- July 27, 2023
- Posted by: lmwalsh
- Category: Analyst notes
Recessionary conditions, inflation, and margin erosion are conspiring to put pressure on the channel to cut costs while maintaining high growth rates.
By Larry Walsh
Across the IT industry, vendors are cutting staff and slashing budgets to counter strong economic headwinds. At least that’s what they’re saying. The C-suites are using words like “restructuring,” “rebalancing,” and “optimization” to convey their goal of cutting costs and maximizing profitability.
The channel is not immune to economic pressure. In the latest Channelnomics Channel Forecast report, released at the beginning of the year, we noted that 39% of channel professionals said their budgets would increase this year — down from 78% in 2022. Another 16% said their budgets would decrease, up 10 points from the previous year. And 45% said their budgets wouldn’t change, up from 16% year over year.
Cutting costs is more than reasonable amid recessionary conditions and economic uncertainty. But is that what’s really going on? Yes and no.
At the beginning of 2023, Gartner reported that global IT spending would increase 5.3%; IDC said 5.1%. At the Global Technology Distribution Council’s annual summit in February, IDC President Crawford Del Prete said GDP growth could go to zero and IT spending would still increase 3% because businesses need technology to power their operations.
How strong are those initial Gartner and IDC numbers? Well, they always come with an asterisk indicating “subject to change.” And — spoiler alert — they always do.
In 2022, IDC started the year with a 5.1% IT growth forecast. By the end of the first quarter, the analyst firm adjusted the number to 4.1%. At the end of the second quarter, the number fell to 3.1%. By November, it settled in at 0.8%.
As for 2023, Gartner recently released its updated forecast, clocking IT spending growth at 4.3% for the full year — down 1 point from the beginning of the year. IDC adjusted its number in May to 4.8% — down, but not significantly.
The problem isn’t whether IT spending is going up; it’s what’s happening with the numbers that are contributing to the overall growth rate.
At a recent channel chief retreat, three numbers were repeated several times like a mnemonic device, “40-20-20.” What do they mean? Channel spending will be cut by 40%; channel head count will decrease by 20%, and the growth in overall channel sales will be 20%.
Are these numbers consistent across all vendors and channel programs? Absolutely not. They’re representative of what’s happening in the channel, with channel chiefs under pressure to cut spending and increase revenue — both at double-digit rates.
While IT spending is increasing, that rise isn’t uniform across the industry. Any hardware category on the desktop is seeing declining sales (although some hardware vendors are reporting that sales productivity is stabilizing). Investments in cloud computing, software (particularly SaaS), and IT services (managed and professional) are increasing, generally.
If growth is happening in most of the major technology categories, why the pressure on budgets and growth? The simple answer: inflation.
For much of the past two years, the overall inflation rate for the U.S. and other major developed markets was above the normal target range of 2% to 2.5% annually. Monthly inflation in the U.S. peaked around 9%, while European countries saw inflation fluctuate between 8% and 15%. Ukraine is the exception, as the war is causing inflation to move into the double digits. Turkey is also seeing high inflation rates due mostly to political instability and the devaluation of the Turkish lira.
Increasing material, manufacturing, and shipping costs are causing technology prices to increase. Every vendor, whether peddling cloud services or devices, is openly raising prices or absorbing cost increases through margin erosion. Vendors have told Channelnomics that they’ve absorbed as much of the inflation impact as they could before raising prices. And those increased prices get passed on to distributors, partners, and, ultimately, end users.
Earnings reports may note healthy top lines across the industry, but they also show lower or unchanged unit sales. This is the result of price increases. Cutting costs is the means of recapturing some of the margin to show Wall Street and the investor community that tech is and can be a profit machine.
Meanwhile, channel chiefs admit that price increases aren’t easy to pass downstream through partners. They recognize that partners can’t easily absorb price hikes. In its research on managed services (conducted on behalf of Axcient), Channelnomics found that MSPs are consolidating their vendor relationships, reducing the number of redundant systems in their technology stacks, and sacrificing margin to avoid layoffs.
How will 2023 end for the channel? At this midyear point, calling the ball is difficult. Many vendors are optimistic that the second half will improve and wipe out any losses booked in the first half. Channel chiefs remain confident that they can grow indirect sales through the year, but that’s largely because it’s their mandate.
Channelnomics believes the channel will remain relatively healthy despite inflation and economic and performance pressures. It just won’t feel healthy, and that will result in many vendors doing more with less and operating under higher stress levels. Channelnomics continues to believe that the channel is the recessionary condition antidote. Vendors can cut only so much without losing capacity. Engaging the channel and deferring roles and responsibilities for driving sales and revenue to partners is a means of offsetting the cuts.
Channelnomics recommends referencing the Channel Recession Survival Guide for insights and direction on how to better engage the channel to offset capacity cuts and maintain productive field sales operations.
Larry Walsh is the CEO, chief analyst, and founder of Channelnomics. He’s an expert on the development and execution of channel programs, disruptive sales models, and growth strategies for companies worldwide. Follow him on Twitter at @lmwalsh_CN.