MarketViews

 

 

A TechMarketView report on the trends and forecasts for the
UK software and IT services market

 

 

February 2009

 

 

www.techmarketview.com


Contents

1     Introduction. 3

1.1.1       About TechMarketView.. 3

1.1.2       About this report 3

1.2      The year in review (2008) 3

1.3      The year(s) ahead. 3

2     global Software and IT services markets. 3

2.1      World S/ITS markets. 3

2.2      European S/ITS markets. 3

3     the UK software and IT services market 3

3.1      Market structure. 3

3.2      Market trends. 3

3.3      Market size and forecast 3

3.4      IT services trends. 3

3.4.1       Market trends. 3

3.5      Software trends. 3

3.5.1       The cloud. 3

3.5.1       PC market 3

3.5.2       Open source. 3

3.5.3       Web 2.0. 3

3.5.4       SOA: dead or alive. 3

3.5.5       Software licensing. 3

3.5.6       Industry consolidation. 3

3.5.7       Cost cutting. 3

3.5.8       Market size and forecast 3

4     Messages for suppliers. 3

5     appendix. 3

5.1      Software and IT services sector definitions. 3

5.2      Currency exchange rates. 3

 


1         Introduction

1.1.1        About TechMarketView

1.1.2        About this report

1.2        The year in review (2008)

·         Predictions (from 2007)

·         Themes/Campaigns, e.g.:

o        Make do and mend/more for less

o        Boring awards

·         Highlights, lowlights and significant events, e.g.

o        Economy

o        Financial markets (public, private equity etc)

o        Industry structure (births, deaths and marriages)

o        Major deals

1.3        The year(s) ahead

·         Themes/Campaigns

·         Predictions

2         global Software and IT services markets

2.1        World S/ITS markets

·         Size and growth by class of expenditure

·         Size and growth by product/service line

·         Size and growth by region

·         Size and growth by vertical

2.2        European S/ITS markets

·         Size and growth by class of expenditure

·         Size and growth by product/service line

·         Size and growth by region

·         Size and growth by vertical

3         the UK software and IT services market

3.1        Market structure

·         Size and growth by class of expenditure

·         Size and growth by product/service line

·         Size and growth by vertical

·         Growth in real terms inc/exc special events


3.2        Market trends

For suppliers to the UK SITS market, there are only three questions that really matter right now:

1.      How deep do you have to dig your bunker?

2.      When will it be safe to climb out?

3.      Who will be left standing?

The first question is best answered this way: keep digging! Although recent trading updates from the major IT services players such as xxx, xxx and xxx, have, on the whole, portended reasonable results for 2008, almost all reported rapidly deteriorating visibility and saw business decline dramatically towards the end of the year and. It’s the same story for many software companies. SAP’s warning late October of “uncertainties surrounding the current economic and business environment” prompted management to revoke its revenue guidance entirely to focus on profit. Similar sentiments were echoed by xxx, xxx and xxx. We have yet to reach the nadir.

For the answer to the second question, look back to our last recession. The real one, that is, not the dot.com bust. Back in 2000, we were coming off a combination of the highs of a massive re-programming effort to ‘fix’ the Y2K problem, coupled with increasingly speculative IT investment in new technologies, notably the internet. One of the effects of the first ‘high’ was to bring forward many new software upgrade programmes slated for the first couple of years of the new decade. The effect of the second was to confirm business leaders’ worst fears about the true return on investment in their IT systems and (clearly belatedly) forced them to institute a more commercial approach to IT proposals as they would for any other capex business case. Both effects combined to severely restrict IT spending for three years and forever change the way major IT projects were justified and structured.

Sample figure (needs header and footer)

The current IT downturn started quite differently, of course. This time the problem is neither caused by nor limited to the IT sector. The credit crunch is throwing the economies of the developed world into recession, and reining back growth in emerging markets. The idea that companies will spend more on IT to help them through the recession is a fallacy. Companies are spending less on IT – they always do in a downturn – and directing that spend on cost-saving initiatives.   (Need some examples of prior recessions and how IT market growth tracked the downs and the recovery). We expect the UK S/ITS market will shrink 2% this year but growth should return in 2010.

As for the third question, as in every other downturn there will be winners and losers. The winners will generally be those companies that have long-term contracted revenue streams with high dependence on their customers’ core business operations and low dependence on transaction volumes. For IT services players, this mainly favours infrastructure outsourcing, applications management, and many types of back-office BPO. Software players will be faced with a paucity of new licence sales and licence upgrades; the most resilient revenues will come from contracted maintenance agreements and, on a much smaller scale, SaaS subscriptions.

Those SITS firms that manage to survive will, as after prior downturns, emerge leaner, meaner and hopefully smarter too. They’ll need to be, because, as before, IT spending will not simply jump back to pre-downturn levels. Instead, customers will rebase their IT budgets to these ‘recession’ levels of spend and re-justify projects that had been put on hold to ensure that the payback is both real and timely.

Another sample chart

Let’s take a quick look at the key trends we think will influence the size and growth of the UK SITS market in 2009 and beyond:

The economy

This will remain the dominant factor affecting SITS demand in 2009. We think the Chancellor’s expectations of a second-half pick up highly optimistic – at least six months too early, more likely closer to twelve months (i.e. 2H 2010).

Demand trends

·         The primary focus for most enterprises will remain on reducing costs and conserving cash.

·         Customers will remain mainly in ‘make do and mend’ mode for their IT systems, and insist on ‘more for less’ from their suppliers. Pricing power will stay with the customer.

·         With the majority of IT spend still allocated to ‘keeping the lights on’, system consolidation and rationalisation (e.g. through virtualisation) and outsourcing legacy application maintenance (including offshoring) will stay high on the CIO agenda.

·         However, CIOs will be far more cautious about outsourcing to Indian players in the light of the Satyam scandal. ‘Onshore’ players with sufficient offshore capacity will benefit, but competition will ensure that they will see little extra pricing advantage.

·         Anything to do with managing risk and regulatory compliance and corporate governance will push its way up the budget priority list.

·         The ‘Green’ IT agenda will be shown up for what it has been all along – a convenient banner to cloak electricity cost-cutting – so, what’s not to like? 

·         Government plans to boost public spending will take time to trickle through to the IT sector, so suppliers are unlikely to gain material benefit in 2009.

Procurement trends

Decision making cycles will remain lengthy as spending proposals go through extra levels of scrutiny, both in terms of absolute cost and return on investment. This will continue to predicate breaking down large-scale programmes into smaller chunks and awarding each piece to the optimum bidder. I say ‘optimum’ because in the light of recent company scandals and failures, CIOs should be applying a higher level of due diligence to their potential (and indeed current) suppliers before deciding whether the lowest bid is also the safest bid! This could provide a boost for third party sourcing advisors such as TPI and Equaterra, though they might feel the need to polish up their own contract liability limitation clauses!

Technology trends

Cloud/SaaS: There will continue to be more heat than light coming from behind the ‘Cloud’, at least for the next couple of years. Established on-premise software vendors may find themselves between a rock and a hard place trying to chase the Cloud. In the current economic climate they will find it difficult to fund the necessary R&D work to convert their products to ‘true’ SaaS delivery. More likely they will be forced to deliver ‘pseudo-SaaS’ by changing their financial model from the traditional upfront licence fee + monthly maintenance charge, to a monthly rental fee, with the obvious adverse effect on revenue, profits and cash flow. Cloud start-ups are probably better positioned (if they can find the funding) but they are hardly likely to upset the traditional market leaders for some considerable time.

Mobile Internet: Frankly, it’s hard to see who’s actually going to make a buck here. With mobile internet devices (MIDs) such as ‘netbooks’ selling for under £100, wafer thin margins will have to be shared along the value chain. Arguably the telcos/ISPs have most to gain if they can find the right charging model. MID software will need to be free or nearly so, which makes it tricky for traditional players to earn money even if MIDs are sold in the millions. That leaves the IT services players, who might pick up some contracts to ‘MID-enable’ business applications, but I can’t see much of that happening while the lid is still firmly closed on the ‘new development’ agenda.

SOA: The ‘nth’ incarnation of modular programming. Brilliant if you are a software vendor, rocket science if you are a CIO. There’s no extra money in this for suppliers – it’s just the way applications will increasingly be developed.

Open Systems: Nothing new here. It’s still as difficult as ever to make money by giving away your product. But as a potential exception, I doff my cap to Misys, which had the canny idea to develop open source interconnect products for the healthcare sector and give them away for free, to try to encourage medical institutions using competitive software to migrate to Misys’ own products. Otherwise, CIOs will generally remain wary about committing critical development to platforms with questionable support commitment. Fine if the applications come as a ‘locked down’ suite that rarely needs updating (e.g. office productivity tools) but risky for ‘real’ business applications.

Supplier trends

We will cover supplier trends and industry dynamics in much more detail in our quarterly TechMarketView IndustryViews report series. But in summary:

·         Just as for user enterprises, the primary focus for most suppliers will remain on reducing costs and conserving cash. External funding will remain tight, so there could be some ‘bargain basement’ rights issues and share placings for those companies perceived to have a strong enough business model to weather the storm. The rest will get consolidated or simply go bust.

·         Suppliers will be even more tempted to ‘win the business at any price’ to feed the top line. It will be impossible to make up the lost margin simply by cutting SG&A. Those suppliers who do not have sufficient low cost ‘delivery’ (and I include product R&D in that term) already in place will see margins massacred.

·         We are sure to see more M&A in the industry this year as players look to grow their businesses inorganically in the face of declining demand. There’s a balancing act here, of course. On the one hand, you may well gain share, but this must not be at the cost of margin and cash flow. This makes the selection of M&A targets even more critical, and leaves no room for error in integration.

3.3        Market size and forecast

3.3.1.1       Summary

3.3.1.2       Outsourcing

3.3.1.3       Project services

3.3.1.4       System support

3.3.1.5       Verticals

3.4        IT services trends

3.4.1        Market trends

The biggest event in IT services in 2008 was undoubtedly HP’s acquisition of EDS. Finally our predictions of ‘big eats big’ came true, and we doubt this will be the last megadeal of this ilk. The ramifications of this merger will take some time to really become apparent, as HP wrestles with the best way to go to market with the Plano giant in its basket. As we write (Jan. ’09), HP has rolled EDS into its enterprise hardware and software business, raising fears that the former outsourcing giant will become a glorified HP channel. This may not do much for EDS’ reputation for ‘vendor independence’ (a moot point anyway) but could really boost HP’s hardware footprint in large enterprises.

We also saw a number of well-known mid-size UK IT services go under the hammer last year, Axon, Northgate, and Detica among them. As we said just before, there’s a lot more yet to come.

On the global IT services scene there were some truly significant acquisition-cum-outsourcing megadeals which affected the UK market in some shape or form, all by Indian players:

·         In July, WNS, the ex-British Airways BPO captive, acquired UK insurance giant Aviva’s Indian BPO captive, Aviva Global Services for £115m, and secured an eight-year, $1bn outsourcing deal

·         In October, TCS did much the same with Citigroup, stumping up over $500m to buy its BPO captive, CGSL in return for a $2.5bn, 9.5 year deal, the largest ever awarded to an Indian player.

·         Just before Xmas, Wipro acquired Citigroup’s Indian IT services captive, CITOS, for $127m and secured a $500m, six-year outsourcing deal. CITOS services most of Citi’s worldwide businesses outside of Latin America including the UK.

These deals should dispel any remaining doubts that the major Indian SIs (excepting Satyam, of course!) are fully accredited players in the global IT services marketplace.

This type of deal was not the sole domain of the Indians. In November, UK recruitment firm Harvey Nash acquired one of Alcatel-Lucent’s strategic R&D centres in Nuremberg, bringing with it a €54m, 27-month outsourcing contract using Harvey Nash’s offshore centres in Vietnam. We fully expect to see more of these deals as cash-strapped enterprises look for ways to raise funds while reducing operational costs.

Here are the key trends we believe will set the scene for IT services firms in the UK market over and above our comments in Market Trends above :

Global delivery

As we said above, cutting SG&A will not make up for lost revenues. Frankly, if you don’t already have sufficient low-cost delivery already in place, then 2009 is going to be a tough year to hold on to your margin. Large players need to build low cost delivery organically or acquisitively (not without risk, of course). Smaller players should partner first and then acquire.

Go-to-market

When there’s little new business around, you need to look after your own! Clearly, competitors will go hunting after those companies still spending money, so suppliers need to make sure their own customers are very well looked after. But you should be doing this anyway, shouldn’t you!

3.5        Software trends

3.5.1        The cloud

If you believe the hype, then “the cloud” is the biggest thing that has ever happened in the computer industry. In fact it has made a negligible financial impact so far but all the vendors are polishing up their offerings for a big push in 2009. Every vendor you can think of will have a cloud offering whether it makes sense or not!

As always caution is recommended; we have been writing about similar offerings (ASP, SaaS) for many years and have been burnt before by being over optimistic about their introduction. However, market conditions do seem ripe for the cloud to have a major impact in 2009. In fact its success is assured as many current offerings will just be re-badged as part of cloud offerings; indeed all IT services will be offered in the cloud.

The pioneer in cloud based applications (aka SaaS) has undoubtedly been salesforce.com which has had widespread corporate acceptance and now generates over $1billion annual revenues. Efforts in this space from the likes of Oracle and SAP have always seemed “me too” and their success has been very limited in spite of the money they have spent on them. However the trend is undoubtedly towards allowing you to run any old software in the cloud so maybe they won’t be disadvantaged so much in the future.

Google has made great efforts to get its Google Docs and Apps programmes up and running. Like many people, we have toyed with them but it’s going to take a lot to move us on from Microsoft Office and all that other Windows stuff we have become accustomed to. Maybe our new netbooks will encourage us to start changing.

Every large infrastructure vendor is gearing up for the cloud; whoever would have believed that a bookseller would have probably the most successful offering so far. Amazon has certainly obtained first mover advantage with its Amazon Elastic Compute Cloud (Amazon EC2) offering. Oracle certainly seems to be jumping on their bandwagon. IBM has been busily opening Cloud Computer Centres around the world during 2008 and we expect a major company wide initiative to be launched in 2009. Clearly it will be a “services” led offering; there’s going to be some interesting discussions about revenue recognition between the various parts of IBM!

And then of course there’s Microsoft’s Azure platform, a cloud extension to Windows. At the moment this is purely a development platform but it will be interesting to see what Microsoft and the rest of the world does with it.

3.5.1        PC market

The PC software market will definitely decline in 2009. This trend was underway even before the credit crunch hit us. Dell’s recent cost cutting announcements underline just how tough things are likely to be. Vista introduction has been very slow and it now seems obvious that many companies will skip Vista all together and wait for Windows 7 in 2010, or whenever the first Service Pack comes out.

The rise of the netbook is certainly gloomy news for Microsoft. Although most netbooks are currently being sold with Windows XP (certainly not Vista!) it does seem that more and more will be offered with Linux.

Apple has had an encouraging year really re-establishing itself in the corporate computing world. However, just as the “organic food” is in for a tough time in the recession, Apple is likely to suffer a similar fate this year.

3.5.2        Open source

We have been writing about the rise and rise of Open Source for some time. The outstanding success has of course been the business built on top of Linux. Most established software vendors now have open source offerings; however for many vendors, it is more like an introductory offer: if you want the real software which has all the features you want and will scale, then you are back to their traditional products.

So far much open source adoption has been bottom up inspired by technicians who had a semi religious hatred of Microsoft. In these recessionary times we are likely to see the threat of more strategic adoption of open source, even if just to keep the existing vendors honest.

It seems somewhat ironic that after all the debate about open and closed source that software itself will disappear into the cloud and its origin will become irrelevant. 

3.5.3        Web 2.0

Has it happened, or did it go away while we weren’t looking? Companies will continue to do mashups with their existing software but will come to realise that in many cases it is just lipstick on a pig. The fashion conscious will clearly switch to their cloud initiatives this year.

3.5.4        SOA: dead or alive

There is a predictable backlash to SOA underway. Having been held up as IT’s latest silver bullet by the marketing departments this was inevitable. There’s no getting away from the fact that SOA is hard to do and as always the number of people we have in the industry capable of doing it remains tiny. However, there is nothing wrong with the concepts underlying SOA. We suspect that just like OO it will disappear from most people’s view and then become really useful to those who do understand it.

3.5.5        Software licensing

Although we struggle to remember how we could get away with it, software revenues (at least for start up companies) have always been dominated by the initial licence fee users could be persuaded to pay. In these recessionary times some new vendors such as the UK’s Bond International and smartFOCUS have been experimenting with a monthly payment type model even for “on premise” software, to bring it more in line with the SaaS model of charging. We think that this is the way forward to promote sales to SMEs and of course government which likes opex rather than capex spending. However both vendors have found the transition difficult issuing profit warnings in last quarter.

For established vendors such as Sage, its support and maintenance contracts will remain the backbone of the business. Sage has been very creative developing new tiered support offerings, witness combined support and software upgrade contract revenues growing 12% in 2008. While the prospects for new licence sales and upgrades look rather bleak in Sage’s mature markets, at least the cash should keep flowing.

3.5.6        Industry consolidation

The software industry is fast consolidating. There is just no room for mid size players; you can only survive in the long term by becoming one of the big boys (tough to do!) or remaining a niche player dominating a sector or geography. We are sure to see more M&A in the industry this year as players look to grow their businesses in the face of declining demand. There’s a balancing act here, of course. On the one hand, you gain share, but this cannot be at the cost of margin and cash flow. This makes the selection of M&A targets even more critical, and leaves no room for error in integration.

3.5.7        Cost cutting

We will see widespread cost cutting during 2009. Microsoft employees are currently waiting on tenterhooks to see where the job cuts are coming and there will be many more. As usual it will be the marketing departments who suffer first. After that it will R&D with continued off shoring of development and maintenance being the principal way of saving cost. We do hope that no one is tempted to cut costs by playing around with creative capitalisation of software costs (a long crusade of Richard’s.)

3.5.8        Market size and forecast

4         Messages for suppliers

5         appendix

5.1        Software and IT services sector definitions

5.2        Currency exchange rates