The Tech Sales Newsletter #63: Where are CIOs going to spend their money in 2025?
2024 has been a rough year for tech sales, predominantly because of the mismatch between our expectations for a visible recovery versus the reality of a soft market.
While Q4 is still in play, the reality is that the planning and budgeting process for next year is in full swing. Key decisions are being made now that will shape the general outline of where investments go.
Let’s peek behind the curtain, by reviewing the latest Morgan Stanley Research CIO survey (Q3 ‘24, conducted in September).
The key takeaway
For tech sales: All of the data indicates a soft 2024 - something that we already knew due to the low attainment recovery in the industry, but it's important to also see it reflected from the perspective of the customers. Spending will accelerate in 2025, but don't expect a quick rebound - executing well and being part of the right company is much more important right now than hoping for an overall bullish trend.
For investors: The majority of the value over the next few years will accrue at the bottom of the stack. Practically speaking, that means a strong focus on the hyperscalers that execute well (i.e. Azure and AWS), as well as players in the ecosystem that have an outsized advantage due to their quality of execution. There is a growing appetite by CIOs to invest in AI-related projects, but we are unlikely to see significant change of pace until customers start reporting significant improvement in outcomes.
Show us the money, CIOs
Now, let's start with the most important metric - there is an expectation of additional spend in 2025 versus this year. This funding will be released for both software and services, while hardware spend will continue to decrease (with cloud infra taking over some of that investment).
While this looks like great news on the surface, it's essential to visualize how the soft 2024 is playing out:
Essentially, there was a constant uptick of expectation for larger budgets and increased spend in software over late '23 and early '24. This did not end up materializing, with estimates now shrinking down.
That doesn't mean that we are not growing, but it does indicate a lack of exponential jumps in spending as customers get more confident about their outlook over the next 24 months.
Deals are simply more difficult to make in this market, which is reflected in discounting:
“Vendor willingness to discount continues to trend higher, with CIOs indicating
experiencing more aggressive discounting in 3Q24. 44% of CIOs perceiving
vendors as more aggressive in discounting in our 3Q24 survey (up from 37% of
CIOs in 2Q24), compared to 14% perceiving vendors showing less willingness to
discount.”
Let’s dig into the key takeaways from the study from a macroeconomics perspective:
• First look at 2025 budget growth expectations suggest modest acceleration, + 24 bps YoY to +3.6%, though growth expectations remain below our survey's historical 10-year average (+4.1%). On a sector view, CIOs expect Software to remain the fastest growing technology industry in 2025, accelerating 17 bps YoY to +3.7%. Communications is expected to accelerate 11 bps YoY to +2.9% in 2025. IT Services is expected to accelerate 11 bps YoY to +2.7%, and Hardware growth expectations tick down 10 bps YoY to +1.6% in 2025.
• Expectations for 2024 IT budget growth held stable at +3.4%, largely inline with prior levels (+3.5% in 2Q24/+3.2% in 1Q24/3.3% in 4Q23). Software continues to be the fastest growing industry in 2024 at +3.5%, followed by Communications (+2.8%), Services (+2.6%), and Hardware (+1.7%). Sequentially, all industries were revised flat-to-slightly-down, with expectations for Hardware spend revised down most meaningfully QoQ (-12 bps).
• Regionally, US CIOs continue to expect higher growth in IT budgets in 2025 at +3.8% compared to their EU counterparts (3.2%). 2024 budget growth expectations ticked down sequentially for both regions, more materially in the US (-13 bps QoQ to 3.6% growth vs -4 bps QoQ to 3.0% growth in the EU).
• CIO confidence in the longer-term spending environment declined modestly in 3Q24. Though 41% of CIOs expect IT spending as a % of revenue to increase over the next three years (downtick form 49% in 2Q24), the % of CIOs expecting IT spending to decrease as a portion of revenue over the next 3 years increased to 17%, up from 14% in 2Q24, the highest reading since 4Q20. Net, the long-term revision ratio ticked down to 2.4x in 3Q24, from 3.5x in 2Q24.
• CIO's expectations for revisions to 2024 budgets remain biased to the downside in 3Q24, with the up-to-down ratio ticking down to 0.5x, from 0.7X in 2Q24 (Exhibit 16). The number of CIOs expecting downward revisions to 2024 budgets outweighs the number expecting upward revisions (39% vs. 21%),
So, if we have to summarize these findings:
CIOs expect to spend even less this year than budgeted.
CIOs will increase spend next year, but it's still below the bull market investment levels.
US companies continue to lead the charge in investment, with software being a key area of focus.
Let’s focus now on cloud infrastructure software:
• While Artificial Intelligence/ Machine Learning does remain atop the priority list for the fourth consecutive quarter (14.3% of responses), net prioritization did tick down sequentially for the first time since 3Q22 (Exhibit 3). Security Software (12.7% of responses), Digital Transformation (8.7%), Cloud Computing (7.3%) and DW/BI/Analytics (6.7%), round out the top 5, with ranking order unchanged relative to CIO priorities in 2Q24
• Security Software (net score of +19%) remains the most defensive IT project in 3Q24, followed by Digital Transformation (net score of 8%), Cloud Computing (net score of 6%), Financial Planning Software (4% net score), and AI/ML/Process Automation (4% net score). Although AI initiatives remain squarely atop CIO priorities, 3Q24 data suggests these initiatives to be relatively less defensible. The least defensible initiatives include Strategy Consulting (net score of -4%), Desktop/Laptop Equipment (net score -3%), and Hyperconverged Infrastructure (net score -3%), largely consistent with prior survey results.
• As workloads shift to the cloud, Microsoft and Amazon remain the clear beneficiaries. Similar to previous surveys, Microsoft and Amazon remain best positioned to gain incremental share of IT budgets, with Salesforce screening as a share gainer in 2024, while Google screens as a likely distant third place winner in the coming years. Conversely, Dell, VMWare, Oracle, IBM and HPE have the highest risk of losing incremental share of IT budgets both in 2024, and over the next three years.
• Artificial Intelligence continues to drive direct impacts to CIO investment priorities, with 3Q24 data suggesting recent innovations around AI/LLMs have directly impacted 78% of CIO's investment priorities, continuing to increase from 68% in 4Q23, 73% in 1Q24, and 75% in 2Q24. However, our 3Q24 survey further cements the outward shift in the timeline of CIOs' expectations for initial AI/LLM projects to enter production: the majority of CIOs (29% of responses, vs 26% in 2Q24) expect their first AI/LLM projects to be in production after 2025. Of the CIO's whose investment priorities have not been impacted by AI, primary frictions cited for not yet leveraging these technologies include lack of appropriate business use cases (47%), prohibitive costs/lack of definitive ROI (46%), and data privacy/security concerns (46%).
• While hyperscalers largely remain the favoured vendor for CIOs in assisting to apply AI, LLM's, and other innovative technologies, our survey results suggest that data management, application, and AI application development vendors are gaining popularity in assisting to implement these technologies. Specifically, among CIOs who responded that AI/LLM's are having some impact on their IT budgets, 33% are using hyperscalers (downtick from 36% in 1Q24), while 18%/13%/10% are using data management vendors/application vendors/AI application development vendors, respectively. Among CIOs who responded that AI/LLMs are not impacting their IT budgets, 36% responded they would be likely to utilize hyperscalers, while 19%/3%/8% would be likely to utilize data management/application/AI application development vendors, respectively.
• 3Q24 data continues to suggest internal initiatives, like internal employee productivity and specialized worker savings, are the top objectives around AI/LLMs today. From a vendor perspective, 3Q24 data suggests Microsoft is the clear beneficiary of incremental GenAI spend, on both a one-year (53% net score) and three-year view (44% net score). Salesforce and Amazon screen positively as net share gainers on a one-year view, while Amazon and Snowflake screen as potential AI spend net share gainers on a three-year view.
While readers of this newsletter would not be surprised by these findings, it's always interesting to see direct observations from the field translate into the "big picture" view:
Companies are prioritizing AI spend, but figuring out that proper implementations impact a lot more than just creating the service. This is pushing the timeline for large-scale production projects into 2025 and beyond.
Cybersecurity remains the strongest vertical of investment for new spend after AI, and is also considered the most "defensible" spend from existing installations (i.e. customers are not churning on their existing deployments without replacing the tool).
While AWS and Azure continue to win the lion's share of workloads on cloud, with Azure dominating the Enterprise AI spend, data platform vendors such as Databricks remain top of mind for a lot of CIOs.
Once you see it, it's difficult to not address the elephant in the room - cloud infrastructure software is where any new incremental spend is going.
One of the core thesis of this newsletter is that the majority of the value will accrue at the bottom of the cloud infrastructure stack, which is easily visualized by the Top 3 Vendors that CIOs are indicating will capture a higher share of the overall IT budget - Azure, AWS, and GCP. Interestingly enough, the Azure team continues to execute well with senior leaders and is consistently flagged as winning additional workloads compared to the other two. This will be an important point of attention as the earnings calls for the 3 hyperscalers will play out over the next 2 weeks.
The other side of the coin, of course, is the soft 2024. Keeping in mind that 2023 was still predominantly a workload optimization year, it's clear that there was no significant rebound in the last months and we are unlikely to see a magical "hockey stick" effect in spending. If anything, I would expect more funding to be pushed into 2025 and released based on the Q1 financial results.
A lot of this growth will depend on how AI implementations progress. Successful projects drive incremental growth across the whole cloud infrastructure software ecosystem; while CIOs are clearly paying more attention with each quarter, it's the quality of execution on the vendor side that will drive outcomes here.
The quality of execution is, of course, the domain of tech sales.
The opportunity is there to be captured - one deal at a time.
