The State of Play

The IT industry has just experienced its worst year ever. What started with the dot-com bust has turned into a global economic slowdown. But is the local market going to feel the economic pinch?

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By  Greg Wilson Published  November 27, 2001

Middle East impact|~||~||~|The Middle East has been holding its breath and waiting for some form of economic ‘ripple effect’ to hit its borders ever since the dot-com crash evolved into the broader tech stock slump. International factors such as a slowing global economy, the telecommunications glut in 2001 and the events of September 11th have combined to contribute to “the ‘perfect storm’ of 2001,” says John Gantz, IDC’s chief research officer. The combined events have ”caused an unprecedented decline in IT spending around the world, particularly in the US. Hardware shipments have suffered most dramatically, as is always the case in an economic downturn. This year, due to other factors, things have been worse than anyone predicted,” explains Gantz.

IDC emphasises the global nature of the slowdown, noting that hardware spending was down 4% in Western Europe and will decline by a further 2% during 2002. In Japan, PC spending is declining by 16% this year. “This is no longer just a US story,” says Gantz. “This is a worldwide slowdown, impacting vendors in every region.”

But in many respects, IDC’s initial slant on the global economic outlook is somewhat of a ‘long distance’ view. Although the US and Europe have been susceptible to global economic dynamics, the local market is continuing to invest heavily in IT.

Many market pundits saw this year’s Gitex as a test to see how the region was responding to the worsening economic climate in light of the terrorist attacks of September 11th. Despite some exhibitors dropping out and a lower number of international VPs than in previous years, many vendors reported strong market growth.

“I spoke to [vendors] specifically about the global economic slowdown and September 11th and how it was affecting them,” says Mohsen Malaki, senior telecoms analyst, emerging markets centre, IDC. “Any sort of headcount reductions were being dictated by the head office for cost cutting purposes and weren’t because of a lack of performance regionally. [In fact] it was unanimous that the region as a whole is booming,” explains Malaki.

But optimistic reports of strong short term growth doesn’t mean that the Middle East is going to remain isolated from international economic market dynamics. The longer the US economic downturn persists the more likely that the region will begin to feel the ripple effects from the US slowdown.

The obvious yardstick for measuring the economic well being of much of the region is the oil price, which is currently lingering at around the US$20-25 mark. “The US slowdown has significantly weakened crude oil demand and prices,” says Randa Azar, an economist with National Bank of Kuwait. “This should depress government oil revenues and could lead to spending cuts if oil prices remain depressed beyond the first quarter of next year. Any postponement or delays in project implementation in the public sector — that controls over 75% of economic activity — should hurt demand for IT products & services,” explains Azar.

With e-government climbing to the top of the agenda in most of the GCC, a drop in oil price could lead to the suspension of government contracts. However, pent up demand in government is likely to win through — governments need to deploy IT as much as private businesses to cut costs and increase efficiency. Malaki adds, “the oil prices have given them good surplus to their budgets and that is obviously going to be invested in these sectors… because there is still strong demand.”

The regional oil industry is also likely to benefit from continued investment from international organisations. In recent weeks Bahrain reiterated its desire to liberalise elements of its energy business. Saudi Arabia is also looking to attract investors as it opens up its oil & gas business to foreign investment. “Oil companies are expected to remain interested in the region — particularly newly opened markets in the Gulf — given the significant potential returns and long strategic view typically taken by industry players,” says Joseph Braude, senior analyst, Pyramid Research.

Although the oil & gas industry may be able to sustain its flow of investment capital, the liberalisation push within the telecoms industry is likely to be delayed by anywhere up to 18-to-24 months. The heydays of making billions of dollars from the sale of telecom operator licenses are going to be a thing of the past.

“The fundamentals of the Arab communications market are the same — they are growing markets and there are monopolies, such as the Gulf markets, which translates into pent-up demand and great revenue growth,” says Jawad Abbassi, president of Arab Advisors Group.

“The foundations are strong but the global picture has changed… there isn’t going to be the same level of valuation again,” he adds.

In recent months, Egypt Telecom and Omantel have postponed licensing programmes. According to Ghazi Atallah, regional manager, service providers, Cisco Systems Middle East, the vendor has seen local operators delay projects. “Projects haven’t been cancelled, but project decisions have been extended… they are spending but its spread over a longer period of time,” he adds.

International operators, such as France Telecom and Cable & Wireless that have already invested in the region aren’t likely to retreat. But on the other hand they aren’t likely to increase their commitment either.

“I don’t see these companies expanding their local investment in the short term,” Malaki says.

“A lot of them have problems with financing and they couldn’t expand even if they wanted to… but further out there is definitely good potential as the market remains under-penetrated,” comments Malaki.

Regional operators could potentially step in to fill the ‘investor’ gap left by the stalled worldwide operators, and kick start the local telecoms market once again. Batelco has already spread its influence to four ISP businesses around the region and Etisalat is also making noises about a possible expansion. “This is definitely an option… it’s all about supply and demand,” says Abbassi.

||**||Telecoms trouble|~||~||~|The global softening of the telecoms segment has also impacted international vendors operating in the region. Lucent Technologies has closed at least one office and scaled back headcount. Nortel, which again has been struggling internationally refused to comment on the state of its local operation. “Lucent and Nortel are in big trouble,” says Abbassi. “They are really facing harsh [times] and they are cutting headcount across the world. That [includes] the Middle East.”

Tough times all round in the telecoms market has also effectively stopped all vendor financing programmes. Vendor financing — where big telco vendors basically handed over millions of dollars worth of networking infrastructure to operators on long-term payment programmes — was “very much used in the region,” says Malaki.

“Before it was a given that vendors would finance. That has completely changed… vendors are going to have much tougher criteria to issue financing to operators, because they have been criticised by their investors and the stock markets,” says Malaki.

The frugal investment environment, further hampered by the tense political atmosphere could also hamstring efforts to set up local IT hubs. Foreign direct investment (FDI) into Jordan and Egypt has given both countries a leg-up in the race to create knowledge-based economies. But, says Joseph Braude with Pyramid Research, US financial institutions are adopting an increasingly conservative outlook on foreign investment in the region.

“The perception of the Middle East as volatile place is not helped by the events of September 11th,” comments Braude. “I know that [the media] perceptions are wrong but try telling people from Morgan Stanley and Goldman Sachs. For whatever reason they are especially wary,” he adds.

Sanjeet Dabral, regional manager, IDC Middle East agrees with Braude. He predicts a possible delay in foreign investment “as a lot of investors are troubled right now.”
Egypt, which is attempting to build its software export business, has reported some adverse effects, particularly in the aftermath of September 11th. Early last year the country won some huge investments from the likes of Cisco and IBM to construct an IT educational infrastructure within the country. Further substantial US investment has followed. However, the local software business is suffering as US contracts are either postponed or cancelled outright.

“The software business is suffering from a slowdown, especially for those companies with US clients,” says Sayed Ismail, chairman of the Software Industry Chamber, part of the Federation of Egyptian Industries. Businesses, which have suffered, are “finding alternatives,” says Ismail.

There are already signs that Egypt’s local software industry is making a come back. There is still a great demand within the market for localisation work. “Many international organisations realise the fact that we’ve got good talented resources… I expect the investment to continue,” comments Ismail.

The chairman of Jordan’s Information Technology Association (Intaj), Karim Kawar, believes the country can maintain investor confidence and fuel the country’s drive for ‘IT hub’ status. Kawar points to the fact that the country’s free trade agreement with the US was signed post-September 11th as evidence of continued foreign support for the country.

“The US is investing a lot in Jordan… they are encouraging [the REACH program] because it’s important to demonstrate that this model can be a success,” says Kawar.
“We are continuing with our strategy, and we are seeing more repeat investment from foreign companies.”

Interestingly enough, in light of economic slowdown there has been an increasing investment in Jordan’s information communication technology (ICT) companies. Further enhancements to the regulatory framework, which are currently undergoing a final reading before becoming law, should help build an increasingly investor friendly environment in the country, adds Kawar.

Dubai is also attempting to achieve similar IT hub status. Faced with trying times, particularly in the tourism sector, Dubai appears determined to spend its way through the tough economic climate, announcing massive airport expansion plans and a US$15 billion investment from Emirates Airlines to revamp its fleet. “The slowdown in the US economy has effected a lot… deposit rates went down sharply,” says Faisal Aqil, general manager, meBank.

“But Dubai has always proved unique as a trading hub. Dubai has diversified — if the oil prices are low [it] pushs tourism, the re-export business and other activities. Now we have IT. Sheikh Mohammed said business as usual. We will continue spending and investing in IT because we know that it’s the future. That is the path the government is pushing,” explains Aqil.

||**||Investor friendly|~||~||~|The Emirates has been looking to set up an investor friendly environment since it opened the doors on Dubai Internet City (DIC) a little over a year ago. Poised to enter phase three the technology park has succeeded in convincing big name vendors to sign up. Although there has been a substantial investment in terms of office buildings by the larger vendors such as Microsoft and IBM, it’s the smaller players that are feeling the financial pinch. Cache Flow, which recently shifted its offices to DIC, has had to downsize its operation from six people to four, due to the slowdown in the international market.

“A lot of the new companies in DIC could be in a very precarious situation,” says IDC’s Sanjeet Dabral.

“[Companies] came here on the optimism of the government spending on e-commerce and the continuing buoyant economy of a year back. Now the economic situation has got a bit gloomier, I really wonder how many tenants are going to stay there within an [18-month] timeframe. There is a correlation when you see what is happening here and how many contracts they can get to justify investments in the local operation,” comments Dabral.

If satellite offices in the region are going to remain operational, they are going to have to survive what is likely to be a thinning revenue stream. “The vendors with deep pockets and some cash flow to keep them going will survive… it might be a slowing market but if you can manage the cash for six-to-12 months [they] should be able to ride out the storm,” explains Dabral.

However, the vendors shedding headcount in an effort to reduce operating costs still have to prepare themselves for the inevitable upswing in the local market. For the most part the large hardware vendors are all claiming strong demand in the local market. However, most local vendors have placed strict controls on the future hiring of staff.

Despite headcount restrictions vendors still have to maintain an operation that can build on last year’s numbers. “If they [the vendors] cut headcount now they might not be prepared for the upturn in the market,” says Dabral. “Demand may be repressed now, but it’s going to bounce back and [the vendors] have to bounce back with it.”

Ironically the economic and political uncertainty in the US and Europe may help many local organisations to retain their IT human resources. With US-based vendors downsizing — particularly holders of temporary work permits — talent is starting to head back towards the Middle East. “There aren’t as many jobs to run to in the US, so people are staying around” says Braude.

Historically, the temporary nature of many employees in the region had resulted businesses not investing in personnel development. However, the current climate “enhances the incentive for companies to invest in training and improving the labour force,”says Braude.

Also entry into the US by ‘Middle Eastners’ could conceivably become harder in the coming months, due to the political situation adds Braude.

Until recently the strong IT spending across the region — fuelled by a continuing need for IT infrastructure — had acted as a buffer to the worst side effects of the US tech slowdown. However, just how long the region will remain aloof depends, on oil prices and other diversification projects ongoing in the region. Dabral predicts that the US market will pick up before the local market experiences any real ‘ripple effect.’ According to IDC’s global research the US economy should start to emerge out of depression sometime between Q2 and Q3 next year.

Although 2001 has been the worst ever year for the global IT industry, there is some ground for optimism, with the software industry expected to make a full recovery and services still growing regardless of the economic conditions, says IDC’s John Gantz.

In the local market there is great enthusiasm for a booming services business next year. For example, the only exception to headcount freezes for the likes of Compaq, HP or IBM appears to be in the respective services & consulting businesses.

According to Nidal Abou-Latif, director of NCR IT infrastructure services, Middle East, Eastern Europe & Africa, (MEEEA), next year will see a marked increase in managed network services, as companies respond to a tight local environment and streamline their IT operations. “For now the buffer is good… but there is a growing need to get value from deals and customers are becoming smarter at evaluating technology services,” says Abou-Latif.

“Next year there is going to be a real focus on managed network services as companies become more caution on spending,” he adds

However, a market upturn is inevitable, says Gantaz. “Technology is the best way for companies to increase the value they provide to their customers, to increase their own profits, and increase their productivity,” says Gantz.

“That is why companies will continue to increase their spending on technology in the months and year ahead.”||**||

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