For reasons I don’t quite understand, I am often being asked the following question by clients, employees, family members, VCs, industry analysts, press contacts, and valets parking my car:

When is the economy going to get better?

My first answer is, I don’t know.  I’m not an economist and I doubt I’d know even if I were. 

It doesn’t appear to me that the global or national economies are in that bad shape, at least relative to long-term historical comparisons.  But I realize that in the Silicon Valley, the question isn’t really about the global economy or the national economy.  It’s about the state of health of the high tech economy.  And high tech is surely in a deep depression. 

So when is that going to get better?  Although I don’t have a complete answer to that, I do have some ways to try to get some insight.

Over the past several months I’ve been talking to lots of CIOs and CIO direct reports.  My primary objective was not to perform a survey about the high tech economy.  Instead, my motivation was to get back in touch with end-user thinking after a couple of years of drifting into projects with companies that were focused on selling to service providers or to other technology companies.  If you do that long enough, you can lose track of the real world.

So for several months I went on a CIO-a-day diet in order to learn more information specifically related to a sequence of storage networking, data management, wireless, and web site acceleration projects I was working on.  But in the process, I gained a lot of more general insights as well.

I went into the process assuming everyone I talked to would be frazzled and stressed out.  The most surprising observation I made was the enterprise IT people I talked to were more comfortable and happy than they were a couple of years ago when I last took a similar pulse check.  In this era of slashed budgets, I wondered how that could be.  I eventually started asking that question directly.  What I learned is this: as budgets have been cut, the expectation of IT quality-of-service has also been dramatically cut.  Now, when there is a problem, people don’t scream and rage at IT any more, but are actually grateful and supportive of any IT help they get.   

Furthermore, it takes a lot more energy to start something new than to maintain something that already exists.  With the budget cutbacks, there are a lot fewer new IT projects being launched.  Not that IT is standing still.  A lot of effort is going into managing what they already have better, squeezing more out of it, addressing those nagging issues they just didn’t have time to get to before, or just making it work for the first time – basically cleaning house (more on that next month).   And they are doing this with a higher quality of people who are experienced and well-trained because the brain-drain march of people to vendors and service providers has reversed direction.

Some new projects are being launched, but enterprise America is being very selective about where it’s focusing new project resources.  Three areas kept coming up: application integration (generally for supply chain automation), storage/data management, and security.  Supply chain and data management because these are two areas where the ROI of the application of state-of-the-art technology is large and proven.  Security because of 9/11 and the economic impact of application down-time due to external attack.  These areas overlap a bit as much of the data management activity is about ensuring disaster recovery should a data center go down – either due to attack, “acts of God,” or “acts of software developers,” i.e. bugs.

Towards the end of the summer and into the early fall, enterprises will start their annual budgeting cycle process.  The amount of money they plan to spend next year will depend on how confident they feel in their business overall, and the world economic/political situation as a whole. The slice of the budget allocated to IT will depend on the necessity of such spending as related to short-term business initiatives.  Personally, I don’t expect enterprises to be all that bullish about their 2003 prospects and I don’t expect them to substantially shift their percentage spending on IT much, largely because in 2002 they’ve survived previous IT budgets cuts just fine.  In other words, I wouldn’t expect enterprise America to be pouring any more dollars into the high tech industry (both products and services) in 2003 than it is in 2002.   

And since service providers are largely fueled by business from enterprise America, I don’t expect them to ramp up their expenditures in infrastructure, either. In fact, they may need to cut back as they try to recover to some reasonably profitable state after having gone through a frenzied period of investment to attract new revenues that has been essentially a total failure. 

At the macro level, business cycles come and go.  It is fairly easy to predict the US economy and the stock market picking up in 2003, partly due to improved business fundamentals.  But it’s probably more so due to people developing a thicker skin to bad news and actively looking for the new growth emerging from the devastation of the wild fire.  In response to that, I could see IT budgets tweaking up in the 2004 budget year, which will help to add some strength to the financials of those who benefit from IT spending, and some reality to the renewed hopes of the investment community. 

But don’t get too excited.  Whenever things do improve, it doesn’t necessarily mean that consumption of the brightest and shiniest new technical thingies will immediately increase.  I expect that after 2-3 years of diminished spending, the initial wave of released IT dollars will go towards new and improved versions of established product categories (servers, routers, switches, databases, applications, desktop PCs and software, storage subsystems) bought from established vendors to refresh the infrastructure.   In other words, I think the so-called technology blue chip category leaders (e.g. Cisco, Microsoft, Intel, EMC, Oracle, SAP) will be the first to see and experience the benefits of the future IT budget expansion. 

After that, as people feel more comfortable about their core infrastructure and can free up some time to look at new things, the appetite for more inventive and disruptive options will ramp up again.  But this could be 2005 or even later.

For start-up companies, this is not a very rosy picture.  For start-up high tech companies for the next couple of years, the facts are:

• A very high number will fail, just due to running out of capital.
   

• The rest will fall into two categories:

o    Thrivers: Those that find a niche the big vendors are not filling and fulfill a major need in the enterprise.  Examples will be few and far between, but they may include storage/data management of various forms, application-savvy security, efficient data import/export/transformation to help glue islands of applications together to form “meta-applications,” or things that significantly reduce IT capital and management costs.

 

o    Survivors: Those that by design or luck essentially fulfill an extended R&D function for one or more of the established category leader vendors (whether they know they are doing this or not).  This includes essentially all semiconductor and optical components companies, but also many software and systems companies whose only real path to getting to the customers is by teaming with a company with an established channel.  These aren’t my favorite kind of companies, but there is old saying “to succeed you must survive.”

Overall, however, I can see why a lot of VCs are either getting out of the business or are starting to look more closely at biotech and other non-IT investments.  For Acuitive, however, IT-related stuff is what we do and what we know.  Luckily we benefited enough from the previous positive cycle to give us staying power through the down times.  So we’ll continue to be looking to help as many start-ups as possible fall into the Thriver and Survivor categories.