Israel information technology report q1 2009

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Including 5-year industry forecasts

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Israel Information Technology

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© 2009 Business Monitor International

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Technology Report Q1 2009

Including 5-year industry forecasts by BMI

Part of BMI's Industry Report & Forecasts Series

Published by: Business Monitor International

Publication date: February 2009

CONTENTS

Executive Summary 5

Israeli IT Sector SWOT 7

Israel Telecommunications Sector SWOT 8

Israel Political SWOT 9

Israel Economics SWOT 10

Israel Business Environment SWOT 10

Middle East Regional IT Markets Overview 11

Market Growth And Drivers 12

Sectors And Verticals 13

IT Business Environment Ratings 16

Table: Regional IT Business Environment Ratings 18

Market Overview 19

Government Authority 19

History And Market Structure 19

Hardware 21

Software 21

Services 22

Industry Developments 23

Industry Forecast 26

Table: Israeli IT Industry (US$mn, unless otherwise stated) – Historical Data & Forecasts 27

Internet Forecast 28

Table: Internet Data & Forecasts 28

Macroeconomic Forecast 29

Table: Israel – Economic Activity 31

Country Context 32

Table: Consumer Expenditure, 2000-2012 (US$) 32

Table: Rural/Urban Breakdown, 2005-2030 32

Competitive Landscape 33

Internet Competitive Landscape 34

Company Profiles 36

Ness 36

IBM 38

HP 39

Matrix 41

Microsoft 42

Country Snapshot: Israel Demographic Data 43

Section 1: Population 43

Table: Demographic Indicators, 2005-2030 43

Section 2: Education And Healthcare 44

Table: Education, 2002-2005 44

Table: Vital Statistics, 2005-2030 44

Section 3: Labour Market And Spending Power 45

Table: Employment Indicators, 2001-2006 45

Table: Average Annual Wages, 2000-2012 45

BMI Forecast Modelling 46

How We Generate Our Industry Forecasts 46

IT Industry 46

IT Ratings – Methodology 47

Table: IT Business Environment Indicators 48

Weighting 49

Table: Weighting Of Components 49

Sources 49

Executive Summary

Market Overview

Despite an anticipated slowdown in 2009, the Israeli IT market should have enough momentum from key

sectors to continue to expand over BMI’s 2008-2013 forecast period BMI estimates that the local IT

market reached a value of US$4.82bn in 2008 The market is projected to grow at a compound annual growth rate (CAGR) of 7.6% over the forecast period, to reach US$6.96bn in 2013

IT spending still grew in H108 with stronger-than-expected demand from both enterprise and household sectors This continued the trend of 2007, with enterprises increasing outlay on IT, while spending in

traditional sectors such as government and military remained strong However, BMI believes that growth

will ease in 2009 thanks to the economic slowdown and unemployment hitting consumer demand for high-tech goods

The Israel IT market has a number of positive fundamentals, which should counterbalance the economic headwinds Low computer penetration, of around 30%, represents potential for organic growth

Meanwhile, some areas of spending by a number of key IT spending verticals, such as defence and financial services, should have a degree of immunisation from the economic crisis

Industry Developments

IT is viewed as an important policy tool for the Israeli government’s 2008-2010 socio-economic policy framework The National Economic Council recently submitted a policy agenda to the government, which specified two main policy tracks of reducing poverty and achieving balanced growth The first track is expected to emerge as the main priority

It has been estimated that Israel currently has around 600,000 children living below the poverty line The gini coefficient is among the highest of any country within the Organisation for Economic Co-operation and Development (OECD) A 2007 survey found that only 30% of children living in poverty have internet

or home PC access, compared with 90% in the top income group There is also an ethnic dimension to digital inequalities In order to deal with the digital divide problem, several specific measures have been proposed

As part of its modernisation agenda, the government is pressing ahead with various other strands of its government project Among other initiatives, there has also been spending on computers in healthcare and the nationwide paperless court initiative The e-government programme is leading to increased demand

e-for computers, with the Israeli government reaching a supply agreement in 2007 with Dell and HP

Competitive Landscape

The top three IT services vendors – Israeli companies Ness Technologies and Matrix, and US firm IBM

– have at least one-third of the local market Israel’s domestic IT service giants have strong advantages owing to local knowledge and contacts Despite their global ambitions, Israel remains an important market for these companies and typically accounts for 40-50% of revenues

Ness Israel posted good results for the first three quarters in 2008, despite the global economic storm

The company reported 6% top-line growth, despite the sale of two business units Ness’s defence and homeland security unit performed particularly well Meanwhile, Matrix also chalked up some successes

in 2008, including a number of public-sector customer relationship management (CRM) projects

In 2008, SAP reached an agreement with Ness to purchase the latter’s SAP sales and distribution division

in Israel The move paralleled the acquisition by SAP, at the end of 2007, of partner SAP Arabia’s

software licences and customer maintenance products SAP implementations are a major IT services category in Israel, and SAP aims to be closer to its customers and partners

Computer Sales

Computer sales in Israel including servers and accessories totalled an estimated US$1.85bn in 2008, up from US$1.68bn in 2007 The market is expected to grow at a CAGR of around 7% over the 2008-2013 forecast period to reach US$2.6bn in 2013 Given the economic slowdown, PC sales growth was stronger than expected in H108 Despite strong growth in demand for notebooks, the desktop sector is still

unsaturated and accounted for as much as 75% of PC sales in 2007, largely to business and government end-users Going forward, the PC market is expected to slow as a result of declining consumer and business sentiment, but one area of growth will be lower-priced mini-computers, or netbooks, which are establishing a position in the market

Software

Israeli software spending was estimated at US$309mn in 2008, up from US$255mn in 2007 The

packaged software segment is expected to grow at a CAGR of around 9% over the forecast period Spending on software is shifting towards the small- and medium-sized enterprise (SME) segment, which forms the mainstay of the Israeli business sector Spending on enterprise solutions has grown since 2007, with reviving or emerging areas of opportunity including security, CRM solutions and business

intelligence In terms of verticals, the financial sector has been a mainstay of demand, with other key

areas including defence and healthcare

IT services

The IT services sector had an estimated value of US$1.54bn in 2008, and this is expected to grow at a CAGR of 8.6% over the forecast period to reach US$2.34bn in 2013 The relatively robust economy and increased investment by a number of key sectors have driven recent growth, although the number of new

projects is expected to be reduced in 2009 thanks to the anticipated economic slowdown A number of major outsourcing deals have highlighted the growing opportunity Although Israel seemingly possesses many advantages as an outsourcing destination – in particular a technologically literate, linguistically skilled workforce, and low labour costs relative to most developed countries – the country has failed to capitalise on these strengths in the past However, Israel is starting to emerge as a desirable location for packaged applications and localisation services

E-Readiness

At the end of 2008, Israel had an estimated 4.5mn internet users, representing a penetration rate of 61.9%

of the population Broadband penetration was estimated at 22.6%, or 1.6mn accounts The government has announced that it intends to make a big effort to narrow the digital gaps that manifest themselves across various demographic lines

Israeli IT Sector SWOT

Strengths ƒ One of the most modern economies in the region, with a highly educated,

linguistically skilled workforce, and relatively low labour costs (compared with most developed countries)

ƒ Strong defence and government spending provides base of IT demand

ƒ Relatively mature IT market, with services accounting for an estimated 32% of spending in 2008 Despite this, the market for basic IT hardware and software is far from saturated

ƒ Strong political support, with government having implemented a number of policies to aid in the development, success and expansion of the IT sector

Weaknesses ƒ The recession at the beginning of the decade created a client mentality of

focusing on the bottom line, with enhanced services customer market power adding to pressure on pricing and margins

ƒ Digital divide, with 3% of bottom income group having home internet access

Opportunities ƒ Despite financial crisis, the financial services sector, which accounts for around

15% of spending, will have to spend on compliance with Basel II and other international standards driving growth

ƒ Defence and government projects should be relatively less sensitive to the economic downturn

ƒ Outsourcing, Software as a Service (SaaS) and applications management likely

to grow fastest out of IT services, with particular opportunities in financial sector

ƒ Opportunities for partnership/investment in Israel’s lively local IT company sector

Threats ƒ Economic downturn and unemployment will lead to weaker consumer and

business sentiment

ƒ Other factors may affect business confidence, notably the security situation

ƒ Aggressive pricing may continue to constrain growth and put pressure on margins

Israel Telecommunications Sector SWOT

Strengths ƒ Well-developed internet/broadband sector compared with regional peers

ƒ Liberal mobile market, consisting of four operators

ƒ Mature market, with strong take-up of value-added and 3G services

Weaknesses ƒ Mobile penetration rate of over 120% means that growth in the mobile

market has slowed considerably and operators must look for alternative revenue sources

ƒ Lack of competition in all telecom sectors

ƒ Regulator has been slow to license new services, such as Worldwide Interoperability for Microwave Access (WiMAX) wireless broadband

ƒ Voice over Internet Protocol (VoIP) licensing and triple-play for Bezeq placed

on hold, which could hinder prospects

Opportunities ƒ Emergence of rival operator HOT Telecom, made up of main three cable

operators – Golden Channels, Matav and Tevel – to compete against Bezeq could provide cheaper services

ƒ Introduction of number portability and the entry of mobile virtual network operators (MVNOs) to the mobile sector could shake up competition and drive down retail prices for consumers

Threats ƒ Continued interconnection tariff reduction could have a devastating effect on

Israel Political SWOT

Strengths ƒ Government members are some of the most accountable in the region

ƒ Elections are free and transparent, for the most part, ensuring that a broad spectrum of political views is represented within government

Weaknesses ƒ The protracted Israeli/Palestinian conflict means there are persistent security

risks, and strategies to minimise or end the conflict are domestically divisive

ƒ Frequent change to the composition of the coalition government often leads

to policies becoming fragmented or significantly diluted

Opportunities ƒ The Annapolis conference in November 2007 laid the foundations for an

eventual peace agreement with the Palestinians, and improved relations with traditionally hostile Arab states, particularly Saudi Arabia

Threats ƒ The victory of Hamas in the 2006 Palestinian elections and subsequent

takeover of the Gaza Strip added to uncertainty and poses a dilemma for Israel, which has previously said it will not talk to the militant organisation (compounded by the recent conflict in the Gaza strip, which can only add to volatility on both sides)

ƒ The construction of the West Bank barrier and the continued home-building

in some West Bank settlements antagonises the Palestinians and stands in the way of the peace process

ƒ Iranian President Mahmoud Ahmadinejad has intensified his anti-Israel rhetoric, adding to Israeli concerns about a possible Iranian nuclear weapons programme

Israel Economics SWOT

Strengths ƒ The policy framework has stabilised in recent years with fiscal deficits

brought well under control

ƒ The workforce is highly educated and skilled

ƒ The country's close ties with the US provide it with substantial financial assistance for economic and military ends

Weaknesses ƒ The main downside risk to the economy is the security situation A sharp

deterioration can have an immediate impact on domestic confidence, tourism receipts, the exchange rate and foreign investment

ƒ The economy is highly exposed to that of the US, in terms of exports, investment and remittances

Opportunities ƒ Rising levels of employment will underpin private consumption growth

ƒ Foreign direct investment (FDI) stocks amounted to 37% of GDP in 2007, according to the United Nations Conference on Trade and Development (UNCTAD), and should continue to propel growth for some years to come

Threats ƒ As a net fuel importer, Israel is vulnerable to large oil price fluctuations; the

surge in prices in the first nine months of 2008 contributed to rising inflation

ƒ Competition from emerging Chinese and Indian producers of high-tech goods and polished diamonds, as well as sluggish growth in the eurozone, could undermine demand for Israeli exports

Israel Business Environment SWOT

Strengths ƒ The business environment is supported by sound infrastructure and

communication networks, as well as transparent legislation

ƒ The banking system is one of the most sophisticated in the region, and offers a wide range of both consumer and commercial credit products

Weaknesses ƒ Historic political instability and, more recently, suicide bomb attacks,

increase the risk premium of investment in Israel

ƒ Some limits on repatriation of capital exist and there are constraints on foreign investment in the high-tech sector

Opportunities ƒ Ongoing cuts are set to bring the top level of corporate tax down from 29%

in 2007 to 25% by 2010

ƒ The Qualified Industrial Zone agreements with Jordan and Egypt boost the potential for trade

Threats ƒ Strike action has proved extremely disruptive to the business environment

over the past two years With economic conditions deteriorating, more strikes are likely to take place in 2009

Middle East Regional IT Markets Overview

BMI projects significant improvement in

regional ICT indicators over the next few

years, driven by rising incomes and

government programmes The Middle

East divides into two groups in terms of

information society development In the

first group are richer and more

technologically advanced countries, such

as Israel and the UAE, where internet

penetration is relatively high and many

households have access to broadband

services In the more emerging markets

such as Egypt, on the other hand,

computers remain a luxury for many

The number of internet users is expected

to grow significantly Egypt will lead the

rankings with 30mn subscribers projected

by 2012 However, even relatively

advanced societies such as Israel have

room to develop, with internet

penetration in the country projected to

increase from the current 58% to 65% by

2012 Saudi Arabia is also expected to

achieve a 7% rise in subscribers over the

forecast period

A similar growth trend is expected for

broadband, where penetration currently

ranges from 0.5% in Egypt to close to

20% in Israel Egypt is forecast to achieve the most dramatic advance, with broadband penetration

exceeding 7% by 2012 Government initiatives are afoot across the region, ranging from wireless

broadband in Dubai to plans to deploy fibre extensively in countries such as Kuwait

Internet penetration will receive a boost from continued efforts to liberalise regional telecoms markets In

2008 the Qatari government announced that eight operators had submitted bids for new fixed line

Internet Penetration

(per 100 population)

0 10 20 30 40 50 60 70

e/f = estimate/forecast Source: BMI

Broadband Penetration (per 100

population)

2007 And 2012

0 5 10 15 20 25 30

e/f = estimate/forecast; Source: BMI

licences Egypt will also continue liberalisation of its telecoms market this year, and similar moves have already been seen in countries such as Saudi Arabia

Growing broadband penetration has become a driver of PC ownership in some segments, due to the variety of multimedia and communication functions it enables There is plenty of room for PC growth, given the current low levels of computerisation, which are often much higher in the business sector than

in the population at large

Finally, governments in the region are allocating significant budgets for e-government development The Saudi Arabian government, for example, has demonstrated a significantly increased financial

commitment to e-government strategies and initiatives across all ministries In the UAE, the federal government is stepping up the pace Despite progress, big challenges remain, particularly in excessive bureaucracy and lagging education systems

Market Growth And Drivers

High oil prices underpin a generally

favourable economic environment for

growth in much of the region However,

there is increasing economic

diversification, and strong spending from

non-oil sectors such as government,

financial, and enterprise sectors By 2012

this should be more evident, with IT’s

share of GDP rising in these countries

A number of factors will drive growth in

IT spending In oil rich Gulf

Co-operation Council (GCC) countries,

having received windfalls from record

high oil prices, governments are continuing with programmes of modernising the oil sector Oil and gas companies are looking to optimise cost structures However, other sectors also have money to spend on

Israel Kuw ait Qatar Saudi Arabia UAE

e = estimate Source: BMI

IT markets in the region should achieve

compound annual growth rates (CAGRs)

ranging from high single into double

figures Notebook sales are now growing

at something like twice the speed of

desktops in most countries, and are the

major driver of computer sales In the

business sector, smaller companies are

realising the opportunities to apply IT to

achieve efficiencies in such areas as

finance and logistics, as well as

marketing and other functions

The highest growth Middle East and

African (MEA) IT market over the forecast period is expected to be Egypt, with compound growth of 82% for 2007-2012 There is room for considerable growth in the country in the next few years, given the current low level of computerisation, which is much higher in the business sector than in the population at large Other high growth countries are expected to include Kuwait (82%) and Qatar (71%), due to a confluence of many of the major growth drivers in the region, such as high oil prices, modernisation programmes and booming property and telecoms sectors

Sectors And Verticals

Hardware dominates regional IT

spending While software and services

will increase their share of spending,

hardware spending will remain strong as

the number of personal computer users

rises steadily over the forecast period

This will be driven by growing

affordability, government initiatives and

the popularity of the notebook

PC prices are continuing to fall, and this

– along with more credit availability – is

bringing computers within the reach of

many more people Government

programmes in Egypt and Saudi Arabia have made low-price computers available in easy instalment payment schemes Strong demand for notebooks is another key factor driving growth, although desktops

IT Market Sizes As % Of National GDPs

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

e/f = estimate/forecast Source: BMI

IT Markets’ Compound Growth (%)

2007-2012

0 20 40 60 80 100 Egypt

Israel Kuw ait Qatar Saudi Arabia UAE

Source: BMI

remain important for small and medium-sized enterprises (SMEs) and other groups Government

investment in education and e-services will mean desktop purchases for schools, colleges and government offices

Spending on software as a share of total

IT spending is as low as 14% in Egypt

and below 20% in a majority of MEA

markets BMI predicts plenty of room for

growth over the forecast period as

numerous untapped sectors still exist

Key verticals will include process

manufacturing (mainly oil and gas),

followed by the finance sector Other key

segments are telecoms and the public

sector

SMEs are likely to lead spending growth,

with manufacturing and trading firms

seeking efficiencies by making the transition from manual environments to full automation of back-office systems During the next five years, in addition to customer relationship management (CRM) and

enterprise resource planning (ERP), high-growth categories are set to include business intelligence, storage and security products Security software is also a growing opportunity, with the UAE currently the largest market

There are some challenges for the

regional software market One key issue

is that of illegal software: across the

region up to 80% of software is

counterfeit Another important factor is

of course low income, and the high costs

of operating systems such as Windows,

which has led to activity to promote open

source in countries such as Egypt,

championed by IBM and other vendors

BMI predicts that IT services will be the

fastest growing segment of the region’s

IT market, with strong double-digit

growth in many countries Currently services’ share of IT spending ranges from around 24% to 32% in

Market Structure (% of total IT market)

2007e Hardw are 2007e Softw are 2007e Services

e = estimate Source: BMI

Market Structure (% of total IT market)

2012f Hardw are 2012f Softw are 2012f Services

f = forecast Source: BMI

the MEA countries covered by BMI Sustained high oil prices will drive spending on large IT projects by

government, as well as in industries such as oil and gas, transport and utilities

Support and maintenance account for around one-third of spending on IT services However, demand for more complex services has increased, with large outsourcing deals in the UAE, Israel and elsewhere There is also demand for services such as hosting, facilities management, and disaster recovery Even in less mature markets such as Egypt, larger customers are becoming more demanding in terms of their IT expectations

IT Business Environment Ratings

BMI’s Middle East and Africa (MEA) IT Business Environment Ratings compare the potential of the key

regional markets over our forecast period, through to 2013 The ratings reflect our consideration of political and economic risks, as well as risks associated specifically with IT intellectual property (IP) rights protection and government projects

In our first 2009 rankings the wealthy, high-tech Gulf Co-operation Council (GCC) markets continue to occupy the higher positions, despite the precipitous fall in oil prices in H208 The wave of investments triggered by the oil revenue windfalls of the past couple of years will continue for the moment to sustain the IT market The top four countries remain the same, although our ratings reflect a slight deterioration

in business environment The UAE with its rapidly growing population keeps top spot for the third consecutive quarter, while Qatar retains second place from last quarter, ahead of Kuwait in third Still in fourth place is Israel, where the IT market should have enough momentum from key sectors to continue

to expand despite the economic headwinds

Saudi Arabia and Bahrain are next in our table and – like Qatar and Saudi Arabia – will continue to feel the benefit of economic diversification programmes and liberalisation in key sectors, such as

telecommunications Turkey and South Africa’s relatively lowly seventh and eighth spots reflect business environment risks, rather than the undoubted latent potential of these country’s IT markets Bringing up the field, Egypt’s high growth potential is constrained by income and business environment

considerations, while Lebanon is still recovering from the events of 2006

A key variable influencing IT spending in this region is economic diversification Some economies in the Middle East, such as Kuwait’s, remain highly dependent on oil In the UAE, however, some 80% of GDP

is accounted for by the non-oil sector, and in Qatar around 38% In GCC countries, government’s have used oil revenues to fund development of other sectors such as manufacturing, and this should provide a source of opportunity for IT sector investors in the years ahead The share of the non-oil sector in IT spending is expected to fall slightly in the UAE but to rise in Saudi Arabia, which accounts for 40% of regional IT spending However there will continue to be significant spending on new technology driven solutions in the hydrocarbons sector

Another factor in IT opportunities is the waves of e-government initiatives being implemented in states like Kuwait, the UAE and South Africa, among others First-placed UAE has continued to roll out e-services in 2008, following the recently announced UAE Strategic Plan, which called for a strengthening

of e-government programmes The UAE’s federal government is attempting to emulate the best practices

of the local governments In Saudi Arabia too, substantial budgets have been allocated for e-government infrastructure development

Government accounts for up to 40% of the IT market in some states, which is a ratings risk given frequent bureaucratic inertia and resistance to reform Over time, this risk should be reduced by economic

diversification as technology-using sectors such as financial services, communications and real estate invest in new solutions Qatar is a good example, with the government recently outlining new ICT

investment plans and the foundation of a new technology park

Saudi Arabia, Bahrain and Oman rank slightly behind their equally fast growing GCC peers on the grounds of business environment, but the IT market metrics remain attractive Saudi Arabia will continue

to be a lucrative market for technology products and services, with few signs as yet that the government intends to cut back on infrastructure investments As with several other countries in the region, the

country’s youthful population supports a continued rapid rise in PC penetration BMI also takes a positive

view of market performance in Bahrain over the forecast period, with the banking, telecoms and real estate sectors accounting for a significant and growing portion of investment in IT Oman, although like Bahrain one of the smaller markets in the region, should benefit from an emphasis on diversification, which has encouraged IT spending in sectors ranging from tourism to ports, with IT as a key component

Of the non-GCC countries, Israel – in fourth place – should maintain its IT market momentum despite exposure to adverse global economic conditions Nearly 50% of IT spending is accounted for by

government and military projects, which are likely to have some immunity to the economic slowdown Israel’s IT market is also benefiting from record-breaking foreign investment, as well as growing demand for major IT outsourcing solutions

South Africa is one of the Middle East and Africa’s most significant IT markets in terms of size and growth potential However, the country loses points for country structure and market risk, where we took account of factors such as high unemployment and an uncertain environment surrounding government tenders The energy crisis and weakening external demand may precipitate a more cautious spending approach by some organisations, but the market will be supported by factors such as the 2010 Football World Cup, government digital divide projects and sectors such as telecoms

Egypt is expected to be one of the fastest growing IT markets in the region over the next few years as household computer penetration rises, despite a number of constraints, including low disposable incomes and economic disparities Lebanon also has strong intrinsic advantages, including a cosmopolitan and multi-lingual labour force, and a strategic position for the Levant markets However, fulfilment of the market’s undoubted potential will depend on a functioning government being able to take the steps necessary to enable this

Table: Regional IT Business Environment Ratings

Limits of potential returns Risks to realisation of returns

IT market

Country structure Limits Market risks

Country risk Risks IT rating

Regional ranking

weighting, respectively, and are based on the growth/size/maturity of the IT industry and government policy towards the industry (Market) and the broader economic/socio-demographic environment (Country) The 'Risks' rating comprises 'Market risks' and 'Country risk', which have a 40% and 60% weighting, respectively, and are based on a subjective evaluation of industry's regulatory and IP regulations (Market) and its broader risk exposure (Country), which is based

on BMI's proprietary Country Risk Ratings The ratings structure is aligned across all the industries for which BMI

provides Business Environment Ratings, and is designed to enable clients to consider each rating individually or as a composite For a list of the data/indicators used, please consult the appendix at the end of the report Source: BMI

Market Overview

Government Authority

The Ministry of Science, Culture and Sport was established in 1982 as the Ministry of Science and Development; it has undergone numerous name changes, receiving its current name in 2006 The

responsibilities of the ministry are the formation of a national policy towards science and technology, technological analysis and organisation, and the co-ordination of research areas

The main priorities for the Ministry of Science, Culture and Sport are as follows:

ƒ Setting up a national policy and priorities for research and development (R&D);

ƒ Development of scientific and technological infrastructure;

ƒ Establishment and strengthening of foreign scientific relations;

ƒ Participation in the establishment of research centres, including regional R&D centres;

ƒ Participation in the development of scientific and technological human resources;

ƒ Increasing awareness of science within the public, especially the youth of Israel;

ƒ Developing digital infrastructure (facilitating access to information); and

ƒ Consulting the government and its offices in the area of science and technology

History And Market Structure

All the major vendors have a direct presence in Israel, employing substantial numbers of staff For

example, IBM has its only IBM Global Services (IGS) regional subsidiary in Petach Tikva, and employs around 2,000 staff at its Haifa Labs and various IBM facilities in Rehovot and Jerusalem HP has as many

as 4,000 employees and has long offered services and support through its subsidiary HP-OMS Other vendors such as Oracle and EDS also have a sizeable presence

FDI first started to play a key role in Israel's economy in the mid-1990s, as the country's high-tech sector underwent a rapid expansion Together with the opening up of the financial and telecom sectors, the high-tech sector succeeded in attracting large FDI flows The government’s policy made foreign high-tech companies eligible for government grants covering 38% of the cost of new R&D facilities Indeed, today, Israel has more offshore R&D centres of US high-tech companies than any other country

Local companies also have a significant presence in the Israeli IT market, with seven of the top 10 IT

services firms being Israeli Major players include Matrix, Ness Technologies and Malam Group, with

Israel typically accounting for between 40% and 50% of their revenues

Table: Government Initiatives

Gov@Net – Government intranet

ƒ A cross-government intranet planned to connect over 80 governmental networks and hundreds of institutes The implementation will create the largest Israeli IP-VPN The project will allow efficient internal communication and resource sharing

Mercava – Government ERP

ƒ Mercava is the largest-ever IT project implemented in Israel It will gradually replace the assortment of unique legacy systems currently operating in governmental bodies with a central, unified ERP system, running on SAP software

ƒ This project will create a unified language for cross-government activities

Government EIP

ƒ This project is intended to promote enterprise portals within the government Since a cross-government portal will be based on information received from the different bodies, the first step involves the construction of a ministry-level

portal This portal will draw information from ‘Merkava’ (see Industry Developments), from ministry-specific

operational systems, and from intra-government shared resources

Tehila – Government ISP

ƒ The GISP project has been operational since 1998, providing essential infrastructure for public-government

communication

ƒ To date, 60% of the governmental bodies have voluntarily joined the project

Shoham – e-commerce infrastructure and service

ƒ A central e-commerce service allowing citizens and companies to access a uniform interface to carry out a variety of payments and purchases, which includes the payment of taxes, fees, fines (VAT, vehicle and driving licence fees and traffic fines) and the purchase of tangible goods (government publications) The service processed over

ILS250mn in its first year

Lehava project

ƒ Group of initiatives to help close digital divide

Hardware

Computer sales in Israel including servers and accessories were valued at an estimated US$1.85bn in

2008, up from US$1.68bn in 2007 The market is expected to grow at a CAGR of 7.2% over the

2008-2013 forecast period to reach US$2.62bn in 2008-2013 Despite the economic slowdown, PC sales continued to grow in H108 with stronger-than-expected spending in both enterprise and household sectors However,

BMI believes that growth will be slower in 2009 with an economic slowdown and unemployment hitting

consumer demand for high-tech goods

Retail spending has been buoyant in the past two years, with drivers including the strong shekel, higher broadband penetration, and demand for multimedia applications Despite strong growth in demand for notebooks, the desktop sector is still unsaturated and accounted for as much as 75% of PC sales in 2007, largely to business and government end-users Going forward, the PC market is expected to slow, but one area of growth will be lower-priced mini-computers, or netbooks, which are establishing a position in the market

The current low rate of PC penetration represents potential for organic growth PC penetration was only 26.4% in 2005, while digital divide issues mean that Israel currently has 600,000 children living below the poverty line, only 3% of whom have internet or home PC access, compared with 90% in the top income group The Israeli government is taking various measures aimed at increasing computer and internet penetration – Computer for Every Child, Window to Tomorrow’s World, Tapuah (The Israeli Society for the Advancement of the Information Age) and others The level of support, however, has been criticised by some industry insiders as too low

The Israeli IT market is relatively mature, but hardware still accounts for around half of the total market (excluding communications hardware) Government and defence tenders are a significant constituent of demand Government IT project investments started to rise in 2007, with IT budgets being restored after many years of cuts

Software

Israel software spending was estimated at US$309mn in 2008, up from US$255mn in 2007 The

packaged software segment is expected to grow at a CAGR of around 9% over the forecast period Spending on software is shifting towards the SME segment, which forms the mainstay of the Israeli business sector Spending on enterprise solutions has grown since 2007, with reviving or emerging areas

of opportunity including security, CRM solutions, and business intelligence

A recent survey of IT managers suggested that current areas of high demand include management of

Microsoft systems and servers, as well as systems management, basic data management, firewalls, ERP

implementation and CRM CRM is a particularly buoyant area, with local IT company Matrix reporting a number of public- and private-sector successes in 2008, while customers for Microsoft’s Dynamics CRM

platform include Israeli health maintenance organisation (HMO) Maccabi Healthcare Services

The security software segment is also an important opportunity, projected to be worth tens of millions of dollars in 2009 Israel has become more aware about the growing threat and sophistication of cyber attacks, and has been encouraging government and private-sector organisations to take action Spending is likely across all sectors, with security content and threat management the current priorities

In terms of verticals, the financial sector has been a mainstay of demand, with other key areas including defence and healthcare These three sectors are likely to be somewhat immunised against the

consequences of the global slowdown Despite the current financial crisis, regulatory compliance

requirements will continue to drive IT spending by banks Similarly, defence spending on new systems is likely to be maintained given the current security situation

Software comprises an important part of Israel’s industrial production and exports, with software exports

of around US$3bn being comparable to about two-thirds of the entire value of the domestic IT sector Almost all global vendors are active in the domestic market, selling licences, along with integration and

applications services Global vendors control more than three-quarters of the market, with SAP in first

place In the past, the Israeli SME segment was dominated by local software companies Now,

international players, including market leaders like SAP and Oracle, are entering with appropriate

software packages Microsoft is also designing a software package for this market segment

Services

The IT services sector had a value of an estimated US$1.54bn in 2008, and this is expected to grow at a CAGR of 8.6% over the forecast period to reach US$2.34bn in 2013 The relatively robust economy and increased investment by a number of key sectors have driven recent growth, although the number of new projects is expected to be reduced in 2009 owing to the economic slowdown

Spending has been particularly strong in the financial sector, where international regulatory compliance and structural and market reforms have driven substantial IT investment The sector accounts for around 25% of total IT services spending, while the government accounts for another quarter

While large organisations still dominate, SMEs have also been investing more Many SMEs are waking

up to the need to compete through more direct investment in support and service infrastructures Similar factors are driving an increase in demand for managed services, with businesses reluctant to invest in internal IT capabilities, or deterred from doing so by a lack of available skills

Outsourcing has become a bigger factor and is estimated to account for up to 20% of IT services

spending, or about US$300mn in 2008 The military is a key sector, with outsourcing deals such as that awarded to HP by the Israeli Navy for management of its IT infrastructure highlighting the opportunities there While the value of the HP deal was not made public, it is estimated to be worth several million shekels The financial sector is another lead vertical for outsourcing In 2006, an outsourcing deal

between First International Bank of Israel and EDS Israel was the largest outsourcing contract in the Israeli banking industry and a milestone at the time Indian consultancy giant Tata’s recent decision to

open a local branch also underlines the potential attraction of the financial sector, now benefiting from

economic recovery and greater security The retail sector offers further opportunities, with IBM Israel having a 10 year outsourcing contract with Clubmarket Marketing Chains, with the contract including

computer systems for the supermarket chain’s branches and point-of-sale terminals

Although Israel seemingly possesses many advantages as an outsourcing destination – in particular a technologically literate, linguistically skilled workforce, and low labour costs relative to most developed countries – the country has failed to capitalise on these strengths in the past Aside from Israel’s small size, another issue is security However, the government is now actively promoting Israel to

multinationals, and there has been a spate of call-centre construction The work seems to be paying off, with Israel starting to emerge as a desirable location for packaged applications and localisation services

Industry Developments

IT is an important element of the Israeli government’s socio-economic policy framework for 2008-2010 The National Economic Council recently submitted a policy agenda to the Government, which specified two main policy tracks of reducing poverty and achieving balanced growth The first track is expected to emerge as the main priority for the government The digital divide is both a symptom and an aggravator

of relative poverty

Israel’s Digital Divide

It has been estimated that Israel currently has around 600,000 children living below the poverty line The gini coefficient has been estimated as among the highest of any OECD country A 2007 survey found that only 30% of children living in poverty have internet or home PC access, compared with 90% in the top income group Alarm at such statistics has helped to make tackling the digital divide central to the

government’s key policy goal of reducing poverty There is also an ethnic dimension to digital

inequalities Recent research by the University of Haifa showed a consistent gap in internet access

between Jews and Arabs, with 72.5% of Jews in Israeli using the internet, compared with 52.5% of Arabs

In order to deal with the digital divide problem, the following measures have been proposed:

ƒ A senior minister for the high-tech sector should be appointed to co-ordinate activities currently carried out by various ministries The minister should prepare a master plan for government policy in the information industry;

ƒ Regulations should be amended to facilitate rapid investments in communications, technological infrastructure, bandwidth and fast internet backbone;

ƒ Massive investment should be made in the educational system for training information workers;

ƒ Aid to be given to the less wealthy to make them part of Israel’s information industry

Leveraging IT For Growth

IT will also be harnessed to the second goal of achieving balanced, long-term growth Israel’s software sector has long been one of the country’s economic pillars and a magnet for inward investment Recently released figures underlined that IT represents a crucial part of Israel's economy The Israeli Association of

Electronics and Software Industries (IAESI) projected that the software sector will generate US$3.2bn

annually by the end of the decade According to recent figures, electronics and software exports had already reached US$1.87bn in 2006 The government is hoping that the high-tech sector will generate US$3.0bn for the nation’s economy by 2010

to around 61,000 in 2006, according to the government’s Central Bureau of Statistics Engineering

salaries in Israel are about half those in the US, but double those in India