenue.