Joel’s market pulse - Q3/2024

In this Q3/2024 market analysis, Joel Liukkonen takes us on a deep dive into the current state of the market. How are the current market conditions and how do they affect the Finnish IT consulting market?

The global and European economies haven’t taken a step for the better, as uncertainty in the market remains. Even the US economy, which had performed relatively well, is beginning to show signs of a slowdown as unemployment rates edge upward. This challenging economic landscape has taken a toll on the Finnish economy as well, impacting the IT sector among others. As noted in the Q2/2024 Market Pulse, while the IT market is not doing too bad, its growth rate has slowed compared to previous years.

A closer look at recent news reveals one potential cause: approximately 20 publicly listed companies or major market players in Finland have engaged in change negotiations this year, a clear signal that cost-cutting measures are necessary due to underwhelming performance. In the overall economy, the gap between open positions and unemployment has widened significantly during 2023 and 2024, as shown on Graph 1.

The Confederation of Finnish Industries (EK) business cycle barometer also underscores this shift, with the majority of respondents citing insufficient demand as their primary challenge since Q1 2022 - a stark contrast to the pre-2022 period when the lack of a skilled workforce was the main concern. The disparity between these two factors has grown sharply, with 52.03% of respondents now pointing to insufficient demand, compared to just 12.49% who struggle with workforce shortages. This shift is also evident in the IT job market, which has cooled since 2022 when companies were aggressively hiring any available experts.

Graph 1: The estimated total number of open positions and unemployed job seekers, individuals

Decreased industrial production and increased bankruptcies

Another way to analyze market conditions is by examining industrial production and GDP growth, both of which have been lacking in Europe this year. Industrial production has declined in both the Euro area and the EU compared to previous years. The challenges of major economies like Germany have had a significant impact on the Finnish market. Similar trend can be seen in Finland based on indicators of changes in output, as explained in Graph 2. The graph reveals that annual growth has been negative between May 2023 and May 2024. However, a positive shift occurred in June 2024, marking the first positive growth in over a year, potentially signaling a turning point in the negative trend.

After a strong post-COVID period, the market has struggled to regain positive momentum, a trend that is also reflected in investment activity. Despite the typically short payback periods and productivity benefits of IT investments, companies have grown increasingly hesitant to invest due to weak demand. Moreover, the challenging times can be seen in a growing trend of filed bankruptcies of companies in Finland during 2024, as seen on Graph 3. These bankruptcies are estimated to cost the Finnish economy at least 1.6 billion euros and result in the loss of over 7,000 jobs. While these figures may seem small in the broader economic context, the trend is both upsetting and concerning.

However, it's worth noting that bankruptcies within the IT sector, particularly among consulting firms and SaaS providers, have remained stable throughout this period. Ultimately, both statistics highlight the challenges facing the overall market, challenges that the IT sector is also grappling with.

Graph 2: The annual percentage change in the production ratio

Graph 3: Filed bankruptcies

Potential for growth found in the public sector

Despite the challenges in the market, and the rounds of change negotiations and layoffs affecting individuals, Finnish companies overall managed to navigate last year relatively well. According to a Kauppalehti analysis of Finnish companies with over €500,000 in revenue, while revenue growth slowed, financial solvency improved. One of the reasons the analysis gives, is major cost-saving and adjustment efforts done by the analyzed companies. This finding is supported by previous change negotiation statistics and EK’s report that investments declined by 4.2% last year. Projections for this year are somewhat similar or even a bit brighter.

Several central banks have signaled potential interest rate cuts later this year, which could stimulate market activity and boost economic confidence. The earnings of IT companies could be significantly impacted as the private sector continues to face challenges and intense competition. Firms focusing on the public sector are likely to perform better, a trend already evident in the first half of 2024.

Even though welfare areas need to reduce their cost structures, IT development might be one key area to relieve the pressure from traditional healthcare which might benefit multiple consultancies with bigger numbers of upcoming projects. However, if the need for savings becomes even more urgent due to high deficits, the situation might develop in another direction, leading to even greater competition among IT consultancies for private sector projects. Nonetheless, I suspect that the public sector will continue to provide significant business opportunities for IT consultancies throughout 2024, despite the potential challenges posed by budget constraints and deficit issues.

M&As reshaping the market

The global IT sector experienced a significant reduction in its workforce between 2023 and 2024, more so than in previous years. Along with companies from other fields in Finland, also many IT companies have undergone change negotiations in 2024 due to declining market demand and realized bench risks - meaning these companies have had too many consultants without active projects.

We have discussed consolidation in the IT-market and an interesting part of this is the late M&As. According to the Transaction Trends report, M&A activity in the IT and technology sectors increased in Q2 compared to Q1. While the overall volume has not yet returned to the level of previous years, some deals have been particularly noteworthy. For example, AMD’s acquisition of Silo AI stands out as a significant development.

The IT consulting market has also experienced both mergers and acquisitions during the first half of the year. The merger of Consultor Finland and Profit Consulting, for instance, is said to be partly driven by the tendency of larger clients to choose bigger consulting firms for risk management purposes. Additionally, these clients are increasingly seeking partners who can provide the necessary manpower to meet their demands.

Another example is from Twoday acquiring Kaito Insight in August. Kaito Insight’s CEO, Saku Sell, explained that the decision to pursue the deal was motivated by their ambition to become “a major player in large listed companies.”

One interesting acquisition occurred in June when the technology services company Etteplan acquired a 20% stake in the Bangladeshi IT consulting firm BJIT. According to the M&A report, this acquisition grants Etteplan exclusive rights to offer BJIT’s services within its market area. This strategic move may be driven by Finnish clients’ growing interest in offshore solutions alongside their current Finnish IT consulting options.

In recent years, many Finnish IT companies have expanded their nearshore capabilities, but acquisitions like the one of Etteplan have been relatively rare. If other firms follow this approach, it could reshape the market dynamics. As part of market consolidation, Finnish customers might prefer to acquire nearshore and offshore capabilities from their Finnish vendors rather than sourcing them independently from foreign providers.

IT market consolidates clearly

The previous examples underscore the ongoing consolidation in the IT market. However, one might question why companies are choosing to sell now, given that valuations are generally lower compared to more favorable market conditions.

One possible explanation is that many smaller and mid-sized players are running out of options in a competitive market characterized by consolidation. For these companies, the long-term prospects may be a choice between merging or losing their position on the market completely. Another factor could be the drive to reduce overhead costs and achieve synergies in this challenging environment.

Regardless of the specific reasons, it is likely that this trend will continue. Many large clients have either initiated or completed their own consolidation efforts, forming so-called strategic or preferred partnerships. These partnerships often favor larger consultancies, which are perceived as better equipped to meet delivery demands.

Another perspective on IT market M&A activities is that sometimes these transactions may be a strategy to avoid bankruptcy. IT companies often have light balance sheets and low debt levels, making them more attractive targets for acquisition compared to firms in other sectors. For company owners, this can provide a “graceful exit,” with market consolidation serving as a convenient explanation.

Even when consolidation is cited as the primary reason, the M&A activity may still offer a way out of a challenging situation where the company has not performed as expected. Although there are no clear-cut examples of this phenomenon in the market, it could explain the relatively stable rate of IT business bankruptcies compared to other industries, where bankruptcies have been higher this year. This analysis does not provide definitive proof of this trend, but it is advisable to approach news and M&A reports with a healthy dose of skepticism.

Many reasons for the consolidation boom

Client companies are actively seeking the right talent, but IT consultancies often have to offer whatever is available on their bench, whereas some market players may not face this issue. This situation creates challenges for clients when selecting vendors, as consolidation limits their options. There can be trade-offs between quantity and quality when choosing vendor partners.

Despite this challenge, streamlining vendors is a rational approach, as managing too many subcontractors can become costly and bureaucratic. Especially after the pandemic, there were many new IT consulting companies popping up as the market was booming and now customers are trying to balance out their vendor pool to be more efficient. Meanwhile, these IT consultancies are competing fiercely for the same clients. From a cynical perspective, consolidation might be seen as a strategy by customer companies to drive down prices amid intense competition.

Regardless of the underlying motives, market consolidation in the IT consulting sector is expected to continue. I also anticipate further mergers and acquisitions in this space before the end of the year.

Stay tuned for the Q4/2024 market analysis and don't forget to subscribe to the Thriv Times newsletter to get more relevant information about the IT market!