IT to ride oil seesaw ?

February 27, 2011 – Does higher oil price have a resultant impact on IT budgets? Two years ago, oil was at $34 a barrel; today, it is hovering at around $110 a barrel. Although tech budgets of companies look much the same as before if not rosier, will they slip on rising oil prices? When the possible oil-IT correlation was recently cited by an analyst to Infosys Technologies, the company's CEO & MD, S Gopalakrishnan, responded, "Very interesting analysis, maybe I should get a copy of this because the correlation you are creating is actually very, very interesting and (for the)first time, I'm actually hearing that." Many others in the industry too have found it an interesting equation – though not much data is forthcoming. "We have not thought about this," say industry people. But those who spoke made interesting interpretations of the correlation. Oil link to IT Fluctuation in oil prices directly impacts the revenues of oil companies. The oil and gas companies allocate IT budgets keeping in mind their average revenues for a period, says Rajeev Nair, Director, Corporate Finance, US Technology, a US-based software company with offshore development centres in India. Using the US economy perspective, he argues that when oil prices go up, consumers generally cut down expenditure on the non-essential items. Driving/car/gas (petrol) is such an integral part of American life, a 10-25 per cent change in oil prices will not cause any behavioural change among people. This means, consumers will not cut down on driving or use public transport but they will be forced to spend more money on gas. With an almost zero per cent saving rate, American families will be forced to cut down expenses on other fronts to pay for the higher gas bill. This gets multiplied by 150-200 million (number of people in the work force) and the overall consumer expenditure goes down. The US economy is heavily dependent on consumer expenditure ($10-Trillion-plus a year) contributing almost 70 per cent of the GDP. When consumer expenditure falls (money goes to an oil company's kitty), businesses are badly impacted and they, in turn, cut down their capital expenditure and discretionary spending. The first to feel the axe will be IT spending and IT budgets are cut, says Nair. This happened in 2008 when oil prices went up from $2.6 a gallon to $4 a gallon (in New Jersey) and the economy itself fell into recession. IT spending was cut by most companies and IT billing rates/salaries went down. On the other side, oil companies in the US made record profits (Exxon - $10-billion- plus a quarter) during the same time. However, sectors such as healthcare, food and essential retail were not badly impacted, says Nair. Once oil prices go very high ($140/barrel from $80/barrel), changes in behavioural pattern start and people cut down on travel/oil consumption. This happened in the US when oil prices touched $4-5/gallon. Demand starts falling and some of the above mentioned changes start reversing. While this is from the perspective of the US economy (the largest spender on IT), it may not be applicable at all to the Indian economy, where government controls oil price, consumer spending is not such a high portion of GDP, and savings rates are high. According to Erin Hichman, Analyst, Professional Services Business Quarterly, Technology Business Research, Inc (TBR), the IT services market reacts to the conditions clients are experiencing, and clients react to the current economic conditions. For example, increased oil prices mean an increase in spending, including IT, in oil-rich countries. However, regions such as the US and Europe may see a slowdown in recovery if oil prices remain high. The key takeaway is, at a high level, the economic conditions determine pricing and orders and if organisations are benefiting or suffering from oil prices, it will likely be reflected in their IT budgets. Large investments may be hit John Caucis, Analyst, Professional Services Business Quarterly, TBR, says with an increase in oil prices, organisations will have to factor in higher energy prices into their budgeting for 2012. This may lead to cuts in IT budgets to compensate, and may cause IT buyers to postpone large IT investments or may compel them to break up large strategic or transformational engagements into smaller projects that are executed on a piecemeal basis. As clients are still determining budgets for next year, a clearer picture will likely be available after the first quarter of calendar 2011. To get back to where it all started, Trip Chowdhry of Global Equities Research, posing this query to Infosys said that two years ago, oil was at $34 a barrel (at the time of writing, it stands at around $110) "We are in a very high global inflation environment and our research has historically said and indicated that higher oil prices have a second derivative impact on IT budgets." The industry is keeping fingers crossed that oil settles and so do its fears. Source: http://www.thehindubusinessline.com/features/eworld/article1492720.ece?homepage=true