The low cost of hard returns

Whatever reasons the Myburgh Commission finds for the slide in the rand/dollar exchange rate at the end of last year, the period it is investigating is only a dramatic blip in a depreciation that`s been happening for years. In 1995, one dollar cost (read it and weep) R3.65. A pound sterling set you back less than R7.

The impact of a cheap currency on SA is dramatic. The instinctive reaction is negativity, and some of it is indeed justified. The government`s myopic policies on telecommunications, Aids and Zimbabwe - whatever their merits and demerits - are doing little to improve foreign or local confidence in the country`s otherwise fairly sound economy.

Andreas Bertoldi, an analyst at local research firm BMI-TechKnowledge, says companies with costs denominated in dollars and revenues measured in rands are in trouble. This includes most importers of hardware and software to the local market.

What worked for us, is that we were very niche-focused. We knew our competition and potential clients.

Joubert Steyn, GM for Africa, Mosaic Software

But there is an equally dramatic upside. According to 1999 statistics, published in 2001 by The Economist Intelligence Unit, SA already exports more than it imports. Simple currency pressure will ensure that this trend continues, and exporters will be one of the most important contributors to the country`s income and skills development.

The technology industry is no exception. The last few months have seen several announcements from companies proud of having landed contracts with overseas customers. Getting paid in hard currency is the Holy Grail for many local software and technology development houses. Even investors that would otherwise have little confidence in the technology sector salivate at phrases like "hard currency revenues" and "rand cost base".

Many local large IT companies have been targeting international earnings for years. Initially, the primary driver was that the local market is simply too small to bring them the growth figures investors are demanding.

The chances of large international companies using more local firms - and not just in the IT sector - is a reality.

John Thorne, director, Jam Warehouse

Some of the big-name players, like the IQ Business Group, Rubico and MIP Holdings, have had considerable success. Others, like Dimension Data, FrontRange and Comparex, while not exactly failing, are finding the going considerably rougher than expected. High-priced acquisitions, more demanding investors and regulators, and a crowded, sophisticated market have made the "green grass" of foreign markets seem decidedly dry.

More surprising, and more encouraging, however, have been the forays offshore of SA`s large but fragmented base of small software and technology development companies.

One does not often get to hear of the failures, of course. A small company that bets the farm on sterling and goes belly up trying to pay for a few lb2 500-per-month billboards in busy London Underground stations will hardly make waves back home.

Bertoldi admits that it is difficult to quantify how many small companies are taking advantage of the favourable exchange rate in this way, saying that BMI is planning a study on the subject later this year.

While it might be difficult to estimate the ratio of successes to failures, the number of reports of ventures to hard-currency countries is growing. Mosaic Software has, in the last few years, opened offices in the US, the UK and Australia to distribute its locally developed payment systems. Cape-based Web application developer Jam Factory landed a juicy contract with a huge supermarket chain in the UK. Solit, a developer of software for the financial services industry, has been selling its products to some of the largest institutions in the UK and elsewhere. PreWorX, maker of a BIOS-level preboot desktop management product, has been picked by Novell over its Silicon Valley competitors for bundling with its network management software. Global Telesales is a call centre operation based in Cape Town, but answers calls on behalf of a major European airline.

The government and local economists have stressed that SA`s economic growth will largely derive from its small, medium and micro-enterprise sector. So the small companies that earn dollars, pounds or euros while paying costs in rand will be crucial in lifting the country out of its current slow growth trap to the 5% or 7% range the finance ministry says it needs to deliver on promises to provide houses and jobs for all.

There are many factors that make these companies successful, and there are almost as many approaches to gaining international exposure as there are companies in the field. The common denominators for success are knowing your market and detailed planning. Blindly spending millions to open an office in London and then looking around to see whom you can sell to is suicide.

"What worked for us," says Joubert Steyn, GM for Africa at Mosaic Software, "is that we were very niche-focused. We knew our competition and potential clients." He advises firms eyeing international prospects to know their market very well. "Do very good market research, and be very sure about your value proposition. Doing business in SA is easy. It`s difficult to compete with someone on their own turf."

Going in too cheap can backfire. Don`t undercut too much.

Grant Shippey, CEO, Amorphous New Media

For John Thorne, a director at Jam Warehouse, it cost very little to land a plum contract for a UK retail giant. He says that a minority shareholder of the company lives in the UK, and consults to an advertising agency that had the packaging and design account for Tesco, a supermarket chain comparable to Pick `n Pay in SA. "The way small companies work is through their extended network," says Thorne. When he heard that Tesco needed a Web-based branding and packaging solution, he teamed up with another Cape-based company, called Wireframe.

"Wireframe is a design house that just won the Grand Prix at the Design Indaba. We developed the back-end business system and they designed the front-end," says Thorne. "We went and pitched for the contract, and won out of 15 other companies. Tesco liked what we presented and gave us two weeks to come up with a demo and put it online. They also visited us in Cape Town, and were impressed with what they saw."

He hints that Tesco`s South African trip may lead to more such work for other companies. "They had meetings with other potential suppliers while they were here. The chances of large international companies using more local firms - and not just in the IT sector - is a reality," says Thorne.

He advises companies to build relationships and work from SA, rather than setting up expensive international offices that erode the local price advantage. However, Mosaic Software has been successful by using investment by the then Persetel (now part of Comparex) to set up a US office. Further share issues, principally to the venture capital arm of international giant GE Financial Services, have funded further expansion.

There are quite a few challenges to earning hard currency, says Mosaic`s Steyn. "Just as hard currency is attractive, so it is expensive to establish a service and support presence. You need funding. If you can get deals before opening an office, wonderful," he admits. "But in our case, we had to show commitment first. We started with a sales office, and gradually built up our technical capacity."

Growth capital is hard - though not impossible - to come by nowadays. Deals like the $80 million purchase of 10% of Ixchange (now FrontRange) by Peregrine, which effectively funded its international growth, largely evaporated with the collapse of the technology bubble. However, a Durban-based developer of point-of-sale financial services software solutions, Spotlight Interactive, proves that venture capital isn`t dead. The i capital Growth Fund I, a private equity fund managed and controlled by i capital, acquired a 25% stake of the software developer, in order to fund growth and offshore expansion.

Many companies start with a single deal, and use the proceeds to fund further international forays. Although Amorphous New Media`s young CEO, Grant Shippey, says the company has major local clients in Nedcor and KPMG, it only started selling its content management and Web development services internationally four years ago. Like the IQ Group, which enters into agreements with potential clients before establishing any international presence, Amorphous New Media started with a single foreign client, and grew the business client-by-client, rather than region-by-region. It developed a rules-based marketing and content management solution for an online gambling client - then based in Cancun. It has since landed big contracts with British Airways and World Group Consulting, among others. The latter has offices in Sydney in Australia, San Francisco in the US, and Kuala Lumpur in Malaysia.

Foreign contracts like these are usually very profitable. "There`s increased risk and tighter project management, because of dealing with a remote customer, but we can price ourselves up a little," notes Thorne.

Doing business in SA is easy. It`s difficult to compete with someone on their own turf.

Joubert Steyn, GM for Africa, Mosaic Software

Shippey tells of an early letdown, when it tendered for a contract from a large London-based company. "We went in with a soft currency approach. Our price ended up being 15% of the nearest competitor`s bid. But in the tender process, they lop off the most expensive and the cheapest bid. So going in too cheap can backfire. Don`t undercut too much."

Says Rhys Taylor, marketing manager at PreWorX: "We generally track market-related rates to maximise profits, while still being able to remain extremely price-competitive."

Because foreign contracts can be particularly lucrative, they are a natural source of growth capital. Local industry should also prove to be a promising provider of capital for technology companies. Victoria Vaksman, director of e-business and enterprise software developer Solit, says the weak rand should force corporate SA to increase its capital investment into product development. "Historically, investment in SA was focused on implementation and services, and little emphasis was placed on the research and development side," she says. "It will be important to overcome this, and industry-specific groupings would do well to invest in the research and development of products that are most suited to meeting their own industry requirements."

Much of this kind of development work has hit the headlines in the last year. Gauteng`s Blue IQ project and Cape Town`s Cape IT Initiative are both aimed at easing access to capital and sharing cost infrastructure, which in turn will improve the ability of small companies to develop innovative IT solutions. The companies fostered by such initiatives stand to benefit greatly by the fact that local industry is under pressure, according to BMI, to replace costly imports with locally developed alternatives, and that exports are financially attractive.

Much is made of the brain drain. Many believe that SA`s best people have already left, and that those remaining are too few and far between, as well as not good enough. The also believe the local standard of education is terrible. This is all popular wisdom and much of it may be largely fallacious.

PreWorX`s Taylor says that while his company`s deal with Novell was driven largely by the desire to lower the high software development costs experienced in First World countries, SA is producing some exciting and innovative new technology - very different to the more basic software replication capabilities sold by countries like India. Thorne agrees with this assessment: "The top computer science schools are turning out very good graduates. And if we want to compete, we`ve got to make sure that we don`t become sweatshops. SA should position itself as a provider of quality, but at a low cost. Otherwise we`ll get into terrible competition with other emerging markets."

Johan Roets, CEO at the IQ Business Group, says local expertise in financial services likewise serves to one`s credit. "South Africans and South African expertise are well regarded."

SA should position itself as a provider of quality, but at a low cost. Otherwise we`ll get into terrible competition with other emerging markets.

Rhys Taylor, marketing manager, PreWorX

Shippey adds, however, that although "skills are coming through, we still have a massive flight risk". He also notes that the popularity and growth of Web and IT skills remains concentrated among the white population. "Penetration of previously disadvantaged individuals into that sector is slow and low. When we put out a job advert for, say, a senior developer, we simply do not get any black applications. It seems they go to the Dimension Datas and large corporates, for large salaries."

These large corporates, of course, are able to make a far greater investment in skills development. IBM stands out as a company that has done more for black economic empowerment through skills development than most other companies. Gail Mlokoti, IBM`s external relations executive, is tasked with driving empowerment in the business. She says IBM`s technical internship programme currently benefits about 120 people, and another 80 or 90 are involved in sales internships. The company also aids its black channel partners with capacity-building and management skills. Mlokoti admits that only big companies manage to attract black skills. IBM has met its employment equity quotas and has a reputation for its highly skilled workforce. But, though IBM itself reaps much of the benefit, many of its staff members eventually filter through into the industry at large.

The challenge remains, however, and in Shippey`s opinion lies with increasing the average levels of education, including basic literacy, as a priority.

The hope that multinational technology firms would consider SA a good location for production seems fairly remote right now. Mark Harris, country manager at IBM SA, says that while it has moved much of its hardware and software development away from hard currency locations, it remains circumspect about where its intellectual capital is kept. "India benefited first," he says. "But a lot of the basic stuff happens in other markets. China is ramping up rapidly, and Russia is streaming people into Java development from universities. On a manufacturing level, Ireland was smartest by providing the infrastructure and a tax holiday that attracted multinationals." This is tough competition, and it does not look like multinational technology firms will rush to set up software development, manufacturing or R&D plants here soon.

Compaq recently launched a local assembly facility to create Compaq-branded desktop PCs at prices that compete with the current volume-sellers. Henry Ferreira, the company`s local MD, says the aim is to supply the local market, and develop export potential to the rest of Africa. However, Andr'e Louw, GM at Ikwezi Technologies, which won the Compaq contract, leaves the question open. Yes, current plans are limited to Africa, he says, but the company will always consider further opportunities. He does not come right out and say it, but exporting to other emerging market regions, and even Europe and America, is a possibility he fails to deny.

South Africans and South African expertise are well regarded.

Johan Roets, CEO, IQ Business Group

Despite not rushing to invest themselves, smaller companies can use relationships with multinationals to slingshot their products overseas. InterSystems, vendor of the high-speed database product Cach'e, recently opened a local office, and prominently mentioned the opportunity for international marketing and distribution of its customers. "Often, developers who use Cach'e to build applications have the capability to conceptualise and produce very good products that might work well in other markets," says Paul Grabscheid, the company`s VP for strategic planning. "We`ve been successful in the Australian and Israeli cases in helping them find other members of the Cach'e community who can complement them and help distribute their product internationally. For us, it`s a partnership kind of thing that helps all of the partners involved: it increases the use of our technology, it helps our partner here to find a bigger market, and it helps some other customer of ours somewhere else in the world."

Yet, expecting the IT industry to flock to SA and establish what automakers have established in and around Port Elizabeth seems too much. The reason cited most often? Telecommunications, of course.

Harris notes that one of the key factors multinationals like IBM look for when considering opportunities for establishing facilities is bandwidth, and that is where he believes SA has a problem. He adds that Doug Maine, the head of the company`s global electronic channels (ibm.com), was over here recently. "They don`t realise how advanced we really are," says Harris. "They think we`ve got language, infrastructure and skills problems."

Discussing why SA hasn`t capitalised on its cheap cost base the way India has, Dana Buys, MD of FrontRange, cites just one thing: telecommunications. "I`ll say it until I`m blue in the face," he declares. "Because I know this is true. I`m really looking forward to moving back here. I love this country, I love the Cape, I love its people, I love Africa as a continent. It`s got many problems, but I think for some people it gets into their systems, and it`s in my system. I would hate to have to live in America for the rest of my days.

"But there I have a 500kbps Internet service for $49 a month, permanently on, 24-hours-a-day. Now I`m going to come here, and I`ve got to pay for my local calls, or ISDN calls, and then you get into this very slow system here. I can see it`s going to freak me out a little bit. I`m just going to have to go and play golf or sell grapes or something, because if I spend more time on the Internet I`m going to go mad."

By comparison, India`s call centre industry was made possible because multinationals can easily and inexpensively take in big fibre pipes. "We`ve got fantastic language capacity out here - a very neutral English accent, if you can believe it. You`ll see the South African presenters on CNN, and it`s no surprise they`re pinching them, because South African English is most easily understood by British or Australians.

We could be a fantastic call centre market for Europe, because we`re in the same time zone.

Dana Buys, MD, FrontRange

"We could be a fantastic call centre market for Europe, because we`re in the same time zone. We could be a fantastic call centre market even for America, because we`re awake when they`re asleep, so we could provide the after-hours service. But in India, they`ve been creating fantastic jobs. We know, because we sell technology into the call centre market. Here we can`t do it, because the cost of telecommunications kills it completely."

Niels Kjellerup, editor and publisher of Call Centre Managers Forum, an Australian trade publication, says SA`s large unemployed workforce - most of whom speak a very understandable English and would require only some linguistic training - is the key to developing this country as a call centre destination for multinationals. But he likewise adds the caveat that bandwidth pricing and international call rates are stifling SA`s competitiveness with other countries.

However, Shippey and Thorne both note an upside. Because local developers are used to a low-bandwidth environment, they have learnt to develop efficient software that does not waste performance on fancy but unnecessary bells and whistles. It would, of course, be preferable if disciplined software development was a matter of choice and excellence, rather than a necessity borne of ill-conceived policy and legislation.

Despite the spate of good news in the development of export opportunities, some serious obstacles remain. Interviews for this article a few days after Zimbabwe`s controversial election raised the spectre of growing sovereign risk perceptions of SA. This country might have a distinct cost advantage over other locations, be conveniently located - temporally in Europe`s time zone, if not geographically - and have the required skills. But many international companies think twice before sending crucial contracts this way or committing to foreign direct investment (ie building plants rather than just buying shares on the stock market).

"Even though it is cheap to develop here," says Taylor, "international companies will not expose themselves to unnecessary risks associated with unstable governments, high taxation, violence, and so on. It also becomes unattractive for international companies to secure any strategic partnerships with companies that exist within those environments."

The head of one company selling its products internationally - who didn`t want to be named in this context - agrees. "After the Zimbabwe election, for the first time, there have been murmurs of sovereign risk associated with SA," he says. "This part of the world has been getting bad press," he adds. "While I don`t agree, our business partners there are looking at Aids and Zimbabwe and corruption and land redistribution issues, and are asking `Is SA really different?`"

Even though it is cheap to develop here, international companies will not expose themselves to unnecessary risks associated with unstable governments, high taxation and violence.

Rhys Taylor, marketing manager, PreWorX

Some believe the establishment of an international marketing council within the Department of Trade and Industry will make a positive impact. "I believe you have the chance to become one of the best performing countries in the world," declares Francois Bornibus, a Compaq VP responsible for the company`s PC, handheld and related businesses. He takes pains to refer not to the usual EMEA region, but to call it "Africa, Europe and Middle East".

But Buys says that in his two years as CEO of FrontRange`s US operations, he discovered that what little perception international investors and companies have of SA is inaccurate and negative. "Unfortunately, we`re tainted by our neighbours," he says. "They see the land being grabbed in Zimbabwe, and all the corruption in Africa - and they kind of just assume SA is the same, unfortunately. So the general level of perception of SA is poor, because one, they confuse us with our neighbours, and two, we`re so far away and so small, economically speaking, for them, that they couldn`t really care."

Besides telecommunications, as Taylor says, this risk factor - whether real or perceived - may prove to be SA`s biggest obstacle in its search for real economic growth through hard currency exports and direct foreign investment.