Israel information technology report q1 2011

... any information hereto contained Israel Information Technology Report Q1 2011 © Business Monitor International Ltd Page Israel Information Technology Report Q1 2011 CONTENTS Executive Summary... International Ltd Page Israel Information Technology Report Q1 2011 Executive Summary Market Overview BMI projects that Israeli IT spending will grow to a value of US$5.5bn in 2011, consolidating... Business Monitor International Ltd Page Israel Information Technology Report Q1 2011 which was expected to boost imports of the device to Israel Previously Israeli users of the tablet were obliged

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TECHNOLOGY REPORT Q1 2011

INCLUDES 5-YEAR FORECASTS TO 2015

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: January 2011

CONTENTS

Executive Summary 5

SWOT Analysis 8

Israeli IT Sector SWOT 8

Israel Telecommunications Sector SWOT 9

Israel Political SWOT 10

Israel Economic SWOT 11

Israel Business Environment SWOT 12

IT Business Environment Ratings 13

Middle East 13

Table: Regional IT Business Environment Ratings 15

Middle East and Africa IT Markets Overview 16

Israel Market Overview 21

Government Authority 21

Government Initiatives 22

Hardware 23

Software 25

Services 27

Industry Developments 29

Industry Forecast Scenario 32

Table: Israeli IT Industry – Historical Data & Forecasts (US$mn, Unless Otherwise Stated) 34

Country Context 35

Consumer Expenditure, 2000-2012 (US$) 35

Rural/Urban Breakdown, 2005-2030 35

Internet 36

Table: Internet Data & Forecasts 36

Macroeconomic Forecast 38

Table: Israel – Economic Activity, 2008-2015 40

Competitive Landscape 41

Internet Competitive Landscape 44

Company Profiles 45

Ness 45

IBM 48

HP 49

Matrix 51

Microsoft 53

Country Snapshot: Israel Demographic Data 55

Section 1: Population 55

Table: Demographic Indicators, 2005-2030 55

Table: Rural/Urban Breakdown, 2005-2030 56

Section 2: Education And Healthcare 56

Table: Education, 2002-2005 56

Table: Vital Statistics, 2005-2030 56

Section 3: Labour Market And Spending Power 57

Table: Employment Indicators, 2001-2006 57

Table: Consumer Expenditure, 2000-2012 (US$) 58

Table: Average Annual Wages, 2000-2012 58

BMI Methodology 59

How We Generate Our Industry Forecasts 59

IT Industry 59

IT Ratings – Methodology 60

Table: IT Business Environment Indicators 61

Weighting 62

Table: Weighting Of Components 62

Sources 62

Executive Summary

Market Overview

BMI projects that Israeli IT spending will grow to a value of US$5.5bn in 2011, consolidating a recovery

in 2010 The market should gain enough momentum from key sectors to expand at a CAGR of 7% over

BMI’s 2011-2015 forecast period, thanks to stable demand from defence and government sectors as well

as opportunities in verticals like financial services and small and medium-sized enterprises (SMEs)

Spending is expected to record single-digit growth in 2011, after PC sales bounced back in 2010 with modest single-digit year-on-year growth Meanwhile 2010 also saw vendors winning projects across a range of sectors from government to telecoms, healthcare and utilities Vendors also reported a revival in demand in the key financial services vertical, where new projects included an US$11mn IT

outsourcing tender by the First International Bank of Israel

The Israeli IT market has strong fundamentals that should keep it in positive territory during BMI’s

five-year forecast period Household computer penetration of around 75% offers potential for further growth High internet penetration, including 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 May 2010, the Israeli Ministry of Finance launched a programme called "Relative Advantage" to provide a boost to Israel’s high-tech sector During the economic downturn, 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

IT is viewed as an important policy tool for the Israeli government’s socioeconomic policy framework In

2009, the National Economic Council 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

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

e-computers, with the Israeli government reaching supply agreements with vendors like Dell and HP

Competitive Landscape

In October 2010, Apple released the Hebrew-compatible version of its operating system for the iPad,

which was expected to boost imports of the device to Israel Previously Israeli users of the tablet were

obliged to pay for a less than optimal Hebrew keyboard application In August 2010, iDigital, the Israeli

importer of the iPad, had announced the availability of the device for sale in Israel, but as of October

2010 the cellular companies were still not offering the device

2010 saw Israeli vendors winning contracts to implement or update SAP solutions as spending recovered following the economic slowdown In September 2010, Ness won a US$3.7mn, five-year SAP ERP system contract from Israel’s Meitav Regional Water and Sewage Corporation, and in October 2010 a contract from Israel Direct Insurance (IDI) to implement a company-wide, SAP-based ERP system

The Israeli IT services market is competitive, with leading multinational competitors IBM and HP

(following its merger with EDS) both estimated to have Israeli IT services market shares of around 10%

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

Computer Sales

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

estimated at US$2.4bn in 2011, up from US$2.3bn in 2010 The market is expected to grow at a CAGR

of 5% over the forecast period to reach US$2.9bn in 2015 In H110, Israeli computer shipments recorded

a modest recovery compared to the same period of 2009 Household consumption moved into negative territory in 2009, and although there was a slight recovery in H209, trading conditions remained tough

Software

Israeli software spending is projected at US$1.2bn in 2011, up from US$1.1bn in 2010 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period Businesses are expected to remain cautious, deferring investments or looking for ‘good enough’ solutions to immediate problems However, there should still be several growth areas

Software spending 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, 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

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 relatively high PC penetration and the growing availability of broadband access mean internet penetration is likely to continue its upward trajectory The government has announced 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 stimulate much greater

SWOT Analysis

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 33% of spending in 2009 Despite this, the market for basic IT hardware and software is far from saturated.

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

Weaknesses ƒ The recession at the beginning of the 2000s 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 the 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 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 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 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 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 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

ƒ The fallout between Turkey and Israel, caused by the Gaza flotilla incident of May 2010, has meant that Israel has lost a key Mideast ally

Opportunities ƒ A warming of relations with Greece has given Israel the ability to engage in

military exercises over a larger geographic area

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 have 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 refusal to give up its nuclear programme raises concerns that nuclear weapons could be used against Israel

in the future

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

Threats ƒ The US Federal Reserve’s QE2 is likely to put appreciatory pressure on the

shekel, which would result in a drop in exports

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 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 Corporate tax rates have fallen 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

ƒ A parliamentary committee is investigating the cost and benefits of changing the country’s oil and gas royalty scheme, which could reduce energy profits in the future

IT Business Environment Ratings

Middle East

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 2015 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 Q111 ratings, the uncertain course of global economic recovery has led to downwards revisions of Country Risk scores for eight of our 11 MEA markets The wealthy, high-tech Gulf

Cooperation Council (GCC) markets continue to occupy the higher rankings Factors such as

comparatively resilient consumer demand and ongoing infrastructure projects make this region relatively well positioned for growth in 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 five-year forecast period

Despite recent financial concerns, the UAE retains the top spot in our Q111 table Qatar moves up to third place, with its projected high rate of GDP growth moving it ahead of Saudi Arabia in fourth In second place is Israel, however, where household computer penetration of around 75% offers potential for continued growth and about 50% of IT spending is accounted for by government and military projects

Kuwait, Bahrain and Oman occupy the next three places, and, like Qatar, spending is expected to grow in

2011, consolidating a recovery in 2010 from the impact of the economic slowdown Economic reform and trade liberalisation will fuel spending on IT by both public sector organisations and enterprises

Turkey, in eighth place in our table, is expected to be a regional IT market outperformer as the focus of demand shifts towards the Anatolian region and the rate of PC penetration rises South Africa’s ninth spot reflects business environment risks rather than the considerable potential of the country’s IT market; however, there will be a wind down of some IT infrastructure projects associated with the 2010 FIFA World Cup

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

One factor that will keep IT spending growing in this region is the wave of e-government initiatives being implemented Government accounts for up to 40% of the IT market in some states, and governments in the region have allocated significant budgets for e-services development First-placed UAE’s Strategic

Plan calls for a strengthening of e-government programmes In Saudi Arabia, too, substantial sums have been allocated for e-government infrastructure development

A number of factors contributed to a recovery in UAE and other GCC markets such as Oman in 2010, including economic recovery and a reversal of population decline seen during 2009 Saudi Arabian population growth, for example, is expected to reach 10% by the end of our five-year forecast period, driving IT spending

In many markets, liberalisation in sectors such as telecommunications and financial services is a factor 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, during BMI’s forecast period, there will continue to be significant spending on new

technology-driven solutions in the hydrocarbons sector

The UAE is forecast to remain the largest market in the region, but there are concerns that

sanctions against Iran could have an impact on the important re-export PC segment Government

investment should help support the market, with further opportunities in sectors such as education, healthcare, utilities, banking and telecoms

Qatar is expected to be one of the fastest-growing IT markets in the region over the next decade In its attempts to diversify the economy, the Qatari government is undertaking modernisation projects, which will offer opportunities to IT vendors The recent success of Qatar’s bid to host the 2022 FIFA World Cup will boost the ongoing development of transport infrastructure as well as the construction of stadiums

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 PC and notebook penetration BMI also takes a positive view of

market performance in Bahrain over the 2011-2015 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 should have enough momentum from key sectors to expand over BMI’s

2011-2015 forecast period Our ratings take account of opportunities in verticals such as financial services and SMEs, and growing demand for major IT outsourcing solutions However, rising job insecurity for those in work could 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, it loses points for Country Structure and Market Risk The market will be supported by factors such as 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

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 BE Rating

Regional Rank

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 Source: BMI

Middle East and Africa IT Markets Overview

BMI forecasts continued improvement in

regional ICT indicators over the five-year

forecast period, driven by investment in

broadband and government initiatives The

Middle East region divides into two groups in

terms of information society development In

the first 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 emerging markets such

as Egypt, on the other hand, computers remain

a luxury for many The number of internet

users in the second group is expected to grow significantly Egypt is projected to advance the most in percentage terms, with penetration rising from 21.1% in 2010 to 30.6% by 2014 (note: figures may vary elsewhere in report due to updated forecasts after time of writing) Qatar, where the second biggest increase is forecast, will have more than 50% penetration by 2014, up from 36.7% in 2010 The UAE is one of the most internet-ready states in the region, with internet penetration predicted to reach 84% within the forecast period Growth in the number of internet subscribers is also forecast to pick up in Saudi Arabia, with a 24% increase between 2010 and

2014

Similar contrasts are apparent in relation to

broadband penetration, which ranges from

1.6% in Egypt to 26.2% in Israel Government

initiatives are underway in most countries,

ranging from wireless broadband in Dubai to

plans to deploy optical fibre extensively in

countries such as Kuwait BMI’s broadband

penetration forecasts have been downgraded in

many markets as a result of the economic

downturn, with Israel the only country

anticipated to reach 30% broadband

penetration by 2014 The UAE is projected to

reach 24%, the second highest among the countries covered by BMI

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

regional telecoms markets Moves towards telecoms market liberalisation have continued in Qatar, Egypt, Saudi Arabia and other countries 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 considerable PC market growth potential as the current level of computerisation is estimated at less than 50% in every country in the region PC penetration in Egypt is estimated at 10% and is forecast

to rise to 19% by 2014 Even in Israel, where household penetration was estimated at around 75% in

2008, there is potential for further growth

Governments have allocated significant budgets for e-government development Egypt aims to make 200 government services available online through a new e-government portal Qatar’s e-government

programme and ‘Hukoomi’ e-services portal will continue to drive investment in computer hardware across government agencies and client organisations Saudi Arabia’s strategy for the IT industry aims to raise the contribution of the industry to 20% of GDP by 2020 Another key policy priority throughout the region is to increase utilisation of IT by businesses, especially SMEs In one of the Saudi government’s policies, vendors are capitalising on is the united instalment scheme (USI) finance option, which makes high-quality notebooks available to SMEs Qatar’s ICT governing body, ictQatar, has also made

increasing IT use for SMEs a key policy objective

Market Growth And Drivers

IT spending was forecast to bounce back

strongly throughout the region in 2010 There

is a strong correlation between economic

growth and IT spending, and some markets

such as Qatar are estimated to have enjoyed

high double-digit GDP growth in 2010

Drivers will be increasing economic

diversification and strong spending from

non-oil sectors such as government, financial and

enterprise sectors By 2014, this should be

more evident, with IT’s share of GDP rising in

many countries Other drivers include fairly resilient consumer demand and ongoing infrastructure projects in major verticals such as oil and gas, telecoms and power

2010 IT Market Sizes

US$mn

Source: BMI estimate

An expected recovery in population growth

underpins our IT market growth projections for

markets such as the UAE and Kuwait, which

experienced an exodus of expatriate workers in

2009 In particular, strong positive population

growth gives Saudi Arabia an advantage, with

growth expected to reach 10% by the end of

our forecast period Youthful population

demographics, retail sector development and

rising PC penetration will drive also growth

Several sectors will offer opportunities for IT

vendors Telecoms liberalisation and a big

push towards broadband penetration are expected to drive demand for hardware and systems 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, was relatively immune to the economic situation Another key area for IT spending in many countries is healthcare

Education will also be a significant

opportunity The UAE’s Ministry of Education

announced an AED79mn allocation in 2009 for

an initiative to supply computers and internet

to state schools The Egyptian government is

also prioritising campaigns to raise levels of IT

use in schools In June 2009, it purchased

10,000 computers for distribution to students

and teachers in what was described as the

largest ever procurement tender by a

government body in Egypt

The highest growing IT market in the MEA

region over the forecast period is expected to be Egypt, with a CAGR of 84% for 2009-2014 There is room for considerable growth in the country in the next few years, given the low level of computerisation, which is much higher in the business sector than in the population at large The fastest growth among the Gulf Cooperation Council (GCC) countries is expected to occur in Qatar (48%), but demand should be strong throughout the region, with 37% spending growth forecast for Saudi Arabia and the UAE

Sectors And Verticals

Hardware will continue to dominate regional IT spending as the number of personal computer users rises

IT Market Sizes, % Of National GDP

2010-2014

Source: BMI estimates/forecasts

IT Markets Compound Growth

2010-2014 (%)

Source: BMI estimates/forecasts

steadily over the forecast period This will be driven by growing affordability, government initiatives and the popularity of notebooks and netbooks There could be a boost from computer hardware tenders

delayed from 2009 and 2010 Sales of Microsoft’s Windows 7 operating system and new Intel core

technology have the potential to help trigger a new cycle of hardware upgrades, although much will depend on business and consumer confidence

Market Structure (% Of Total IT Market)

Scores out of 100 Source: BMI estimates/forecasts

Sales of notebooks are growing roughly twice as fast as desktops in many markets, and netbooks were one of the fastest-growing PC market segments during the global economic downturn

Prices are continuing to fall, and this, along with more credit availability, is bringing computers within the reach of many more people The advance of ‘big box’ retailing, with larger outlets offering lower prices and more choice, will also stimulate sales The growth of fixed and mobile broadband penetration will also be a significant driver of demand for notebooks as a connectivity device, after telecoms operators launched new PC bundling deals in 2009 targeted at subscribers

Government programmes in Egypt and Saudi Arabia have made low-price computers available in easy instalment payment schemes 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 the majority of MEA markets The global economic crisis led some companies to review IT budgets or to defer systems updates, but others see IT as a means of achieving greater efficiencies in difficult times In the current economic climate, business software vendors will pitch for efficiency gains, as declining margins encourage companies to focus on reducing costs Sales of the Windows 7 operating system could have a positive impact on the market, with a boost from systems upgrades deferred from 2009

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 There has been growing demand in the market for applications tailored towards particular verticals

SMEs are likely to lead spending growth, with manufacturing and trading firms seeking efficiencies by making the transition from manual environments to the full automation of back-office systems Customer relationship management (CRM) will be a growth area and other high-growth categories will include business intelligence, storage and security products The security software market is very important throughout the region as increased investment in IT hardware over recent years is now driving spending

on secure content management technologies

There are some challenges for the regional software market One key issue is illegal software Across the region up to 80% of software is counterfeit Another important factor is low income, including the high costs of operating systems such as Windows, which has led to activity to promote open source software in

countries such as Egypt, as championed by IBM and other vendors

BMI predicts that demand for IT services will grow strongly during the forecast period The regional IT

services market is dominated by demand from oil and gas, government, finance and telecoms sectors, which many markets account for more than half of total spending In markets such as Saudi Arabia, most enterprise application spending still comes from segments such as oil and gas and banks However, more projects are expected in segments like education and health

IT services’ share of IT spending ranges from 25% to 33% in the MEA countries covered by BMI

Support and maintenance account for about a third of spending on IT services, but demand for more complex services has increased, with large outsourcing deals taking place in the UAE, Israel and

elsewhere There is also demand for services such as hosting, facilities management and disaster

recovery

There is growing demand for services to enable the use of models such as hosting and cloud computing Vendors have reported an evolution in demand for services, with a shift away from the dominance of product implementation and installation to greater interest in managed services, value-added services, facilities management, hosting and business continuity and disaster recovery Even in less mature markets such as Egypt, larger customers are becoming more demanding in terms of their IT expectations

Israel Market Overview

Government Authority

Government Authority Ministry of Science and Technology

Minister Daniel Hershkowitz

The ministry of science and technology has undergone numerous name changes and received its current name following the election of Binyamin Netanyahu’s government in March 2009

The ministry’s responsibilities include forming a national policy towards science and technology,

coordinating research areas and technological analysis and organisation

The main priorities for the ministry are as follows:

ƒ Establishing a national policy and priorities for R&D;

ƒ Developing scientific and technological infrastructure;

ƒ Establishing and strengthening of foreign scientific relations;

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

ƒ Participating 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);

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

Background

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

IBM has its only IBM Global Services 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 offers 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 As well as the opening up of the financial and telecoms sectors, the high-tech sector succeeded in attracting large FDI inflows The government’s policy made foreign high-tech companies eligible for government grants covering 38% of the cost of new research and development facilities Today, Israel has more offshore research and development 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 40-50% of their revenues

Government Initiatives

Gov@Net – Government intranet

ƒ A cross-government intranet planned to connect more than 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, ministry-specific operational systems and

intra-government shared resources

Tehila – Government ISP

ƒ The Government ISP 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, including 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 more than 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 forecast

at US$2.4bn in 2011, up from US$2.3bn in 2010 The market is expected to grow at a CAGR of 5% over the forecast period to reach US$2.9bn in 2015

In H110, Israeli computer shipments recorded a modest recovery compared to the same period of 2009 However, lower average prices meant revenue growth was flat or slightly negative Businesses are

expected to maintain a cautious attitude to IT investments in 2011 due to uncertainty about a sustainable

global economic recovery, but there should still be growth areas BMI forecasts single-digit Israel PC

market growth for 2011, consolidating a recovery from the impact of the economic slowdown which hit consumer demand for electronics goods

Sales could receive a boost from computer hardware tenders previously delayed as a result of the

economic situation Migrations to Microsoft’s Windows 7 operating system and new Intel core

technology could trigger a new cycle of hardware upgrades, although much will depend on business and consumer confidence Notebooks remained the main growth driver in 2010, while desktops sales were down year-on-year (y-o-y) in H110 The share of netbooks in total notebook sales may have peaked as the price differential compared with full-featured notebooks becomes less significant

The current rate of PC penetration, while high for the region, represents potential for organic growth Household penetration was estimated at around 75% in 2008 Digital divide issues mean 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 took around two-thirds of unit sales Despite strong growth in demand for notebooks

in 2009, the desktop sector is still significant, largely due to business and government end-users

Netbooks were a main driver of PC market growth in 2010 but face competition from other form factors

In particular, smartphones from Palm, RIM, Apple and other vendors are being offered as alternative

connectivity solutions and often include a Wi-Fi option

Tablet notebooks emerged in 2010, spearheaded by Apple’s iPad In October 2010, Apple released the Hebrew-compatible version of its operating system for the tablet, which was expected to boost imports of

the device to Israel Previously Israeli users of the iPad were obliged to pay for a less than optimal

Hebrew keyboard application

In August 2010, iDigital, the Israeli importer of the iPad, had announced the availability of the device for

sale in Israel, but as of October 2010 the cellular companies were still not offering the device The Israel Ministry of Communications had cleared import of the Apple iPad for Israel in April, after previous concerns that iPads were in non-compliance with Israeli wireless standards One Israeli chain was selling the iPad at a retail price of ILS3,800, or around US$1000; about twice the price of the device in the United States

Other vendors are expected to follow Apple in releasing net tablet devices, which have a form factor between the size of a smartphone and a netbook NetTabs are being designed to appeal to consumers who find a smartphone inconvenient for consuming video media or surfing the web, but for whom a netbook is still too big or heavy NetTabs are expected to be significantly more expensive than smartphones, but despite a previous mixed record with this form factor, are seen as a growth area in 2010-2011

Another area vendors will watch is the e-reader market Like iPads, Kindles are not yet readily available

in Israel, but that situation is expected to change Currently Amazon, Barnes and Noble and Apple do

not permit the use of an Israeli credit card at their online bookstores However, Amazon now offers Israeli consumers the ability to download content directly to their PC or Kindle using an Israeli credit card

In 2009, the PC market slowed due to a combination of reduced consumer and business confidence Government IT project investments are usually a major component of Israeli computer hardware demand, but tighter fiscal conditions for the new administration in 2009 placed budgets under pressure Retail computer spending had been buoyant in the two years before the global economic downturn, with drivers including the strong shekel, higher broadband penetration and demand for multimedia applications

Software

Israeli software spending is projected at US$1.2bn in 2011, up from US$1.1bn in 2010 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period In 2010 local IT giant Ness was among those vendors reporting a rebound in Israeli market revenues growth, with the company’s annualised revenues growth increasing in each of the first three quarters

2010 saw vendors winning projects across a range of sectors from government to financial services,

telecoms and utilities Large organisations investing in SAP-based systems included the Meitav Regional Water and Sewage Corporation and Israel Direct Insurance (IDI)

Meanwhile the SME segment, the mainstay of the Israeli business sector, has emerged in recent years as

an important growth area for enterprise systems 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

Migrations to the Windows 7 operating system should have a positive impact on 2011 sales despite business caution More than 50% of Israeli computer users are estimated to still be using Windows XP operating system, and this represents a significant potential market, as support for XP will be withdrawn

by 2014

2011 should, in any event, see a boost from systems upgrades previously deferred as a result of the impact

of the economic crisis in public and private sectors Going into 2010, there were signs of a pick-up in project flow The slowdown had continued 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

During the economic downturn, a 2009 survey of Israeli IT managers suggested current areas of

enterprise 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 Maccabi Healthcare Services

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

Given the current focus on many businesses of controlling costs, the pay-on-demand SaaS model has grown in popularity and spread beyond the initial core application area of CRM The economic crisis may have provided a lasting boost to the SaaS model, particularly as broadband penetration grows More vendors are looking for channel partners to help them offer cloud computing and rented software services

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 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 Vendors reported in Q110 that the key financial services segment had started to see demand recovery 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 US$3bn representing around two-thirds of the value of the entire domestic IT sector Almost all global vendors are active in the domestic market, selling licences alongside 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 forecast at US$1.9bn in 2011 and this is expected to grow at a CAGR of 8% over the forecast period to reach US$2.4bn in 2015 In 2010, there were reports of a pick-up in the flow of projects in key sectors such as government and financial services, after demand had slowed in 2009 due

to economic uncertainty

Vendors reported that in 2010 demand had revived in the key financial services vertical, where new

projects included an US$11mn IT outsourcing tender by the First International Bank of Israel

Government agencies were also commissioning or extending IT contracts, including a US$2.6mn

outsourcing contract extenson awarded by Israel’s Ministry of Environmental Protection Meanwhile Healthcare and Utilities were also generating outsourcing projects

In 2011 much will depend on confidence in the 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 reduction Defence and government spending represent a significant component of Israeli IT demand, however, and have some immunity to economic vicissitudes

The relatively robust economy and increased investment by several key sectors have driven recent

growth, but the number of new projects decelerated in 2009 owing to the economic slowdown Public sector spending helped to prop up demand, however Among public sector organisations tendering IT outsourcing contracts in Q409 were the Israeli Ministry of Immigration Absorption and the Israeli

Ministry of the Interior

Growth is expected to reach a higher trajectory in the second half of our five-year forecast period Key Israeli IT services spending verticals include 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

Along with defence, these two key sectors are likely to be a continued source of opportunities because the factors driving spending in each case are not particularly sensitive to the economic downturn Indeed, the new administration will likely feel pressure to ramp up government spending to combat lower private consumption and rising unemployment Another key area of opportunity is healthcare IT

One potential demand driver will be organisations looking for help to utilise efficiencies from cloud computing such as SaaS and Infrastucture-as-a-Service (IaaS) Particular areas of opportunity for cloud computing include banking and retailing as organisations in those fields look to save money on hardware investments

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

Outsourcing

Outsourcing has become a bigger factor and is forecast to account for about 20% of IT services spending,

or at least US$320mn, in 2011 Key sectors for IT outsourcing include:

ƒ The military 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

ƒ The financial sector is another lead vertical for outsourcing In 2006, a 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 The contract includes 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 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 In May 2010, the Israeli Ministry of Finance launched a programme called "Relatie Advantage"

to provide a boost to Israel’s high-tech sector

Apple iPad Import Cleared for Israel

In April 2010, the Israel Ministry of Communications announced import of the Apple iPad had been cleared for Israel The tablet PC had previously been banned due to its Wi-Fi capability, which according

to the ministry was in non-compliance with the European wireless standards that Israel follows

Previously, Israeli officials claimed the iPad’s stronger signal would hinder other device’s wireless capabilities According to news reports, 20 iPads were confiscated by Israeli customs, leading to

confusion among consumers

Leveraging IT For Growth

IT will also be harnessed to the second goal of achieving balanced, long-term economic 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 projected that the software sector will generate

US$3.2bn annually by the end of the decade The government hopes the high-tech sector will generate US$3.0bn for the nation’s economy by 2010

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 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 workforce, with an estimated 6-8% have been reportedly laid off since October 2008 In 2009, 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’s high-tech mergers were down by 19% y-o-y to US$2.64bn The average deal size was also down to around

US$31mn An even more striking development was the whole year passing 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 in 2008 was just one down on the

2007 figure, at 84 companies, indicating the supply of promising companies has not dried up Indeed, current low valuations represent an opportunity for investors, although JVC forecast Israeli high-tech companies would raise only US$300mn in 2008, down by 62% compared with last year

Offshoring

Israel is also working hard to ensure 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 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

E-Services

As part of its modernisation agenda, the government is also pressing ahead with various other strands of its e-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 for computers, with the Israeli government reaching a supply agreement 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

The 2005-2007 masterplan of the government’s ERP project called for implementation in around 90 government units by the end of 2007 The project leveraged my SAP ERP (content delivery software) and had a focus on financial, logistics and human resource components Dubbed Merkava, the project cost an estimated ILS800mn since its launch in 1999

Israel’s Digital Divide

It has been estimated that Israel currently has around 600,000 children living below the poverty line, and the Gini coefficient has been estimated as among the highest of any Organisation for Economic

Cooperation and Development (OECD) country A 2007 survey found 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 the Jewish and Arab populations, with 72.5% of the former using the internet in Israel compared with 52.5% of the latter

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 coordinate 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