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Headline

Jul 31, 2012

Moderate growth in IT spending across economies

Abstract
The global economic turmoil of last year had cascading effect on employment and GDP growth. During 2011, growth in IT
spending was moderate as global macro-economic unceratinty forced clients to exercise extra caution while spending their IT
budgets. Also, cross currency effect had a significant impact on US dollar revenues of global major players.

Key Issues
- What is the size of the global IT industry?
- What is the worldwide spending pattern on IT and related business services?
- What will be the impact of currency volatility on the industry?
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Global IT Industry
Overview
According to NASSCOM, the worldwide information technology industry, comprising hardware, software, information technology (IT)
services and BPO, is estimated to have clocked aggregate revenues of $1,800 billion in 2012, an increase of 5.0 per cent over the
previous year. IT + ITeS account for a major chunk of IT revenues close to 45 per cent, followed by hardware and software, which
contribute around 38 per cent and 18 per cent, respectively.

Worldwide spend on IT and related business services

Source: NASSCOM

In the next 3-4 years, total spending on IT is expected to grow at a CAGR of 5.5 per cent globally. At 8.2 per cent, IT-ITeS spend is
likely to grow faster as compared to other segments.

Worldwide IT spending forecasts

In the US, spending on equipment and software increased from $1,028.4 billion in the first quarter of 2011 to $1,122 billion in the
fourth quarter of 2011. At $1,140.8 billion, it grew by 1.7 per cent in the first quarter of 2012 over the fourth quarter of 2011. The
growth has been flat in the last two two-three quarters, reflecting a modest spending on equipment and software.

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Spending on equipment and software in the US (quarterly)

Source: US Bureau of Economic Analysis

Hardware
Overview
According to NASSCOM estimates, hardware spending is expected to cross $767 billion in 2014, from $599 billion in 2010,
registering a CAGR of 6.4 per cent.

Worldwide hardware spending

Source: NASSCOM

In 2012, North America and Asia Pacific are expected to account for 30 and 31 per cent, respectively, of the hardware market;
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Western Europe is likely to be third with 17 per cent of the market.

During 2012, the hardware market is estimated to grow by 6.3 percent as against 7.6 per cent growth in 2011. Tablet and storage
markets were the major growth drivers in the segment.
In 2012, North American and Western European markets are expected to rise by 7.3 and 2.1 percent respectively, while Asia-Pacific
market is expected to post a growth of 7.5 percent over the previous year.

Region wise hardware spend

Source: IDC

Key trends

Recovery in revenues
In 2011-12, revenues in the hardware segment grew by 16 percent. Revenues across key hardware players grew positively. Apple
posted a staggering 66 per cent y-o-y growth. Among all hardware companies represented in the table below, Seagate and
Lexmark were the only players to register a decline (-3.7 per cent and -0.6 per cent respectively) in revenues during the year.

Hardware players: Revenue growth

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Growth driven by emerging economies

In 2011, economies around the world were impacted by slow recovery in the US and sovereign debt crisis in Europe.
However, emerging economies like Asia-Pacific and Middle East fared better as compared to advanced economies. Growth in
Asia-Pacific is primarily driven by an increase in demand in the Chinese and Indian markets.

Growth in worldwide GDP

Currency volatility impacts margins

In 2011-12, the US dollar has appreciated against Euro and Pound due to the crisis in Euro zone. However, Yen appreciated
against US dollar due to difference in real interest rates of Japan and the US. Such currency fluctuations have an adverse impact on
the revenues of the global IT players. The results of many Indian IT companies have been impacted by the same cross-currency
effect.

Movement of 1 American dollar vs 1 unit of base currency

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Source: CRISIL Research

SGA and R&D expense increased

Although most of players witnessed a marginal rise in revenues, the growth in margins was varied. Given the intense competition in
the hardware industry, individual players do not have much control over prices and margins of a company tend to be affected by its
ability to control costs. Most companies undertook overall cost management exercises such as inventory control and overall
workforce reduction, which either saw margins remain flat or improve marginally. Margins were impacted unfavourably in the case of
players where SG&A and R&D costs increased.

Percentage change in R&D and SG&A expenses of major players in 2011-12

Source: Company reports

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Moving ahead
As realisations fall, cost reductions become imperative
Given the commoditised nature of the hardware industry, competitive pricing pressures are expected to continue over the medium
term. To maintain/improve margins, firms will have to sharpen their focus on reducing their manufacturing costs, warranty costs,
structural or design costs and overhead or operating expenses. Firms will also have to undertake productivity and efficiency
initiatives to improve utilisation rates of their existing workforce.

Increased investments in R&D likely to differentiate offerings

In order to differentiate product offerings, firms will have to increase investments in R&D. With product development cycles in the
hardware industry being long (3-4 year), it would take time before these investments can start generating returns.

Internal supply chain management to become critical

Given the pricing pressure within this segment, it is imperative for firms to cut costs. One of the aspects that will help in cost
reduction is effective supply chain management. Organisations could either manage their supply chain internally, or outsource the
same to an external service provider. Effective supply chain management will help reduce inventories and associated costs. Cost
savings thus generated can help directly improve financial results. Companies can also pass on such benefits to their clients by
offering a further reduction in prices.

Software product industry

Overview
The global software product market is characterised by stiff competition, rapid technological changes and high rate of piracy,
besides changing customer needs, and frequent product introductions and enhancements.
As employee costs escalated, margins continued to be under pressure. Organisations became more client-centric, decreasing the
product installation time and improving the ease of product use.

Worldwide spending on packaged software (2009-2014)

Source: NASSCOM

According to NASSCOM, spending on packaged software is expected to reach $362 billion in 2014 from $272 billion in 2009,

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registering a CAGR of 5.8 per cent (2009-2014). However, in 2012 the growth is estimated to slow down due to macroeconomic
weakness.

Key Trends
Marginal rise in revenues of major players
As compared to 2010-11, revenues of all major software players in 2011-12 exhibited an increase of 5-12 per cent, excepting SAP,
which posted a robust growth of 59 per cent.

Change in revenues of major players in the software industry

SG&A costs as a percentage of sales decreased marginally

With effective client-mining strategies and administrative management, selling, general and administrative (SG&A) expenses
dropped moderately. On an average, SG&A expenses stood at 30-35 per cent of the company's total revenue in 2011-12, which was
marginally high compared to the last year.

SG & A costs of major players

R&D expenses as a percentage of sales decline marginally

Software companies require healthy investment in R&D to develop innovative products for addressing client-specific requirements.
In 2011-12, most of the players indicated a slow rate of investments in R&D.

R&D costs of major players

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In light of the long product development and testing cycles in the software product sector, CRISIL Research believes that significant
revenues from new product and service investments is unlikely to be achieved for the next several years. As delays in releasing new
products adversely affect revenues, software companies should adhere to product development timelines.

Software piracy declines marginally

Software piracy is the unauthorised copying or distribution of copyrighted software. This is done by copying, downloading, sharing,
selling, or installing multiple copies of copyrighted software onto personal or work computers. Software products are highly subject to
piracy, especially in developing countries. According to a study conducted by Business Software Alliance (BSA), 42 per cent of the
software installed in 2010 on personal computers (PCs) worldwide, were obtained illegally. Among the emerging markets, India,
China and Russia registered a drop in piracy rates. The global rate was increased from 35 in 2005 to 42 in 2011, as emerging
markets such Middle East/Africa, Central/Eastern Europe region and a handful of Asian countries continue to dominate the software
market. Emerging markets like BRIC (Brazil, Russia, India and China) who have the highest rate of piracy of around 70 per cent,
witnessed a significant drop of 6 per cent, over the last 5 years.
Globally, piracy rates were the highest in Central/Eastern Europe (62 per cent), Latin American countries (61 per cent), the Middle
East/Africa (58 per cent) and Asia-Pacific region (60 per cent). Some positive changes could be seen in the rapidly developing
countries such as Russia, India and China. Software companies are actively trying to educate consumers about the benefits of
licensing genuine products and lawmakers about the advantages of the business climate, where intellectual property is protected..

Region-wise piracy rates (per cent)

Piracy rates in BRIC countries (per cent)

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Going ahead
With rising threat of unauthorised access, security software demand set to increase
As concerns of electronic attacks from viruses and unauthorised access to systems increase, we believe that demand for security
software is likely to go up. Security investments will be considered strategic as opposed to discretionary in those organisations
where customer confidence rests on data and infrastructure security.

Global IT services industry

Overview
According to NASSCOM, the global IT services industry is expected to grow at a CAGR of 3.8 per cent from $566 billion in 2009 to
$684 billion in 2014, led by outsourcing engagements.

World-wide IT services spending by foundation market

Source: NASSCOM

Global IT service lines

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Key trends
Topline growth increased for most of the players
In 2011-12, the topline of major players increased on an average of 10-15 per cent due to increase in volumes across geographies.
Pricing pressures continued as clients either invested cautiously or postponed their IT investments. While there was strong demand
for business process offshoring, project and consulting segments remained lacklustre for most part of the year. Again, the fluctuation
of US dollar against the major global currencies has also affected revenues.

Revenue of major players

Going ahead
As offshoring increases, topline will continue to be under pressure
Revenues of global IT service majors will continue to be under pressure over the medium term as offshore activity is expected to
rise. In order to improve billing rates, firms need to increase revenues from higher-end service lines such as package
implementation, consulting and systems integration. To preserve margins, firms will have to maintain workforce at optimal levels and
improve utilisation rates, besides controlling the SG&A expenses.

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IT services: Key business drivers

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