Canalys 2020 trends and beyond - Part 1
The technology industry has had a profound affect, for better or for worse, on society, economies and the environment over the last decade. It has changed the way people interact with each other, access and consume content, as well as purchase and use products. For businesses, technology has evolved from primarily underpinning operations to defining, delivering and differentiating their offerings in new marketplaces. Technology has contributed to the changing political fabric, including elections and referendums. New technology titans have emerged, while others have fallen after missing major transitions. New leaders have gained influence, not just confined to the technology sector, but also politically. On an environmental level, however, technology has mostly contributed to climate change rather than innovate and alleviate the growing problems.
Predicting all the major events of the last decade would have been impossible. Even predicting what happens over the course of 12 months is challenging. Nonetheless, predictions are important to provide points of view on current and developing trends impacting the industry. This two-part report aims to outline the key trends Canalys expects to impact technology vendors and channel partners in 2020 and beyond.
Overall, Canalys predicts the 15 largest technology vendors will grow by just over 4% in 2020. This masks some big variations by sector, as infrastructure and Windows 10 upgrade cycles slow and customer investments continue to shift towards cloud, software, software-defined infrastructure, cybersecurity and services. Focus will continue to increase on enabling hybrid and multi-cloud environments to support the adoption of digital technologies by businesses of all sizes and verticals. These demands will accelerate the uptake of AI, automation, analytics, 5G and IoT, among others. In 2019, the channel outpaced the overall growth of the vendors. Canalys predicts that this trend will continue in 2020, with global channel growth of between 8% and 10%. In this complex environment, the importance of channel partners will continue to grow, in architecting, deploying, securing, and supporting complex multi-vendor solutions for customers that allow data and applications to be deployed across cloud, data center and edge. Partners will continue to shift their businesses towards higher value segments, and expand their own services including consulting, managed services and IP creation. However, the channel faces challenges to build the skill sets to support these complex customers environments, and the resources to deliver new services, which will put pressure on profitability. It is also important to remember that most growth in the channel in 2019 came from product resell, not services. That core resell business will remain important for partners to offset disruptions to profits and cash in other parts of their business. Other key trends include:
Investment in cybersecurity will exceed US$44 billion in 2020, as organizations address new vulnerabilities, counter increasing threats and adhere to stricter regulations. Large enterprises currently account for over half the combined spending on data security, endpoint security, network security, web and email security as well as vulnerability and security analytics. They will also be the catalyst for further growth among smaller businesses, as they dictate the security policies and postures to be adopted in order to win or maintain contracts within supply chains, as well as other ecosystems. Successful cyber-attacks like those at British Airways, Capital One and Target came from compromised partnership companies within their ecosystems. Heavy-weight companies will force suppliers to meet their own assessment criteria, much like the HHS Security Risk Assessment Tool and NIST HIPAA Security Rule Toolkit for SMB healthcare practices used in the US to self-assess their HIPAA compliance. This will drive managed services opportunities for partners, as many organizations will struggle to implement and operate the required security technology, processes and policies.
Organizations and people will continue to be challenged by a broadening and diversifying threat landscape. Stealing sensitive data, social engineering and phishing attacks for financial gain, and holding operations to ransom are commonplace, while new persona hacks utilizing AI have emerged. As a result of this escalation, unfortunately, the first loss of human life directly linked to a cyber-attack is predicted within the next 12 months. Within the next five years, over 50% of security partners will blend digital and physical security to address attacks specifically incorporating onsite social engineering techniques, as well as counter new threats from machines like drones. During the same timeframe, Canalys expects 10% of the security channel will focus solely on the healthcare sector, which saw a dramatic rise in attacks in 2019, compromising both data and operations. Cybersecurity is a key growth opportunity for vendors across all technology sectors, as well as private equity firms. This will result in a lot of change in the current vendor landscape, with five new names predicted to enter the top 10 list by 2022.
Activist shareholders had a major influence on the direction of many vendors across the technology industry five years ago, when growth rates matured, and investors demanded greater return on value. Firms like Carl Icahn, Elliott Management, Third Point and ValueAct forced vendors to alter strategies, increase share buy-backs and drive efficiency gains through cost cutting initiatives, divestitures, mergers and acquisitions, leadership change and having more representation at board level. Apple, BMC Software, Dell, eBay, EMC, Juniper Networks, Microsoft, NetApp, Oracle, Riverbed and Yahoo! were just some of the high-profile vendors that were targeted and pressured. Since then, activity has been relatively quiet, albeit with some notable exceptions. The focus of activist shareholders turned to other industries, while extending their influence beyond US-headquartered companies to those based in Europe and Asia Pacific, for example Scout24 in Germany, Kirin in Japan, and JustEat in the UK. However, this will change in 2020, with leading publicly listed technology vendors targeted again.
Revenue and profit growth rates are moderating and look set to slow further in 2020. This follows a significant boost in both vendors' top and bottom lines in 2017 and 2018. New technology adoption is maturing, while refresh cycles are ending across many sectors. This will be a catalyst for activist shareholders to target those vendors perceived not to be delivering enough return, particularly those with low dividends, debt, return on capital and valuations as well as those with high capital expenditure. AT&T is already the subject of a campaign from Elliott Management, which disclosed in September that it had taken a US$3.2 billion stake. It urged the service provider to focus its strategy and improve operational efficiency by divesting non-core businesses. More recently, Xerox's attempt to acquire HP is being publicly supported by Carl Icahn, which holds a 10.9% stake in Xerox and 4.2% percent stake in HP. Vendors with fragmented shareholder bases will be targeted by activist shareholders via PR campaigns, which can take control of messaging and cause disruption. The market capitalization of the Canalys IT Titans has soared over the last 10 years, from US$1.5 trillion in 2009 to US$4.9 trillion. However, expect up to a third of the 15 vendors in the index to come under pressure over the next 12 months.
The continued investment by private equity firms in technology vendors is a lit fuse which is designed to ignite value (and return) for shareholders, but which often ignores the long-term value brought by the channel. Investment houses, even ones specializing in technology portfolios, can view the value of these vendors as binary and react adversely to short-term shocks. Many technology vendors such as Gigamon, LogMeIn, McAfee, Sophos, Symantec (Broadcom's acquisition strategy has been like that of private equity investment), Veeam, and Veritas have been the subject of private equity funding in recent years. However, those funds see vendors in parts rather than as an entity whose value is greater than the sum of its components. The risk of breaking up those businesses and selling them off or divesting elements to third parties (as in the case of Symantec selling its security services arm to Accenture most recently) is clear.
Technology vendors and their channel partners have long sought to develop value creation through business-focused solutions. The acknowledgement that as customers transform more of their businesses to take on digital elements, value can be created by helping them understand how products AND services can help their progress. Some partners have struggled to maintain profitability with this strategy and (some) have returned to a volume product-led business mindset. Indeed, with recurring revenue and as-a-service models disrupting that profitability it is just as vital now to blend product sourcing and integration capabilities with professional and managed services. Changing the sales culture of an established channel organization is another significant stumbling block to transformation according to partner feedback. This will take time, but these partners are growing and their role in delivering value as part of a vendor's ecosystem is clear. Indeed, the enterprise value of channel partners has increased three-fold in the last five years.
The danger for partners if their key vendors are acquired by private equity is the channel element of that vendor's business will see less investment. This is because the fund will see the product business as the most profitable to the vendor's bottom line. But the amount of cash the vendor generates, and which helps to fund large portions of the business, comes from the channel. If the business is split and the interdependency of the separate units ignored, it puts at risk hundreds or even thousands of partners globally, which can in return be a risk to the value of the vendor.
Private equity investment activity shows no sign of slowing in 2020, following the US$5 billion buy-out of Veeam. For startups, this is vital. Funding rounds can get a business off the ground and investors have been a large part of the growth of small specialist startups, particularly in the cybersecurity space. But for mature businesses, there is a real element of risk. They require calm heads and long-term transformational thinking. If those equity investors can do this, they can help these businesses and their channels to grow.