The past two and a half years have been challenging for companies seeking to acquire new capital equipment, the vendors providing it and the leasing/financing community that provides much of the capital to enable those investments. A review of the macroeconomic data for the ten calendar quarters from Q1/08 to Q2/10 shows that U.S. spending for capital equipment and software declined by 19.8%, and has been slowly recovering since then, such that it is now “only” 9.3% below the Q1/08 peak. Clearly, this has been quite a challenging time.
Figure 1 presents a summary of the Bureau of Economic Analysis (BEA)-derived data showing yearly U.S. investments in capital equipment and software. Diving into the data shown in Figure 1 (which shows ten quarters of data on U.S. capital equipment and software investment) can be a bit tricky. Capital equipment and software spending has a strong seasonality factor, so the typical approach of analyzing quarterly data has limitations. A better method, adopted by the BEA some years ago, is to annualize the quarterly data. Doing so simplifies the comparisons with prior years and quarters, and enables business and financial leaders to readily see market performance.
Computers, Software & Communications Investment Spending
Compared with the volatility of the spending data overall, the largest single category, investment spending on computers, software and communications (IT capital spending) has fared much better. In fact, from the Q1/08 peak through to the trough in Q3/09, the market declined only 5.4%. By Q2/10, IT capital spending had risen by 3.1% to $464 billion — an all-time high — showing clearly this sector’s recovery.
Compared with the last recession (the “dot-com bust” in 2001-2003), IT leasing and financing companies have not seen the declines in business investment spending compared with other sectors, and they have not faced the cascade of credit defaults seen during the dot-com bust. IDC believes that as the market returned in 2003, IT leasing and financing providers generally maintained their underwriting discipline. Of course, credit defaults have increased somewhat, but they have not reached the levels seen during the last cycle.
Another striking data point that can be derived from Figure 1 is the percentage IT capital spending comprises of total investment spending. During the period reviewed, IT capital spending made up 39.2% of all U.S. capital investments in equipment and software. Most recently, in Q2/10, IT capital spending had risen to 45% of all investments. At one point during the period, IT capital spending reached an amazing 47.3% of all capital equipment and software investments in the U.S. Please keep in mind that this does not include investments for IT equipment embedded in the backbone of most industrial and transportation equipment. This spending — including the IT sensors and systems installed on everything from farm combines to medical equipment, is counted as investment spending within each category — not as IT capital spending.
IDC believes there are two principal reasons IT capital spending has reached 45%+ of all U.S. equipment and software spending:
IDC believes that the relatively high percentage of investment devoted to IT Capital Spending will continue until robust economic expansion resumes. Therefore, for leasing and financing companies seeking to grow in today’s challenging times, it would be difficult not to consider exploring the business options available in computers, software and communications.
Leasing and Financing Outlook for
IT Equipment, Software and Services
IDC tracks IT markets worldwide in exhaustive detail, including the IT leasing and financing market, and provides its clients with detailed statistical market analysis and forecasts. For 2010, IDC believes the U.S. IT leasing and financing market will exceed $50 billion. This includes all IT buyers leasing or financing using dedicated financing instruments. IDC has noted that many small- and mid-sized companies use their commercial credit line (revolving line of commercial credit or revolver) to fund IT resources; other smaller companies use credit cards to acquire/finance their IT resources. As acquisitions of this type are not using a “dedicated instrument,” IDC does not include them within this segmentation. Details of the forecast, by type of resource, are detailed on Figure 2.
For those not familiar with the IT leasing and financing market, the amount of software and services financing, which together exceed 50%, may come as a surprise.
Software financing covers software that is developed by external software companies and licensed to buyers — in IDC parlance — packaged software. The forecast shown here does not include the value of internally developed software that may have been capitalized. A number of large organizations, especially in the financial services arena, have completed sale leasebacks on capitalized, internally developed or custom software. Again, this forecast does not include this market activity because these financing structures often include a mixture of packaged and custom software, as well as IT equipment. IDC expects this type of all types of software financing activity to continue to grow.
Services financing is another category that can be puzzling. IDC is not referring to “break/fix maintenance.” Services that are financed are usually large consulting or advisory services projects associated with major infrastructure updates or new initiatives. As many IT organizations continue to shift their staffing models, bringing in “experts” only on a contractual basis (versus keeping them on staff), this type of financing is also expected to continue to grow.
Server systems are the largest segment of leased or financed IT equipment. Overall, the server market is undergoing significant shifts. High-end mainframe machines, which typically support business applications, are seeing their workloads being shifted to less expensive LINUX or x86 architecture servers as IT organizations seek to reduce IT operating expenses. Most of the segment growth is coming from x86–based volume servers linked together using virtualization software. Because servers are the centerpiece of most IT renewal and investment projects, the IT vendors are especially competitive in this space — as are their financing captives.
Storage equipment spending continues to increase, for the simple reason that most organizations continue to struggle when managing rapidly increasingly volumes of data. The result is continued expansion of their storage capacity, and, as with servers, an intense and competitive financing market dominated by captive financing suppliers.
PC & Laptop
PC and laptop spending has recovered (and accelerated) faster than other equipment segments as the economy has recovered, resulting in an expanding financing market. Even though unit prices have declined, many business leaders report they plan to lease their PCs, both to manage technology obsolescence and their capital budgets. Buyers often seek a combination of equipment bundled with acquisition services, configuration, deployment and retirement services. While the segment is competitive, a large number of financing players participate. The financing market outlook is especially positive through 2013, as a large corporate portfolio replacement of Windows XP machines is underway.
Network equipment and telephony gear increasingly rely on structured leasing and financing options. Previously, many IT organizations purchased network equipment because it was relatively long-lived, but the growing reality for most companies is that their network traffic is increasing and steadily requiring more systematic upgrades — and a structured renewal cycle. For all but the largest organizations, network and telephony gear is often acquired as part of infrastructure renewal or a larger project/initiative.
Peripherals include a wide range of equipment, much of which is generally not financed. The segment of interest to leasing and financing companies is printers. These devices have a longer useful life than PCs, and are often acquired at the same time.
IT Leasing Market Assessment
Unlike most other major capital equipment financing markets, the IT leasing and financing market is dominated by captive financing suppliers — companies such as Cisco Capital, Dell Financial Services, EMC Global Finance, Fujitsu Finance, HP Financial Services, IBM Global Financing, Microsoft Financing and Oracle Financing — to name some of the players.
For most other non-IT equipment types, typically some two-thirds of each market’s financing needs are met by external providers and one-third by captive financing organizations. The IT market is the inverse. Beyond the intense competitive dynamics among various IT vendors (and their captive financing organizations) for most transactions, two other key factors challenge financing “generalists.”
IT equipment is increasingly packaged with multiple devices inside each box. New types of devices are not a “server” or “storage.” An individual device might include a server, storage capacity and network equipment within one chassis — a so-called “converged infrastructure” device. Even beyond converged infrastructure devices, each piece of new equipment is often custom configured for each client. This creates potential complexity at the end of lease if equipment is returned. To sell returned devices as a “system,” they often must be reconfigured and recertified. Of course, additional parts and pieces are usually required, making the task even more complex. This need to reconfigure devices means that secondary market asset management needs to be increasingly sophisticated.
Software License Management
This is an area that continues to grow in importance and complexity. For example, Microsoft recently changed its licensing practices for leased PCs, requiring a separate fee to license the operating system on returned PCs. When reconfiguring a device, additional software licenses may be required. With the higher levels of vendor tracking and scrutiny, IT customers increasing look to the (used) equipment supplier to help them with license management questions. For asset managers, this often means a working relationship with a qualified reseller with software license management expertise is necessary — increasing complexity.
IDC Market Analysis and Guidance
The IT leasing and financing marketplace remains one of the more vibrant sectors with reasonable growth prospects through 2014. Even with the moderate economic growth forecast, IDC expects companies will continue to invest in technology that improves efficiency and helps them expand their reach into new markets — sustaining IT capital spending demand — and IT leasing and financing requirements.
On the supply side, the IT industry continues to be a tumult of new technologies, intense competition and vendor consolidation. Virtually every major and most minor players have invested in customer financing and reseller working capital finance programs. The programs span an incredibly broad spectrum of internally operated and partnered programs. Most software and services providers offer “extended terms” programs, a form of factored receivables, through an independent provider or their commercial bank.
Vendors and their IT leasing and financing partners continue to struggle with the need to support the range of financing programs needed: micro-deals up to mega transactions exceeding $100 million, the need for international coverage — even in countries with volatile political environments and investment financing for transactions in which the “assets” have an increasingly high percentage of “intellectual property.” It is a complex undertaking for vendors assembling a portfolio of leasing/financing partners to meet the full range of their needs. IDC expects the vendors’ need for more comprehensive leasing and financing support will drive an expansion of capabilities within major leasing program providers and consolidation within the financing partner ecosystem.
New IT platforms such as cloud computing are already on the horizon. With this technology model, companies share computers owned by a central operating company (cloud provider). The model is not really that different from the early days of computing when “timesharing” was a standard operating practice for many companies. These new cloud providers continue to need large blocks of capital to build out these new shared data centers — clearly an interesting market opportunity with lots of potential. Some researchers have suggested that cloud computing could increase the scope and span of the IT business much the way PCs did 20 years ago — perhaps growing it five- or ten-fold. They point to the early days of the PC when some researchers proclaimed the “the mainframe is dead,” and argue that computing workloads would shift from mainframes to PCs — obviating a hugely important and profitable business.
Of course, that was not the case. Most workloads remained on the mainframes. What the PCs offered was a new computing platform where the price for each unit of computing was so much cheaper that the market expanded a thousand fold. IDC believes cloud computing may have that same potential — the ability to dramatically expand the computing market by again lowering prices through the use of a new computing platform — and with it — through the construction of an entirely new computing infrastructure, again perhaps radically expanding the business.
In 1964, worldwide spending for computers was $2 billion. By 2014, 50 years later, IDC expects total IT spending will exceed $1.7 trillion — continuing to require hundreds of billions of dollars in working capital loans, customer financing and equipment lease funding. As Bill Gates said, “The amount of change we witness in two years is disappointing; the change we see in five or ten years is mind-boggling.” Nowadays it is not fashionable to be enthusiastic, nevertheless, IDC believes the IT leasing and financing market will remain the most dynamic and one of the most attractive for many years to come.
Joseph Pucciarelli, program director of IDC’s Technology Financing & Management Strategies, provides a wide range of research on IT leasing and financing strategies to providers and IT organizations, as well as research coverage for leading IT financing providers. With more than 20 years of experience in the financing and technology industries, Pucciarelli has held a variety of consulting, product marketing, risk management and senior management positions with companies including Gartner, GE Capital, Peregrine Systems and his own company, complianceofficerforum.com.
For more than 46 years, International Data Corporation (IDC) has been a global provider of market intelligence, advisory services and events for the IT, telecommunications and consumer technology markets. IDC helps IT professionals, business executives and the investment community make fact-based decisions on technology purchases and business strategy. IDC is a subsidiary of IDG, a leading technology media, research and events company. To learn more about IDC visit, www.idc.com.
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