Asia competition barometer information technology services

Assessing a universe of 296 IT services companies that are publicly listed in eight countries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—the Baro

An Economist Intelligence Unit report

Supported by

Asia’s growing importance for corporate performance and global competitiveness 5

in key sectors and assessing the intensity of competition in them Drawing upon company-level data on profitability and other indicators, the Barometer quantifies the changing dynamics of competitiveness in Asia for select industries between 2004 and 2009

This report focuses on the Barometer findings for the information technology (IT) services sector Assessing a universe of 296 IT services companies that are publicly listed in eight countries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—the Barometer examines changing profitability and the competition landscape for the IT services sector

Other reports in this series look at the transport and logistics, precision engineering, petrochemicals and chemicals, and pharmaceuticals sectors in Asia

January 2012

Preface

•Despite a slight increase in market concentration, competition in Asia’s IT services sector remains fierce Among publicly-listed Asian firms, the industry’s largest players increased their market share

between 2004 and 2009 However, Asia’s IT services market remains highly competitive, and a more crowded playing field will continue to put pressure on profits Smaller players may have a particularly difficult time in the future for two reasons First, global firms seeking outsourcing partners to enhance their own operational efficiencies—a key driver of growth—will be looking for companies with size and scale Second, small and medium-sized enterprises who might otherwise have been customers for these smaller outsourced service providers may switch to on-demand IT capabilities available via cloud computing services, forgoing the need for third-party IT services players altogether Nevertheless, there will continue

to be opportunities for small firms that can provide a highly specialised or niche service

•Profitability in Asia’s IT services sector has been declining, and margins in some markets, such as India, may have peaked The average gross margin of publicly-listed Asian firms declined from 47.8% in

2004 to 41.2% in 2009 Competition is only one factor pushing down profits A number of others—from the global economic downturn, the commoditisation of certain services, rising wages and the advent of cloud computing—have put pressure on margins To maintain profitability, many firms will try to move up the value chain, focusing on what is referred to as “non-linear growth”—that is, increasing revenue but not headcount—through R&D and by leveraging new technologies and applications, first and foremost those enabled by cloud computing

•Industry-leading firms could bring growth to other markets as they seek to escape rising costs

at home Given rising wages, firms operating in India, which have been the market leaders to date in

this sector, have been expanding to emerging low-cost centres, such as the Philippines This trend will continue, as IT services firms are still in the early stages of leveraging their global footprint for the most cost-effective service delivery This shift will also provide growth opportunities for domestic firms in these new markets

Asia’s growing importance for corporate

performance and global competitiveness

3 Asia and Australasia here includes Australia, China, Hong Kong, India, Indonesia, Japan, Malaysia, New Zealand, Pakistan, Philippines, Singapore, South Korea, Taiwan, Thailand.

Similarly, deepening mobile penetration around Asia has also been driving growth in the IT services sector The mobile subscription rate in Asia and Australasia increased from under 11% in 2001 to more than 70% in 2010 The EIU expects this to rise to more than 110% by 2016 Countries such as Malaysia, Singapore and Vietnam already have penetration rates well above 100% This has created numerous opportunities for video game and application developers, as well as other software providers Many Asians, particularly in remote areas, will be increasingly connecting to the Internet primarily through mobile devices, boosting demand for higher-value mobile services

Asia is increasingly important for corporate performance in the IT services sector globally For instance, Asia revenues at Oracle, an American IT services firm, more than doubled from US$1.4bn

in 2003 to US$3.4bn in 2009 Meanwhile, between 2006 and 2009, American video game developer Activision Blizzard’s Asia revenues almost doubled from US$135m to US$263m

Foreign IT services firms have been operating in Asia for several decades Recently, in recognition of Asia’s growing importance, they have been investing heavily in the region Between January 2003 and September 2011, fDi Markets, a research house, recorded a total of 4,070 IT services investment projects

in Asia.5 Most of those investments originated from the US (60% of the investment projects), the UK (7%) and India (4%) The top three investment destination markets were India (30% of the investment projects), China (21%) and Australia (9%)

IBM, an American IT services and consulting firm, plans to invest RM1bn (US$317.2m) in a new global delivery centre in Malaysia SAP, a German software and services firm, more than doubed its headcount in Asia between 2004 and 2009 from 4,863 to 10,248 As a proportion of the firm’s total global workforce, SAP’s Asia team increased from 15.1% in 2004 to 21.5% in 2009

Major players in the IT services sector obviously see opportunity in Asia But there are also challenges These include a shortage of IT services workers, which has led to spiralling wages Many firms in Asia also face the challenge of refocusing their attention away from developed markets, where economic growth

is slowing, towards emerging markets, which have a relatively robust economic outlook This switch will require new corporate strategies, including a rethinking of global human resource deployment IT services firms are also having to quickly adjust to the advent of cloud computing, which has led to a range

of alternative offerings to managed IT services Linguistic differences also present a challenge in Asia, particularly for firms hoping to penetrate markets that use “double-byte” character sets, such as China, Japan and Korea.6

Finally, software developers will continue to suffer from losses associated with intellectual property theft, despite Asian governments’ efforts to clamp down on it Gary Locke, the US Ambassador to China, recently noted that the value of legitimate sales of software in Vietnam is higher than in China, whose population is 15 times as big.7 A related challenge for multinational software firms in Asia is in making original software and services more affordable to the SME segment, possibly through cloud computing services or through flexible payment schemes

not to interfere in business

decisions” The China Post

Nov 19th 2011

4 “China’s microblog user

population tops 300 million”

Xinhua Nov 21st 2011

Competition and profitability at Asian firms

2007 2006

2005 2004

Source: Economist Intelligence Unit

IT services industry increased from 4.88 in 2004 to 5.73 in 2009 (see Figure 1), signifying that the 50 biggest firms in the Barometer increased their market concentration over that period.8

The total number of listed companies in the industry increased from 2004 to 2009, at the same time that the three largest companies—Tata Consultancy Services (TCS), Infosys and Wipro, three Indian IT services firms—grew their combined revenue share from 31.8% to 37.4% (see Figure 2)

8 A measure of the size of

companies in relation to the

industry, and an indicator of

the amount of competition

Figure 2: Top ten publicly-listed Asian firms by turnover

Note: These are the ten biggest companies by turnover that were analysed in the Barometer, which considered only publicly listed firms in eight countries: China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam

This increased market concentration suggests that despite the entry of new firms to the market, there has been a slight fall in competition, as the biggest firms have become more dominant Nevertheless, the Asian IT services sector remains highly competitive, as denoted by its low absolute HHI score

Profitability: On the decline overall, but pockets of growth exist

To measure the profitability of the IT services sector, we developed a composite index of five ratios which measure different aspects of a company’s margins (for more details, see the note on methodology at the end of this report) All profit margins for the IT services industry have fallen relative to 2004 (see Figure 3) Profitability showed the steepest decline between 2007 and 2008.9 This was partly a reflection of the gathering financial storm at the end of 2007 that led to some clients in developed markets cutting IT spending

Profitability has also been hurt by several broader industry trends, including the commoditisation of certain IT services, which is likely to continue The advent of cloud computing, meanwhile, has led to a range of alternative offerings to managed IT services, putting further pressure on prices Margins are likely to remain under pressure, particularly given the entrance of new competitors into the industry Rising wages in many parts of Asia have also eaten into profits As a proportion of operating revenues, total wages rose on average from 30.6% in 2004 to almost 40% by 2009 Operating revenue per employee

2007 2006

2005 2004

Source: Economist Intelligence Unit

Case study: Wipro

Wipro: Opportunities in Asia

Wipro faces competition from foreign MNCs, Indian MNCs, as well as other local players in Asia Nevertheless, Mr Mathur does not really see them as threats “The market is large and there is enough to do for all

of us,” he says

Given the region’s torrid growth, Mr Mathur believes that Asia’s contribution to all firms’ revenues will increase substantially in the years ahead Furthermore, he expects local Asian firms to grow and expand across the world “All this will present interesting opportunities

to collaborate with each other in some cases and compete in others,”

he says

Cloud computing, mobility and other emerging technologies will have a major impact on the industry Mr Mathur also cites three larger trends that will drive IT spending: “IT variabilisation” (converting fixed IT costs to variable ones); “IT consumerisation” (increased use

of consumer technology in the workplaces); and the increased use of business analytics

In order to boost profitability, Mr Mathur believes that Wipro and other IT services firms will have to offer their customers better value while relentlessly driving down costs

Positioning for success in Asia

Competing for the new frontier: Asia’s markets

Although the recession delayed or decreased the IT services orders of many companies in the Western

Singapore Philippines

Malaysia Indonesia

India China

2010 2016

Source: ITU, EIU

to China The EIU estimates that only 6% of the Indian population used the Internet in 2010—the second-lowest rate out of the countries studied, above only the Philippines The EIU forecasts that India’s Internet penetration rate will reach almost 10 out of 100 people by 2016 The National Association

of Software and Services Companies (NASSCOM), an Indian trade chamber, sees IT services as one of the fastest-growing segments in India’s domestic market Public-sector reforms that encourage IT acceptance, like National eGovernance Programmes (NeGP) and the Unique Identification Development Authority of India (UIDAI) programme, may also encourage higher IT adoption

Of the countries studied, after China and India, Singapore and Malaysia have the highest IT-services spending forecasts for 2016, at US$3.9bn and US$3.3bn respectively (see Figure 5) There are signs that Asian IT services firms are looking within Asia for opportunities However, it is too early to gauge the success of these efforts In its financial year 2009, only 6% of TCS’s revenues came from the Asia-Pacific region It is similarly unclear if companies’ cross-penetration is to take advantage of domestic growth within these Asian markets, or to reap cost or proximity advantages to service traditional mature markets

A common consensus is that Indian firms reach into China primarily to have local branches to service multinational firms that operate there For example, while Wipro is expanding into China, at least part of the motivation has been to use China as an outsourcing base for Japan’s more developed market

Figure 5: IT services spending

(US$bn)

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000

Vietnam Thailand

Singapore Philippines

Malaysia Indonesia

India China

2010 2016

Source: IDC, EIU

Nevertheless, as Chinese multinationals grow in size, and the cost of doing business both at home and abroad rises—Chinese wage increases have been three times as fast as any other Asian market for the past decade, and China’s overall workforce is likely to shrink after 2015, putting further pressure on wages—business leaders will start to think more about IT-enabled efficiency decisions They will likely follow the lead of their peers in developed countries, and engage more with IT services providers

In order to capitalise on this growth, in November 2011 SAP announced that it would invest more than US$2bn over the next four years in China, opening five to six new offices, and doubling its workforce in the country.10 SAP said that the investment will be geared towards new product research, as well as improving services for its local and global clients

10 “SAP to Invest US$2 Billion

in China Expansion” PCWorld

Nov 15th 2011

Firms will broaden their footprint across Asia for efficient service

IT industry competitiveness 2009” The Economist Intelligence Unit Sep 2009

Figure 6: Aggregate regional IT services spending

(% growth per annum)

2014 2013

2012 2011

Similarly, demand for social media services is likely to grow rapidly given the popularity of social networking in Asia For instance, Indonesia has the second largest number of Facebook users in the world (after the US), with about 40m people India, currently in third place with more than 32m users, is fast catching up, buoyed by Facebook’s decision to offer a mobile-only version in some 40 countries, including India, which can be used without incurring any data charges.14 Companies in Asia are increasingly using social media monitoring and marketing tools to engage with their customers

Location-based mobile services should also enjoy strong growth in Asia, as consumers in the region increase their use of search, maps and navigation services that rely on location information Strategy Analytics, a research firm, forecasts that global consumer and advertiser expenditure on location-based services will reach US$10bn by 2016, with Asia-Pacific accounting for 20.5% of that market.15

Case study: TIBCO Software

TIBCO Software: Niche services, broad opportunities

Given TIBCO’s niche focus, it has not really faced much competition

in Asia “Given the unique real time, event-driven nature of our products, we don’t really see intense competition in our space,” Mr Shaabi says In fact, TIBCO’s challenge is in making sure it has the necessary coverage across different Asian markets in order to bid for all the contracts out there

In particular, Mr Shaabi says that TIBCO has hardly any Asian competitors—its main competitors are the likes of IBM and Oracle Nevertheless, he believes the broader IT services market is experiencing intense competition, partly due to the commoditisation

of certain services All that could eventually affect TIBCO, because

“much of IT is a catch-up game We are unique today, but we may not

be unique tomorrow.” Mr Shaabi adds that the big IT services firms are already making the necessary investments to improve their capabilities

in TIBCO’s space

To stay ahead, Mr Shaabi believes that TIBCO will have to continuously find ways to transform its clients’ businesses with its software services