I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

Monday, January 10, 2011

The Tech Sector: Bull, Bubble or Both, and What it Means For IT (Part I)

There's been a sea-change in the technology sector, from counter-cyclical to pro-cyclical.

Tech, and especially tech services, went counter-cyclical a few months into the last recession (2008). Companies entered the downturn with record levels of cash. With so much uncertainty, most firms didn't bet on expansion. Instead, they elected to preserve cash rather than deploy it, and slashed payrolls to cut operating costs. Cutting payrolls meant firms needed to get the same work done with fewer people, so they spent modestly on IT to increase productivity. As a result, tech, and in particular tech services, has been counter-cyclical to the broader economy for most of the past 2 years. This created modest inflationary pressures in IT, notably on wages, but those were kept in check by the deflationary cycle affecting the host businesses. On the whole, tech went through this recent recession much as it did the 1995-6 recession.

But tech is becoming pro-cyclical. The success of both tablets and smartphones (and to a lesser extent the fringe battlegrounds of e-readers and other specialized devices), as well as the rapid maturation of cloud-based services, has created a tech hardware war, an OS war, a bidding war for tech firms, and spawned a feeding frenzy in application development. This is happening during a period of excess liquidity (a result of Quantitative Easing, low borrowing costs and other loose monetary policies), and low yields on most investments. Put simply, there's a lot of money in search of yield.

A lot of that money is now coming into tech, because tech offers investments with the potential for high yield. Or, more crassly, tech offers "gambling opportunities" for investors. This means the money coming into tech has changed from "we're investing in tech to reduce operating costs" to "place your bets on tech!" This, in turn, is changing the tech space from counter- to pro-cyclical. That's great during a bull market, but painful during a bear market.

There's no certainty of how this will play out. This could simply be the next stage of what may be a multi-year bull run for tech, similar to its 1983-2001 bull run that had several mini-cycles. It could be a bubble, with too much cash chasing more yield than will materialize. It could be both: a bit of excess euphoria during what is otherwise a fundamentally strong bull run in tech.

Such euphoria in any sector tends to come with little in the way of popular recognition of what's behind it, and mass underappreciation for how vulnerable it is. We saw this in the housing bubble, the internet bubble before it, and bubbles going back to the Dutch Tulip trade in the 17th century. But this sudden rise in tech calls for as much caution as enthusiasm. This is true particularly for those who are long tech (e.g., those building wealth by building companies and careers in it) more than those who are comparatively short (those investing capital in pursuit of yield). While investors can be burnt by a bubble, careers can be wrecked.

One of the things that makes tech a potential bubble now is the resilience of that capital coming in. Capital has stayed largely on the sidelines for the last two years because of so much economic uncertainty. That capital, while being deployed now, is still jittery and remains at risk of systemic shock. Problems lurk in peripheral Eurozone debt, US housing debt and US muni debt. China and India are fighting inflation while the US is trying to stoke it. The net effect is, capital is still highly nervous. It's also highly mobile, as evidenced by the volatility of many different asset classes in 2010. Tech can take no capital placement for granted: what the capital markets giveth tech, they can just as quickly taketh away.

As tech has gone pro-cyclical, it will rise and fall with the broader market. Those peaks and valleys will be amplified by the amount of capital coming in. If the broader market is characterized as "volatile" in 2011, tech could be in for a wild ride.

In the next post, we'll look at the different ways volatility manifests itself in tech. We'll also look at what a tech boom, and potential bubble, means for people leading and managing captive IT and tech firms.