Israel information technology report q4 2011

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TECHNOLOGY REPORT Q4 2011

INCLUDES 5-YEAR FORECASTS TO 2015

Part of BMI's Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: October 2011

CONTENTS

Executive Summary 5

SWOT Analysis 8

Israel IT Sector SWOT 8

Israel Telecommunications Sector SWOT 9

Israel Political SWOT 10

Israel Economic SWOT 11

Israel Business Environment SWOT 11

Business Environment Ratings 12

Middle East & Africa 12

Regional IT Business Environment Ratings 15

Africa IT Markets Overview 16

Israel Market Overview 23

Government Initiatives 24

Industry Forecast 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

Industry Forecast Internet 36

Table: Internet Data And Forecasts, 2007-2015 36

Macroeconomic Forecast 38

Table: Israel – Economic Activity 40

Competitive Landscape 41

Company Profiles 45

Ness 45

IBM 48

HP 49

Matrix 51

Microsoft 53

BMI Methodology 55

How We Generate Our Industry Forecasts 55

Transport Industry 55

Sources 56

Executive Summary

Market Overview

BMI projects that the Israeli IT market will grow to a value of US$5.7bn in 2011, consolidating a

recovery in 2010 from the impact of the global economic situation The market is forecast to reach US$8.0bn in 2015 The market should gain enough momentum from key sectors to expand at a compound

annual growth rate (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 such as financial services and small and medium-sized enterprises (SMEs)

In H111, vendors reported solid demand for IT services across industrial, government, defence, and financial services segments, with new projects initiated by the Israeli Ministry of Defence (MOD) and the

Israel Electric Company 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

As part of its modernisation agenda, the government is pressing ahead with various 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 such as Dell and HP

Competitive Landscape

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

Israeli IT leader Ness reported revenues of US$141mn in Q211, with just 1% annualised growth, and

revenues from the Israeli market at 42% of the total Among major developments in H111 was a

US$75mn five-year agreement that Ness signed with global finance leader Barclays Capital to develop a

high-tech research and development centre in Israel

Cloud computing is a major focus of IT company investment in the Israeli market In H111, US PC hardware leader Dell inaugurated a new Israeli R&D centre, which will focus on developing storage technologies and cloud computing solutions Meanwhile, cloud computing now accounts for around 70%

of the work at Microsoft's Israel-based R&D centre

Computer Sales

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

forecast to reach US$2.5bn in 2011, up from US$2.3bn in 2010 The market is expected to grow at a

CAGR of 7% over the forecast period to reach US$3.3bn in 2015 BMI has upwardly revised its Israeli

PC market growth for 2011, as demand recovers from the impact of the economic slowdown, which hit consumer demand for electronics goods

In 2010, 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$1.3bn in 2011, up from US$1.1bn in 2010 The packaged software segment is expected to grow at a CAGR of around 10% over the forecast period In Q111, the pick-up in demand for systems and upgrades continued in both public and private sectors, with

investment by government organisations such the MOD and Israeli Police, and from utilities and financial sector companies

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

IT Services

The IT services segment is forecast to reach a value of US$2.0bn in 2011, and this is expected to grow at

a CAGR of 10% over the forecast period to reach US$2.9bn in 2015 In 2011, vendors reported a

continued flow of new projects in sectors such as government, financial services, homeland security, and utilities

Government and defence are two key sectors likely to be a continued source of opportunities, while other growth areas include healthcare IT and utilities 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

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 competition

SWOT Analysis

Israel IT Sector SWOT

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

ƒ Strong defence and government spending provides base for 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

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

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

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

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

ƒ Liberal mobile market consisting of four operators

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

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

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

Israel Political SWOT

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

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

exercises over a larger geographic area

Gaza Strip, and Israel's military incursion into the territory in December 2008/January

2009 has added to uncertainty Finding a lasting solution poses a dilemma for Israel, which has previously said it will not talk to the militant organisation

ƒ The construction of the West Bank barrier and the continued home-building in some West Bank settlements antagonises the Palestinians and stands in the way of the peace process

ƒ Iranian President Mahmoud Ahmadinejad's refusal to give up his country's nuclear programme raises concerns that nuclear weapons could be used against Israel in the future

Israel Economic SWOT

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

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

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

ƒ The discovery of large offshore gas deposits will bring foreign investment and is expected to serve the country's energy needs for decades

has been targeted frequently in 2011, forcing the country to buy more expensive fuels from alternative sources

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

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

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

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

past two years

ƒ The parliament approved a plan to increase the country's oil and gas royalties, which could reduce energy profits in the future

Business Environment Ratings

Middle East & Africa

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 Q411 ratings, country rankings are unchanged, reflecting stabilisation in most markets after the impact of the global economic downturn and political unrest 2011 is expected to see IT market verticals continue spending momentum, following a strong rebound in PC sales in 2010 To help maintain social stability, many regional governments have announced spending increases, including both capital investment and wage increases, which should boost spending on information technology

Vendors also reported a pick-up in IT services project flow, with new IT projects in verticals such as banking, government, real estate and education Despite this, continued credit restrictions and political instability mean that cautious spending patterns are likely to persist in 2011 across many Gulf Co-

operation Council (GCC) markets

The wealthy, high-tech 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 continued financial concerns concerning Dubai, the UAE retains the top spot in our Q311 table

In second place is Israel, 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 Qatar takes third place, with its projected high rate of GDP growth keeping it ahead of the larger market

of Saudi Arabia in fourth

Kuwait, Bahrain and Oman occupy the next three places, and, as in 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 Meanwhile, South Africa's ninth spot reflects business environment risks rather than the considerable potential of the

country's IT market

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, government bodies have pressed ahead with ambitious e-government and IT projects

A number of factors contributed to a recovery in the 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 However, in markets such as the UAE, a property price slump and tighter credit are likely to continue to influence business and consumer caution

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, despite these developments, the hydrocarbon sector remains key to IT spending, with oil and gas companies investing in IT to enhance operational efficiency, optimise cost structures and boost overall business agility

The UAE is forecast to remain the largest market in the region The UAE IT market has received a buffeting from global economic headwinds but demand for IT products and services has continued to revive in 2011 In the wake of the Dubai financial crisis, new growth potential exists in the northern emirates where the government has launched a major infrastructure investment programme Government investment should also help support the market, with cloud services central to the Emirates' e-

Government strategy for the next three years

There will be further UAE market opportunities in sectors such as education, healthcare, utilities, banking and telecoms A pick-up in the number of tourist visitors should provide a boost to the carry trade,

although there are concerns about the impact of sanctions against Iran

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 The Qatari government has outlined plans to invest QAR6bn (US$1.6bn) in information technology and

IT services as part of its ICT-2015 strategy

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 The kingdom's relative political

stability compared with some other markets in the region will also attract vendors Government-driven investments in transportation, property constructions and water and power plants will drive opportunities for IT vendors

In 2010/11 Kuwait’s government spending was expected to increase by 10%, following a 38% decrease

in the previous year, and some of this spending should carry through into 2011 A four-year government infrastructure spending plan, launched in February 2010, should mean more public sector IT

opportunities 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 In H111, vendors reported a continued pick-up in the flow of IT projects, with

a new large tender from the Israeli MOD Our ratings also take into account opportunities in verticals such as financial services and small and medium-sized enterprises (SMEs), and growing demand for major IT outsourcing solutions Healthcare, the public sector and utilities are also generating new projects

or significant contract extensions Falling unemployment and low inflation and interest rates should support domestic spending

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 recent spate of wage bargaining, along with low interest rates and relatively low inflation, has increased spending on big-ticket items such as computers Projected improvement in South Africa's broadband infrastructure, and international bandwidth, will also be a growth driver

The South African market will be supported by factors such as government projects and investment by sectors such as telecoms The South African Department of Education has announced a target of rolling out laptops to all school children in the country by 2014

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 Prolonged political instability following the events of February 2011 could also impact on the market's development The country's IT budget will benefit from youthful demographics, rising PC penetration and improving ICT infrastructure, despite a sub-optimal distribution network outside of Cairo

Lebanon also has some intrinsic advantages, including a cosmopolitan and multi-lingual labour force, and

a strategic position for the Levant markets There is potential for IT vendors in sectors such as telecoms, banking, utilities, real estate and government, but much will depend on the political stabilisation

necessary to implement reforms

Regional IT Business Environment Ratings

Country

IT BE Rating

Regional Ranking

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

Africa IT Markets Overview

MEA IT Regional Overview 2011

The Middle East region 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 more emerging

markets such as Egypt, on the other hand,

computers remain a luxury for many

Across the MEA region, the number of

internet users is expected to grow

significantly Qatar is projected to advance

the most in percentage terms, with

penetration rising from about 57.2% in

2011 to 82.8% by 2015 (note: figures may

vary elsewhere in report due to updated

forecasts after time of writing) Saudi

Arabia, where the second biggest increase

is forecast, will have 66% penetration by

2015, up from 52.5% in 2011 The UAE is

one of the most e-ready states in the

region, with internet penetration seen as

reaching 89% within the forecast period

Growth in the number of internet

subscribers is also forecast to pick up in

Saudi Arabia, with a 55% increase

between 2011 and 2015

Similar contrasts are apparent in relation to

broadband penetration, where mobile broadband is now a major driver of overall penetration, due to 3G mobile service rollouts across the region Broadband penetration currently ranges from 5.1% in Kuwait to 27.7% in Israel

Government initiatives are afoot in most places, ranging from wireless broadband in Dubai to plans to

deploy optical fibre extensively in countries such as Kuwait BMI's broadband penetration forecasts have

been downgraded in many markets as a result of the economic downturn, with Israel's 28.6% penetration seen as the highest in 2015 Saudi Arabia is projected to reach 25.7%, 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 also 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 around 10% and is forecast to rise above 20% by 2015 In Saudi Arabia, PC penetration is currently about 24% and should increase to more than 30% by 2015 Even in Israel, where household penetration was estimated at around 75% in 2008, there is potential for further growth

Government initiatives will drive more use of computers in education In the UAE, the Ministry of Education is leading an initiative to supply computers to state schools Around 25% of Egypt's schools are not equipped with computers and significant spending is expected as part of an EGP150bn project to build new schools Meanwhile, the South African Department of Education has announced a target of rolling out laptops to all school children in the country by 2014

Governments in the region have also allocated significant budgets for e-government development Egypt aims to make 200 government services available soon 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 South Africa's IFMS (Integrated Financial Management Systems) project manages the evolution of government IT systems to support

interoperability and e-government service development

Another key policy priority throughout the region is to increase utilisation of IT by businesses and in particular small and medium-sized enterprises (SMEs) One of the Saudi government policies that

vendors are capitalising on is the United Instalment Scheme (USI) finance option, which makes quality notebooks available to small and medium businesses Qatar's ICT governing body, ictQatar, has made increasing SME utilisation of IT a key policy objective Access to credit remains a barrier for

high-smaller companies in Egypt, as elsewhere, but initiatives such as that launched by the Bank of

Alexandria in 2010 will help SMEs to invest in IT

Market Growth And Drivers

IT spending bounced back strongly

throughout the region in 2010 There is a

strong correlation between economic

growth and IT spending, and many

countries in the region, such as Qatar, are

forecast to report robust economic

expansion in 2011 However, in markets

such as the UAE, access to credit remains

a constraint on domestic consumer

demand

Drivers going forward are increasing

economic diversification and strong

spending from non-oil sectors such as

government, financial and enterprise

sectors By 2015, this should be more

evident, with IT's share of GDP rising in

many countries In Saudi Arabia, for

example, government-driven investments

in transportation, property constructions

and water and power plants will create

opportunities for IT vendors In South

Africa, despite a drop-off in IT investment

associated with the 2010 FIFA World Cup,

other major infrastructure and transport

projects will provide growth opportunities

In the wake of the political unrest that

swept the Arab world in the first half of

2011, government spending is expected to help address economic concerns that may have underpinned dissatisfaction in some cases In 2011 the Saudi government has announced US$93bn in handouts, including wage increases, which should boost consumer spending on electronic items such as PCs Prolonged political instability in countries such as Egypt could potentially cause disruptions to

distribution networks and have an impact on outsourcing operations

IT Market Sizes (US$mn)

2011e

e = estimate Source: BMI

IT Market Sizes As % Of National GDPs

2011e-2015f

e/f = estimate/forecast Source: BMI

An expected recovery in population growth underpins our IT market growth projections for markets such

as the UAE and Kuwait, which saw an exodus of expat 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 five-year forecast period

Across much of the MEA region, youthful population demographics, and rising PC penetration will drive growth An evolving retail landscape will also help to stimulate sales, with the traditional domination of smaller stores having been diluted by the appearance of multi-brand electronics sections in hypermarkets and mono-brand stores in malls

Several sectors will offer particular

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, proved

relatively immune to the economic

situation Another key area for IT spending

in many countries is healthcare, with

several major projects launched

The highest growing IT market in the MEA IT market over the forecast period is expected to be Egypt, with compound growth of 86% for 2011-2015 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 The fastest growth among the GCC countries is forecast to occur in Qatar (57%), where the decision to award Qatar the 2022 FIFA World Cup is expected to fuel a wave of investment in IT products and services

Sectors And 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 There could be a boost from computer hardware tenders preciously delayed

as a result of the economic situation 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

IT Markets Compound Growth

2011e

e = estimate Source: BMI

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 However, the growing popularity of tablets is expected to provide a growth area in 2011, after the product category

enjoyed a surge of popularity in 2010, fuelled by Apple's iPad Around 190,000 tablets were reported

sold in Saudi Arabia in 2010 With growing 3G penetration in the region, telecoms operators will be an increasingly important channel for portable connectivity devices such as tablets and netbooks

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

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 a majority of MEA markets As the regional economy improves, more investment is likely to be driven by plans for expansion, rather than merely to realise cost efficiencies Similarly the growing regional

ambitions of South African companies will be a factor driving corporate spending on software in that market

Across the region, however, many businesses remain focused on costs, and software vendors will pitch efficiency gains from virtualisation and cloud computing, as companies focus on return on investment Sales of the Windows 7 operating system have the potential to impact positively on the market, and 2010 should, in any event, see a boost from systems upgrades deferred from 2009

BMI predicts plenty of room for software market 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 full automation of back-office systems Customer relationship management (CRM) will be a growth area, and other high-growth categories are set to include business intelligence, storage and security products The security software market is very

important throughout the region as increased investments in IT hardware over recent years are now driving spending on secure content management technologies

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 low income, including the high costs of operating systems such as Windows, which has led to the promotion of open source in

Over BMI's five-year forecast period, software-as-a-service (SaaS) business models are expected to

provide a growing opportunity for vendors, with increasing demand for industry-specific applications Government adoption will also be a key driver in many countries such as the UAE, where cloud services are central to the Emirates government's e-Government strategy for the next three years

BMI predicts that demand for IT services will grow strongly during the 2011-2015 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 such as education and health

Currently, IT services' share of IT spending ranges from around 24% to 37% 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

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

In both the private and public sectors, MEA organisations are looking for help to utilise efficiencies from cloud computing services such as SaaS and infrastucture-as-a-service (IaaS.) Cloud computing is

becoming viable in markets such as South Africa due to improved and lower-cost bandwidth availability Particular areas of opportunity for cloud computing include government, banking and retailing as

organisations in those fields look to save money on hardware investments

Internet Penetration

e/f = estimate/forecast Source: BMI

Israel Market Overview

Government Authority

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 science and technology policy, 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 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 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 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 government communication

public-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 to reach US$2.5bn in 2011, up from US$2.3bn in 2010 The market is expected to grow at a CAGR of 7% over the forecast period to reach US$3.3bn in 2015

BMI has upwardly revised its Israeli PC market growth for 2011, consolidating a recovery from the

impact of the economic slowdown, which hit consumer demand for electronic goods Businesses are now

investing more to facilitate expansion and development, rather than purely to realise cost efficiencies, but there should be growth areas

As the Israeli economy recovers, enterprise sales could receive a boost from computer hardware tenders

previously delayed because of the economic situation Migrations to Microsoft's Windows 7 operating system and new Intel core technology should stimulate new cycles of hardware upgrades, although much

will depend on business and consumer confidence

In 2010, Israeli computer shipments recorded a solid recovery However, lower average prices meant revenue growth in most segments was flat or slightly negative Notebooks remained the main

growth driver in 2010, while desktops sales were down 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 popularity of alternative devices such as smartphones and tablets are forecast to constrain notebook sales

The current rate of PC penetration, while high for the region, represents potential for organic growth Household penetration is estimated at around 75% 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$1,000, 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

Software

Israeli software spending is projected at US$1.3bn in 2011, up from US$1.1bn in 2010 The packaged software segment is expected to grow at a CAGR of around 10% over the forecast period In 2010 local

IT leader 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

In Q111, the pick-up in demand for systems and upgrades continued in both public and private

sectors, with investments by government organisations such as the Israeli MOD and Israeli Police, and

from utilities leader Israel Electric Company 2010 saw vendors winning projects across a range of

sectors from government to energy, 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 the 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

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

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, while in H111 vendors continued to sign up new business intelligence

customers The security software segment is an important opportunity, potentially 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 segments, 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

to local organisations

New cloud computing offerings and increased competition in this segment should fuel further demand from users As well as cost savings, businesses will look to boost efficiency and increase flexibility of response to customer needs Large businesses are most likely to put IT applications such as mail, phone systems and document management into the cloud However, enterprise applications that require a high level of customisation, or which are subject to regulatory or data-sensitivity constraints, are more likely to stay on premise

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 such as 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 to reach a value of US$2.0bn in 2011, and this is expected to grow at

a CAGR of 10% over the forecast period to reach US$2.9bn in 2015 In 2011, vendors reported a

continued flow of new projects in sectors such as government, financial services, homeland security, and utilities Key sectors such as government and financial services had driven a pick-up in growth in

2010 after demand was hit by a slowdown in 2009

In H111, demand for IT services continued to be healthy, according to leading vendors, with new projects across public sector, industrial and financial verticals The defence and homeland security sector was also solid However, much will depend on confidence in the global economic recovery, particularly in key Israeli export markets Vendors have had 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 and have some immunity to economic vicissitudes In Q410, the Ministry of Defence awarded a US$6mn IT contract, and in Q111 the same department awarded a US$10mn contract for a new command and control system Among other smaller government projects in 2011, the Israeli Police awarded a US$6mn contract

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 extension awarded by Israel's Ministry of Environmental Protection Meanwhile, Healthcare and Utilities were also generating outsourcing projects This continued into H111 with the award of a US$17mn deal by Israel Electric Company The development of a natural gas sector should be one driver of opportunities in the utilities vertical

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 opportunity 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