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Economists predict slow profit growth for Canadian IT manufacturers

Despite forecast, one Canadian distributor says customer demand is reaching record rnhighs this yearrn

Profit levels for the Canadian computer and electronic product manufacturing industry reached $2.1 billion in 2006, nearly double 2005 levels, but will now begin to slow, according to a recent report from the Conference Board of Canada.

The strong growth in 2006 was attributed mainly to declining capital and material costs, and while profit levels have recovered they still lag behind their tech boom highs. Margins are even stronger and are forecasted to reach six per cent in 2007, just off the pre-bust peak.

“The industry’s performance is finally getting back to normal after the tech-bust,” said Michael Burt, a senior economist with the Conference Board. “The industry is smaller than it was at its peak, but in terms of profitability and profit margins it’s back where it was.”

The strong profit growth of 2006 isn’t likely to be repeated though, said Burt, predicting average annual growth of just 3.1 per cent over the next five years thanks to declining prices, modest production growth, and a lack of access to skilled workers combined with increasing wages. A high Canadian dollar had also lowered the cost of input components, but the dollar’s forecast decline will also dampen profit growth.

“This lack of further appreciation in value of the dollar and even a small decline from its current level will take away some of the benefit the industry has received in terms of lower input prices, detracting from profitability,” he said.

In addition, much of the industry’s recent strong profit growth has been due to cost-cutting and the contraction of the industry, Burt said, noting the sector has cut material costs alone by one-third over the past six years.

“Most of the low-hanging fruit has been plucked in that regard,” said Burt. “They cannot continue to drive costs down forever.”

By industry, growth in demand for IT products is expected to remain weak in the telecommunications sector as traditional incumbents, dealing with the challenges posed by new competitors and technologies, remain cautious about new investments. The financial services sector, however, will continue to have a large appetite for IT to fuel its strong profit growth.

Constraining the IT industry’s ability to meet that demand however is the current high capacity utilization, which Burt said Statistics Canada pegs at just under 90 per cent. Utilization is at its highest levels since 2000, and the industry will need to invest in infrastructure just to maintain current capabilities.

“We have seen an increase in investment by the industry in Canada but not at a rate to match the increase in demand,” said Burt, adding many of the investments by Canadian companies are happening overseas.

That’s not the case for IT distributor TechData Canada, however. TechData opened an expanded integration centre in Mississauga, Ont. earlier this year that includes 160 benches with Gigabit Ethernet connectivity, KVM switching control from 25 stations and additional servers to manage image uploads and back-up capabilities.

TechData Canada president Rick Reid said the enlarged facility has helped fuel a tenfold surge in order and unit production since it came online.

“More and more of our customer base is discovering that it just makes more sense to have the configuration function take place at the source of the product procurement,” said Reid. “We’ve expanded our configuration capabilities, both here and in the West, to allow our customers to have the configuration work done before it leaves our centre and is shipped directly to our end-user accounts.”

Only one quarter into the fiscal year, TechData Canada is already on track for the highest volume year in the history of the subsidiary, exceeding even the peaks of the dot-com boom, Reid said. And while he admits average selling prices have dropped by 50 per cent or more over the past five to six years, Reid notes revenues are higher than ever and demand is increasing.

“End users are migrating from desktops to notebooks and they’re migrating to more enhanced network capabilities,” said Reid. “VoIP is becoming commonplace and security software was small a few years ago but is now one of our largest revenue creators.”

And with the expanded integration centre in place, Reid is confident the company now has the capacity to meet that increased future demand.

“We’re not at all uncomfortable. We’re in a position to bring on much more than we currently do,” said Reid. “We’re already up to multiple shifts and we handled peak volumes through the March period, which is our biggest period, with ease.”

Comment: cdnedit@itbusiness.ca