Israel information technology report q4 2009

... completeness of any information hereto contained Information Technology Report Q4 2009 © Business Monitor International Ltd Page Information Technology Report Q4 2009 CONTENTS Executive Summary ... Ltd Page 45 Information Technology Report Q4 2009 have been translated into Hebrew at a cost of US$100mn © Business Monitor International Ltd Page 46 Information Technology Report Q4 2009 Country... Monitor International Ltd Page 40 Information Technology Report Q4 2009 HP Services Revenues Technology services, consulting and integration In 2007, HP Israel reported local computer sales of

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Israel Information Technology

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All information contained in this publication has been researched and compiled from sources believed to be accurate and reliable at the time of publishing However, in view of the natural scope for human and/or mechanical error, either at source or during production, Business Monitor

Technology Report Q4 2009

Including 5-year industry forecasts by BMI

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Publication date: October 2009

CONTENTS

Executive Summary 5

SWOT Analysis 8

Israeli IT Sector SWOT 8

Israel Telecommunications Sector SWOT 9

Israel Political SWOT 10

Israel Economics SWOT 11

Israel Business Environment SWOT 12

MEA IT Business Environment Ratings 13

Regional IT Business Environment Ratings 15

Middle East Regional IT Markets Overview 16

Market Growth & Drivers 17

Market Overview 21

Government Authority 21

Government Initiatives 22

Outsourcing 25

Industry Forecast 29

Israeli IT Industry Historical Data & Forecasts (US$mn, unless otherwise stated) 31

Internet 31

Table: Internet Data & Forecasts 31

Country Context 33

Consumer Expenditure, 2000-2012 (US$) 33

Rural/Urban Breakdown, 2005-2030 33

Competitive Landscape 34

Company Profiles 37

Ness 37

IBM 40

HP 41

Matrix 43

Microsoft 45

Country Snapshot: Israel Demographic Data 47

Section 1: Population 47

Demographic Indicators, 2005-2030 47

Section 2: Education & Healthcare 48

Education, 2002-2005 48

Vital Statistics, 2005-2030 48

Section 3: Labour Market & Spending Power 49

Employment Indicators, 2001-2006 49

Average Annual Wages, 2000-2012 49

BMI Methodology 50

IT Industry 50

IT Ratings – Methodology 51

IT Business Environment Indicators 53

Weighting 54

Weighting Of Components 54

Sources 54

Executive Summary

Market Overview

BMI projects that the Israeli IT market will have a value of US$4.7bn in 2009 The market is forecast to grow to reach a projected US$5.9bn in 2013 The Israeli IT market should have enough momentum from key sectors to expand over BMI's 2009-2013 forecast period despite a contraction this year

Major IT vendors reported challenging trading conditions in H109; a key factor has been unemployment hitting consumer demand for electronics goods In H209 rising job insecurity for those in work is

expected to have a negative impact on consumer sentiment, while many companies facing tight credit conditions will continue to be cautious about IT spending However, BMI tentatively expects conditions

to improve in the final quarter of the year

The Israeli IT market has a number of positive fundamentals that should keep it in positive territory over BMI's five-year forecast period Spending by a number of key IT spending verticals such as defence, and financial services, should be to some extent insulated from the economic crisis Low computer

penetration, of around 30%, offers potential for continued growth

Industry Developments

In H109, 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 socioeconomic policy framework The National Economic Council recently submitted a policy agenda to the government, which specified two main policy tracks of reducing poverty and achieving balanced growth The first track is expected to emerge as the main priority

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

e-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 is projected to take around 10% of the Israel IT Services market this 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 Q209, Matrix reported an approximately 12% growth in profits and 15% in operating profits from core businesses, compared with the same quarter of the previous year It reported a good quarter in Q109 despite the deceleration in economic growth Ness Israel, by contrast, reported a 25% decline in revenues for Q209, although two-thirds 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 2009, down from US$2.3bn in 2008 The market is expected to grow at a compound annual growth rate (CAGR) of 4% over the forecast period to reach US$2.6bn in 2013 The Israeli government has launched various initiatives to increase computer and internet penetration

However, BMI believes that spending will contract in 2009 with an 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 forecasts a slight recovery in H209, trading conditions will remain tough

Software

Israeli software spending is projected at US$993mn in 2009, up from US$965mn in 2008 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period Businesses are 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

Spending on software is shifting towards the small and medium-sized enterprise (SME) segment, which forms the mainstay of the Israeli business sector Spending on enterprise solutions has grown since 2007, with reviving or emerging areas of opportunity including security, customer relationship management (CRM) solutions and business intelligence In terms of verticals, the financial sector has been a mainstay

IT Services

The IT services segment is estimated at US$1.6bn in 2009, and this is expected to grow at a CAGR of 7% over the forecast period to reach US$2.0bn in 2013 In H109, 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 downturn 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

Israeli IT Sector SWOT

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

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

ƒ Strong defence and government spending provides base of IT demand

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

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

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

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

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

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

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

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

ƒ Outsourcing, software as a service (SaaS) and applications management likely

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

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

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 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 are 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 has intensifyied his anti-Israel rhetoric, adding to Israeli concerns about a possible Iranian nuclear weapons programme

Israel Economics SWOT

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

well under control (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 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 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 and, more recently, suicide bomb attacks, increase

the risk premium of investment in Israel

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

Opportunities ƒ Ongoing cuts 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 With economic conditions deteriorating, more strikes are likely to take place in 2009

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 2013 The ratings reflect our consideration of political and economic risks, as well as risks associated specifically with IT intellectual property (IP) rights protection and government projects

Our updated Q409 rankings represent a stabilisation compared with the relative turbulence of recent quarters due to the global economic headwinds The wealthy, high-tech Gulf Co-operation Council (GCC) markets continue to occupy the higher positions in our table, with factors such as comparatively resilient consumer demand and ongoing infrastructure projects making this region better placed than most

to withstand the economic slowdown However, a few states including Turkey saw a further downward revision of their IT Market and Country Risk scores, due to an ongoing, or belated, economic

deceleration

The top four countries in our IT rankings table remain the same For the fourth quarter running, the UAE has the top spot, while Kuwait is in second place, ahead of Qatar in third Still in fourth place is Israel, where spending in government and defence verticals and growing PC and broadband penetration should

be enough to prevent stagnation, despite an expected further easing in 2009

Saudi Arabia, Bahrain, and Oman occupy the next three places and – like Qatar – are expected to remain

in positive growth territory A key factor will be continued opportunities in sectors such as government, education and telecommunications, even as spending declines in other sectors more affected by the economic headwinds such as construction and real estate

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 now forecast to experience a full-year economic contraction in 2009, but the fundamentals of low computer penetration and rising incomes should keep the market on an upwards path Bringing up the field, Egypt’s high growth potential is constrained by income and business environment considerations, while Lebanon

is still recovering from the events of 2006

A key variable for IT spending in this region is economic diversification Some economies in the Middle East, such as Kuwait’s, remain highly dependent on oil In the UAE, however, some 80% of GDP is accounted for by the non-oil sector, and in Qatar around 38% In many countries, liberalisation in

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 despite the economic downturn is the waves of government initiatives being implemented in states like Kuwait, the UAE and South Africa, among others First-placed UAE has continued to roll out e-services in 2009, in line with the UAE Strategic Plan, which called for a strengthening of e-government programmes Areas of opportunity will include

e-healthcare IT and education, with new funding for computers in schools announced in April 2009 In Saudi Arabia, too, substantial budgets have been allocated for e-government infrastructure development

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

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

Saudi Arabia, Bahrain and Oman rank slightly behind their equally fast-growing GCC peers on 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 2009-2013 forecast period, in line with our GDP and oil price projections 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 also benefit from an emphasis on diversification, which is encouraging 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 five-year forecast period, despite the current economic slowdown Nearly 50% of IT

spending is accounted for by government and military projects, which are less likely to be affected by a short-term slowdown Israel’s IT market is also benefiting from record-breaking foreign investment, as well as growing demand for major IT outsourcing solutions However, 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 energy crisis and weakening external demand may precipitate a more cautious spending approach by some organisations, but the market will be supported by factors such as the 2010 Football World Cup,

government digital divide projects and sectors such as telecoms The Department of Home Affairs (DHA) has announced that it will spend more than ZAR500mn on IT projects in the current financial year

Lebanon has strong intrinsic advantages, including a cosmopolitan and multi-lingual labour force, and a strategic position for the Levant markets However, fulfilment of the market’s undoubted potential will depend on a functioning government being able to take the steps necessary to enable this Meanwhile, 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 country has the potential to rise up the regional rankings over time as computer penetration rises

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 Ranking

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

Internet Penetration Broadband Penetration

(per 100 population) (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

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

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 nearly 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 78% within the

forecast period By contrast, Saudi Arabia is forecast to achieve a 7% rise in subscribers, but at this rate would still reach only 30%

Similar contrasts are apparent in relation to broadband penetration, which currently ranges from 0.8% in Egypt to 22.6% in Israel Again, Qatar is forecast to achieve the most dramatic advance, with broadband penetration in the small state exceeding 30% by 2013 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

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

IT Market Sizes (US$mn) IT Market Sizes As % Of National GDPs

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

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

IT Markets Compound Growth, (%)

2008e-2013f

e/f = estimate/forecast Source: BMI

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

will also stimulate sales

Market Structure (% Of Total IT Market)

2008e 2013f

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

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

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

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

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

Government EIP

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

The Government ISP (GISP) project has been operational since 1998, providing essential infrastructure for

public-government communication

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

Shoham - E-commerce infrastructure and service

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

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 2009, down from US$2.3bn in 2008 The market is expected to grow at a

CAGR of 4% over the forecast period to reach US$2.6bn in 2013 However, BMI believes that spending

will contract in 2009 with an 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 forecasts a slight recovery in H209,

trading conditions will remain tough

Retail computer spending has been buoyant in the past two years, with drivers including the strong shekel, higher broadband penetration and demand for multimedia applications Despite strong growth in demand for notebooks, the desktop sector is still unsaturated and accounted for as much as 75% of PC sales in 2007, largely to business and government end-users In H109, however, the PC market slowed, through a combination of reduced consumer and business confidence Notebooks will remain the main growth area, with the popularity of netbooks helping to keep the momentum going in this segment

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 Government and defence tenders are a significant constituent of demand Government IT project investments started to rise in 2007 with IT budgets being restored after many years of cuts, but tighter fiscal conditions for the new administration in

2009 may place some budgets under pressure

Software

Israeli software spending is projected at US$993mn in 2009, up from US$965mn in 2008 The packaged software segment is expected to grow at a CAGR of around 7% over the forecast period In recent years,

Spending on enterprise solutions has grown since 2007, with reviving or emerging areas of opportunity including security, CRM solutions and business intelligence In the current economic climate, vendors will look 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

However, the slowdown is 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, in terms of either operational efficiencies or increased market share 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 in 2009 Israel has become more aware about the growing threat and sophistication of cyber attacks and has been encouraging government and private-sector organisations to take action Spending is likely across all sectors, with security content and threat management the current priorities

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

consequences of the global slowdown Despite the current financial crisis, regulatory compliance and demand for new services, requirements will continue to drive IT spending by banks Similarly, defence spending on new systems is likely to be maintained given the current security situation

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

of around US$3bn being comparable to about two-thirds of the entire value of the domestic IT sector Almost all global vendors are active in the domestic market, selling licences, along with integration and applications services Global vendors control more than three-quarters of the market, with SAP in first place In the past, the Israeli SME segment was dominated by local software companies Now,

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

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

Services

The IT services segment is estimated at US$1.6bn in 2009, and this is expected to grow at a CAGR of 7% over the forecast period to reach US$2.0bn in 2013 The relatively robust economy and increased

investment by a number of key sectors have driven recent growth, but the number of new projects is expected to be reduced in 2009 owing to the economic slowdown

In H109, there were reports of IT managers scaling back projects, but, in the near-term, budgets have often already been commissioned, and so the effects were more likely to be felt in H209 and 2010 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 reduction

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 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

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

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

Outsourcing

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

spending, or at least US$300mn, in 2009 Key sectors include:

ƒ The military, with outsourcing deals such as that awarded to HP by the Israeli Navy for management of its IT infrastructure highlighting the opportunities there While the value of the

HP deal was not made public, it is estimated to be worth several million shekels

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