Israel information technology report q1 2010

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Technology Report Q1 2010

Including 5-year industry forecasts by BMI

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Publication date: January 2010

CONTENTS

Executive Summary 5

SWOT Analysis 8

Israel IT Sector SWOT 8

Israel Telecommunications Industry SWOT 9

Israel Political SWOT 10

Israel Economic SWOT 10

Israel Business Environment SWOT 11

IT Business Environment Ratings 12

Regional IT Business Environment Ratings 14

Middle East Regional IT Markets Overview 15

IT Penetration 15

Market Growth & Drivers 16

Sectors & Verticals 17

Market Overview 19

Government Authority 19

Government Initiatives 20

Hardware 20

Software 22

Services 23

Industry Developments 24

Industry Forecast Scenario 27

Israeli IT Industry - Historical Data & Forecasts (US$mn, unless otherwise stated) 29

Internet 30

Table: Internet Data & Forecasts 30

Country Context 31

Consumer Expenditure, 2000-2012 (US$) 31

Rural/Urban Breakdown, 2005-2030 31

Competitive Landscape 32

Macroeconomic Forecast 35

Table: Israel – Economic Activity, 2006-2014 37

Company Profiles 38

Ness 38

IBM 40

HP 41

Matrix 43

Microsoft 45

Country Snapshot: Israel Demographic Data 46

Section 1: Population 46

Table: Demographic Indicators, 2005-2030 46

Table: Rural/Urban Breakdown, 2005-2030 47

Section 2: Education And Healthcare 47

Table: Education, 2002-2005 47

Table: Vital Statistics, 2005-2030 47

Section 3: Labour Market And Spending Power 48

Table: Employment Indicators, 2001-2006 48

Table: Consumer Expenditure, 2000-2012 (US$) 48

Table: Average Annual Wages, 2000-2012 49

BMI Methodology 50

IT Ratings – Methodology 50

Ratings Overview 50

Table: IT Business Environment Indicators 51

Weighting 52

Table: Weighting Of Components 52

How We Generate Our Industry Forecasts 52

IT Industry 53

Sources 53

Executive Summary

Market Overview

BMI projects that the Israeli IT market will have a value of US$4.9bn in 2010 and will grow at a

five-year CAGR of 6% to a projected US$6.2bn in 2014 The Israeli IT market should have enough

momentum from key sectors to expand over BMI's 2010-2014 forecast period, thanks to relatively stable

demand from defence and government sectors, and opportunities in verticals like financial services and small and medium-sized enterprises (SMEs)

Spending is forecast to resume single-digit growth in 2010, with a boost, particularly in the second half of

2010, from computer hardware tenders delayed from 2009 BMI tentatively expected conditions to

improve in the final quarter of 2009 with a seasonal upturn reinforced by procurements deferred from the first half of the year

The Israeli IT market has a number of positive fundamentals, which should keep it in positive territory

during BMI's five-year forecast period Low computer penetration of around 30% offers potential for

continued growth High internet penetration and growing broadband penetration are drivers for the retail segment, while the financial services sector accounts for about 15% of Israeli IT spending

Industry Developments

In 2009, Israel's high-tech sector suffered as demand for high-tech exports dropped by at least 10-15%, with as many as 10,000 sector jobs feared to be at risk This represented a major concern for the Israeli government given that high-tech accounted for around 10% of Israel's economy, with annual sales

estimated at around US$25bn Major IT firms were retrenching in Israel, including SAP, Cisco and HP

IT is viewed as an important policy tool for the Israeli government's 2008-2010 socio-economic policy framework In 2009 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 was expected to emerge as the main priority

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 agreements with vendors like Dell and HP

Competitive Landscape

The Israeli IT services market is competitive, with leading multinational competitors IBM and HP both estimated to have Israeli IT services market shares of below 10% Following its merger with EDS, US giant HP was projected to take around 10% of the Israel IT services market last year HP Israel's

software division hosts HP's biggest research and development (R&D) centre worldwide, and the

company also has significant production facilities in Israel

Leading Israeli IT services vendors experienced mixed fortunes in H109 Market leader Matrix reported

wins in a number of key sectors including healthcare, financial services, defence and government In Q309 Matrix reported 100% annualised growth in net profits, and 7% growth in operating profits on flat

revenue growth Ness Israel, by contrast, reported a 19% decline in revenues for Q209, although 30% of

this was due to currency translation

In 2009, enterprise software giant Oracle was in discussion with Israel Credit Cards Cal (ICC-Cal)

concerning the future of a major computerisation project being implemented by Oracle Oracle initiated the project, to replace and upgrade ICC-Cal's computer systems, some 18 months ago However,

differences had apparently arisen between Oracle and ICC-Cal concerning the project Meanwhile, in

2008, Oracle rival SAP reached an agreement with Ness to purchase the latter's SAP sales and

distribution division in Israel

Computer Sales

The Israeli computer hardware market, including desktops, notebooks, servers and accessories, is

projected at US$2.2bn in 2010, up from US$2.1bn in 2009 The market is expected to grow at a CAGR of 5% over the forecast period to reach US$2.7bn in 2014 The Israeli government has launched various initiatives to increase computer and internet penetration

Spending is expected to resume single-digit growth in 2010, after a contraction in 2009 due to the

economic slowdown and unemployment hitting consumer demand for electronics goods Household consumption moved into negative territory in 2009, with spending on household equipment down

by 6.7% in Q109, and although BMI forecast a slight recovery in H209, trading conditions remained

tough

Software

Israeli software spending is projected at US$1.0bn in 2010, up from US$973mn in 2009 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period Businesses were expected to remain cautious in H209, deferring investments, or looking for good enough solutions to immediate problems However, there should still be several growth areas going forward

Spending on software is shifting towards the SME segment, which forms the mainstay of the Israeli business sector Spend on enterprise solutions has grown since 2007, with reviving or emerging areas of opportunity including security, customer relationship management (CRM) solutions and business

intelligence In terms of verticals, the financial sector has been a mainstay of demand, with other key opportunities including defence and healthcare

IT Services

The IT services segment is estimated at US$1.6bn in 2010, and this is expected to grow at a CAGR of 7% over the forecast period to reach US$2.2bn in 2014 In 2009, there were reports of IT managers scaling back projects, and vendors will have to adapt to an environment where some projects are commissioned more in response to immediate needs

Government and defence are two key sectors likely to be a continued source of opportunities, because the factors driving spending in each case are not particularly sensitive to economic vicissitudes Another key area of opportunity is healthcare IT Despite failing to capitalise in the past, Israel is starting to emerge as

a desirable location for packaged applications and localisation services

E-Readiness

Israel's high PC penetration and the growing availability of broadband access mean that internet

penetration is likely to continue its upward trajectory The government has announced that it intends to make a big effort to narrow the digital gaps that manifest themselves across various demographic lines

Israel's strong broadband growth has long relied on a handful of developments across the market These

include the competition between Bezeq and the cable companies, with five major internet service

providers (ISPs) vying for market share from both the corporate and residential markets, which enjoy high PC penetration rates, advanced telecoms infrastructure and minimal regulatory intervention Another development likely to stimulate growth is the introduction of local loop unbundling (LLU), which will give alternative operators access to Bezeq's network and will stimulate much greater competition LLU is due to be implemented by end-2009

SWOT Analysis

Israel 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

ƒ Healthcare IT will be a growing source of opportunity

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 The weaker local currency, and aggressive pricing, may continue to constrain growth and put pressure on margins

Israel Telecommunications Industry 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 telecoms 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 Despite corruption allegations against some officials and members of parliament,

government members are still some of the most accountable in the region

ƒ Elections are for the most part free and transparent, ensuring that a broad spectrum

of political views is represented within government

Weaknesses ƒ The protracted conflict with the Palestinians means there are persistent security

risks, although violence in the West bank has been reduced significantly 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, its subsequent takeover of

the Gaza Strip, and Israel's military incursion into the territory in December 2008/January 2009 has added to uncertainty Finding a lasting solution poses a dilemma for Israel, which has previously said it will not talk to the militant organisation

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's re-election will add to Israeli concerns about a possible Iranian nuclear weapons programme

Israel Economic SWOT

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

under control (although the deficit is set to expand again in 2009)

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 In the long term, rising levels of employment will underpin private consumption

growth

ƒ FDI stocks amounted to 37% of GDP in 2007, according to UNCTAD, and remained robust in 2008; this should continue to propel growth for some years to come

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

prices in 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 the 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 increases 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 will 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

IT Business Environment Ratings

MEA 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 2014 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 updated Q110 ratings, the wealthy, high-tech Gulf Co-operation Council (GCC) markets continue

to occupy the higher rankings, with factors such as comparatively resilient consumer demand and ongoing infrastructure projects making this region relatively well positioned for the post-credit-crunch era

However, in most cases we do not see IT spending returning to its pre-crisis rate of growth over our year forecast period

five-The top four countries in our IT rankings table remain the same Despite recent financial concerns, the UAE has the top spot Qatar moves into second place, ahead of Kuwait, which drops to third Still in fourth place is Israel, where low computer penetration of around 30% offers potential for continued growth and about 50% of IT spending is accounted for by government and military projects

Bahrain, Saudi Arabia and Oman occupy the next three places, and – like Qatar – spending is expected to pick up in 2010 following a slowdown in 2009 when businesses and consumers spent cautiously due to the economic slowdown Economic reform and trade liberalisation will fuel spending on IT by both public sector organisations and enterprises

South Africa’s ’s relatively lowly eighth spot reflects business environment risks rather than the potential

of the country’s IT market, which will receive stimulus from infrastructure initiatives Turkey is expected

to be a regional outperformer as the focus of demand shifts towards the Anatolian region and the rate of

PC penetration rises Bringing up the field, Egypt’s high growth potential is constrained by income and business environment considerations, while uncertainties continue to surround the Lebanon IT market, with a mixed picture with regards to economic policy

A key variable for IT spending in this region is economic diversification In many markets, liberalisation

in sectors like telecommunications and financial services are factors driving demand for IT products and services 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 that will keep IT spending growing in this region is the waves of e-government initiatives being implemented Government accounts for up to 40% of the IT market in some states First-placed

UAE continued to roll out e-services in 2009, in line with the UAE Strategic Plan, which called for a strengthening of e-government programmes In Saudi Arabia, too, substantial budgets have been allocated for e-government infrastructure development

A number of factors contributed to the slowdown in the UAE and other GCC markets like Oman in 2009, including the impact of a falling population on consumer spending, as numbers of expats returned home

BMI expects this to be a short-term trend, however, and Saudi Arabian population growth for example is

expected to reach 10% by the end of our five-year forecast period, driving IT spending

Saudi Arabia, Bahrain and Oman rank slightly behind their equally fast-growing GCC peers on grounds

of general business environment, but the IT market metrics remain attractive Saudi Arabia will continue

to be a lucrative market for technology products and services, with the country’s youthful population

supporting a continued rapid rise in internet, PC and notebooks penetration BMI also takes a positive

view of market performance in Bahrain over the 2010-2014 forecast period A particularly important factor is Bahrain’s growing status as a financial hub Oman, although, like Bahrain, one of the smaller markets in the region, should benefit from infrastructure projects in sectors ranging from tourism to ports

Of the non-GCC countries, Israel – in fourth place – should have enough momentum from key sectors to

expand over BMI’s 2010-2014 forecast period Our ratings take account of opportunities in verticals like

financial services and SMEs, and growing demand for major IT outsourcing solutions However, in 2010 rising job insecurity for those in work will have a negative impact on consumer sentiment

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 The market will be supported by factors such as the 2010 Football World Cup, government projects and investment

by sectors such as telecoms Projected improvement in South Africa's broadband infrastructure, and international bandwidth, will also be a growth driver

Egypt is expected to be one of the fastest-growing IT markets in the region over the next few years, but has a number of constraints, including low disposable incomes and economic disparities The market will benefit from youthful demographics, rising PC penetration and improving ICT infrastructure, despite a sub-optimal distribution network outside of Cairo Lebanon also has some intrinsic advantages, including

a cosmopolitan and multi-lingual labour force, and a strategic position for the Levant markets There is potential for IT vendors in sectors such as telecoms, banking, utilities, real estate and government, but much will depend on the political stabilisation necessary to implement reforms

Regional IT Business Environment Ratings

Limits Of Potential Returns Risks To Realisation Of Returns

IT Market Structure Country Limits Market Risks Country Risk Risks Rating IT BE Regional Ranking

Source: BMI Scores out of 100, with 100 highest The IT BE Rating is the principal rating It comprises two

sub-ratings 'Limits Of Potential Returns' and 'Risks To Realisation Of Returns', which have a 70% and 30% weighting, respectively In turn, the 'Limits' Rating comprises IT Market and Country Structure, which have a 70% and 30%

weighting, respectively, and are based upon growth/size/maturity/govt policy of the IT 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

regulatory and IP regulations (Market) and the industry's broader Country Risk exposure (Country), which is based on BMI's proprietary Country Risk Ratings The ratings structure is aligned across the 14 Industries for which BMI

provides Business Environment Ratings methodology, and is designed to enable clients to consider each rating

individually or as a composite, which the choice depending on their exposure to the industry in each particular state For a list of the data/indicators used, please consult the appendix at the back of the report

Middle East Regional IT Markets Overview

IT Penetration

BMI projects continued improvement in

regional ICT indicators over the next few

years, driven by investment in broadband

and government ICT initiatives 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 across the region Qatar is projected to advance the most in percentage terms, with penetration rising from about 50% in 2008 to 78% by 2013

(note: figures may vary elsewhere in report due to updated forecasts after time of writing) Egypt will

have over 23mn subscribers in that same year, up from 11mn in early 2009 The UAE is one of the most advanced states in the region in this respect, with internet penetration seen as reaching 72% within the forecast period By contrast, Saudi Arabia is forecast to achieve a 7% rise in subscribers

Similar contrasts are apparent in relation to broadband penetration, which currently ranges from 1.2% in Egypt to 24.5% in Israel Government initiatives are afoot in most places, ranging from wireless

broadband in Dubai to plans to deploy optical fibre extensively in countries such as Kuwait Broadband penetration is seen as being at about 25% or above in the UAE, Saudi Arabia and Israel by the end of the forecast period, but at only around 3% in Egypt and Kuwait

Internet and broadband penetration growth will receive boosts from continued efforts to liberalise

regional telecoms markets In 2008 the Qatari government announced that eight operators had submitted bids for new fixed-line licences Egypt also continued liberalisation of its telecoms market last year, and similar moves have been seen in the Kingdom of Saudi Arabia Broadband penetration has become a driver of PC ownership in some segments, due to the growing variety of multimedia and communication services available There is plenty of room for PC growth, given the current low levels of

computerisation, which are estimated at less than 50% in every country in the region

Internet Penetration

(per 100 population)

Note: figures may differ from other sections of this report due to updated forecasts after time of writing e/f = estimate/forecast Source: BMI

Governments in the region are allocating significant budgets for e-government development The UAE launched several new projects in 2008, including an ID card initiative that will be a key element

underpinning future information society development Meanwhile, in June 2008 Saudi Arabia's governing Shoura Council approved a draft national strategy for the IT industry that aimed to raise the contribution

of the industry to GDP to 20% by 2020 Israel has announced that it intends to make a big effort to narrow the digital divide, and there has also been spending on computers in healthcare and a nationwide paperless court initiative

Market Growth & Drivers

Despite the global economic slowdown, the Middle East appears better placed than most other regions to withstand the current global economic headwinds In GCC states, the precipitous fall in oil prices in H208 had a negative effect on spending in previously fast-growing IT spending verticals such as oil and gas, construction and real estate Companies, hit by slowdowns in key export markets and credit tightening, were looking to cut costs

However, the region has a number of positive factors to help it avoid stagnation 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 Other drivers include fairly resilient consumer demand and ongoing infrastructure projects in major verticals such as oil and gas, telecoms and power

As a result, IT market growth is expected

to remain in positive territory in most

places in 2009 Youthful population

demographics, retail sector development

and rising PC penetration will drive

growth Growing regional competition

and opportunities, with the development

of the Arab Free Trade Zone, will

encourage spending

Several sectors will offer opportunities

despite the economic headwinds

Telecoms liberalisation and a big push

towards broadband penetration are

expected to drive demand Banks are implementing solutions to increase business flexibility and

introduce new services, including Islamic banking In Israel, spending in two of the largest IT verticals, defence and government, should be relatively immune to the economic situation Another key area for IT spending in many countries will be healthcare, with several major projects launched

IT Markets Compound Growth, (%)

2008e-2013f

e/f = estimate/forecast Source: BMI

The highest growth Middle East & Africa (MEA) IT market over the forecast period is expected to be Egypt, with compound growth of 65% for 2008-2013 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 markets are expected to include Kuwait (64%) and Qatar (64%)

Sectors & Verticals

Hardware will continue to dominate regional IT spending 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 notebooks and netbooks Notebook shipments grew about 50% in the Gulf last year, with notebooks the main product category driving retail segment growth, as consumer sales feel the benefits of aggressive channel promotions

The economic slowdown and credit tightening may have an impact on hardware spending in the

enterprise sector, as companies look to cut costs However, PC prices are continuing to fall, and this - along with more credit availability - is bringing computers within the reach of many more people

Meanwhile, the advance of 'big box' retailing, with larger outlets offering lower prices and more choice, will also stimulate sales

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 remain important for SMEs and other groups Government investment in education and e-services will mean desktop purchases for schools, colleges and government offices

Market Structure (% Of Total IT Market)

2008e (LHS) and 2013f (RHS)

e/f = estimate/forecast Source: BMI

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 Despite the difficult economic environment, which will encourage companies

to focus on the bottom line, demand from the oil and gas segment was hit in H208, but BMI predicts

plenty of room for growth over the forecast period as numerous untapped sectors still exist Key verticals will include telecoms, finance, retail, healthcare 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 Customer relationship management (CRM) will be a growth area, as fewer than 2% of SMEs in the Middle East region have a specialised CRM application in place Other high-growth categories are set to include business intelligence, storage and security products Security software is 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 remain in positive territory during the 2008-2013 period However, the

economic situation is likely to have an effect in some key verticals, particularly real estate and oil and gas In H208 there were reports of IT managers in various sectors looking to cut costs, although in some cases the emphasis was more on scaling back projects rather than cancellation In the government sector, budgets have often already been commissioned, and so the effects are more likely to be felt in the second half of 2009 and in 2010

Currently, IT services' share of IT spending ranges from around 24% to 32% in the MEA countries

covered by BMI Support and maintenance account for around one-third of spending on IT services, but

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

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

Background

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

Foreign direct investment (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 telecoms 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 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

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 enterprise resource planning (ERP) system running on SAP system 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 Government ISP (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, 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

The Israeli computer hardware market, including desktops, notebooks, servers and accessories, is

projected at US$2.2bn in 2010, up from US$2.1bn in 2009 The market is expected to grow at a CAGR of 5% over the forecast period to reach US$2.7bn in 2014 Spending is expected to resume single-digit growth in 2010, after a contraction in 2009 due to the economic slowdown and unemployment hitting consumer demand for electronics goods

Household consumption moved into negative territory last year, with spending on household

equipment down by 6.7% in Q109, and although BMI forecast a slight recovery in H209, trading

conditions were expected to remain tough Businesses are expected to maintain a cautious attitude to IT investments in 2010 due to uncertainty about a sustainable global economic recovery, but there should still be growth areas

Retail computer spending had been buoyant in the two years preceding the economic downturn, with drivers including the strong shekel, higher broadband penetration and demand for multimedia

applications In H109, the PC market slowed, through a combination of reduced consumer and business confidence Government IT project investments are a major component of Israeli computer hardware demand, but tighter fiscal conditions for the new administration in 2009 placed some budgets under pressure

There could be a boost, particularly in the second half of 2010, from computer hardware tenders delayed from 2009 The launch of the Windows 7 operating system, in October 2009, has the potential to help trigger a new cycle of hardware upgrades, although much will depend on business and consumer

confidence Notebooks will remain the main growth area, although the share of netbooks in total

notebook sales may have peaked as the price differential compared with full-featured notebooks becomes less significant

These factors were apparent in H208, but because of the upwards trend in the first half of the year, total

2008 PC sales were still up overall, at around 439,000 One area of growth will be lower priced computers, netbooks, which are establishing a position in the market The current low rate of PC

mini-penetration represents potential for organic growth PC mini-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 has launched various initiatives to increase computer and internet penetration, including 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 Notebooks are the fastest growing segment of the market, but in

2008 desktops still dominated with around two-thirds of unit sales Despite strong growth in demand for notebooks, the desktop sector is still significant, largely to business and government end-users

Software

Israeli software spending is projected at US$1.0bn in 2010, up from US$973mn in 2009 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period In recent years, the SME segment, the mainstay of the Israeli business sector, has emerged as an important growth area Spending on enterprise solutions should continue to grow steadily, with reviving or emerging areas of opportunity including security, CRM solutions and business intelligence However, in the current

economic climate, vendors will continue to pitch the efficiency gains potentially offered by these

applications

A 2009 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 release of the Windows 7 operating system, in October 2009, has the potential to impact positively on sales in 2010, despite business caution 2010 should in any event see a boost from systems upgrades deferred from last year when the economic crisis had an impact in public and private

sectors The slowdown was expected to continue into H209, with companies deferring investments, or looking for 'good enough' solutions to immediate problems Vendors will need to convince enterprises of benefits to the bottom line from software investments; however, there should still be several growth areas

The security software segment is an important opportunity, projected to be worth tens of millions of dollars 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 and demand for new services 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 segment is estimated at US$1.6bn in 2010, and this is expected to grow at a CAGR of 7% over the forecast period to reach US$2.2bn in 2014 The relatively robust economy and increased

investment by a number of key sectors have driven recent growth, but the number of new projects

decelerated in 2009 owing to the economic slowdown

In H109, there were reports of IT managers scaling back projects, but, in the near term, budgets had often already been commissioned, and so the effects were more likely to be felt in H209 and 2010 Defence and government spending represent a significant component of Israeli IT demand and have some immunity to economic vicissitudes This year much will depend on the speed of global economic recovery,

particularly in key Israeli export markets However, vendors will have to adapt to an environment where some projects are commissioned more in response to immediate needs, and with a focus on cost

consumption and rising unemployment Another key area of opportunity is healthcare IT

While large organisations still dominate, SMEs have also been investing more, and represent a growth opportunity 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

ƒ 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 Tata Consultancy Services' decision to

open a local branch also underlines the potential attraction of the financial sector, now benefiting from economic recovery and greater security

ƒ 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

Economic Impact On Israel Tech Sector

In H109, Israel's high-tech sector continued to suffer the effects of the global economic slowdown and credit crunch Demand for high-tech exports was estimated to have dropped by at least 10-15% with as many as 10,000 sector jobs feared to be at risk this year This represents a major concern for the Israeli government given that high-tech accounts for around 10% of Israel's economy, with annual sales

estimated at around US$25bn

The high-tech industry directly employs around 7% of the country's work force, and 6-8% have been estimated to have been laid off since last October In 2009, some major IT firms were laying off staff in Israel, including SAP, or cutting salaries, like HP

Israel's high-tech merger activity also fell in 2008 as a result of the downturn in the global economy According to figures from Israel's Venture Capital Research Centre (JVC), the value of Israel high-tech mergers were down by 19% year-on-year (y-o-y) to US$2.64bn The average deal size was also down, to around US$31mn An even more striking development was that the whole year passed without a single

high-tech initial public offering (IPO), a first since 2003 This was due largely to the weakness of the global capital markets, which affected, not just investment banks, but also venture capital

However, the number of Israeli tech companies involved in mergers was just one down on the 2007 figure, at 84 companies, indicating that the supply of promising companies has not dried up Indeed, current low valuations represent an opportunity for investors, although JVC forecasts that Israel high-tech companies will raise only US$300mn this year, down by 62% compared with last year

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 Organisation for Economic Co-operation and Development (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 Israel 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; and

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

Offshoring

Israel is also working hard to ensure that it benefits from the global offshoring trend, which it sees as an area of potential Despite the political and security situation, Israel has marketed its IT skills with some

success, and attracted outsourcing operations from major IT corporations such as Intel, IBM and

Microsoft, as well as Motorola One factor in this, of course, has been incentives that the Israeli

government started to offer back in 2006, with subsidies of up to ILS1,000 per employee per month Several major public- and private-sector outsourcing deals have also highlighted the growing importance

of outsourcing

However, there are fears of a skills bottleneck In 2007, the government said that Israel hopes to produce 10,000 engineers a year by 2010, up from the present graduation rate of 4,900 - small numbers by the standards of China, India and the US, but a big challenge for Israel The number of jobs in the sector rose

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

of 2007, about 40 government units and more than 3,000 users were estimated to have been covered

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 for computers,

with the Israeli government reaching a supply agreement last year with Dell and HP The government

chose Microsoft search technology to power its government services portal, gov.il

Meanwhile, the Israeli government was progressing with its plans to roll out Smart ID card systems intended to cover the entire population With an urgent need for the government to update technology and strengthen authentication systems, the original target was to introduce 2.5mn smart ID cards In

December 2008, HP was awarded a contract to produce 5mn ID cards; however, it is yet to receive the

go-ahead from the Knesset, which is deliberating over the passing of the biometric database bill The ID

cards, set to cost Israel US$67.49mn, would use 'smart' identification methods involving fingerprints and digital photography