The impending enforcement of the Sarbanes-Oxley Act of 2002 could trigger an IT spending spree among publicly traded high-tech companies that will soon become legally obligated to keep a better accounting of their business processes and procurement habits.
Signed into law by President Bush on July 30, 2002, the act was a reaction to the collapse of Enron, WorldCom, and other corporate scandals, and already demands that chief executives and financial officers include their signatures on all SEC filings. Other requirements of the law will take effect June 2004 for large U.S. companies and April 2005 for smaller businesses.
"More people throughout entire organizations now understand this compliance is real and that internal financial controls touch a large percentage of employees and functions within a company," said Dan Driscoll, chief operating officer at Viacore, a software integration services provider in Irvine, Calif. "In the last three to six months, between 30% and 50% of companies are asking questions on compliance and integration relative to the act. This is compared with the topic never coming up in conversation a year ago."
The act, which has several components, could result in hundreds of millions of dollars in new IT spending among electronics companies, perhaps most notably in the area of inventory controls and the recognition of revenue from the sale of materials.
"A company might have transferred ownership to you before they record the sale," said Seamus Moran, director of financial applications development at Oracle Corp., Redwood Shores, Calif. "That is not your problem; however, once you have acquired ownership and responsibility for the material, even if they have not recorded the sale, you have procured it."
Section 401(a) of the Sarbanes-Oxley Act requires disclosure of all off-balance-sheet transactions and other agreements that have a "material effect" on the financial performance and financial statements of a company, according to the SEC.
This will force chief financial officers and supply chain managers to keep a tighter tab on material commitments, leasing and outsourcing arrangements, volume guarantees and forecasts, and orders covered under supply contracts, according to Tim Minahan, vice president of supply chain for the Aberdeen Group, Boston.
"The high-tech sector could be under particular scrutiny considering the use of outsourced manufacturing and vendor/channel-managed inventory," Minahan said.
"Enterprises will need to develop clear ways to delineate who owns this inventory at any given time and at what cost. They will also need to establish ways to quickly track and assess their inventory and financial exposure across the extended value chain."
Analysts said this could increase the amount companies allocate to IT budgets to better monitor such transactions. In fact, companies in the computing, consumer and industrial electronics, semiconductor, and telecommunications sectors are allocating an average of 16% of their 2004 applications budgets to supply chain management, up from 13% this year, according to a study by AMR Research Inc., Boston.
"Fortune 1000 companies this year across all industries will spend $2.5 billion on activities and technology related to the Sarbanes-Oxley Act," said John Hagerty, a vice president at AMR. "Between 90% and 95% will be spent just in the planning stage as companies try to figure out what type of IT system they need."
By demanding better and more immediate accountability of financial transactions and risk assessment, the act is also placing pressure on companies to automate and integrate their systems with other supply chain partners.
"Sarbanes-Oxley will force system integration, automation, and real-time notification of events to give companies more visibility into everything that goes into their financial books," said Alex Veytsel, a research analyst at the Aberdeen Group.
"Automation reduces risk factors in business-to-business transactions like credit, dispute settlements, unauthorized purchases, and cash flow issues that arise from not having the funds to pay bills," he said.
As a result, worldwide business integration spending is expected to grow at a CAGR of 11% between 2002 and 2006 and reach $3.93 billion this year, according to the Aberdeen Group. The research firm said sales of software licenses will reach $869 million in 2003, and related hardware sales should total $104 million.
Companies like electronic components distributors Arrow Electronics Inc. and Avnet Inc., which already have sophisticated IT systems in place, view the legislation as an opportunity to revisit their supply chain practices to further reduce cycle times and cost.
"Automating processes is a way of making sure that the information going into your financial statement is accurate," said Ray Sadowski, chief financial officer at Avnet, Phoenix.
Similar to Avnet, distributor Arrow views challenges posed by Sarbanes-Oxley as an opportunity to educate its workforce and align processes globally. Since 1984, Arrow each year has required its North American employees to sign a statement that certifies they understand and are willing to follow the company's ethics polices. Sarbanes-Oxley requires companies headquartered in North America to implement a similar ethics standard worldwide, which the distributor is in the process of completing.
"The challenge for large multinationals is to educate others within the company worldwide," said Paul Reilly, chief financial officer at Arrow, Melville, N.Y. "We have spent time educating the international finance teams with face-to-face and videoconference meetings."
While the greater emphasis on systems integration will effect how companies share information with their suppliers and customers, it will also force them to clean house internally.
"If a company has five purchasing departments, it probably has that many procurement business processes," said Sue Ann Celentano, a market manager for WebSphere Business Integration for Energy & Utilities within IBM Corp., Somers, N.Y. "The key is to first standardize the process for all five departments, so all can recognize revenue based on the same decisions."
Though compliance with the new law may result in new corporate IT spending, it could also have a positive result, according to analysts, by improving business-to-business information flow and reducing costs in other areas. Indeed, the act doesn't actually require spending on new software and hardware, merely that companies meet the more rigorous SEC guidelines.
"If you automate procurement processes, your checks and balances are built in," said Samuel Starr, president and chief executive of software intergration provider Sterling Commerce, Columbus, Ohio. "The company not only reduces costs, but there is a process in place to ensure the integrity of the transaction and data."
The reason: most companies in high- tech are tied to others outside their four walls, making visibility into the supply chain even more important.
"Buyers procure product based on customer forecasts," said Srini Murty, vice president for SCM solutions at software provider i2 Technologies Inc., Dallas. "Anytime I buy something and don't sell it in the same quarter, it is inventory I must carry. That shows up as a liability on my balance sheet."