Australia information technology report q2 2015

This is in part a consequence of market maturity, meaning growth will underperform the APAC average, which is weighted to emerging markets, but there is also macroeconomic downside as BM

Q2 2015 www.bmiresearch.com

AUSTRALIA

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2019

Q2 2015

INCLUDES 5-YEAR FORECASTS TO 2019

Part of BMI’s Industry Report & Forecasts Series

Published by: BMI Research

Copy deadline: March 2015

© 2015 Business Monitor International Ltd

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copyrighted in the name of Business Monitor International Ltd, and as such no part of this

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BMI Industry View 7

SWOT 9

IT SWOT 9

Wireline SWOT 11

Political 13

Economic 14

Operational Risk 15

Industry Forecast 17

Table: IT Industry - Historical Data And Forecasts (Australia 2012-2019) 17

2015 Outlook 17

Macroeconomic Forecasts 23

Economic Analysis 23

Table: Economic Activity (Australia 2010-2019) 28

Industry Risk Reward Ratings 29

Industry Risk Reward Index 29

Table: Asia Pacific Risk/Reward Index - Q2 2015 31

Market Overview 32

Hardware 32

Software 40

Services 44

Industry Trends And Developments 52

Regulatory Development 58

Table: Government Authority 58

Government Initiatives 58

Regulatory News 60

Competitive Landscape 63

International Companies 63

Table: Dell 63

Table: Datacom 64

Table: SAP 65

Table: Panasonic 66

Local Company 66

Table: The Good Guys 66

SAP 67

Hewlett-Packard 73

Table: Hewlett-Packard Financial Performance By Division 78

Regional Overview 82

Demographic Forecast 86

Table: Population Headline Indicators (Australia 1990-2025) 87

Table: Key Population Ratios (Australia 1990-2025) 87

Table: Urban/Rural Population & Life Expectancy (Australia 1990-2025) 88

Table: Population By Age Group (Australia 1990-2025) 88

Table: Population By Age Group % (Australia 1990-2025) 89

Methodology 91

Industry Forecast Methodology 91

Sources 92

Risk/Reward Index Methodology 93

Table: It Risk/Reward Index Indicators 94

Table: Weighting Of Components 95

BMI Industry View

BMI View: Due to high labour costs, BMI believes Australian enterprises could be among the early

adopters for AI applications such as IBM's Ask Watson service, which has already been trialled by ANZ Bank Emerging technologies aside, the growth outlook is relatively weak in Australia This is in part a consequence of market maturity, meaning growth will underperform the APAC average, which is weighted

to emerging markets, but there is also macroeconomic downside as BMI expects economic growth to slow over the medium term.

Headline Expenditure Projections

■ Computer Hardware Sales: AUD8.2bn in 2014 to AUD8.5bn in 2015, up 3.8% in local currency terms.

Slowdown in tablet demand due to market saturation will be offset by a stabilisation in desktop andnotebook sales in 2015 due to design innovation in the hybrid notebook market

■ Software Sales: AUD4.7bn in 2014 to AUD4.8bn in 2015, up 0.8% in local currency terms Security

software will outperform, particularly for small and mediumsized enterprises (SMEs) and consumers but the effect of XP enterprise upgrades will be diminished

-■ IT Services Sales: AUD9.7bn in 2014 to AUD10.7bn in 2015, up 9.6% in local currency terms IT

services will be fastest growth area of the IT market over the medium term, with cloud services the keygrowth driver as local companies try to use efficiencies enabled by the National Broadband Network(NBN)

Key Trends And Developments

After a sustained boom since 2012, the Australian tablet market appears to have peaked, in line with BMI's expectations High-street consumer electronics retailer JB Hi-Fi reported that sales in July 2014 fell by

5.5% year-on-year, mainly due to a significant slump in demand for new and replacement tablet computers

We believe this data reflects the level of consumer satisfaction with existing products and the slower rate of

innovation by leading vendors such as Apple and Samsung that have produced iterative improvements

rather than significant changes in recent announcements Although a small uptick is expected in 2016 asmobile network operators seek to attract customers to their new 4G mobile broadband networks by

including tablets in new service bundles, sales are expected to fall in the following years as the operationallives of high-spec devices - as well as their high cost - obviates the need to buy a replacement in the short tomedium term

In contrast to the slowdown in tablet demand the Australian cloud computing growth story has plenty ofmomentum remaining The latest research by the Australian Communications and Media Authority

(ACMA) showed the adoption of cloud computing services continued in 2013 In March 2014 the ACMAclaimed that 36% of SMEs actively using cloud services believed that such services provided easier or moreconvenient access to data and key resources (36%), assisted in making key productivity tools accessiblefrom multiple locations (15%) and that disaster recovery would be facilitated through the use of cloud-basedplatforms (11%)

■ Strong government support for ICT programmes.

■ IT-literate population with high levels of PC ownership and a propensity for premiumdevices

■ Strong financial sector, a large source of demand for enterprise software andservices

■ Tablet boom has offset the decline in desktop and notebook sales

Weaknesses ■ Australia has a relatively mature domestic market, with correspondingly slow growth

rates

■ Sensitive to volatility in the global economy

Opportunities ■ High labour costs and proximity of low-cost competition make Australia a fertile

market for automation technologies such as IBM's Watson and other personalassistant products

■ Considerable demand for cloud computing services from both the public andenterprise sector

■ Government cloud computing strategy creates opportunities for vendors in the publicand SME sectors

■ Potential for a rebound in notebook sales as hybrid designs evolve

■ Other major IT projects in areas such as healthcare, education and smart cards

SWOT Analysis - Continued

Threats ■ A cheaper Australian dollar would affect consumer and business demand in the

import-dependent IT market, with downside weighted towards the latter years of ourforecast

■ Vendors face threat of parliamentary enquiry into product pricing and are comingunder pressure regarding tax arrangements

■ Data from retailers indicate a sharp slowdown in the tablet market in 2014, in line withour long-held view that saturation and slower rate of innovation would result in longerreplacement cycles

Wireline SWOT

Australia Wireline SWOT

Strengths ■ Australia's overall wireline sector is host to a large number of service providers, many

of which offer a full range of voice, data and internet services

■ Many service providers offer broadband internet connectivity by means of severaldifferent technologies

■ The penetration rate, measured as a proportion of buildings reached with broadbandnetwork infrastructure, is extremely high

■ The residential market supports strong demand for pay-TV services

■ The business market supports strong demand for converged data services

■ Australia's leading broadband operators continue to report strong internet andmultimedia service sales

Weaknesses ■ Despite a significant number of service providers, the broadband market continues to

Opportunities ■ The National Broadband Network, announced in April 2013, aims to be completed

sooner and more cheaply, with the trade-off being slower connectivity

■ Demand for wireless broadband services, including WiMAX, 3G datacard and USBmodem-supported services is growing

Australia Wireline SWOT - Continued

■ Australia's leading broadband operators are investing in the development of higherspeed broadband services This has potential to drive demand for new data services

■ The government revealed that it has set aside AUD60mn for regional, rural andremote telecoms projects; satellite and wireless broadband networks are seen as asource of potential investment in remote regions

Threats ■ Fixed-line sector may decline at a more rapid rate than expected, with potentially

negative consequences for ADSL growth

■ Proliferation of naked ADSL could hasten the decline of the fixed-line sector

■ Growing popularity of wireless broadband services could negatively affect the marketfor fixed broadband access based on DSL and cable

■ The high rate of broadband penetration reduces the scope for further growth in thebroadband sector; growth will slow as the market nears saturation point

■ Following the election of the new Liberal-National Coalition government in September

2013, the NBN is likely to offer slower connectivity than originally envisaged

SWOT Analysis

Strengths ■ Australia is a mature democracy with a broadly stable party system

■ Economic stability over recent years supports the current political system and radicalgroups are unlikely to gain substantial support

Weaknesses ■ As one of the region's largest and most stable states, the country attracts many

refugees and economic migrants The issue is a key source of domestic tension andhas been hotly debated in parliament in recent times as the capsizing of a boat led tothe death of a number of refugees The issue continues to be debated in the federalparliament with no sign that political parties will find a viable alternative that wouldensure the safe passage and fair processing of the refugees, while reducing thepossibility of people smuggling

■ The fragility of the state governments' finances compared to the large infrastructureprojects that they need to undertake has led to questions with regards to thecompatibility of the federal-state system with the country's current developmentneeds

Opportunities ■ Australia has historically enjoyed close military ties with the US However, with the

rise of regional economic powers such as China, it will need to balance competingmilitary and economic ties

Threats ■ Australia's early support for the US 'War on Terror', among other things, has made

Australians abroad a target for Islamic extremists

■ Australia's close alliance with the US, particularly under John Howard, has left alingering feeling among some Asian governments that it is America's 'deputy sheriff'

in the region

SWOT Analysis

Strengths ■ A free-market economy supported by a highly educated workforce

■ Blessed with rich natural resources, Australia's economic activity has beenaugmented by demand for commodity exports and the investments made in themining sector

Weaknesses ■ The persistent current account deficit increases vulnerability to capital flows and, by

extension, currency volatility

■ The export basket is highly concentrated in commodities, and consequently exposesthe economy and currency to fluctuations in world prices for metals, coal andagricultural goods

Opportunities ■ The rapid expansion of Asian economies in recent years offers new opportunities for

diversifying trading ties from core European markets

■ A low level of government debt has provided a certain amount of flexibility in fiscalpolicy to support domestic demand through the downturn

Threats ■ The high level of private sector debt - especially mortgage loans - fuelled by overseas

funding poses a threat to sustained growth and financial stability

■ A collapse in exports from a drop in resource demand from China and other hungry countries would severely impact headline GDP growth

resource-■ Australia is vulnerable to extreme weather that may lead to droughts and floods,which have become increasingly severe in past years as a result of global climatechange

Operational Risk

SWOT Analysis

Strengths ■ A highly educated workforce and comparatively modern transport infrastructure

underpin economic prospects

■ A number of free trade agreements with countries such as New Zealand, Thailand andthe US serve as a boon for trading activities

Weaknesses ■ Despite its openness, Australia requires the Foreign Investment Review Board to

approve any commercial real estate investment by a foreign company or individualvalued at USD5mn or more

■ With a population of just over 23mn, the domestic consumer base is small by regionalstandards

Opportunities ■ Australia is currently in talks with the Gulf Cooperation Council, India, and Indonesia

regarding bilateral free trade agreements It is also part of PACER and RCEP talks

■ Upgrade and expansion of urban infrastructure will be needed to sustain populationgrowth in Australia's main cities, providing opportunities for public-private

partnerships in the future The government is also targeting infrastructureimprovements to rural areas

■ More healthcare infrastructure will be needed to support the ageing population, andwith the introduction of the federal government's National Disability InsuranceScheme, the industry is likely to see increasing demand for services

Threats ■ Corporate taxes for foreign investors in Australia remain higher than in other

countries, and it seems unlikely that the government will succeed to reduce the rates

in the near future

■ Recent investment proposals by Chinese firms regarding the agricultural and resourceextraction sector have raised fears that strategic assets will be lost to foreign players.This has led to more conditions attached to the sale agreements, which is likely toreduce the attractiveness of these assets It remains to be seen if the recent

SWOT Analysis - Continued

implementation of a database to increase transparency around foreign-ownedAustralian assets will spur more regulation

e/f = estimate/forecast Source: BMI

We maintain our view for solid growth in Australia's IT market in local currency terms, as we forecast acompound annual growth rate (CAGR) of 5.3% 2014-2019, with the market reaching AUD28.93bn by theend of our five-year forecast period in 2019 Over this period, the market will remain stable at around 1.4%

of GDP The Australian IT market has considerable medium-term potential, particularly in areas such astablets, cloud computing, real-time enterprise software and data centre growth

However, it should be noted that as a result of BMI's in-house Country Risk forecast for significant

weakening of the Australian dollar against the US dollar over the forecast period, the IT market is forecast

to grow at a CAGR of just 0.1% in US dollar terms 2014-2019

of 2.3% in 2015 (the same as for 2014), and an increase from 1.3% real growth in 2014 to 1.6% in 2015

PC penetration is high in Australia, limiting growth potential, but nonetheless we expect sales growth tocontinue as high income consumers purchase personal devices on a short replacement cycle We expect

2015 to be a strong year for sales of traditional form factors such as desktops and notebooks after recent

declines The withdrawal of Microsoft official support for the legacy operating system (OS) XP in April

2014 should continue to cause hardware upgrades, particularly in the enterprise and public sector markets

However, it will be tablet sales that again outperform as the largest device category Meanwhile, BMI

considers there to be potential for growth of hybrid notebook sales running Windows 8/8.1 as a result ofdesign innovation on the part of vendors, while at the low-end, Microsoft's decision to cut OS licensing fees

on low-cost notebooks should make them more cost-competitive versus tablets

The Australian government is an important factor in the IT market through programmes such as the

National Broadband Network (NBN), which is extending connectivity across the country National and stategovernments will continue to roll out new initiatives, and the Victoria government has invested more thanUSD150mn in IT in schools New South Wales and Queensland were also rolling out IT for schools

projects Meanwhile, an initiative by the not-for-profit organisation One Laptop Per Child saw 50,000laptops distributed to the nation's schoolchildren by June 2014

The enterprise IT outlook is the weakest out of retail, public sector and enterprise, with business confidencesusceptible to global headwinds and the domestic slowdown in economic activity There are however areas

of rapid growth within the enterprise segment, which are mainly based on the increasing prevalence ofconnectivity Three key areas that stand to benefit are cloud computing, data analytics and machine-to-

machine communications, about which BMI holds a positive medium-term view.

In 2015, uptake of cloud services will continue to increase Surveys indicate that cloud computing is apriority for Australian chief information officers, while the release of the government's cloud computingstrategy in Q213 should also boost deployments Cloud initiatives have already been implemented by many

of the country's leading banks, and across sectors cloud adoption is spreading from storage and email toareas such as human resources management The government has adopted a six-year cloud computingstrategy Cloud computing spending could reach around AUD4bn by 2017

Market Drivers

The medium-term outlook is for stable IT market growth, underpinned by economic stability BMI

forecasts the Australian economy will remain on a lower growth trajectory over the medium term, with realGDP growth forecast to average 2.6% 2015-2019 and real private consumption growth to average 1.7%

undermine domestic confidence levels, and reduce consumer purchasing power of imported products, both

of which would be detrimental to IT market spending

The maturity of the Australian hardware market means growth rates will be significantly slower than the

APAC average 2014-2098 BMI estimates that household PC penetration in Australia at just below 90% in

2014, meaning there is little scope for growth in first-time PC sales However, there are large opportunities

in the personal/upgrade device market as we expect consumers will continue to be willing to spend oninnovative devices that offer new use cases Tablets are the most prominent device meeting these

requirements, but we believe hybrids/convertibles and ultrabooks that use Haswell and, soon, Broadwellchips could gain traction in Australia There is also a significant medium term opportunity in the wearabledevices market, although it is too early to gauge potential market impact in 2015

Increased reach of broadband infrastructure over the medium term will boost activities such as onlinebanking and shopping, while the increased upload speeds delivered by the NBN will be a crucial enabler forwidespread adoption of cloud computing services The expansion of broadband infrastructure will also act

as a foundation for the ongoing modernisation of retail operations, including improved logistics and

distribution, as well as a shift to online sales

One important feature of the Australian economy which could position it as a leader in emerging

technologies is the high labour costs in Australia that will generate demand for services that replace labour

For instance, IBM's Ask Watson was adopted by ANZ Bank in H113 to enhance customer services and cut costs Such technology is in the early stages of commercial deployments, but BMI believes that Australia

could be a fertile market for such technology over the medium term due to the scale of potential labour costsavings

IT Market Growth

(2012-2019)

IT market value, mn (RHS) IT market value, AUDmn, % y-o-y (LHS)

2012 2013 2014e 2015f 2016f 2017f 2018f 2019f 3.5

4 4.5 5 5.5 6

0 10,000 20,000 30,000 40,000

e/f = estimate/forecast Source: BMI

Segments

Enterprise software demand in key verticals will continue to be centred on enterprise resource planning(ERP), customer relationship management (CRM) and business intelligence solutions - but we also expectthese applications to gain traction among small and medium-sized enterprise (SME) market A catalyst forwider adoption of enterprise software suites among SMEs is likely to be the provision of basic software

delivered in the cloud Further, BMI believes security software has potential for strong growth over the

medium term as awareness about threats grows, particularly among SMEs

In the enterprise segment regulatory compliance will result in continued spending by banks, and intensecompetition in the retail sector is spurring spending on CRM and back-office systems Competition in thetelecoms field is a driver for that key IT spending segment, where deregulation has led to new entrants

computing should see strong growth with the rollout of the NBN and the release of the government's cloudcomputing strategy in 2013 Opportunities will exist in telecoms, healthcare and utilities verticals Cloudcomputing will be key as businesses look for opportunities to reduce cost and increase flexibility, and hasalready gained traction in the market and spread beyond initial core application areas, with around one-third

of Australian organisations estimated to be using some cloud services

Over the medium term the development of supporting infrastructure, new cloud computing offerings andincreased competition in this segment are expected to fuel further demand from end-users for this

technology The federal government has set out a timetable for migrating government agencies' computingsystems to a public cloud environment Australia's big four banks will remain in the vanguard of movestowards cloud computing after revaluating their IT spend during the economic downturn

Meanwhile, government initiatives such as e-government, healthcare and education will drive significantopportunities for IT vendors over the medium term The National E-Health Transition Authority aims tocreate a paperless environment in Australia's health sector, including public hospitals Although the

government is pursuing investments in IT in a number of areas, it is reviewing procurement procedures toreduce cost, which could squeeze vendor margins For instance, in early 2013 the Australian GovernmentInformation Management Office (AGIMO) consolidated its contracts with Microsoft through a singlereseller to deliver cost savings of AUD100mn

Australia GVA By Vertical (%)

IT services from AUD10.7bn to AUD13.8bn

Macroeconomic Forecasts

Economic Analysis

BMI View: Australia's deteriorating terms of trade and unwinding investment boom are creating major

obstacles to growth The Q314 GDP miss supports our view that full-year real GDP growth will come in at 2.8%, below consensus expectations of 3.1%, before slowing further in 2015 to 2.3% The growing

importance of dwelling construction for growth will keep the Reserve Bank of Australia in a dovish mode.

Australia's Q314 GDP miss supports our view that full-year real GDP growth will fail to meet consensusexpectations, and we maintain our forecast of 2.8% Going into 2015, we continue to see growth slowingfurther to 2.3%, versus consensus expectations of 2.8%

Looking at the Q314 figures, the economy grew at an annual pace of 2.7% year-on-year (y-o-y), slowingfrom 3.1% in Q214 On a seasonally-adjusted quarter-on-quarter (q-o-q) basis, the economy grew just 1.2%annualised, marking the slowest pace in six quarters Looking at the breakdown by expenditure,

consumption spending on the part of both the government and the private sector, outperformed, withgovernment consumption expanding at a 3.3% q-o-q seasonally-adjusted annualised rate (SAAR), andhousehold consumption rising at a 2.2% q-o-q SAAR

Slowdown Continues

Australia - Real GDP Growth, % chg

Source: BMI, ABS

Investment Contraction Rolls On

Gross fixed capital formation was particularly weak, contracting by an 11.0% q-o-q SAAR, the largestcontraction in over a decade In year-on-year terms, investment has been in contraction for seven

consecutive quarters, the longest period of contraction since the 1990-1991 recession Large contractionswere seen in both private and public investment Non-dwelling construction, related to the ongoing windingdown of the resource boom, continued its deep contraction as expected Non-dwelling construction nowstands at 8.5% of GDP, down from a peak of 9.7% in Q312 With the long-term average closer to 4.2%,though, and the commodity bull market firmly in the rear-view mirror, continued contractions are to beexpected

Construction Increasingly Important

Australia - Performance Indices

Source: BMI, AIG

Dwelling Construction Joining In The Weakness

One recent bright spot in economic activity, dwelling construction, also weakened in Q314 As we argued in

'Mini Construction Boom Set To Slow', November 20, in the face of a stagnating manufacturing sector and

renewed weakness in service sector activity, Australia's construction industry has been a bright spot in theeconomy this year, but growth looks set to slow over the coming quarters While the sector continued topost year-on-year growth of 6.8%, in q-o-q terms it posted a contraction of 3.8%, suggesting that headwindsare beginning to mount against the industry

Mean Reversion Has Much Further To Go

Australia - Non-Dwelling Construction, % of GDP

Source: BMI, ABS

Terms Of Trade Reversal A Major Headwind

With the weakening Australian dollar amid the reversal in the country's terms of trade boom, there is nosurprise to see net exports begin to contribute positively to growth in real terms Indeed, exports expanded

at an 11.3% q-o-q SAAR in Q314, while imports contracted by 3.7% However, this merely represents thedifficulty that the Australian economy will face in rebalancing its external accounts amid a deterioration inits terms of trade The chart below shows the trade balance in nominal and real terms rebased to 2004 Upuntil 2012, Australia was consuming at a faster pace than it was producing, but higher export prices andlower import prices meant its trade account could improve The exact opposite situation is now in play,where the economy is swimming against a heavy tide, and is likely to need a contraction in imports toprevent a significant deterioration in the trade account

Swimming Against The Tide

Australia - Index Of Real Versus Nominal Net Exports, Rebased To 2004

Source: BMI

Forced Import Reduction To Undermine Growth

While lower imports appear as a positive in terms of their direct impact on GDP by expenditure

calculations, in reality, lower imports, which will be necessitated by higher prices for external goods due to

a cheaper AUD, mean a reduction in consumer surpluses and profit margins This, combined with theprecarious nature of the housing market, is a major reason for our below consensus view on Australiangrowth in 2015 and 2016

Table: Economic Activity (Australia 2010-2019)

2010 2011e 2012e 2013e 2014e 2015f 2016f 2017f 2018f 2019f

Nominal GDP, USDbn 1,247.30 1,499.60 1,555.10 1,501.20 1,476.20 1,300.30 1,297.80 1,315.90 1,383.50 1,454.70 Real GDP growth, %

Industry Risk Reward Ratings

Industry Risk Reward Index

The extension of our forecasts and inputs to 2019 has led to a change in the outlook for many markets inAsia Pacific Previous regional leader South Korea fell three places, returning Singapore to the top spot Theindex remains largely unchanged in the latest update, with forecasts to 2019 having little impact on themarkets offering the greatest or fewest rewards High-spend markets that are home to large internationalcompanies tend to fare best, relying on established connectivity to support ongoing growth

Many of the emerging economies in our indices suffer from weaker telecommunications infrastructure,which underpin the growth of IT services in particular Consumers and companies may own hardwarewithout the requirement of internet access, but it is data usage that supports much of the ongoing growth ofthe IT market

It is therefore no coincidence that Sri Lanka remains at the bottom of our indices, below Vietnam Whileboth have vibrant mobile markets, it is the broadband sectors in both that lag Mobile broadband servicesoffer some opportunities but the markets' growth will be towards the end of our forecast period Both arestarting from a low base of PC penetration, and weak consumer spending capability compared with regionalpeers also limit prospects These markets still require hardware growth to take off in order to encourage thegrowth in IT services and software that denote more developed IT sectors

India, the Philippines and Thailand hold similar scores; their positions in the index were unchanged thisquarter India and the Philippines in particular have generated strong revenues from business processoutsourcing (BPO) Although the spending on these services largely takes place in other markets, thedevelopment of BPO sites requires spending on hardware and software in the local market to support thedevelopment of these platforms India's IT market has boomed, but largely as it has sold services overseas

Thailand has benefited from investment in data centres by several international companies and local usershave turned to cloud computing quickly Although the segment remains comparatively small, it will drivemuch of the overall market growth, as it starts from such a low base Thailand pulled ahead of its lowerranked peers with a brightening economic outlook and greater political stability combining to improve thecountry's IT growth prospects Thailand has closed the gap on the Philippines and India, which rank justabove

India saw no change to its score with the country remaining one of the key global business process

outsourcing (BPO) destinations However, IT spending among local companies remains low and thecountry's limited reach of PCs means hardware does not exist in many regions to support the growth of ITservices The trend is similar in the Philippines, which has built a strong BPO presence also, but lacksIndia's scale The internal market for IT services is weak in both countries although companies present inthe markets have increased spending on technology

As seen in the emerging market economies of our Asia Pacific Risk Reward Indices there is growingdemand for cloud computing among SMEs in order to cut costs and introduce technology in a cost effectivemanner Indonesia in particular has encouraged the growth in data centres to serve international companiesand drive more investment into IT services In all cases, a lack of hardware in smaller companies limits thereach of these products As desktops and notebooks are made increasingly affordable, enterprises will spendmore on IT service products

In the centre of the table Malaysia is separated from Indonesia by almost six points, marking a considerabledifference in outlook Only China joins Malaysia in the top half of the table with China's sheer scale the keydetermining factor in its high position China shares the characteristics of its emerging market peers - low

PC penetration, limited spending on IT services - but the large government sector and growing interest indeveloping businesses in the country encourage greater spending

The large gap between the top four markets and China, the highest ranked emerging market, reflects thematurity of IT development in Singapore, Hong Kong, South Korea and Australia These countries havehigh PC penetration rates with growth over 2011-2014 focused on tablets sales as additional devices ratherthan alternatives to notebooks IT services and software comprise the bulk of enterprise spending, pushingthe markets' growth rates Services such as enterprise resource planning and customer relationship

management are gaining ground as companies seek to automate processes and learn from data generatedinternally

The relative position of the markets is based principally on the size of the economies, and the ease ofreaching businesses City states Singapore and Hong Kong have a number of advantages in this, allowingthem to place highest in our Index

Table: Asia Pacific Risk/Reward Index - Q2 2015

Rewards Risks Country Rewards Industry Rewards Country Industry Risks Country Risks IT Score Rank Previous Rank

Market Overview

Hardware

BMI forecasts the Australian computer hardware market value will increase by 3.8% in 2015 to a total of

AUD8.5bn, although in US dollar terms we forecast a contraction of 0.7% due to depreciation of theAustralian dollar The outlook extends over the medium term as we forecast a compound annual growth rate(CAGR) of 3.2% 2015 to 2019, with total demand expected to reach a value of AUD9.46bn by the end ofour five-year forecast period to 2019

Over the medium term we identify new products such as hybrid/convertible ultrabooks and tablets as themain opportunities for growth However, in 2015 we expect the decline in desktop and notebook sales willdecelerate, and tablet unit growth will slow, as a result of tablet market maturity and the availability ofcompetitive hybrid notebooks from Windows partner vendors Meanwhile, government procurementprogrammes and growing broadband penetration will also boost sales

Government programmes are significant factors in the PC market Government subsidies of computers ineducation provide support for the market National and state governments have continued to roll out newinitiatives, with the Victoria government investing more than USD150mn in IT in schools Large educationprogrammes were rolled out in Queensland and New South Wales in 2012

The government's ambitious broadband plans will also drive expansion The National Broadband Network(NBN) plan should further the development of Australia's digital economy and services such as onlinebanking and shopping Converged multimedia services such as internet protocol television (IPTV) will alsofeed demand for PCs and notebooks with entertainment features Bundling deals by 3G mobile telecoms

service providers such as Vodafone will help drive sales of portable computers as connectivity devices.

PC Market

Data for 2013 show the market performed in line with our expectations Research firm Gartner reported

that desktop and notebook shipments declined, while tablet sales continued to soar, driven higher by thebroader range of devices by price and screen size

JB Hi-Fi reported that sales in July 2014 fell by 5.5% year-on-year (y-o-y), mainly due to a significant

slump in demand for new and replacement tablet computers

In addition to secular slowdown in tablet demand, there is a fightback underway from Microsoft's partner

vendors The launch of touch-integrated Windows 8 operating system (OS), a new wave of lower-cost

ultrabooks, and the release of Intel's new Haswell chipset architecture should stimulate new cycles of

hardware upgrades, and also blur device categories by enabling ultrabooks and convertibles/hybrids to offerthe mobility benefits of tablets and the productivity benefits of notebooks

Despite recent discounting, prices remain on average higher in Australia compared with many other

development country markets, a fact that triggered a parliamentary enquiry The Parliamentary Committeelooking into IT said in 2012 that the enquiry had struck a chord with the public, resulting in a high level ofsubmissions from consumers Consumer groups have blamed differential pricing by multinationals forprices, sometimes as much as 80% higher than for equivalent products in other countries In a study of more

than 200 products, consumer group Choice found that a selection of 12 Dell computers were 41% more

expensive on average in Australia However, IT companies argued that higher Australian prices were notIT-specific They pointed to higher wages and distribution costs, and high prices charged by Australianchannel agents

Hardware Market

(2012-2019)

Personal computer sales, AUDmn Servers sales, AUDmn

2012 2013 2014e 2015f 2016f 2017f 2018f 2019f 0

2,500 5,000 7,500 10,000

e/f = estimate/forecast Source: BMI

Desktops And Notebooks

There is a well-established shift in demand away from desktops and notebooks to tablets, hybrids/

convertibles and Ultrabooks that has occurred over the decade to 2014 Looking ahead, BMI believes

traditional device categories will become less significant in coming years, as tablets become

higher-powered, and hybrids/convertibles gain ground

The outlook for traditional form factors including conventional desktops and notebooks is weak Theenterprise market is a stalwart for desktop sales, but PC penetration is high among Australian businesses,with around 95% of small businesses and 100% of medium-sized and large businesses having computers.Small business comprises more than 99% of all Australian businesses and slightly more than 50% ofbusiness PC sales

believes this potentially relates to first-time buyer households opting for the additional functionality ofnotebooks over tablets Meanwhile, higher income households have preferred to acquire tablets as

complimentary to a traditional PC form factor

Meanwhile, household PC penetration is high, approaching 90% by 2014 This means there is a limitedfirst-time buyer market, with vendors instead focusing on the upgrade/replacement market when it comes toconventional desktops and notebooks Upgrades are estimated to account for at least 80% of businesspurchases, and more than 50% in the case of households However, we believe this figure is beginning toerode, with the lifecycle of desktops especially lengthened as consumers maintain devices and insteadpurchase mobile computing devices

In the notebook market, sales of netbooks have declined since 2010, due in large part to the popularity oftablets, as well as a blurring of the netbook and notebook categories Netbooks were the fastest growingsegment during the economic downturn and reached nearly 15% of notebook sales in Q209, with more than90,000 units sold However, the popularity of netbooks added to the downward pressure on average salesprices as consumers preferred lower-priced models Netbooks were never as popular in Australia as in someother markets, peaking at around 16% of the PC market, and the emergence of tablets is expected to result

in a continued decline in the netbook share

Australia Household Penetration By Device (%)

devices, which we believe continued somewhat in 2014, but, with the Apple iPad and Samsung Galaxy

devices outselling lower-spec products, we anticipate replacement cycles to lengthen and the pool of newcustomers to dwindle, causing a sharp slowdown in total sales

We expect to see 4.29mn units sold in 2015, which represents a slight decline from 2014 as fewer newcustomers look for tablets Although a small uptick is expected in 2016 as mobile network operators seek toattract customers to their new 4G mobile broadband networks by including tablets in new service bundles,sales are expected to fall in the following years as the operational lives of high-spec devices - as well astheir high cost - obviates the need to buy a replacement in the short to medium term

The diffusion curve of tablets has been steeper than for any other consumer electronics product of recent

years According to an estimate by market research firm Telesyte, by the end of September 2010 around

300,000 tablets had been sold in Australia, of which the large majority were understood to be iPads

Telesyte estimates tablet sales reached 2.4mn in 2012, with Apple again leading the market

Meanwhile, data from Statcounter support our view that the iPad dominates the tablet market The data

show that Apple's iOS, run on its tablets, accounted for 14.4% of Australian PC browsing traffic in August

2014, a figure that was up by 4.4 percentage points (pp) year-on-year (y-o-y), and a higher share of total

traffic than that observed in the majority of developed markets Meanwhile, Google's Android OS, which is used on Samsung, ASUS and Google's own Nexus range, accounted for just 1.2% of PC browsing traffic

(down 0.1pp y-o-y) Android has had relatively little success in the higher income Australian marketcompared to emerging markets, with Australian consumer demonstrating a propensity for premium productsextending from tablets to Apple's range of desktops and notebooks running MacOSX

While Android has had little immediate impact on Apple's dominance of the Australian tablet market it isimportant to note the gap between the strategies of some of the leading players Apple and Samsung are

hardware vendors and look to profit from the sale of devices, while Google and Amazon are services firms

and offer tablets almost at cost The strategies of services firms (combined with low cost original equipmentmanufacturer [OEM] tablets from China) will likely put pressure on the margins of hardware-centricvendors

Hybrids And Ultrabooks

The most significant medium-term development derived from Windows 8, and the arrival of more efficient Haswell chipsets, is the impact on innovation and form factors Windows has a traditional strength

energy-in productivity use cases and software, with the OS beenergy-ing central to the enterprise market and Microsoft's

Office Suite ubiquitous There is an opportunity for vendors to leverage this strength over rival iOS andAndroid devices by designing tablets with strong productivity functionality alongside the passive mediaconsumption features

Early examples have been hybrid devices such as Microsoft's own Surface (RT & Pro), Hewlett-Packard (HP)'s Envy, Dell's Idea Pro range and Lenovo's Yoga and Helix Although design innovation has some

way to go, and prices of hybrids will need to decline, the multi-use device has scope to capture a share ofthe tablet market by offering a stronger value proposition to consumers while not compromising userexperience The arrival of Haswell chipsets in June 2013 enabled a new generation of higher powered,

slimline and long battery life devices, as well as presaging cheaper Ivy Bridge prices This has deepened the

ultrabook and hybrid/convertible market, which BMI believes boosted sales higher in H213 and 2014.

Industry Trends - PC Volume Forecast ('000)

2011-2018

e/f = estimate/forecast Source: BMI

Vendor Developments

Multinational brands dominate the Australian PC market The major players include HP, Apple, Dell,

Lenovo and Acer The share of unbranded 'white box' products in Australia has dropped to less than 20%.

HP has around a 19% share of the brand PC market, ahead of nearest rival Apple with around 17%, andDell has a share of around 14% The top five vendors, including Acer and Dell, together account for morethan 70% of the market

Competition for government tenders continues to be a significant part of the market, particularly in

partnership with an IT deployment company to roll out 10,000 netbooks to Victoria public schools over2009-2012 The project will provide Lenovo and Acer netbooks to students in years five through to eight.

More recently, in June 2013, Lenovo and Dell became the first two technology companies to sign up to theNew South Wales government's IT hardware panel The panel, worth USD85.68mn, provides IT hardwarefor the whole of government as part of the NSW government's IT policy reforms It initially covereddesktops, laptops and tablets but will be extended to servers, storage, imaging devices and virtualisation.Both companies will be on the panel until April 30 2015, with three 12-month extension offers

Lenovo remains a relatively small player in Australia and spends little in the country on mass mediaadvertising Lenovo's brand is hardly a presence in major consumer electronics retail chains such as Harvey

Norman and JB HiFi Instead the company relies on smaller independent retailers However, it still has some large organisation clients inherited from IBM, including several banks It also has an ongoing

relationship with several government departments, with the New South Wales Education department beingone major client

Australia's PC Browsing Traffic By OS (% and percentage point change

y-o-y)

August 2014

Source: Statcounter

High penetration rates for enterprise software mean the software market will underperform emerging

markets in APAC over the medium term However, BMI believes there is potential for further investment in

Australia due to the high cost of labour, meaning automation software that can provide a cost basis forimplementation is likely to find a receptive market Given the extremely high labour costs in Australia, andits proximity to low-cost markets, we believe it could prove a testing ground for new deployments, for

instance IBM's Watson-as-a-Service initiative.

Software is expected to account for 19.9% of the Australian IT market in 2015, with forecast spending ofAUD4.8bn Software sales are forecast to have a CAGR of 4.8% 2014-2019, with the total market expected

to reach a value of AUD5.69 in 2019

Operating Systems

In terms of OS, migration to the Windows 8/8.1 OS retained the potential to have a positive impact on sales

in 2014 as a result of the withdrawal of official support for XP and cuts to OS licensing fees by Microsoft.The cut to OS licensing fees for notebooks under USD250 should make notebooks more competitive against

Android tablets at the low-end - although BMI believes the impact in Australia will be relatively muted due

to consumer affluence and a propensity for premium products

The withdrawal of official support for XP in April 2014 acted as a push factor for OS upgrades, particularly

in the enterprise segment, as businesses sought to maintain information security However, the developednature of the Australian IT market meant that many organisations had already migrated to Windows 7/8/8.1.Recent research by Statcounter shows that Australian consumers are upgrading from Microsoft's Windows

XP OS more quickly than their counterparts in the US and UK markets XP usage has fallen in Australiafrom 71% in 2008 to 4.0% in August 2014 (and down 5.6pp y-o-y)

Enterprise Software

Cost-saving software including enterprise resource planning (ERP), customer relationship management(CRM) and other e-business products will be increasingly popular in the small and medium-sized enterprise(SME) market, as companies try to enhance productivity through automating essential functions and ease