Playing catch up: Varied segments flourish, as infrastructure and internet use expand

Sustained government efforts to expand the Philippines’ high-value-added industries are gaining momentum, as new subsectors within the information and communications technology (ICT) industry are joining with flourishing business process outsourcing (BPO) operations in driving the local tech sector to prominence. In particular, the software industry has shown strong growth in 2011.

Infrastructure has also made significant strides, driven by demand, as millions of young users flock to the internet for social and entertainment applications, as well as by supply, with domestic telecoms operators boosting their capabilities while offering a widening range of internet services.

SOFTWARE: In operation since the 1970s, the Philippines’ software industry has successfully carved out a niche for itself in the global IT market, and is now posting strong double-digit growth in both export revenues and employment. According to the Philippine Software Industry Association (PSIA), export revenues for the sector have increased 27.6%, from $568m in 2009 to $725m in 2010.

These exports went primarily to developed economies, with 57% of the total going to the US. The second-largest market was the UK, with 25%, followed by Canada and Japan (5% each) and Europe (4%), with the remainder divided among Australia, the Middle East and other Asian-Pacific countries. Many in the industry give credit to the country’s well-regarded labour force for helping to draw Western buyers to the local software industry.

The sector’s labour force is keeping pace with expansion, adding 9662 new employees between 2009 and 2010, bringing the total to 44,962 workers. According to a 2011 study commissioned by the PSIA and funded by the government’s commission on ICT, the most profitable software subsector was maintenance accounting, with 18.23% of export revenues, followed by software testing at 12.56%, custom application development (11.54%), product engineering for local industry (7.01%) and system infrastructure support service (6.75%).

In terms of demand, the top industries seeking locally developed software included banking, financial institutions and insurance, which accounted for 17.61% of all industry revenues for 2010. The ICT sector was second with 9.63%, followed by medical, health care and bio-engineering (6.26%); manufacturing firms (6.01%); and the energy sector (5.53%). The rest of distribution was spread among a wide variety of business activities, with no one category accounting for more than 5% of revenues.

As a step towards its ultimate goal of creating a global outsourcing service centre with a focus on software development, the PSIA has set ambitious targets of 30% year-on-year (y-o-y) revenue growth to $1.5bn by 2013, as well as 25% y-o-y employment growth, culminating in a labour force of at least 80,000 by the same year.

A UNIQUE MARKET: According to George Royeca, business development associate at IPVG, a local communications, gaming, technology and payment firm, there are unique features that distinguish the local market from others in the region. “The Philippines differs from regional neighbours such as Indonesia and China in that its population easily and rapidly adapts online applications that were originally developed by Western countries, particularly by the US,” he said. “By contrast, China has substantial difficulty in adopting products that are not published in Chinese and subsequently co-opts these ideas into its native language, as it has done with the Chinese social network Renren, for instance. This uniqueness is a challenge in that local firms have to compete with software powerhouses for the domestic market, but it also represents an opportunity – particularly in the future – for early adopters of digital advertising.”

E-GOVERNMENT: Despite the country’s notable success in many aspects of the ICT sector, the government’s adoption of more efficient technologies is lagging behind that of the private sector. Although the government has devised a number of strategies to increase the state’s uptake of new equipment and practices, these efforts have in most cases failed to gain traction. Some of the more ambitious – although largely unsuccessful – plans include the National IT Plan for the 21st Century (IT21), developed by National IT Council in 1997; the Government Information Systems Plan for 2000-04, championed by the administration of then President Gloria Macapagal-Arroyo; and the more recent e-government portal initiative, which is being promoted as a means to deliver a virtual one-stop shop for the electronic delivery of information and frontline services to the general public.

RANKING READINESS: According to the 2010 “E-Governance Readiness Survey” undertaken by the UN Public Administration Network, the Philippines ranked 78th out of 183 countries overall and 4th among the ASEAN-6, ahead of only Vietnam and Indonesia. The survey focused on two key indicators: the state of e-governance readiness and extent of e-participation.

Another study, the 2010 World Economic Forum (WEF) “Networked Readiness Index” rankings, consistently gave the government lower scores than those of individual and corporate entities within the Philippines. An index score of 21 out of 100 was allocated for government readiness in 2009, well behind the business and individual rankings of 36 and 58.

In addition to its reticence in adapting new technological practices, the government has also come under fire from the ICT industry for its failure to strengthen the sector’s legal framework. The year 2010 was particularly difficult in this regard, as three new sector-related bills all failed to pass through parliament. These included the Cyber Crime Prevention Act, the Data Privacy Act and a third bill that would have created a Department of ICT. All three bills were passed by the Senate in early 2012, though it remains unclear if and when they will be signed into law.

WIRED FOR SUCCESS: While new technologies such as mobile broadband are still in their infancy in the Philippines, with early adopters totalling approximately 5m as of 2011, internet usage on the whole is still growing through alternative means, such as internet cafe use. As of 2010 there were 29.7m internet users in the Philippines, with this projected to grow by a compound annual growth rate of at least 10% to around 67.7m users by 2015, according to IPVG.

In keeping with historical trends, new telecoms development – now in the form of high-speed internet – is being spearheaded by the private sector. Anticipating an increased uptake of new fixed and mobile broadband services and the growing volume of data traffic associated with them, local fixed-line incumbent and internet market leader Philippine Long Distance Telephone Company (PLDT) announced plans in September 2011 to upgrade its 10,000-km domestic fibre-optic network. The new project will aim to improve network service, building a capacity of 1.6 TB per second in the northern and central regions of Luzon, along with other new segments that link the capital of Manila to South Luzon. The company is also aiming to improve the traffic capacity of its internet gateway (linked to several international cables) to a total of 250 GB per second.

This boost in capacity looks necessary for the near future, given the current growth trends in the sector. PLDT’s combined broadband subscriber base increased by 14% from the end of 2010 to September 2011, reaching a new high of 2.3m clients. Of these, fixed-line DSL subscribers accounted for 725,000 of the total, with the remaining 1.58m broadband customers getting online via mobile connections. The rapid uptake of the new service is proving highly profitable for the company, with internet revenues totalling P13.9bn ($315.53m) in the first nine months of 2011, up 10% over the same time period the previous year. By subsector, DSL revenues rose by 13% to P6.9bn ($156.63m) and wireless broadband revenues, including mobile internet, also improved by 13% to P6.4bn ($145.28). This resulted in an average revenue per user (ARPU) of P1223 ($27.76) and P369 ($8.38) for DSL and wireless subscribers, respectively.

Despite the progress made in the adoption of new technology, the Philippines still has work to do, as it ranks behind many of its regional counterparts in key indicators. According to the 2010 WEF “Networked Readiness Index”, the Philippines ranks in the lowest 40th percentile of the 133 countries surveyed in terms of overall ICT infrastructure preparedness and adoption of more technologically advanced systems. The country was the only ASEAN-6 member to be ranked in the lower half of the field with a rating of 36 out of possible 100 in 2009, trailing Indonesia (50), Vietnam (60), Thailand (65), India (68), China (73), Malaysia (80) and Singapore (99). The Philippines scored highest on business usage at 74 and individual readiness at 58, with the lowest ranking going to government readiness and infrastructure at 21 and 20, respectively. As a consequence of the relatively low income levels in the country, as well as a lack of access to hard-line infrastructure outside urban areas, internet cafes are the primary access point for the majority of users. While home usage has increased, figures from marker researcher, Nielsen, shows that 71% of Filipinos frequently use internet cafes, compared to fewer than 30% for home use.

INCENTIVES: To attract more investment into the sector, the government has instituted incentive schemes that target both foreign and domestic investors. These benefits are often multiplied when companies qualify for pioneer status, which is bestowed on businesses that launch new products or processes in the country, or otherwise conduct business in specific government-approved sectors.

One of the most widely available incentive programmes for the IT sector is offered through the government’s Philippine Economic Zone Authority (PEZA). Under the terms of the arrangement, eligible enterprises are granted a number of financial incentives, including an income tax holiday (ITH) that exempts firms from paying 100% of their corporate income tax for a period of six years for pioneer-status operations and four years for non-pioneers. Extensions for ITH may also be granted to a company if the average net foreign exchange earnings of the project for the first three years of operations is at least $500,000, or if the capital equipment-to-labour ratio of the project does not exceed $10,000:1 for the year immediately preceding the ITH extension year. A one-year extension is granted for each criterion met, with a maximum entitlement of eight years. In addition to new greenfield operations, PEZA also offers three-year ITHs for expansion projects.

A host of other PEZA incentives kick in after the ITH period expires, including a gross income tax of 5% and exemption from all other federal and local taxes. Other fiscal benefits include tax and duty-free importation of equipment and parts; exemption from wharfage dues on import shipments of equipment; a value-added tax zero-rating of local purchases of goods and services, including basic infrastructure; and exemption from payment of any and all local government imposts, fees, licences or taxes.

IN THE ZONE: As of October 2011 there were 18 firms within designated PEZA zones in the multimedia graphics, animation, printing and other services industry category, as well as 11 IT research and development industry businesses, 123 BPO businesses, 136 software developers and 34 companies in the other IT-enabled services industry.

Numerous ICT-related industries also fall within the Philippines Board of Investments’ (BOI) list of promoted investments under the categories of BPO, creative industries, and research and development. While only Filipino-registered companies are eligible for BOI incentives, foreign-owned companies may also qualify if they are granted pioneer status, export at least 70% of their production or operate in a business sector deemed underdeveloped by the BOI.

Incentives for BOI-approved companies are mandated under the Omnibus Investments Code of 1987. These include similar fiscal inducements to PEZA, such as 100% corporate ITHs, zero duty on imports of capital equipment, additional tax deduction on expenses for employee training programmes, eased restrictions of employment of foreign nationals and others. During the first six months of 2011, approved ICT investments by the BOI totalled P1.34bn ($30.42m), down 52.6% on the P2.83bn ($64.24m) approved over the same time period in 2010.

SOCIAL NETWORKERS: Known as the texting capital of the world, the Philippines has more recently claimed a new title as the country with the single highest reach of Facebook users worldwide. As measured by digital business researcher ComScore’s “State of the Internet” survey published in March 2011, Facebook reaches 93.7% of all internet users in the Philippines aged 15 and above. The site is the country’s most commonly visited web address, with users spending an average of seven hours per week on it. Other regional countries ranking high on the scale include Malaysia, with an 88.4% reach (ranked number five), and Indonesia, with an 87.4% reach (ranked eighth).

The Philippines also ranked eighth in the reach of the micro-blog Twitter, with 13.8%, while the local internet population also displayed growing affinities for blogs and other multimedia sites.

DEMOGRAPHICS OF USERS: These trends are especially pronounced among younger internet users, and the Philippines is among the youngest per capita in the region. According to the ComScore survey, 40% of the country’s internet audience was between the age of 15 and 24, tied with Indonesia for the lowest per capita internet population within the ASEAN-6. An additional 30% of the audience was 25-34 years old, meaning that 70% of the total internet audience was under the age of 35.

This distinction becomes more relevant when comparing the average hours different groups spend online, which is negatively correlated with age. On average, 15-34 year-olds in the Philippines spend 17.1 hours online per week, compared to 15.8 hours for those 35 and older. This figure is only expected to rise as the country becomes increasingly wired and younger people gain greater access to the internet. For instance, in Hong Kong and Singapore, which have smaller populations but higher penetration rates of high-speed internet access, average weekly online hours per user are 25.9 and 22.3, respectively, compared with 16.7 hours in the Philippines. The trend becomes more pronounced in younger generations, with those between the ages of 15 and 24 spending an average of 31 and 25 hours online per week in Hong Kong and Singapore, respectively.

According to Ricardo Pascua, the chairman and president of Happy Communications, a local telecoms firm, the popularity of social media is leading the sector to expect a convergence between the IT, telecoms and media industries. “Social media has emerged not only as a significant forum for networking, but also as powerful tool for marketing and services firms, both of which the telecoms industry is looking to capitalise on,” he told OBG.

GAME ON: While the internet and IT services have evolved and become so intertwined in daily life that it is hard to imagine working without them, research is showing that it is not commerce, communication or practical applications of the internet driving the uptake of internet usage, but games. The majority of Filipinos access the internet primarily via internet cafes, but just 12% of customers did so for the purpose of general internet surfing. An overwhelming 88% of respondents indicated they used the service to play online video games, according to a 2010 Yahoo-Nielsen Net Index survey.

“There are two primary growth drivers for internet usage,” Royeca of IPVG told OBG. “The first is the rapid adoption of social networks. At one point, Filipinos were the number one users of Friendster, and there are now 26m Facebook users in the country. The second driver is online gaming, in which 51% of the country’s 29.7m online users participate.”

With more than 15m online gamers in the country and some 6000 internet cafes, this subsector generates revenues of approximately $175m annually – not only from game providers, but individual cafe owners as well. According to IPVG, total annual online game revenue amounts to approximately $25m for 52 locally published client-based games and 20 regional web games. These sales are generally derived not from initial access to play the games, which are generally free to participate in, but in item sales that users pay for to enhance their gaming experience. Digital advertising revenue generates another $20m per year, leaving $130m in annual revenues for general internet cafe operations.

One of the most successful firms to take advantage of this trend is IPVG through its online games publisher subsidiary, IP E-Game Ventures, which has a listed market capital of $52m. The company introduced free-to-play games and maintains a market share of 35% for games published in the Philippines, including the top two ranked titles. It also operates 129 internet cafes with 4000 workstations that bring in more than five times the ARPU of online games, according to the firm. IPVG estimated the total internet gaming industry earns P5bn ($113.5m) per year.

OUTLOOK: Anchored by the success of a strong BPO industry, other nascent commercial IT subsectors should continue to display solid growth in the coming years, backed by government incentives, a strong labour force and increasing demand from both Asian and Western economies. Although starting from a relatively low mark, IT infrastructure roll-out and internet adoption are proceeding at a rapid pace that should continue well into the future as the country rushes to catch up with more developed economies.

Efforts to improve government oversight and regulation will be necessary for the sector to maintain its pace of growth. The resolution of issues such as the creation of a stable and effective regulatory framework, more focus on e-government services and the passage of stronger intellectual property rights, should help keep further investment flowing in.