But inbound M&A activity beset by challenges
While Japanese providers of IT services are searching for growth opportunities abroad, foreign firms are looking to secure a beachhead or expand their presence here by buying local firms. The industry is ready for consolidation, but how important are cross-border transactions?
The country’s IT-services industry is vast, mostly comprising software development, data processing and internet-related services. The Japan Information Technology Service Industry Association says the sector had an aggregate turnover in 2009 (the most recent figures available) of ¥21.2 trillion (£163 billion), with 960,000 people employed by 15,000 firms, 182 of which were in the first and second sections of the Tokyo Stock Exchange and represent the fourth-largest cluster of listed firms.
Given the industry’s size and complexity it is hard to generalise, but here are my observations:
• The large number of participants means a multi-tiered market structure, with many focusing on secondary or tertiary contracting, acting as “body shops” for the few primary contractors closely linked to end users.
• The direct, senior-level and, usually, long-standing contacts with end-users enable primary contractors to control or influence sub-contractors, as well as define the scope of services that secondary and tertiary suppliers provide.
• Many IT-services providers are “captive”, serving clients in their own corporate group and with no need to market what they do to third parties. Therefore, there is some inefficiency, with room for firms to collaborate for size and synergy. A widely shared view is that system integrators with turnover of less than ¥100bn will not survive over the medium- to long-term, forcing smaller firms to merge or change business models.
I know a multinational professional-services group in Japan that is trying to expand its footprint here in the IT-services market. However, the industry is beset by a shortage of successors to incumbent owners and managers; increasing competition and a shrinking population; as well as limited scope for service differentiation, except in the area of price. These factors may favour this respected global brand with its deep pockets, but the group has been surprised by shareholders and management who are reluctant to even discuss selling. Only in rescue situations have such firms agreed to negotiate, usually getting very disadvantageous terms.
The long-held notion that firms represent a community of stakeholders not for sale is still evident, while other industries are more M&A-friendly. IT-services firms, though, can ill afford such conservatism.
Abroad, a few Japanese giants—notably NTT Data Corporation—have been widening their geographic coverage by steadily buying firms, in both the developed and the newly industrialising economies. Only a few Japanese IT-services providers will survive on a global scale while others, mostly parts of larger corporate groups, will have to focus only on the domestic market.
Meanwhile, Indian IT firms appear to be targeting Japan for growth opportunities. My firm knows some that are hoping to buy medium-sized primary contractors to get business from Japanese end-users in order to buy client relationships and shift consulting and implementation work to inexpensive locations in India and elsewhere for cheaper and, possibly, quicker delivery.
One hurdle buyers face is the Japanese language, for which the keener ones will be prepared. But tougher still is persuading Japanese to sell to newly arrived foreigners. British and US buyers may be more welcome as they are better known in Japan, but it will take longer for others to be accepted, unless as a last resort. In this respect, the IT-services industry in Japan is much like many other industries.