The Impact of the Economic Crisis on the Romanian Software and IT Services Market

PIERRE AUDOIN CONSULTANTS S.R.L.

 

Current situation and outlook

While many were still optimistic about unaffected software and IT services industry in Romania throughout 2009, PAC's expectations concerning a hardly hit IT sector have unfortunately confirmed for the first half of the year. The worsening of business confidence became mainstream, while the inability and poor commitment of the current government to redress the economy have only deepened their negative effects on the level of IT spending for this year. The public sector is especially disappointing, since there was high hope that during the downturn the depressed commercial sector could be offset by IT opportunities in public administration. However, a weak coalition government and the presidential elections in the fall stalled most IT initiatives for the near term.

While there were people still hoping for growth in the overall economy and in IT in particular in very early 2009, today almost everybody agrees on a clear decline in the software and IT services market; the majority of IT suppliers have considerably reevaluated their annual targets, and for many achieving the same level of turnover as in 2008 seems highly ambitious.

During the first half of the year most IT spending was kept on a freeze mode, while certain end users were still packaging and de-packaging IT budgets. Even towards June, certain customers had not finalized their IT budgets, partially because of the high volatility of the overall spending policies of companies, and partly because of a very fluctuant and insecure business horizon in their core business, which imposed a constant re-sizing of budgets.

The strong depreciation of the Leu in late 2008/early 2009 also has an indirect effect on IT budgets, primarily on the companies that have budgets in local currency. Based on a 10-20% depreciation of the Leu against Euro, many companies instantly saw their budgets assigned for non-Leu purchases down by 10-20%. Especially hit are the purchases of hardware and software products, which are typically sold in foreign currency.

Most IT providers report a very poor visibility in the pipeline. The IT suppliers that sell licenses and products are hit the worst, with adoption substantially lower than a year ago. Poor utilization rates among IT services suppliers move competition in the price arena, with suppliers sometimes bidding on the zero margin or even dumping prices in hope of rebound in profitability in the medium term. The fight on pricing may sharpen towards the third quarter of 2009, as demand tends to shrink seasonally in this quarter, followed by a price relaxation towards the end of the year, when part of the companies will flush pieces of unconsumed budgets. The buy side also exerts price pressure - largely in the commoditized areas, as IT end users are much more careful with the money they have been allocated.

Sometimes the reduction in IT spend was brutal - with projects dropping from hundreds of thousands to tens of thousands of euros. This provides evidence that IT in Romania was previously in a phase of initial systems construction, and that IT has still not become a critical part of the internal operations. Since the consumption of those systems was not critical to business operations, companies could drop investments or defer IT rollouts until better horizons emerge, because they did not have the chance to fully reap the benefits of IT. ERP rollouts or infrastructure development are investments that bring their ROI on the longer term, while the measurement of results comes after sufficient time of consumption. In Romania, the majority of the companies were actually in the implementation phase, so IT did not find the time to deeply entrench into operations. For this reason, IT budgets slid downwards with the postponement of IT implementations.

Should IT environments have become mature and external IT budgets moved on to heavy systems maintenance and application development, the impact on project services would have been milder, as is noticed in mature countries.

Interestingly enough, if in more mature Eastern European markets (e.g. Czech Republic, Poland) large customers tend to reassess and shrink their lists of preferred suppliers in order to get volume discounts on systems integration deals, in Romania, because of the limited volume of external application development, behavior illustrates that end users tend to award deals to small local players.

However, the international suppliers operating in Romania are likely to gain market share in the near-to-medium run because of a higher level of centralization of budgets and decision-making within the foreign companies operating locally. Because certain deals will be signed at central level spanning multiple territories, international providers with a local coverage across the region will be definitely in advantage.

Because of the uncertainties surrounding their operations, certain customers begin to reopen fixed-price contracts to renegotiation, looking to get better contractual conditions not only on price and/or a downsized volume, but sometimes also reassess service level agreements (SLA). The renegotiation of the SLA levels may result in price taking the priority over the quality of services; such reevaluation of SLAs where quality is affected for the sake of cost is also seen in the Western European markets.

The control of purchasing became obviously stricter. Traditionally, purchasing among domestic enterprises in Romania has been under strong supervision from the local entrepreneur, especially when it came to areas such as IT. Today however, there is an even tighter control on what is being spent - with the CEO or CFO much more involved in budget dislocation and decision to buy. Purchasing becomes more bureaucratic also at international companies, as the procurement department gets more involved in budget allocation.

During times of economic turmoil, outsourcing finds good premises to get adopted. The externalization of selected IT functions tends to find better resonance because companies look to cut costs and reduce non-strategic assets from their balance sheets. However, this is valid for mature IT markets. In Romania, like in most of Eastern Europe, the mindset of end users remains very conservative and patrimonial. Most domestic companies are actually still looking to expand internal IT operations and IT assets, should the crisis have not occurred. For such reasons, outsourcing is not a real offset opportunity during the economic crisis in Romania, unless deals get signed as part of international outsourcing agreements. Besides the reluctance and immaturity of the buy side, the domestic supplier community is not ready to push outsourcing. With the exception of international IT services providers that own the methodology and expertise required to deliver managed services, local providers are somewhat restricted from crafting outsourcing proposals due to poor expertise. Nevertheless, PAC still expects sporadic samples of outsourcing to be seen in the near-to-medium term, covering mostly infrastructure management.

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Legal updates

25 Februarie 2010 Legislative Summary - January 2010 19 Februarie 2010 Certification of annual profits tax returns 5 Februarie 2010 State Budget and State Social Security Budget for 2010 Laws 5 Februarie 2010 Changes brought to certain VAT statements 5 Februarie 2010 Draft amendments to the Fiscal Procedure Code 29 Ianuarie 2010 Certification of the annual tax returns by a tax consultant 29 Ianuarie 2010 Fiscal regime for micro-enterprises

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