Australia information technology report q4 2014

Slowdown in tablet demand due to market saturation will be offset by a stabilisation in desktop and notebook sales in 2014 due to XP support withdrawal and design innovation in the hybri

Q4 2014 www.businessmonitor.com

AUSTRALIA

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2018

Report Q4 2014

INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: September 2014

Business Monitor International

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DISCLAIMER

BMI Industry View 7

IT SWOT 9

Wireline SWOT 11

Political 13

Economic 14

Business Environment 15

Industry Forecast 17

Table: IT Industry - Historical Data And Forecasts (Australia 2011-2018) 17

Macroeconomic Forecasts 23

Economic Analysis 23

Chinese Reform Efforts To Weigh On Export Growth 24

Consumption Growth To Slow Further 25

Residential Investment To Fall Short 26

Table: Economic Activity (Australia 2009-2018) 27

Industry Risk Reward Ratings 28

Table: APAC IT Risk/Reward Ratings - Q4 2014 31

Market Overview 32

Hardware 32

Software 40

Services 45

Industry Trends And Developments 53

Regulatory Development 58

Table: Government Authority 58

Government Initiatives 58

Regulatory News 60

Competitive Landscape 64

International Companies 64

Table: Dell 64

Table: Datacom 65

Table: SAP 66

Table: Panasonic 67

Local Company 68

Table: The Good Guys 68

Company Profile 69

SAP 69

Hewlett-Packard 75

Table: Hewlett-Packard Financial Performance By Division: 79

Regional Overview 84

Asia Pacific Overview 84

Demographic Forecast 89

Table: Australia's Population By Age Group, 1990-2020 ('000) 90

Table: Australia's Population By Age Group, 1990-2020 (% of total) 91

Table: Australia's Key Population Ratios, 1990-2020 92

Table: Australia's Rural And Urban Population, 1990-2020 92

Methodology 93

Industry Forecast Methodology 93

Sources 94

Risk/Reward Ratings Methodology 95

Table: It Risk/Reward Ratings Indicators 96

Table: Weighting Of Components 97

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 slowover the medium term

Headline Expenditure Projections

Computer Hardware Sales: AUD7.9bn in 2013 to AUD8.2bn in 2014, up 3.6% in local currency terms.

Slowdown in tablet demand due to market saturation will be offset by a stabilisation in desktop and

notebook sales in 2014 due to XP support withdrawal and design innovation in the hybrid notebook market

Software Sales: AUD4.3bn in 2013 to AUD4.7bn in 2014, up 8.8% in local currency terms Security

software will outperform, particularly for small and medium-sized enterprises (SMEs) and consumers - but

it is XP enterprise upgrades that will make software the outperforming segment in 2014

IT Services Sales: AUD9.2bn in 2013 to AUD9.7bn in 2014, up 6.3% in local currency terms IT services

will be fastest growth area of the IT market over the medium term, with cloud services the key growthdriver 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 (y-o-y), mainly due to a significant slump in demand for new and replacement tabletcomputers 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 as mobile 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

operational lives of high-spec devices - as well as their high cost - obviates the need to buy a replacement inthe short to medium 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%)

IT SWOT

SWOT Analysis

Strengths ■ High incomes and strong supporting infrastructure drive high levels of IT spending per

capita

■ 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

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

SWOT Analysis - Continued

■ 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 cheaper, 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

Business Environment

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 US$5mn or more

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

Opportunities ■ Australia is currently in talks with China, Malaysia, the Gulf Co-operation Council,

Indonesia, India, Japan and South Korea regarding potential bilateral free tradeagreements It is also part of negotiations for the Trans-Pacific Partnership and aregional south pacific pact, PACER plus

■ 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 to

SWOT Analysis - Continued

reduce the attractiveness of these assets It remains to be seen if the recentimplementation of a database to increase transparency around foreign-ownedAustralian assets will spur more regulation

AUDmn 7,584.7 7,756.5 7,904.2 8,185.2 8,499.3 8,718.8 9,006.9 9,241.0Personal computer sales, AUDmn 6,048.0 6,231.6 6,397.7 6,612.8 6,853.8 7,017.8 7,236.1 7,410.4 Software sales, AUDmn 4,087.1 4,162.3 4,345.1 4,728.1 4,764.4 5,099.4 5,272.1 5,483.8 Services sales, AUDmn 8,044.1 8,666.4 9,165.6 9,741.6 10,677.9 11,351.6 12,134.2 12,943.0

e/f - BMI estimate/forecast Source: BMI.

BMI made a minor downward revision to historical data for the Australian IT market in the Q414 update,

but our medium-term outlook is unchanged We maintain our view for solid growth in local currency terms,

as we forecast a CAGR of 5.3% 2014-2018 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 2014-2018

2014 Outlook

BMI forecasts the IT market will expand by 5.8% in local currency terms in 2014, to reach a value of

AUD22.7bn We expect growth to be stronger than in 2013, despite a macroeconomic slowdown, as a result

of positive IT market developments including the withdrawal of support for Windows XP in April 2014,which triggered hardware and software upgrades by enterprises and the public sector

Despite the economic environment becoming less supportive of IT market expansion, we continue toforecast GDP and private final consumption will grow in real terms in 2014 We forecast of a slowdown inreal GDP growth to 2.3% in 2014 versus 2.4% in 2013, but the slowdown in private consumption will befaster, declining from 2% real growth in 2013 to 1.3% in 2014

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

2014 to be a strong year for sales of traditional form factors such as desktops and notebooks after decline in

2012 and 2013 The withdrawal of Microsoft official support for the legacy OS XP in April 2014 shouldtrigger hardware upgrades, particularly in the enterprise and public sector markets However it will 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 of design innovation on the part ofvendors, while at the low-end, Microsoft's decision to cut OS licensing fees on low-cost notebooks shouldmake 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 We expect overallgovernment spending to increase by 2% in real terms in 2014, presenting opportunities to vendors Nationaland state governments will continue to roll out new initiatives, and the Victoria government has investedmore than USD150mn in IT in schools New South Wales and Queensland were also rolling out IT forschools projects Meanwhile, an initiative by the not for profit organisation One Laptop Per Child will see50,000 laptops 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 2014, uptake of cloud services will continue to increase Surveys indicate that cloud computing is apriority for Australian CIOs, while the release of the government's cloud computing strategy in Q213 shouldalso boost deployments Cloud initiatives have already been implemented by many of the country's leadingbanks, and across sectors cloud adoption is spreading from storage and email to areas such as humanresources management The government has adopted a six-year cloud computing strategy Cloud computingspending 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% 2014-2018 and real private consumption growth to average 1.7%annually 2014-2018 However, we also highlight downside risk to this outlook, which could result in marketdisruption We expect a weakening of the Australian dollar from an average of AUD1 to the US dollar in

2013 to AUD1.3 in 2017 and 2018 Depreciation could undermine domestic confidence levels, and reduceconsumer 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 2014-2018 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, Broadwell

chips 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 2014

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

5,000 10,000 15,000 20,000 25,000 30,000 35,000

e/f = BMI estimate/forecast Source: BMI

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 customer relationship management (CRM) and back-

office systems Competition in the telecoms field is a driver for that key IT spending segment, wherederegulation has led to new entrants.

IT services are forecast to be the outperforming segment of the IT market in the medium term, as demand isdriven by cloud computing services, data analytics and machine-to-machine communications Cloudcomputing 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 Government

Information Management Office (AGIMO) consolidated its contracts with Microsoft through a single

reseller to deliver cost savings of AUD100mn

Australia GVA By Vertical (%)

IT services from AUD9.7bn to AUD12.9bn

Macroeconomic Forecasts

Economic Analysis

BMI View: The strong performance by Australian exports lifted Q114 real GDP growth to 1.1%

quarter-on-quarter (q-o-q) in real and seasonally-adjusted terms, and we have upgraded our 2014 growth forecast

to 2.3% on the back of these figures However, our growth forecast remains below consensus as an austere budget and easing mining investment intentions should keep domestic demand subdued.

The Australian economy grew by 1.1% quarter-on-quarter (q-o-q) after seasonal adjustments in Q114,reaccelerating from a pace of 0.8% recorded in Q413 Strong export growth was further accentuated by acontraction in imports, which saw the goods and services balance move into the black in Q114 for the firsttime in nine quarters Given that latest data from the Chinese customs authorities for April showing anothersurge in iron ore imports (which are primarily from Australia) to 24.2% year-on-year (y-o-y), we haveupgraded our real GDP growth forecast to 2.3% to account for the stronger export performance

This upgrade, however, in no way changes our downbeat and below-consensus outlook for the Australianeconomy We maintain that the economy remains on shaky foundations, as the mining sector continues to

be the heavy lifter for the rest of the economy We believe that a slowdown in the Chinese economy andongoing reforms efforts should weigh on Australia's export performance beyond H114 At the same time,

we believe domestic demand will be moderate at best, as government consumption growth is likely to slowunder a more austere federal government and the services sector will struggle to offset the declines from themanufacturing and mining sectors

Still Reliant On Mining

Australia - Growth Contribution By Sectors (% chg q-o-q, LHS) & Chinese Iron Ore Imports (mn

Tonnes)

Source: BMI, ABS, China General Customs Administration

Chinese Reform Efforts To Weigh On Export Growth

We maintain that both our downbeat outlook for the Chinese economy and reforms that local officials areimplementing will weigh on exports and reduce the tailwind they have provided to the Australian economy.Exports contributed more than 96% of the growth recorded in Q114, while the simultaneous contraction inimports boosted overall net exports to contribute 1.4 percentage points (pp) to q-o-q growth for the quarter

On the back of this strong growth in Q114, we have upgraded our expectations for real export growth tocome in at 6.0% (versus 4.5% previously)

However, given our bearish outlook for the Chinese steel sector and property market, we believe thatcurrent levels of demand for Australian exports from China will not be sustained Additionally, we believethat the Chinese authorities will continue to pursue reforms, and this could include the government crackingdown on commodity financing deals which have reportedly provided some support for industrial

commodities such as copper, aluminium and iron ore To this end, we believe that recent news that the port

of Qingdao, China's third largest port, has halted shipments of metals starting from June 3 due to an

investigation by local authorities suggests that the crackdown may begin sooner rather than later As such,

Australia's stellar export performance may be curtailed in H214, in line with our previous expectations (see '

Downbeat Outlook For Steel To Cap Iron Ore Export Growth', March 7 and ' China Imports: Robust Growth To Give Way In H214', June 2).

Consumption Growth To Slow Further

With the export boost expected to fade in the coming months, growth in domestic demand will need tobecome much stronger to fill the gap In this respect, we maintain our outlook for the domestic economy toexperience a period of slow growth as a combination of high debt levels (which implies a need for

deleveraging or for incomes to grow) and near-term job cuts weigh on domestic expenditure So far, webelieve that these dynamics are already playing out Indeed, after stripping out the effects on growth fromexternal demand, domestic demand contracted by 0.3% q-o-q in Q114 compared to 0.5% q-o-q growth inthe previous quarter This was driven by moderating consumption growth as well as a severe contraction ininventories In particular, growth of total public and private consumption decelerated, coming in at 0.3% q-o-q in real and seasonally-adjusted terms, versus 0.4% q-o-q in Q413 In addition, the austere federalgovernment budget for FY2014/15 (July-June) announced in mid-May presents another headwind toconsumption growth given that proposed tax hikes and subsidy cuts have begun to weigh on consumerconfidence Monthly retail sales have also shown signs of weakness over the last few months

Barely In The Black

Australia - Gross Capital Formation & Components (pp contribution To Real GDP q-o-q Growth)

Source: BMI, ABS

Residential Investment To Fall Short

Our outlook for the investment picture in Australia remains dim, as we expect the weaker investment fromthe mining sector to outweigh initial spurts of growth from the other sectors of the economy in the nearterm Moreover, we believe that residential construction will struggle to offset the declines in other non-dwelling investment sub-segments In Q114, inventories suffered yet another deep contraction, subtracting0.7 pp from the headline real GDP growth figure Moreover, q-o-q growth of gross capital formation barelymade it to the black, despite the stronger investment in residential dwellings This is despite data from the

Australian Bureau of Statistics (ABS) showing that the 6.8% q-o-q increase in residential construction

activity in Q114 successfully offset contractions in non-residential construction and engineering

construction, to lift the sector's overall activity by 0.3% q-o-q With house price growth showing signs ofcooling, we believe that residential investment will struggle to grow sufficiently to offset the declines fromthe other sectors This is especially so as a number of major liquefied natural gas (LNG) projects are nearingcompletion, such as Gorgon, Gladstone, APLNG and QCLNG, while mining investment intentions continue

to ease based on latest ABS estimates

Private Consumption: We expect private consumption growth to ease as wage growth wanes in 2014 and

2015 Moreover, with household debt above 90% of GDP, we see little scope for debt-driven consumption

to rise significantly, and therefore cap the likelihood for private consumption growth

Private Investment: While confidence has improved, we note that businesses remain cautious and as such

expect spending and employment activity to be subdued Moreover, we do not expect the elevated

residential building activity to be maintained for the rest of the year as we believe that the strong growth inhouse prices over the past year will wane as wage growth appears even less likely in the months ahead

Government Consumption And Investment: Although Prime Minister Tony Abbott is keen to push

through plans for austerity, we believe that the fragmented composition in the federal Senate will preventany significant cutbacks That said, with the rollback of carbon tax and limited scope for implementing taxreform with the support of the states, we do not expect the authorities to significantly increase their

infrastructure spending in 2014, although there is scope for greater public spending in the years beyond

Net Exports: We believe that the pick-up in mineral exports will subside in the coming quarters, given the

decline in commodity prices and shutdown of fringe mine operations That said, we expect import growth toslow with wage growth on the decline

Table: Economic Activity (Australia 2009-2018)

Nominal GDP, USDbn 982.0 1,247.3 1,499.6 1,555.1 1,501.2 1,449.8 1,376.2 1,362.1 1,408.0 1,488.6 Real GDP growth, % y-o-y 1.4 2.7 2.5 3.8 2.4 2.3 2.3 2.5 2.8 2.9 GDP per capita, USD 44,967 57,009 67,166 66,664 61,709 63,044 59,268 58,100 59,471 62,276 Industrial production, % y-

o-y, ave -0.7 4.7 1.2 4.6 3.6 1.6 1.6 2.1 2.0 2.0Population, mn 22.0 22.4 22.7 23.1 23.3 23.6 23.9 24.2 24.5 24.8 Unemployment, % of

labour force, eop 5.5 4.9 5.2 5.4 5.9 6.5 6.1 5.7 5.5 5.5

National Sources/BMI

Industry Risk Reward Ratings

BMI's Asia Pacific IT Risk/Reward Ratings (RRR) compares the potential of a selection of the region's

markets over our medium term forecast period to 2018 The Q414 ratings reflect our analysis of the politicaland economic risks, as well as the risks associated specifically with IT intellectual property (IP) rightsprotection and the implementation of state spending projects

There was only one positional change in the Q414 ratings as Singapore returned to the top position

However, scores remain tight at the top of the table and there is scope for further positional changes in thecoming quarters Meanwhile, there was a 0.3pps decline in the regional average IT risk/reward rating to55.6 - with the decline primarily caused by a decline in South Korea's industry rewards score

Singapore now tops the Asia Pacific RRRs in Q414, after being overtaken by South Korea in Q114

Singapore moved up the table despite receiving an unchanged overall score of 72.8 Singapore has alwaysscored highly in our ratings, as one of only two countries with the maximum score of 100 in the countryrewards category The only area of weakness is that Singapore scores slightly below average in the industryrewards categories due to the relatively small size of its market However, this is offset by Singapore'sposition as a regional hub for cloud computing services and data centres, which is continuing to attractmajor inward investment by global and regional vendors

South Korea dropped to second position in the table in Q414 as its score in the industry rewards categorydeclined 5pps q-o-q The South Korean hardware market is one of the most valuable in the region in percapita terms - with high penetration of not only desktops and notebooks but also tablets and increasinglyhybrid notebooks However this maturity results in more limited growth prospects over the medium termcompared to emerging markets in the region The rapid growth of the tablet market, which we now believe

to be largely saturated in terms of first-time buyers, has resulted in a downgrade to the industry rewards

score as BMI expects a plateau in the hardware market over the medium term.

The other developed city-state in APAC with a maximum score of 100 in the country rewards category isHong Kong, which sits in third position in our table Despite the limitations of its small population HongKong could in fact be higher up the table without the drag of being under the China policy umbrella on theindustry risk category However, Hong Kong remains a prime financial hub, a high-spending vertical for ITsolutions, and is driving the development of the cloud computing market as banks demand advancedsolutions

Australia's score increased 0.4pps q-o-q but remained in fourth position in Q414 High incomes support alucrative retail hardware market, while the developed nature of the wider economy ensures strong demandfor enterprise solutions Meanwhile, investments in supporting infrastructure, particularly the NationalBroadband Network (NBN), present upside potential over the medium term Cloud computing is expected

to be a key trend, with strong demand from SMEs for cloud services evident in surveys in 2014

China is the largest market in the region owing to its huge population and relatively advanced IT marketconsidering income levels The outlook has been boosted by the latest round of economic reforms that willtake place through the forecast period and on to 2020 Major reforms include urbanisation development,strengthening institutions and reform of the one-child policy, all of which are expected to boost growth andincrease private sector confidence in the IT market Wider support for the service sector and modernisation

of state-owned enterprises, including finance, telecoms, healthcare, education and professional services (egcall centres) will be the most important reforms for boosting the IT sector, with software and services well

placed for faster growth BMI considers the intention of the reforms positively, and could present upside to

its overall score, however we have held-off changing our ratings until more detail about the reforms isreleased

Malaysia sits just below China in sixth position, with its far smaller market only partially offset by thehigher incomes and level of development Although trailing regional leaders such as Singapore and HongKong, Malaysia is home to a vibrant cloud computing market that should ensure medium term growth.Growth has been catalysed by government policy, with MSC Malaysia seeing it as a strategic priority andworking to develop a national cloud computing platform Cloud projects are not confined to the nationallevel, as state governments are also exploring this area

There is then a substantial gap in the ratings to India which scores 8.1pps below Malaysia Several of thecountries in the bottom section of the table have considerably larger populations than some countries ahead

of them in our table; they are held back by weak country rewards scores which reflect lower GDP per capitaand rate of urbanisation, as well as higher rates of unemployment

India is a market of great contradiction - on the one hand it is home some of the world's largest players in

the IT services segment such as Wipro, Tata Consultancy and Infosys However, on most metrics it falls

far behind its regional peers, for instance in PC penetration, broadband access, IP protection, adoption ofsolutions by enterprises and public authorities Ineffectual governance and weak institutions have been themain obstructions to faster development, and we do not see a short term improvement despite the positiverhetoric of reform from the incoming government That said, rising incomes and the sheer size of the Indian

market will ensure vendors continue to invest, and there is upside potential if Modi's reform agenda gathersmomentum.

Indonesia and the Philippines are unchanged in 8th and 9th positions respectively The Philippines is a established player in the business process outsourcing (BPO) industry but there are signs that the country istrying to move towards high-value services such as software development Meanwhile Indonesia is

well-emerging as a regional powerhouse but the depreciation of the rupiah - which has a knock on impact onprices in the hardware market - has meant it continues to score well down the regional ratings

Thailand remains in 10th place this quarter, but its position could be weakened further if the newly-installedmilitary junta were to extend its control over the telecoms sector to the broader IT market The military isgenerally distrustful of the ease with which dissenters could utilise telecoms services to organise protestsand has shown its willingness to clamp down on social media and broadband-delivered services It hasalready cancelled two upcoming spectrum auctions and has withheld financing for a long-awaited fibre-to-

the-home (FTTH) project run by incumbent telco TOT and is being lobbied by the state utility to ensure

that next-generation mobile licensees are forced to use the state operators' infrastructure Clearly, this hassignificant long-term implications for the IT sector, if these proposals are pushed through

Vietnam is becoming a more important manufacturing hub for the region The first major investment came

from chip manufacturer Intel, announced in 2006, but other investments have followed from Samsung Electronics, which expects to produce as much of 40% of its global smartphones and tablets in Vietnam by

2015 Vietnam is also an emerging destination for outsourcing, with multinationals increasingly turningaway from China in favour of lower cost and higher security locations

Sri Lanka continues to be at the bottom of the APAC RRRs in 12th position with an aggregate score of38.6 Sri Lanka scores poorly in all categories of the ratings, with incomes and institutions only just

recovering from a lengthy civil conflict However, there are bright spots and confidence returns and localand international firms invest This can be gauged from recent launches, for instance, SAP announced the

launch of its cloud portfolio in Sri Lanka in April 2014, following the launch of Amazon Web Services

-the leading global cloud hosting provider - in December 2013 A continuation of this trend could see SriLanka's score improve over the medium term

Table: APAC IT Risk/Reward Ratings - Q4 2014

Country Industry Rewards Country Rewards Industry Risks Country Risks IT Rating Rank Previous Rank

Singapore 58.3 100.0 70.0 74.4 72.8 1 2 South Korea 70.0 80.0 75.0 65.4 72.2 2 1 Hong Kong 58.3 100.0 45.0 77.7 70.4 3 3 Australia 61.7 95.0 57.5 66.9 70.3 4 4 China 75.0 35.0 45.0 55.1 58.0 5 5 Malaysia 58.3 55.0 37.5 67.7 56.7 6 6 India 66.7 15.0 45.0 50.9 48.6 7 7 Indonesia 53.3 35.0 42.5 51.4 47.2 8 8 Philippines 53.3 30.0 42.5 50.9 45.9 9 9 Thailand 53.3 20.0 35.0 62.9 44.7 10 10 Vietnam 53.3 15.0 35.0 53.7 41.8 11 11 Sri Lanka 46.7 15.0 37.5 50.9 38.6 12 12

Average 59.0 49.6 47.3 60.6 55.6

Scores out of 100, with 100 highest The IT Risk/Reward Rating comprises two sub-ratings 'Rewards' and 'Risks' Scores are weighted as follows: 'Rewards': 70%, of which Industry Rewards 65% and Country Rewards 35%; 'Risks': 30%, of which Industry Risks 40% and Country Risks 60% The 'Rewards' rating evaluates the size and growth potential of an IT market in any given state, and country's broader economic/socio-demographic characteristics that impact the industry's development; the 'Risks' rating evaluates industry specific dangers and those emanating from the state's political/

economic profile, based on BMI's proprietary Country Risk Ratings that could affect the realisation of anticipated returns Source: BMI.

Market Overview

Hardware

BMI forecasts the Australian computer hardware market value will increase by 3.6% in 2014 to a total of

AUD8.2bn, although in US dollar terms we forecast a contraction of 1.3% due to depreciation of theAustralian dollar The outlook extends over the medium as we forecast a compound annual growth rate(CAGR) of 3.2% 2014 to 2018, with total demand expected to reach a value of AUD9.2bn in 2018

Over the medium term we identify new products such as hybrid/convertible ultrabooks and tablets as themain opportunities for growth However, in 2014 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

In 2014 BMI expects the PC market is projected to report low single-digit growth, however, there is

downside risk emerging with a faster than expected slowdown in tablet demand High-street consumer

electronics retailer 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 We factored in a slowdown in

tablet demand for 2014 in the 2013 reports, against broad consensus at the time, but the market may now bedecelerating even faster than we anticipated.

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

vendors The launch of touch-integrated Windows 8 operating system, 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 offer themobility 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

(2011-2018)

Personal computer sales, AUDmn Servers sales, AUDmn

2011 2012 2013e 2014f 2015f 2016f 2017f 2018f 0

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

e/f = BMI 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, althoughdesktops should fare slightly better due to demand from the enterprise segment in 2014 related to upgradesfollowing the withdrawal of official Microsoft support for XP in April 2014 The enterprise market is astalwart for desktop sales, but PC penetration is high among Australian businesses, with around 95% ofsmall businesses and 100% of medium-sized and large businesses having computers Small businesscomprises more than 99% of all Australian businesses and slightly more than 50% of business PC sales

Despite the weak outlook as tablet sales dominate, it is worth noting that data from UK telecoms regulator

Ofcom indicates household notebook penetration increased again in 2013 after decline in 2012 BMI

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 (%)

We expect to see 4.37mn units sold in 2014, a figure that will fall in 2015 to 4.29mn as fewer new

customers 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

However, it should be noted that hybrids/convertibles will increasingly blur the distinction between tabletsand notebooks over the medium term, and this trend is expected to gain traction from 2014

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.

BMI estimates a lower sales figure for 2012 compared to Telesyte However, we share their assessment of

Apple dominating the market This is unsurprising given the high incomes of Australian consumers,

meaning they have the disposable income to pay a premium for the cachet of owning Apple devices

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 (pps) 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

0.1pps y-o-y) Android has had relatively little success in the higher income Australian market compared toemerging markets, with Australian consumer demonstrating a propensity for premium products extendingfrom 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 OEM tablets fromChina) will likely put pressure on the margins of hardware-centric vendors

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'sOffice 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 of

the tablet market by offering a stronger value proposition to consumers while not compromising userexperience The arrival of Haswell chipsets in June 2013 will enable a new generation of higher powered,slimline and long battery life devices, as well as presaging cheaper Ivy Bridge prices This should deepen

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

Industry Trends - PC Volume Forecast ('000)

2011-2018

e/f - BMI 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

connection with the computers in education programme Chinese vendor Lenovo has won a number of

tenders to provide computers to New South Wales schools These have included a three-year contract inpartnership 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, will provide IThardware for the whole of government as part of the NSW government's IT policy reforms It will initiallycover desktops, 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 extensionoffers

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 JBN 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

Software

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, forinstance IBM's Watson-as-a-Service initiative

Software is expected to account for 20.9% of the Australian IT market in 2014, with forecast spending ofAUD4.7bn Software sales are forecast to have a CAGR of 4.8% 2014-2018, with the total market expected

to reach a value of AUD5.5bn in 2018