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Tim Stammers, Computing [02-06-2000]

If you don't speak 'e', the UK software industry is already losing interest in you.

That's the conclusion of Richard Holway, market watcher and author of The Holway Report, the thirteenth issue of which will be published this month. The annual three-volume report surveys the state of more than 2000 companies operating in the software and IT services industry, and covers the 12 months from April 1999 to March 2000.

Around half of the UK's IT staff now work for services companies. In 1998, service companies hired so many extra staff to cope with the surge in work that the contracted labour market ballooned by a record 29 per cent to £2.8bn. Because of a slowdown in the industry, following the end of the year 2000 boom, some of those people have become surplus to requirements.

"When growth slows down, people at service companies are hired out at lower rates, and more of them sit around not earning money at all. It takes months for companies to realise that they need to downsize," says Holway.

The need to lay off staff is not good news for people with so-called legacy skills - a category that includes expertise in even relatively recent software such as Windows NT or Visual Basic.

"Look at the redundancies announced by EDS, Cap Gemini, Sema, or Computer Sciences. They've all been laying off legacy people," says Holway. The slowdown is a consequence of the accelerated spending and systems replacements as a result of the millennium bug. "Some people naively believed the boom would go on forever," he says. "At the moment anyone without up-to-date internet and e-services skills is going to find it difficult to get top-rate jobs."

Ecommerce skills will be particularly sought-after. Ecommerce projects accounted for less than 10 per cent of the sector's business last year. But that will soon change. "E-services is the strongest-growing sector of all, and could well represent 30 per cent of the total revenues of the industry by 2003. Our only fear is that we have made this forecast too low," the report says.

Next month the software and services market will pass a turning point. Its growth rate - which fell dramatically last year - will begin to climb again. At the same time, the rash of mergers which broke out last year will accelerate.

The report predicts that for the year to March 2001, the total turnover for the industry will grow by about 14 per cent. Last year it grew by 16 per cent, to reach £19.3bn.

Those are busy and impressive expansion rates, but compared with the recent past, they're pale and sickly. In 1997 and 1998, growth reached 27 per cent and 25 per cent respectively. "The lowest point will come around June or July, and we'll see growth recovering in the second half of the year," Holway says.

Falling profits
The profit margins of outsourcers and service companies have narrowed because of the slowdown in growth. Profits grew by just 15 per cent during the year covered by the report, compared with 25 per cent for the previous 12 months.

Nearly half the companies surveyed by Holway reported worsening financial performance. Large companies quoted on the London Stock Exchange fared worst - a reduction from 40 per cent profit growth in 1998 to just five per cent in 1999. "The high number of profit warnings indicates that profit performance might be even worse in 2000," the report warns.

On top of these changes, the worldwide software and services industry is undergoing a shakedown which has been highlighted by a number of takeovers and mergers.

"It's the size of the mergers and acquisitions, not just the number, which has amazed us. The total value shot up from £3.5bn to £10.9bn last year. There's no [services] company in the UK that's immune to this," Holway says.

Between April 1999 and March 2000, the number of buyouts recorded by the survey increased by 16 per cent. There were 19 deals involving considerations of more than £100m, compared with just six in the previous 12 months.

Heading the charge with the largest UK deals last year was Sema, which acquired LHS in a £2.9bn deal, and Vedior, which bought Select for £1.1bn. This year, CMG bought Admiral for £1.4bn.

Holway predicts that the merger bonanza will continue on a global basis, and that this year there will be at least one and maybe as many as three acquisitions where both parties will be international companies. "Even EDS may be bought," Holway says.

Future UK deals may not be exclusively British. "Although fine UK companies such as Sage, Logica and Misys might look invincible, their very strengths and qualities make them attractive candidates for mainly US companies with deep pockets looking to the long term," says Holway. A weakening of the domestic market (and associated valuations) and a possible weakening of sterling could accelerate that trend.

New competitors
Services companies are not the only ones ready to shop till they drop. As software suppliers' profit margins continue to narrow, they have begun to migrate towards the supply of services - not as an exit strategy, but certainly as a buoyancy aid.

"More than 50 per cent of Oracle's revenues now come from services, and the largest part of IBM's revenue is from services. SAP has already said that it is on the acquisition trail. If it bought a UK company, that would put the cat among the pigeons," Holway says.

For companies offering SAP-based services in the UK, such a move would dramatically alter both their competitive landscape and their relationship with the German enterprise resource planning software supplier.

Holway thinks IBM's purchase of services supplier Data Sciences in the mid-1990s underpins the surge which last year saw Big Blue became the joint largest software and services business in the UK, alongside EDS.

IBM UK's outsourcing revenues leapt by an estimated 60 per cent last year and reached £950m, compared with EDS's industry average growth of about 12 per cent to £700m.

For their total software and services businesses (including outsourcing and other services such as consultancy, development and support), the UK organisations of EDS and IBM each enjoyed revenues of £1.45bn, Holway estimates.

Whether consolidation will be good or bad for buyers of services remains to be seen, but Holway is generally optimistic. "I don't know of any industry that hasn't gone through a period of consolidation to achieve economies of scale, and to let it operate on a global basis. The consolidation in this industry is going to accelerate. That much is certain."

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