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Tech's Mixed Signals


It's enough to give technology investors whiplash. On Apr. 14, IBM (IBM) shocked the market by announcing disappointing earnings, which knocked its stock down 6%. The news, coupled with poor results at computer maker Sun Microsystems (SUNW), consumer electronics and semiconductor giant Samsung Electronics, and software supplier Siebel Systems (SEBL), left investors and economists alike wondering if demand for tech products had unexpectedly hit a wall. Even mighty Dell Inc. (DELL) warned that large customers were delaying purchases. Yet, lo and behold, on Apr. 19 the stock of EMC Corp. (EMC) zoomed 11% after the computer-storage leader reported better-than-expected earnings. Shares of chipmakers Texas Instruments Inc. (TXN) and Intel Corp. (INTC) also jumped after upbeat earnings reports.

What gives? Blame a whole lot of change coming simultaneously -- and plunging the tech business into a state of high anxiety and uncertainty. Part of the problem is an economy that can't decide where it's going, prompting risk-averse corporate buyers to snap their pocketbooks shut at the mere hint of a slowdown. But the bigger reason behind this bundle of contradictions is a confluence of technological shifts.

New generations of chips, open-source software such as Linux, and the pervasive, always-on connections of the Internet and wireless devices are hitting the market at once. They're providing vast new opportunities, both for upstarts such as Linux supplier Red Hat (RHAT) and well-positioned established players such as Intel and EMC. But in many markets they are also a fearsome deflationary force that is disrupting some established suppliers, such as Sun and Siebel, dependent on high-margin products to thrive.

Put it all together, and there's a new scramble for leadership and, in some cases, even survival in the economy's most dynamic sector. If history holds, the acceleration of lower-cost technology ultimately should boost demand by opening vast new applications that are suddenly economical. But as cheaper products hit the market en masse, the short-term result could be slower revenue growth: Market watcher IDC forecasts only 6% industry growth, on average, from 2005 to 2008 -- way under the 10% annual rate of the 1990s. So tech companies will have to run faster than ever just to stay in place. Says BellSouth Corp.'s (BLS) chief technology officer, Bill Smith: "The tech market is incredibly competitive, more so than it probably has ever been."

HANDHELDS ARE HOPPING

The most immediate reason is the economy. Rising oil prices and interest rates have corporate tech buyers worried anew that the U.S. recovery is faltering. As a result, some are slapping a hold on big tech purchases. After spending out their information-technology budgets in the fourth quarter of last year, U.S. tech buyers are now underspending budgets in the first quarter by 3.7% compared with a year ago, according to a running survey by market watcher Gartner Inc. (IT) And with high energy costs and the strong euro combining to sap growth in key economies such as Germany and France, tech companies aren't finding much salvation overseas, either. Although strong consumer demand led European PC sales to surge 15% in the first quarter, Forrester Research Inc. projects that business tech spending there will rise only 3% this year.

All that's hitting some tech suppliers with surprising speed. IBM, for instance, blamed problems closing some services deals in late March, especially in Europe, for its tepid 3% rise in sales, to $22.9 billion. IBM has performed well in recent years by building up in that area, including a recent 40% jump in revenues, to $900 million, from its new business-transformation services. Such contracts, though, are susceptible to sudden shifts in demand. Even buyers who aren't yet cutting back are keeping their eyes open. Robert P. DeRodes, chief information officer at Home Depot Inc. (HD), still plans to up his tech spending by at least 9% this year but concedes that "technology is always one of those things you can put off for a little bit."

Those who are buying aren't necessarily buying the same old stuff. That's slashing demand for some companies while boosting revenues for others. Portable wireless gadgets such as BlackBerrys and cell phones are helping the likes of Qualcomm, Research in Motion, TI, Motorola, (MOT) and disk-drive maker Seagate Technology. "Instead of a laptop, some people are asking for a BlackBerry," says Paul Douglas, chief information officer at Aon Corp. (AOC)

Indeed, through much of the sector, there are plenty of signs of strength -- especially at companies that cater to consumers. On Apr. 13, Apple Computer Inc. (AAPL)reported that its sales shot up 70%, to $3.2 billion, in its March quarter, thanks to skyrocketing demand for its iPod music player and new Macintosh PCs. Intel reported that its first-quarter profits jumped 25%, to $1.2 billion, on a 17% rise in sales, to $9.4 billion, partly owing to strong sales of chips for cell phones and other portable devices. "Demand is real," said Chief Financial Officer Andy D. Bryant.

Still, beyond the vagaries of the economy, there's a common thread that's starting to emerge: the long-awaited arrival of computing on demand. New hardware, software, networking gear, and wireless devices are being woven together by the connective power of the Internet into a potent, upsetting force. "We're in a period of the most concentrated technology change yet," says Mark Stahlman, an analyst at investment bank Caris & Co.

ONLINE ADVANTAGE

Well-positioned companies stand to reap the profits of this shift to more mobile, less expensive gear, while others are increasingly vulnerable. The difference is starkly apparent in the tech mainstay of computer hardware. New microprocessor chips from Intel and Advanced Micro Devices Inc. are giving servers such as inch-high machines called "blades" -- sold by IBM, Hewlett-Packard, Sun, and others -- the power that million-dollar mainframes used to have. IDC expects sales of blade servers to jump 67% this year, to $2 billion. Yet these $3,000-and-up machines are a double-edged sword for many technology suppliers. Sun, for instance, has seen tremendous growth of cheap servers based on Intel or AMD chips and Linux software -- but their low prices mean that big boosts in unit sales aren't matched by revenue gains. In Sun's most recent quarter, sales fell 1%, to $2.6 billion.

One company's struggles, however, are another's opportunity. EMC saw sales of its high-end storage systems fall 3%, to $653 million. But the company more than made up for the drop because it was faster than its rivals to offer smaller storage servers, whose sales grew 47%, to $419 million. That's not all. EMC's VMware Inc. subsidiary, whose software lets information-technology departments shift computing jobs among whatever servers have spare processing power, saw sales more than double, to $80 million. "It's going to be the new wave in the way data centers will run," says EMC Chief Executive Officer Joseph M. Tucci.

Nowhere is the challenging new world of tech more apparent than in software. Salesforce.com Inc. (CRM), for instance, has one-upped traditional rival Siebel Systems by offering its customer-management software as a less expensive online service instead of a multimillion-dollar license. As a result, Salesforce's sales shot up 82%, to $54.6 million, in its most recent quarter, while Siebel warned that its quarterly revenues could fall as much as 14% below expectations.

Then there's the explosion of open-source software upstarts. They harness the talent of programmers outside the company who improve the software for their own use and let others use those improvements. Red Hat, for instance, charges 30% to 100% less for a yearly subscription to its business versions of Linux than the up-front cost of comparable Unix and Windows software. "Open-source software is starting to squeeze the economics out of the traditional software industry," says Red Hat CEO Matthew Szulik. Red Hat's revenues rose 56% in its most recent quarter, compared with the 6% to 7% March-quarter rise expected by Microsoft Corp. (MSFT)

That suggests the era of fat tech margins, whose demise began in post-bust 2001, is ending for most tech companies. While the changes sweeping through the tech industry will provide huge openings for some tech companies, others will see opportunity pass them by.

By Robert D. HofWith Cliff Edwards and Peter Burrows in San Mateo, Calif., Roger O. Crockett in Chicago, and Steve Hamm in New York


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