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Asia Competition Barometer: Information technology services
 

Asia Competition Barometer: Information technology services

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Supported by Singapore’s Economic Development Board (EDB), the Economist Intelligence Unit (EIU) has developed the Asia Competition Barometer with the aim of understanding the changing market ...

Supported by Singapore’s Economic Development Board (EDB), the Economist Intelligence Unit (EIU) has developed the Asia Competition Barometer with the aim of understanding the changing market dynamics 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.

The Barometer has two dimensions: profitability and market concentration. To assess the aggregate profitability of the IT services sector in Asia, the EIU developed a composite index of five ratios that each represents a different aspect of a company’s profitability. To assess market concentration, the EIU calculated the Herfindahl-Hirschmann Index (HHI) for the IT services sector in Asia from 2004 to 2009. A measure of the size of companies in relation to the industry, and an indicator of the amount of competition among them, the HHI is defined as the sum of the squares of the market shares of the 50 largest firms from the universe of 296 listed companies assessed.

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

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    Asia Competition Barometer: Information technology services Asia Competition Barometer: Information technology services Document Transcript

    • Asia Competition BarometerInformation technology servicesAn Economist Intelligence Unit reportSupported by
    • Asia Competition Barometer: Information technology services Contents Preface 2 Executive summary 3 Asia’s growing importance for corporate performance and global competitiveness 5 Competition and profitability at Asian firms 7 Competition: Increasing concentration, but still highly competitive 7 Profitability: On the decline overall, but pockets of growth exist 8 Case study: Wipro 10 Positioning for success in Asia 11 Competing for the new frontier: Asia’s marekts 11 Firms will broaden their footprint across Asia for efficient service delivery 13 Emergent technologies 13 Case study: TIBCO Software 14 Outlook 15 Barometer methodology 17© The Economist Intelligence Unit Limited 2012 1
    • Asia Competition Barometer: Information technology services Preface Supported by Singapore’s Economic Development Board (EDB), the Economist Intelligence Unit has developed the Asia Competition Barometer with the aim of understanding the changing market dynamics 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 20122 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesExecutive summaryW hat does the emergence of Asia as a major engine of global economic growth mean for companies operating in the region? Asia’s robust economic outlook—coupled with diminished growthprospects in many other parts of the world—has attracted new investment into the market both fromregional players and Western multinationals. As a result, competition in the region is expected tointensify. Given the darkening global economic outlook, and the expected impact on some economiesand sectors in the region, growth and profitability look uncertain in the near term. But over the mediumto longer term, Asia’s strong economic fundamentals will ensure consistent growth across a range ofindustries. How are companies positioning themselves to capitalise on Asia’s growth opportunities overthe next few years? The Asia Competition Barometer assesses the intensity of competition and changing market dynamicsin several key sectors. This report examines information technology (IT) services, which include thefollowing sub-segments: software development, including computer games; IT programming; ITconsultancy; IT facilities management services; other IT and computer service activities; data processing,hosting and related activities; and web portals. Among the key findings of this report are the following: • Asia’s IT services sector has been expanding rapidly, in line with the region’s stellar economicgrowth. Several broad macroeconomic trends, including global corporations’ increasing appetite foroutsourcing their internal functions to Asia, higher demand for IT services from fast-growing Asianfirms, and rising desktop PC, Internet and mobile phone penetration rates, have boosted demand for ITservices in the region. According to the Economist Intelligence Unit (EIU), between 2001 and 2010, ITservices spending in Asia doubled from US$45.6bn to US$90.7bn. Despite the sombre global economicoutlook, the EIU forecasts that IT services spending in Asia will reach US$141.3bn by 2016.© The Economist Intelligence Unit Limited 2012 3
    • Asia Competition Barometer: Information technology services • The number of players, homegrown and global, is rising. The number and size of publicly-listed firms in the IT services sector in Asia has increased dramatically. The total number of listed companies in the1 We assessed a total of 296 industry rose by more than 30% between 2004 and 2009, from 211 firms to 279.1 Total combined revenuespublicly-listed IT servicesfirms in Asia between 2004 nearly tripled from US$16.7bn to US$46.3bn during the same period. Meanwhile, in recognition of Asia’sand 2009. In 2009, there increasing importance to the global IT services sector, foreign MNCs have been building up their presencewere 279 who were listedand published financial in the region. statements. • 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.4 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesAsia’s growing importance for corporateperformance and global competitivenessO ver the past decade, Asia has rapidly grown in importance to the global economy. Its share of global GDP, measured in purchasing-power parity terms, increased from 26.8% in 2001 to 33.8% in 2010.2By 2016, the Economist Intelligence Unit (EIU) expects this proportion to rise to 38.9%. 2 Asia here includes Bangladesh, China, Hong Kong, Indonesia, India, There are three broad trends associated with Asia’s rapid growth and development that have been Japan, South Korea, Malaysia, Myanmar, Philippines,driving its IT services sector. The first is globalisation, and global corporations’ increasing appetite for Pakistan, Singapore, Sri Lanka, Thailand, Taiwan, andoutsourcing their internal functions to places such as China, India, Malaysia and the Philippines. This Vietnamtrend has lowered costs for these global corporations, spurred the growth of numerous Asian IT servicesfirms, and raised the standard of living for thousands of IT services professionals in the region, who haveseen their wages rise continuously. The second is growing demand from Asian companies. Thousands of Asian firms across a range ofindustries have grown exponentially over the past decade, in tandem with the region’s growth. Some,such as Haier, a Chinese white goods firm, and Tata, an Indian conglomerate, are now household names inmany parts of the world. As these firms have grown and expanded, they have increased their consumptionof IT services. The adoption of some IT innovations, such as enterprise resource planning (ERP) and, morerecently, cloud computing services, has transformed traditional business models, boosting productivity atAsian firms. The third trend is the rapidly growing PC ownership and Internet penetration rates in Asia, which aredriving demand for IT services among consumers. The stock of PCs per 100 people in Asia and Australasiaincreased from above 4 in 2001 to almost 19 by 2010, according to the EIU. 3 We expect this to climb to 3 Asia and Australasia here includes Australia, China,more than 30 per 100 people by 2016. Meanwhile, Internet penetration in Asia and Australasia increased Hong Kong, India, Indonesia,from about 5 users per 100 people in 2001 to 24 in 2010. We expect this to rise to more than 36 per 100 Japan, Malaysia, New Zealand, Pakistan, Philippines,people by 2016. Singapore, South Korea, Taiwan, Thailand. China has the world’s biggest population of Internet users, with about half a billion people online© The Economist Intelligence Unit Limited 2012 5
    • Asia Competition Barometer: Information technology services4 “China’s microblog user today. Of those, more than 300m are registered microbloggers.4 This spike in the number of Internetpopulation tops 300 million”.Xinhua. Nov 21st 2011 users in Asia is a huge driver for the IT services sector, particularly for those enterprises engaged in the fields of web-based applications, social media, and Internet gaming. 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 projects5 fDi Markets defines the in Asia.5 Most of those investments originated from the US (60% of the investment projects), the UKsector as “Software & ITservices” (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,6 A double-byte character Japan and Korea. 6set is one that representseach character with 2 bytes. Finally, software developers will continue to suffer from losses associated with intellectual propertyChinese, Japanese and Korean theft, despite Asian governments’ efforts to clamp down on it. Gary Locke, the US Ambassador to China,are all double-byte languages.English, by contrast, is a recently noted that the value of legitimate sales of software in Vietnam is higher than in China, whosesingle-byte language. population is 15 times as big.7 A related challenge for multinational software firms in Asia is in making7 Gary Locke urges China original software and services more affordable to the SME segment, possibly through cloud computingnot to interfere in businessdecisions”. The China Post. services or through flexible payment schemes.Nov 19th 20116 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesCompetition and profitability at Asian firmsR eflecting the booming growth in Asia’s IT services sector, the number and size of publicly-listed firms in Asia has increased dramatically. The total number of listed companies in the industry rosefrom 211 in 2004 to 279 in 2009, while their total combined revenue almost tripled from US$16.7bnto US$46.3bn. The influx of new players, both Asian and non-Asian, has led to a highly competitiveoperating environment.Competition: Increasing concentration, but still highlycompetitiveWith many companies raising their expectations of Asia for growth and profits, it is reasonable to expectcompetition intensity in the region to increase. To capture this intensity we have used the Herfindahl–Hirschman Index (HHI), which measures the market concentration of an industry’s largest firms. HHIFigure 1: Herfindahl–Hirschman Index6.05.55.04.54.0 2004 2005 2006 2007 2008 2009Source: Economist Intelligence Unit 2004 2005 2006 2007 2008 2009 Herfindahl—Hirschman Index (HHI) 5.77 5.66 5.08 5.78 5.44 4.34© The Economist Intelligence Unit Limited 2012 7
    • Asia Competition Barometer: Information technology services values can range from 0 (extremely fragmented market) to 1.0 (monopoly). Here we have multiplied the values by 100 to achieve a scale consistent with profitability indicators (see below). The HHI for Asia’s IT services industry increased from 4.88 in 2004 to 5.73 in 2009 (see Figure 1), signifying that the 508 A measure of the size of biggest firms in the Barometer increased their market concentration over that period.8companies in relation to theindustry, and an indicator of The total number of listed companies in the industry increased from 2004 to 2009, at the same timethe amount of competition that the three largest companies—Tata Consultancy Services (TCS), Infosys and Wipro, three Indian ITamong them, the HHI isdefined as the sum of the services firms—grew their combined revenue share from 31.8% to 37.4% (see Figure 2).squares of the market sharesof the 50 largest firms fromthe universe of 296 listed Figure 2: Top ten publicly-listed Asian firms by turnovercompanies assessed. For moreinformation on the Barometer Company Country of origin 2004 turnover (US$bn) 2009 turnover (US$bn)methodology, please refer tothe last section in this report. Tata Consultancy Services India 2.19 6.75 Wipro India 1.83 6.10 Infosys India 1.67 4.91 ECS Holdings Singapore 1.45 2.53 HCL Technologies India 0.63 2.20 Xiamen Xinde China 0.37 1.36 Satyam Computer Services India 0.78 1.24 Aisino China 0.31 1.12 Mphasis India 0.17 0.96 Patni computer systems India 0.33 0.71 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 Figure9 The composite Profitability 3). Profitability showed the steepest decline between 2007 and 2008.9 This was partly a reflection of theIndex is made up of fiveratios that each represent gathering financial storm at the end of 2007 that led to some clients in developed markets cutting ITa different aspect of a spending.company’s profitability. Formore information on the Profitability has also been hurt by several broader industry trends, including the commoditisation ofBarometer methodology,please refer to the last section certain IT services, which is likely to continue. The advent of cloud computing, meanwhile, has led to ain this report. 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 employee8 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesfell from US$122,000 in 2004 to US$86,000 in 2009. To maintain profitability, many firms will try to moveup the value chain, focusing on what is referred to as “non-linear growth”—that is, increasing revenue butnot headcount—through R&D and by leveraging new technologies and applications, first and foremostthose enabled by cloud computing.Figure 3: Profitability Index120100 80 60 2004 2005 2006 2007 2008 2009Source: Economist Intelligence Unit 2004 2005 2006 2007 2008 2009 Profitability index 115.3 100.0 93.2 100.4 75.2 83.3 EBITDA margin (%) 24.0 21.1 19.9 23.3 16.4 17.4 Gross margin (%) 49.8 43.0 39.7 39.4 33.7 39.8 Return on capital employed (%) 14.1 12.5 11.8 14.5 8.0 5.8 Return on equity (%) 16.0 13.5 12.8 16.3 6.7 5.4 Return on assets (%) 7.2 6.0 5.9 7.4 2.8 2.2 Herfindahl—Hirschman Index (HHI) 5.77 5.66 5.08 5.78 5.44 4.34 Trends in profitability differ by country. Given the large proportion of Indian firms in the Barometer—they constituted 139 of the 296 publicly listed companies assessed for the Barometer—the ProfitabilityIndex reflects most closely their results. Their average gross margin declined from 73.7% in 2004 to53.5% in 2009. Conversely, Chinese companies’ average gross margin climbed from 24.4% in 2005 to29.4% in 2009, no doubt reflecting their focus on local demand, which was relatively insulated from theeconomic turmoil in Western markets, on which Indian companies depend. The only other countries where average gross margins improved from 2004 to 2009 were Indonesiaand Singapore. One possible reason is that Indonesian companies could tap into a larger domestic marketwhich, despite its relative immaturity, is particularly attracted to mobile data and social media services.This makes it a fertile ground for applications development in those spaces. Singapore-based companiestend to offer services higher up the value chain. Given how the focus and operations of IT services firms differ from one Asian country to the next,unique factors will continue to drive profitability in each market. This could translate into markedprofitability variations within Asia in the years ahead. Each company’s profitability will be heavilydependent on its particular product and market spread.© The Economist Intelligence Unit Limited 2012 9
    • Asia Competition Barometer: Information technology services Case Study: Wipro large and cost-effective talent pool available providing an interesting extension to our global delivery model,” Mr Mathur says. Wipro faces competition from foreign MNCs, Indian MNCs, as well as Wipro: Opportunities in Asia other local players in Asia. Nevertheless, Mr Mathur does not really see Wipro, an Indian conglomerate with a large IT services business, has them as threats. “The market is large and there is enough to do for all expanded across the world over the past decade. Wipro’s IT business of us,” he says. today employs some 131,000 people across the world. Given the region’s torrid growth, Mr Mathur believes that Asia’s Though Wipro has established itself globally by providing IT services contribution to all firms’ revenues will increase substantially in the to firms in developed Western markets, today the countries closer years ahead. Furthermore, he expects local Asian firms to grow and to home—including in India, Japan, the rest of Asia and the Middle expand across the world. “All this will present interesting opportunities East—contribute about 20% of the firm’s global revenues. “This has to collaborate with each other in some cases and compete in others,” been the fastest growing geography for us,” says Rajat Mathur, Wipro’s he says. senior vice president and chief sales and operations officer for Asia Cloud computing, mobility and other emerging technologies will Pacific and Japan. “Most of the countries in this region are showing have a major impact on the industry. Mr Mathur also cites three larger very high economic growth and it is hence important for us to tap into trends that will drive IT spending: “IT variabilisation” (converting these markets and be part of their growth story.” fixed IT costs to variable ones); “IT consumerisation” (increased use But this growth is attracting Wipro’s competitors as well. Mr Mathur of consumer technology in the workplaces); and the increased use of sees many firms investing in the region, drawn by, among other things, business analytics. “large end-to-end and turnkey deals” happening in places such as In order to boost profitability, Mr Mathur believes that Wipro and China, Indonesia, Malaysia and Vietnam. “The region is interesting not other IT services firms will have to offer their customers better value only as a market but also as a resourcing destination since there is a while relentlessly driving down costs.10 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesPositioning for success in AsiaCompeting for the new frontier: Asia’s marketsA lthough the recession delayed or decreased the IT services orders of many companies in the Western world, personal demand for IT products and services in Asia grew steadily throughout that period,especially in China. As private consumption in the region grows, the IT services sector will be poised tobenefit. The EIU forecasts that China, bolstered by a vast potential rural market and committed governmentsupport, will overtake Japan to become the world’s second-largest IT market in 2013, behind only the US.China’s Internet penetration will be close to 60 users per 100 people by 2016 (see Figure 4). The explosionof consumer demand, paired with strong government support and investment in infrastructure, will drivethe growth of the domestic IT sector. That said, government interference and censorship may prove to beobstacles to the sector’s development.Figure 4: Internet users(per 100 people) 2010 2016100 80 60 40 20 0 China India Indonesia Malaysia Philippines Singapore Thailand VietnamSource: ITU, EIU© The Economist Intelligence Unit Limited 2012 11
    • Asia Competition Barometer: Information technology services Companies can similarly tap the Indian domestic market, though the potential appears small relative 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) 2010 2016 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 China India Indonesia Malaysia Philippines Singapore Thailand Vietnam 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 the10 “SAP to Invest US$2 Billion country.10 SAP said that the investment will be geared towards new product research, as well as improvingin China Expansion”. PCWorld.Nov 15th 2011 services for its local and global clients.12 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesFirms will broaden their footprint across Asia for efficient servicedeliveryTwo trends are forcing large IT services firms to broaden their footprint across Asia. The first is atalent shortage in places such as India, which has been driving up wages there. According to a reportcommissioned by NASSCOM, India faces an IT talent shortfall of between 800,000 and 1.2m workers by2012, with rising salaries and an appreciating rupee exacerbating the industry’s woes.11 11 Finding cited in “Resilience amid turmoil: Benchmarking The second is the relatively higher growth outlook for IT services in Asia versus other regions (see IT industry competitivenessFigure 6), which is prompting firms to rejig their service capacities towards Asia. 2009”. The Economist Intelligence Unit. Sep 2009Figure 6: Aggregate regional IT services spending(% growth per annum) Asia and Australasia US Western Europe World1210 8 6 4 2 0-2-4 2010 2011 2012 2013 2014 2015 2016Source: IDC,EIU Some Indian companies, for instance, have for several years been building up their operationsabroad: Infosys and TCS, for example, have set up units in the Philippines. According to Gartner, an ITconsultancy, Indonesia and Vietnam are emerging as the low-cost leaders in the sector.12 Malaysia, 12 “Gartner’s 30 Leading Locations for Offshoremeanwhile, is attracting much investment in, among other things, shared services outsourcing. Services, 2010-2011”. As lower-value work moves abroad, firms in India are striving to move up the value chain, focusing on Gartner. Dec 20th 2010R&D and the use of new technologies in order to grow revenues without increasing headcount. This trendwill continue, as IT services firms are still in the early stages of leveraging their global footprint for themost cost-effective service delivery. This shift will also provide growth opportunities for domestic firms inthese new markets.Emergent technologiesFirms offering niche services focussed on emergent technologies are likely to experience rapid growthin Asia over the next few years. This is partly because of Asia’s secular growth story, but also because ofthe region’s generally high adoption rates of new technology, as well as technology leapfrogging. Forinstance, many consumers bypass landlines and desktop computers in favour of mobile devices and thishas led to a spike in mobile penetration rates. Asia’s cloud computing market is poised to expand, both for cloud consumers as well as cloudproviders, according to John Galligan, regional director for Internet Policy at Microsoft. “The knowledgeeconomy will fuel Asia’s future and we think that cloud computing is the next great ‘leveller’ for the© The Economist Intelligence Unit Limited 2012 13
    • Asia Competition Barometer: Information technology services region, poised to help accelerate the momentum around trade,” he said at the launch of Asia’s first “Cloud13 “Asia’s first “Cloud Readiness Index” in September 2011.13Readiness Index””. Asia CloudComputing Association. Sep Similarly, demand for social media services is likely to grow rapidly given the popularity of social7th 2011 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, including14 “India Facebook Users India, which can be used without incurring any data charges.14 Companies in Asia are increasingly usingGrowing Fast, May OvertakeIndonesia”. Penn Olson. Aug social media monitoring and marketing tools to engage with their customers.16th 2011 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. Strategy15 “The $10 B Rule: Location, Analytics, a research firm, forecasts that global consumer and advertiser expenditure on location-basedLocation, Location”. StrategyAnalytics. May 20th 2011 services will reach US$10bn by 2016, with Asia-Pacific accounting for 20.5% of that market.15 Case Study: TIBCO Software “We are helping companies become ‘real time’ and we find that firms in Asia are more open and well positioned to make that leap forward,” says Mr Shaabi. He contrasts young Asian firms with other companies TIBCO Software: Niche services, broad opportunities that may be overinvested in large data centres and data-mining TIBCO Software is an American provider of infrastructure software technologies, which he believes is “the twentieth century way of that enables companies to capture and process time-sensitive looking at things”. information, aiding their decision-making processes. Asia contributes Given TIBCO’s niche focus, it has not really faced much competition about 10% of TIBCO’s global revenues, and is the firm’s fastest-growing in Asia. “Given the unique real time, event-driven nature of our region today, with year-on-year revenue growth of 45% in 2010. products, we don’t really see intense competition in our space,” Mr In recognition of the region’s potential, TIBCO has grown its Shaabi says. In fact, TIBCO’s challenge is in making sure it has the presence in Asia rapidly. From 2006 to 2010, its headcount in Asia necessary coverage across different Asian markets in order to bid for all doubled. Almost a quarter of its global workforce is now based in Asia. the contracts out there. “Some of the most cutting-edge and world-class stuff that we do today In particular, Mr Shaabi says that TIBCO has hardly any Asian is in Asia,” says Neeraj Shaabi, managing director and regional vice competitors—its main competitors are the likes of IBM and president for TIBCO in Asia. Oracle. Nevertheless, he believes the broader IT services market is According to Mr Shaabi, this is partly because many parts of Asia do experiencing intense competition, partly due to the commoditisation not have to worry about legacy investments. “Greenfield projects here of certain services. All that could eventually affect TIBCO, because do not get encumbered by considerations about past investments,” he “much of IT is a catch-up game. We are unique today, but we may not says. “They can easily adopt cutting-edge technology.” be unique tomorrow.” Mr Shaabi adds that the big IT services firms are For instance, TIBCO has done work for Reliance Telecommunications already making the necessary investments to improve their capabilities in India to help it better understand its pre-paid market. “They have no in TIBCO’s space. relationship with the customer because there is no monthly bill—there To stay ahead, Mr Shaabi believes that TIBCO will have to is no customer profile,” he says. As a result, traditional CRM (customer continuously find ways to transform its clients’ businesses with its relationship management) software and analytics do not work. software services.14 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesOutlookA lthough the IT services industry in Asia has been growing rapidly, profitability has been on a downward trend over the past five years, largely due to increased competition in the sector. Facingslower growth in the developed Western markets, and fending off the advances of lower-cost providers,IT services firms will either have to move up the value chain to maintain primacy in the developed world,create scale to compete in high-volume services, or shift emphasis to take advantage of the higher growthin the emerging markets. With many global companies headquartered in developed markets still seeking to control costs andestablish efficient outsourcing arrangements for their business processes, they may shift their businessaway from traditional centres such as India, where wages are rising, towards lower-cost countries in Asiaand other emerging regions. For example, the US is beginning to see more allure in the sizeable talentpool, serviceable infrastructure, and improving government support of Latin American countries suchas Mexico. Gartner considers places such as Bulgaria, the Czech Republic, Egypt, Hungary, Mauritius,Morocco, Poland, Romania, Russia, Slovakia, South Africa, Turkey and the Ukraine as possible outsourcingalternatives for Western firms.16 16 “Gartner’s 30 Leading Locations for Offshore On the product front, traditional industry leaders may be able to grow profit margins by providing new Services, 2010-2011”.technologies such as cloud and mobile computing. For companies operating in developed markets, they Gartner. Dec 20th 2010are perhaps more likely to build competitive advantage in the future through the use of higher-qualityrather than lower-cost labour. In particular, companies that are losing their labour cost advantage but wish to compete in developedmarkets will need to employ workers with not only technical IT skills, but also softer management skills,such as entrepreneurship, innovation and marketing. Companies that wish to break away from growthdependent on abundant, low-cost labour will need to generate intellectual property and develop newplatforms for service delivery. Among other things, IT services firms will need to continue to invest intraining and collaborate with universities in order to ensure access to skilled labour.© The Economist Intelligence Unit Limited 2012 15
    • Asia Competition Barometer: Information technology services Current trends in the industry suggest that smaller firms are most at risk from the competitive landscape that is emerging. Size and scale become increasingly important determinants for global firms seeking outsourcing partners to enhance their own operational efficiencies. They are likely to seek IT partners who can provide a full range of cost-effective services in multiple locations. On the other end of the demand spectrum, however, small and medium-sized enterprises are more likely to use cloud-based services rather than third-party IT services players, for reasons of cost. As mass- market, cloud-enabled services become ubiquitous, prices will fall, and the best performing firms will be either those that can take on a high volume business in a cost-effective manner, or those that can provide a highly specialised or niche service. Mr Shaabi at TIBCO believes there will always be opportunities for smaller firms, partly because big firms tend to become dependent on their “cash-cow” businesses, and may not have the commercial motivation to venture into niche fields. “Small firms who do not have these cash cow business models are able to innovate further,” he says. Asia’s rapidly evolving IT services market is likely to throw up opportunities for big and small firms alike.16 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesBarometer methodologyT o assess the intensity of competition and understand the changing market dynamics in key sectors, the Economist Intelligence Unit (EIU) has developed the Asia Competition Barometer. Drawingupon company-level data on profitability and other indicators, the Barometer quantifies the changingdynamics of competitiveness in Asia for select industries between 2004 and 2009. Assessing a universe of 296 publicly listed information Technology (IT) services companies across eightcountries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—theBarometer examines changing profitability and the competition landscape for the IT services sector. How do we define the IT services sector? While both IT hardware manufacturers and software companies have a significant presence in theAsia-Pacific region, it is the IT services sector that has attracted the attention of foreign and domesticcompanies in recent years. As the IT sub-segment with the highest value-added, we would expect tosee pronounced trends in profitability and market competition in the context of Asia’s fast-changingeconomic environment. In the context of this analysis, the IT services sector includes the following sub-segments:17 17 Based on NACE (nomenclature statistique des software development, including computer games; IT programming; IT consultancy; IT facilities activités économiques dansmanagement services; other IT and computer service activities; data processing, hosting and related la Communauté européenne) 2.0 classification. NACE isactivities; and web portals. the statistical classification of economic activities in the European Community.MethodologyThe Barometer has two dimensions: profitability and market concentration. Profitability IndexTo assess the aggregate profitability of the IT services sector in Asia, the EIU developed a composite indexof five ratios that each represent a different aspect of a company’s profitability: © The Economist Intelligence Unit Limited 2012 17
    • Asia Competition Barometer: Information technology services • EBITDA margin (%): A measure of a company’s operating profitability. It is equal to earnings before interest, tax, depreciation and amortisation (EBITDA) divided by total revenue. Because EBITDA excludes depreciation and amortisation, EBITDA margin provides a clearer view of a company’s core profitability. An increase in competition may put pressure on an industry’s profit margins. • Gross margin (%): When used as a market measure of competition, gross margin measures the profitability considering only the costs of goods sold. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations. An increase in competition tends to reduce firms’ ability to increase prices and thereby increase its gross margin. • Return on capital employed (%): A measure of the efficiency and profitability of a company’s capital investments. Return on capital employed also indicates whether the company is earning sufficient revenues and profits in order to make the best use of its capital assets. An increase in competition may require firms to employ additional capital to maintain profitability. • Return on equity (%): A measure of the rate of return on the shareholders’ equity. It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity. Return on equity shows how well a company uses shareholder funds to generate earnings growth. A rise in competition tends to put pressure on returns on shareholder funds. • Return on assets (%): A measure of how profitable a company’s assets are in generating revenue, or how profitable a company is relative to its assets. Return on assets determines a company’s ability to utilise its assets efficiently and effectively. Higher competition tends to put pressure on firms’ ability to maintain return on assets. We aggregated company-level data for 296 publicly-quoted IT services companies and examined their profitability ratios. To enable observation of trends over time, a composite Profitability Index was developed (where year 2005 = 100). EBITDA and gross margin are given a higher weighting in the index as they speak directly to bottom line profitability, while the return on capital employed, return on equity and return on assets ratios speak to how a company make use of its various resources to drive return (i.e efficiency/ productivity). Profitability indicator Weight in Profitability Index EBITDA margin (%) 35% Gross margin (%) 35% Return on capital employed (%) 10% Return on equity (%) 10% Return on assets (%) 10% Market concentration To assess market concentration, the EIU calculated the Herfindahl-Hirschmann Index (HHI) for the IT services sector in Asia from 2004 to 2009. A measure of the size of companies in relation to the industry,18 © The Economist Intelligence Unit Limited 2012
    • Asia Competition Barometer: Information technology servicesand an indicator of the amount of competition among them, the HHI is defined as the sum of the squaresof the market shares of the 50 largest firms from the universe of 296 listed companies assessed.18 HHI 18 Or summed for all the firms in the case that there arevalues can range from 0 to 1.0, moving from an extremely fragmented market (0) to a monopoly (1). HHI fewer than 50.values have been multiplied by 100 to achieve a scale consistent with profitability indicators. A rising HHIindex generally indicates falling market competition, while a fall in the HHI suggests that competition isincreasing.© The Economist Intelligence Unit Limited 2012 19
    • Whilst every effort has been taken to verify the accuracyof this information, neither The Economist IntelligenceUnit Ltd. nor the sponsor of this report can accept anyresponsibility or liability for reliance by any person on thisreport or any of the information, opinions or conclusionsset out herein.