Tuesday, September 16, 2008

Take your partners, please (FT.com)

Take your partners, please
By Alan Cane

Published: September 16 2008 16:50 | Last updated: September 16 2008 16:50

Cost reduction has become the watchword in the information technology department and there are certainly bargains to be had as far as hardware, software and services go. However, the cheapest deal is unlikely to prove the best.

This is the view of vendors and customers alike, as the triple whammy of the credit crunch, rising energy costs and the threat of recession distorts world markets and puts the survival of some suppliers in question.

Nonetheless, the overall picture is patchy with certain market sectors enjoying exuberant growth. Alastair Sorbie, chief executive of the enterprise resource planning software vendor IFS, says he has yet to feel pressure for better deals from customers: “Contrary to the general mood of doom and gloom which hangs over the economy at the moment, some markets outside of the consumer and financial areas are doing well.

“Our customers in the oil, gas and defence manufacturing industries are booming and keen for business software which supports their operation.”

Globally, the situation is even more complex. Duncan Tait, managing director for Unisys’ Europe, Middle East and Africa (EMEA) operations, describes a two-speed market, with the MEA part of his title streaking ahead of Europe and the US: “There are three big things going on that fundamentally affect how organisations like ours take advantage of the market place.

“First, in Europe companies have neither cash nor capital to spend and this has a huge impact on the way IT companies have to sell. In the past, hardware companies have resorted to massive discounting but when customers have no upfront cash, things have to change.

“Second, input prices are going up across the economy – inflation in certain sectors is higher than broadcast and this is causing chief executives to pull hard on that big red lever in their offices titled ‘save money’. And third, citizens are worried about their personal and financial security.”

He argues that cash is moving eastwards and finding its way to African states such as Angola, as governments invest ahead of the end of the oil boom: “We are seeing substantial growth in police forces, transportation, ID cards and transborder security. Finance and cost-cutting there is not a problem because they have cash which turns up from the east, quite often from the Chinese. It’s a very different picture from the UK.”

In the west, there is substantial movement in the market with competition increasing and margins tightening: “These are tough times. It is getting difficult. There are some good deals to be had out there but you have to be smart to get them,” says Peter Stroud, managing director of Panacea, the computing services group. He suggests, as an example, that purchasers look for discounts on, say, support for desktop computers, which form a much larger part of the overall cost of a system than the hardware alone.

Scott Petty, global head of services for the IT group Dimension Data, offers another instance of smart rather than aggressive bargain-hunting: “We were looking for new software for our management platform and there were a couple of vendors who could do the job. We decided to create a win-win situation for our preferred vendor. We knew it wanted to close the order in a particular quarter and we knew that asking for a deeper discount was unlikely to work.

“So we decided to build the foundation of the platform we wanted to buy, with 75 per cent of the functionality. As we approached the end of the quarter, rather than asking for discounts, we asked for free software – software that had not been part of the negotiation but which we were keen to have. The vendor was very excited about this. Our request for new software modules was evidence of our long-term commitment to it and it was willing to give away quite a bit of software. The vendor was happy and we saved about 25 per cent on the cost.”

Most industry experts believe that establishing long-term relationships between suppliers and supplied are more important than simply forcing down the price, especially when the business environment is unstable. David Elton of PA Consulting Group says there are more influential factors affecting the price of hardware and software than a particular point in the economic cycle, pointing out that the price of hardware continues to come down and the availability of open source software offers alternatives at a lower initial price: “which doesn’t mean it is not a good time to have a negotiation or a conversation with a supplier about factors which affect the total cost of ownership”, he says.

“I don’t think we’ve been in a faster-moving situation for a decade or more. Given this rate of change, most of the clients I’m working with are exercising extreme caution. What they are looking for is value from the relationship.

“So a conversation around ‘How much can you take off the price?’ will not go very far because the supplier is not interested in it. A conversation around ‘What can we do to benchmark the price in years two and five of the agreement’, say, allows the customer to have some confidence that they are going to get good value right through the agreement and it gives the supplier the opportunity to say ‘I’ve got the potential for a five-year engagement here and that is worth quite a lot to me’ – particularly when you consider the costs of winning some of these deals.”

Customers such as Jos Creese, head of IT for Hampshire county council in the UK, who spends £30m a year on hardware and software with companies including IBM, Microsoft and SAP is concerned that as competition increases and margins tighten, some suppliers will be in trouble – and that could adversely affect their customers: “I think we are going to see quite a lot of shake-out in the market place.

“A number of niche suppliers will struggle. There will be good deals to be had but buyers should be wary because some of those deals could be built on sand. Customers want to work with suppliers in which they have confidence to survive the downturn.”

He said most suppliers are locked into a business model which is rapidly becoming obsolete: “As the industry wakes up to the fact that value in IT does not come from the acquisition of the product, but from its application in the business, so you need a longer term relationship with suppliers that helps you to carry out that exploitation.

“That requires different thinking around the contracts, a different business model from the suppliers and a different approach to risk management because, if you are going to build in that kind of flexibility then the standard, ‘We have a product, it costs this much, we will charge this much and we will make our money over 18 months,’ no longer works because you have to be able to flex and respond to the unexpected – to new competitors, for example, or customers who want to use your product in a different way.”

Mr Creese said he was increasingly looking for relationships with vendors based on a standard catalogue of products and prices but incorporating an ability to respond to unpredictable change to ensure that the organisation remains competitive – in the “top quartile” of IT users.

But according to Mark Nutt of the strategy experts Morse Group, many businesses are wasting money on a grand scale by inept purchasing behaviour. The problem, he explains, is that individual departments frequently buy equipment and services on an ad hoc basis, without looking to see what the rest of the organisation already has.

“To address this challenge,” he says, “businesses need to eradicate the old siloed buying approach and instead implement centralised purchasing through the IT department. By bringing purchasing back under the control of the IT department, businesses can better prepare when approaching vendors to get the best price.”

In the end, however, if cost reduction is the watchword, then value from IT must be the rallying cry and this is difficult to factor into vendor negotiations.

Mr Elton of PA says: “I think there are miles to go before businesses really get the value that they are looking for from IT. It is more about the people and the change you are seeking to achieve in the business that drives the value, rather than the IT itself.”
Copyright The Financial Times Limited 2008

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