China Information Technology Report Q2 2008

Market Overview China's IT market is expected to continue growing at a double-digit rate over the next few years, passing a value of US$100bn by 2012. Total IT Spending in China is expected to rise from US$57.8bn in 2007 to US$100.9 by 2012, growing at a CAGR of 12%. Spending will receive a boost from heavy investment in a number of major IT projects associated with the 2008 Beijing Olympics and the Shanghai World Expo in 2010. Aside from these headline events, major sectors driving double-digit IT spending growth currently include telecoms, finance, government, energy, social security, education and transport.

Three years of phenomenal economic advance have fuelled an IT investment trend that shows little sign of tailing off, although BMI does expect GDP growth to moderate slightly to around 10.4% in 2008 in response to further monetary tightening. Despite pressure on prices in the hardware segment, spending growth will be sustained by an expansion into Western China, rural areas and lower-tier cities, growing demand for IT services and outsourcing in key verticals, and more sophisticated demand from enterprises.

The government gave ICT a high priority in the 11th National Five Year Plan, which has designated 120 cities for 'digital city' infrastructure development. As a result of rising computer sales and internet usage in recent years, IT is also being applied by enterprises to upgrade traditional technologies, and strengthen research strategies. The market is showing a new sophistication, with growing demand for new types of services and software, including CRM. There is a growing demand from medium and larger companies for management software.

Industry Developments As the CPPCC (Chinese People's Political Consultative Conference) meets in Beijing, rumours continue to circulate concerning a widespread reorganisation in the ICT sector and the fate of the Ministry of Information Industries. There are rumours that this ministry, which is responsible for the IT sector, may be absorbed into a super-Ministry of Industry.

In 2007, the Ministry of Information Industry (MII) revealed that its plan to promote informatisation in China will comprise four main initiatives. According to MII, the four policy planks are: 1) to promote rural and agricultural informatisation to support construction of the new socialist countryside; 2) to promote informatisation among SMEs; 3) to promote informatisation in cities and communities; and 4) to promote informatisation of modern logistics.

MII figures indicate that investment in the mainland's IT industry grew by one third in H107. MII described the growth as 'stable and controllable', reporting that fixed asset investment reached US$15bn in the first six months of 2007, up 34.4% year-on-year (y-o-y). The biggest growth area was electronic components, which surged 55.7%, followed by telecoms with 32.5% growth. Computer hardware recorded 19.8% growth. The figures revealed the growing influence of telecoms sector as a driver of IT investment.

One key strand of government policy, the 'Develop the West' campaign, is to spread the benefits of economic development to China's vast but relatively poor Western region. The government has recently selected the autonomous municipal region of Chongqing to be the Western region's prime IT hub due partly to its current large scale chip production.

Competitive Landscape In 2007 the PC competitive battleground expanded to tier four-six markets. Domestic vendors dominate the desktop segment, with Lenovo continuing to be the market leader in both desktop and notebook PC segments. HP is the most aggressive international challenger, with y-o-y growth of around 50% in some quarters of 2007. Dell recently said that it intends to expand its business from the current 45 Chinese cities to 1,000. The business had previously mainly focused on bigger Chinese cities.

In the notebook segment, the top five vendors, which include international giants like Acer and Dell, as well as Lenovo, have more than 70% of a concentrated market. Dell has departed from its direct-sales model in China, with the opening of its Experience Stores, and a new programme allowing regional dealers to display Dell products at their sales sites. Meanwhile, Acer is hoping to leverage its new partnership with Gateway.

In the software sector, global vendors like Microsoft, Oracle, SAP and IBM compete against Chinese and Asian giants like Kingdee and Ufida. Oracle recently announced plans to dramatically increase its presence in China, opening branches in Hangzhou and other parts of mainland China. Since 2006, the company has been implementing a 'China Plan' to expand its presence and build relationships with government, suppliers, and customers, and localise.

Computer Sales BMI forecasts computer sales (including notebooks and accessories) of US$22bn in 2008, up from US$20bn in 2007. Already the second-biggest PC market in the world, relatively low PC-penetration in smaller towns and rural areas ensures continued strong growth prospects, despite strong pressures on prices. China's market is likely to stay hardware-centric for the next five years however, with shares of overall IT spending declining from about 69% to around 65%. Hardware CAGR for the 2007-2012 period will be around 10%, with small-to-mid-sized enterprises (SMEs), smaller towns and rural areas providing growth, along with replacement of desktops with notebooks. Unit sales growth will be much higher than revenues, as intense competition is leading to aggressive price cuts.

Market leaders Dell, HP and Lenovo are all following each other in cutting prices and expanding production. Servers and networking equipment will form the fastest growing elements of SME demand, with entry and mid-range servers showing the greatest potential. Vendors are also using new business models as China's relatively high and growing broadband penetration emerges as a significant driver of PC sales in the more mature regional markets. Recently, consumers in Jiangsu province have been offered to chance to purchase an HP branded PC from China Telecom bundled with broadband service for CNY198mn. Dell's announcement that it is to lower costs in China through procurement of Advanced Micro Devices (AMD) chips signifies more downward pressure ahead and, facing a declining market share, Lenovo has recently signalled that it will also cut prices further.

Software According to BMI, the Chinese software market will grow at a CAGR of 14% over the 2007-2012 period.

The total value of the Chinese software market reached US$6.9bn in 2007, up from US$6.3bn the previous year. Despite the fast growth, Chinese enterprises still tend not to pay enough attention to software. However, there is a growing trend for companies to seek greater efficiency by using IT to improve productivity and lower costs, including labour costs. The mid-market business has therefore become a key driver for most vendors' overall business growth in China. Software is also a key industry for the government with the IT regulator MII recently launching an initiative jointly with the Ministry of Commerce and State Administration of Taxation to offer a reduced 10% rate of corporate tax to 152 software firms in China.

Manufacturing is one of the main drivers of ERP demand at present. In the financial sector some providers are looking for scale, with Kingdee and Ufida among those to develop standardised financial software. Elsewhere however, companies are profiting from different vertical specialisations.

Development of embedded software was also mentioned as a new focus by MII in a recent report. The report forecast that revenue from the industry should reach CNY129.5bn by 2010, with more than 65% from software sales and information services.

IT Services With strong spending in sectors including banking and financial institutions and government, the IT services market is growing fast, and will continue to do so, achieving an expected sector CAGR of 15% between 2007 and 2012. The market value rose to around US$10.9bn in 2007, as banks, telecoms operators and manufacturers invested to meet the challenge of WTO membership. Outsourcing is expected to account for up to 30% of the IT services opportunity by 2010, with a potential value of more than US$6bn in that year. A recent report by India IT industry body NASSCOM highlighted the increasing challenge posed by China to its dominance of the global outsourcing market. While China still has some way to go to catch up, with its new education drive and better infrastructure it is in a position to leverage the advantages of low costs and scalability.

The top three vendors currently are IBM Global Services, HP and Lenovo. Seeking the higher margins associated with IT services, an increasing number of local companies are attempting the transition from equipment manufacturers to professional service providers. China Soft, a Beijing company, switched its focus from hardware to services in 2006 and was rewarded with a 37% increase in profits for the last three quarters, even as turnover fell 11%. Meanwhile, Lenovo Holding's unit Digital China, which got 58% of its sales from hardware in 2006, has also announced its intention to invest more in its IT services operation. A process of consolidation is continuing in the sector, particularly among local companies, which are looking to grow through mergers and acquisitions.

E-Readiness The number of internet subscribers is expected to pass the 200mn mark by 2010, from around 154mn in 2007. However, the penetration rate is low, at just 12% last year. PC-penetration is forecast to reach around 22% by 2010, although it is much higher already in some areas. The stock of PCs per thousand inhabitants was estimated by International Data Corporation (IDC) at around 120 in 2006.

MII has said that over the next five years its goal is to make the internet available in every administrative village in Central and Eastern China, and every township in the West. To this end, foreign company support is expected to be important, such as the agreement recently signed between Intel and the Guangdong Provincial Information Industry Department, to promote the use of IT in rural areas of the province. E-government developments have been in the spotlight recently, with two landmark developments. Firstly, the State Administration of Foreign Exchange in Shanghai launched a longawaited e-settlement system. The 'E-Payment Settlement System' was more than one year in development and will help users achieve instant foreign-exchange transfers between different banks in Shanghai.