Opportunities for Investment and Cooperation in the Information Technology Sector in Latvia

Opportunities for Investment and Cooperation in the Information Technology Sector in Latvia: A Study of the Information Technology Services Sector

Baltic IT Review 4 '99

The IT service sector is one of the fastest growing sectors in the world, and it has begun developing in Latvia, too. The purpose of this study, which was done by Ernst & Young in 1999 on the basis of a commission from the Latvian Development Agency, is to analyze this development and to evaluate the competitive characteristics and growth potential of this industry. Information for the study was collected through interviews with industry professionals, as well as through documentary research.
As the 21st century draws near, information technologies have affected the way in which business is conducted worldwide. Increasing productivity and the decreasing cost of computer hardware have created new demands from enterprises which use IT in their businesses. The IT sector is one of the fastest-growing sectors in the world today, and growth rates in the sector, when measured globally, have surpassed growth rates in the world’s GDP. Consequently, IT represents an increasing proportion of the global economy.
The demand for IT services has led to a shortage of professional software developers in the world’s developed markets. The outsourcing of software development to other countries has become a common practice. Such countries as India, Ireland and Israel have taken advantage of these opportunities and have developed strong industries aimed at the export of IT services.
Latvian companies which are active in the IT sector are relatively small and lack such critical resources as capital and marketing channels to Western markets. Latvian companies are actively seeking foreign partners to set up joint ventures and to offer IT services.
The purpose of this report is to analyze the current development of the IT services sector in Latvia, as well as to evaluate the competitive opportunities which are available to this market in the context of global trends in the IT services industry. We will also identify the most attractive areas for investment in this sector. For the purposes of this report, the following sectors are identified as being part of the field of IT services:
• Hardware maintenance and support;
• Software maintenance and support;
• Consulting;
• Development and integration of software products;
• Education and training
• Management services
The study is based on the following major sources of information:
• Interviews with industry representatives in Latvia;
• Publications, press releases and other information about IT in Latvia;
• Official statistical sources;
• Research on IT industry trends and developments elsewhere in the world;
• Other publications on industry-specific issues and on research concerning the various sectors of the IT services field;
• Information about IT that is available on the Internet.

<big>The IT sector in Latvia</big>
Fundamental changes in Latvia’s economy and growth in GDP (especially in the services sector) have contributed to a growth in local demand for IT services. Newly established companies in Latvia have not inherited outdated technological solutions, and they are investing in state-of-the-art technologies. At the end of 1998 there were more than 180,000 PCs in use in Latvia, 87% of them in businesses.
When the Soviet Union collapsed, Latvia had one of the most advanced IT infrastructures in the former USSR, the result of a heritage of highly qualified human resources trained at a number of computing centers that operated under the auspices of various institutions in the 1980s. The potential of these specialists, however, is being used only marginally in the Latvian IT services market. A new generation of university-educated computer science students is entering the market of growing IT companies in Latvia.
The government is one of the leading investors in IT, and a strong local market, with demanding customers, has emerged. Growth in the IT sector has also been stimulated by cooperation between Latvian companies and Western clients.
The outsourcing of software development has become the core competence of several Latvian software companies. The main reason why Western clients outsource critical business application development to Latvian companies is that the services which are provided are of high quality and represent considerable cost-effectiveness. Latvian software developers have gained significant experience from several large-scale software development projects.

The IT services market in Latvia
The Latvian IT services sector has increased by more than 500 private companies during the past decade, and these firms employ more than 3,000 workers. Most of the companies are located in Rīga. Enterprises in other sectors, too, have been developing their internal IT infrastructures, and significant numbers of software developers are employed there, too.
Since the early 1990s, rapidly growing demand for IT services locally, as well as attractive opportunities for export of these services to Western countries, have attracted many skilled entrepreneurial people to the IT services sector.

In 1998, the value of domestic sales in computer-related services amounted to USD 46 million. Figure 1 illustrates growth in the IT services sector. During the first quarter of 1999, the sale of these services amounted to a value of USD 12 million, and these figures do not include internal spending by companies and government institutions. Given that financial institutions and newly established enterprises have been developing their IT systems from scratch in many instances, the amount of internal spending may in fact be considerably higher than the value of outsourced services.
The proportion which IT services represent in Latvia’s GDP has been on the rise for the past several years, as is seen in Figure 2.

International trade in IT services has also grown, and Latvia is now a net exporter of these services, as indicated in Figure 3.
Initial demand for IT services locally came from financial institutions which needed to set up back office systems. Gradually companies in other business areas, too, began to invest in the development of computer networks, communications, accounting and financial control systems. Along with developments in the private sector, significant investments are being made by the state in order to develop its communications networks and to redesign the country’s national registers.
It is complicated to divide the field of IT services into sub-segments in Latvia, but it is nevertheless clear that software design is the most significant element in the picture. Software maintenance, integration, consulting and training are rapidly growing areas.

In Latvia, sales per professional programmer are thought to be at a level of USD 40,000 a year – five times less than is the average in Western countries. This means that projects can be developed in Latvia at considerably lower costs.
Many of Latvia’s software development companies are relatively small and young, and they have only limited opportunities to join large international projects. Nevertheless, some of the companies have already established a good reputation as reliable and stable partners for long-term projects among some of the leading Western companies.
The industry is undergoing restructuring, including mergers and acquisitions. A developer of payment card systems, Konts, was acquired by Finland’s Tieto Group, for example. Usually the largest acquisitions are made by companies with access to international public capital markets.

Companies that are active in software development
It is estimated that there are some 100 companies active in the field of software development in Latvia. Most of them are very small, and companies typically focus on specific solutions instead of offering a wide spectrum of services.
Only some 25 or 30 companies regularly undertake sizeable software development projects. Unlike companies in other Central and Eastern European countries, Latvian IT companies provide turn-key solutions to clients. These services have been exported to more than 10 different countries. Several Latvian companies have begun to move from the provision of cheap solutions as subcontractors to becoming the main contractors in complex areas such as system integration. The originators of new companies are often highly qualified researchers and academics from universities, research institutes and computing centers.
Companies which are active in this sector are attempting to enter foreign markets, and in many cases they have succeeded in finding reliable business partners in developed countries.
The largest companies in the field of software development are listed in Table 1. A number of Latvian companies have been excluded because software development is not their core activity. There are, however, computer hardware retailers, for example, which also develop or adapt accounting software packages.

Table 1. Leading companies in Latvia’s IT services sector

Company / Employees / 1998 sales, mill. Ls / Main products
DATI / 515 / 4.6 / Systems development, reengineering, software testing, CASE tools
SWH-Tehnoloģijas / 185 / 2 / Systems development, SAP consulting, JAVA-based program development
Tieto-Konts / 70 / 1.3 / Systems integration, development of payment card systems
IT Alise / 62 / 1.24
Datapro / 40 / 0.26 / Computerized business process analysis and modeling
Tilde / 40 / 1.9 / Software localization, documentation
Datorikas institūts / 25 / 0.18 / Information systems analysis, database development

The availability of high quality specialists
The number of people obtaining a higher education in Latvia is increasing significantly. In 1998 there were 77,000 students at Latvia’s universities, and a higher education in Latvia was being provided by 19 state-owned and 15 private institutions. In 1998 there were 27,000 new enrollees and 9,400 graduates from Latvia’s universities.
A higher education in IT is provided mostly by state-owned universities, especially the University of Latvia and the Rīga Technical University. Programs in the IT sciences are also run by regional universities in Daugavpils, Liepāja and Rēzekne. Educational programs in computer sciences have recently been restructured and are in line with similar programs at leading universities throughout the world. Educational programs in Latvia have received international certification. The Rīga International College of Business Administration offers professional training for future managers of E-commerce.
The number of people graduating with degrees in IT and engineering sciences in 1998 was 1,200, while the number of people enrolling in IT-related study programs was 1,900. Statistics show that fewer than 50% of enrollees go on to graduate on schedule, mostly because many people in Latvia need to work in order to finance their studies.

Table 2. The number of applicants and enrollees in computer science study programs at Latvian universities

Applicants / Enrollees
University of Latvia / 402 / 191
Rīga Technical University / 672 / 352
Liepāja Pedagogical University / 34 / 28
Rēzekne University / 35 / 25
Rīga Aviation University / 100 / 78
Total / 1,243 / 674

As can be seen in Table 2, there is great interest in the computer sciences in Latvia, but only some 54% of applicants are admitted at the country’s universities. The vast majority of computer science education takes place in Rīga, and the interest of secondary school graduates in the IT sciences is thought to be high. Computer classes are being installed at many schools under the auspices of a school informatization project, and the reputation of jobs in the industry is very high. Salaries are good in the IT sector, and the best technologically oriented students are attracted to these programs.
Local demand for software engineers comes from newly established enterprises such as banks which want to create their own IT systems. Once the systems are in place and companies require only maintenance services, highly experienced professionals will become available in the market.
Several IT training programs in Latvia are run by private software companies such as Lotus, Oracle and Microsoft. Basic computer training is also part of most educational programs at the university level.
The annual cost of education for students remains low. The present cost of education in the computer sciences program of the University of Latvia, for example, is Ls 690 per year for bachelor’s degree students and Ls 915 a year for master’s degree students. Given the low cost of education, it would be both beneficial and possible to increase the number of students. On the other hand, it is likely that the cost of education will increase, because salaries for academic personnel are very low and cannot be sustained over the long term.
It is becoming more common for private companies to make contributions to the education system in the field of IT in Latvia. IBM, for example, has sponsored the establishment of a computer class at the University of Latvia. Additionally, there are IT service companies like DATI which are working with banks to provide student loans to the best students. The loans are usually between USD 200 and 300 per month.

Professional associations and industry events
The Latvian IT&T Association: This is a professional, non-profit organization which coordinates cooperation among IT companies that are engaged in the design and maintenance of information systems. It creates and maintains training programs and other elements of the infrastructure in this area.
The Latvian Association of Hardware Producers was established by major producers and assemblers of computer hardware.
The Baltic IT&T Conference and Exhibition take place every year with more than 3,000 exhibitors and 30,000 visitors.
The Latvian agency for the protection of software copyright was established in cooperation with the Business Software Alliance. The main task for the association is to educate users and to reduce the incidence of software piracy.

The cost-efficiency of resources
The major cost factor in software development is clearly the cost of human resources. One of the key competitive advantages of human resources in Latvia is their cost-efficiency. Official statistics show that the average gross wage for computing professionals is Ls 249 per month (~US $420), while the average gross wage for professionals in associated fields is Ls 180 per month ($300). These statistics do not, however, reflect the real situation. In truth salaries are higher, and the average gross monthly salary for professional software engineers in Latvia is between Ls 300 and Ls 900 ($500-1,500). These rates remain significantly below those in other parts of the world. In America, for example, software engineers, on average, earn between $50,000 and $90,000 per year.
The cost of support functions in Latvia, too, is significantly lower because of low salary levels among non-professional staff, as well as lower infrastructure costs. In Latvia the cost of a single programming workplace is usually between $10,000 and $20,000 – close to Western standards. The investment can usually be recovered very quickly, though, because the average revenue generated by a professional programmer is somewhere around $40,000.

<big>The IT infrastructure in Latvia</big>
Data communications services
In Latvia, as in many European countries, telecommunications have traditionally been dominated by a single monopoly firm. When Latvia regained independence from the Soviet Union, it inherited a technically outdated telecommunications network. The state monopoly, Lattelekom, was partially privatized, and more than Ls 280 million have been invested in upgrading the technologically outdated telecommunications network. The company has also invested more than Ls 5 million in high-speed data transmission networks for corporate clients. Lattelekom at present retains a monopoly on fixed line telecommunications. The government intends to liberalize the telecommunications market by the year 2003.
Latvia has also reached a very high level of mobile telephone penetration. Mobile telephones are used by 230,000 people in Latvia – 9.4% of the total population. Competition between two GSM service providers has served to decrease prices. It is expected that a third GSM network operator will be licensed in the relatively near future.
There is free competition in the provision of data communications services in Latvia. Several companies operate in this area and provide both fixed line and wireless data communications solutions. The leading provider of fixed line services is Lattelekom, but there are also several international companies which offer data communications services in the country, including Telia and Equant.
Several companies have established private data communications networks for specific needs – Latvia Post, Latvian Railways, Latvenergo and several banking networks. Larger business companies use data communications services extensively, and special service packages are also being developed for small and medium-sized enterprises.
Communications tariffs in Latvia are lower than in neighboring countries, and the quality of services that are provided is higher. Data communications services which are currently available in Latvia include ISDN, Frame Relay, x25 packet switching and leased digital lines. In Latvia the monthly cost for a 2 Mbit/s digital line is Ls 375, or $625 – a lower cost than applies in other countries.
There are some 35 Internet service providers in Latvia, the vast majority of them in Rīga. Rapid consolidation is occurring in this area. The most popular types of communications are 56K and ISDN dial-up connections. Radio links, too, are becoming very popular, due to their low cost. Cable modems are not yet as popular.
The total Internet bandwidth from Latvia is above 15 Mbit and is growing rapidly. Key Internet penetration figures are presented in Table 3.

Table 3. Internet Penetration. Source: RIPE Hostcount

End 1997 / End 1998
Number of Internet residental users / 5,000 / 8,000
Number of Internet residental users per 1,000 inh. / 2.0 / 3.2
Number of Internet professional users / 35,000 / 72,000
Hostcount by DNS domains / 7,100 / 14,3000
Hostcount by DNS domains per 1,000 inh. / 2.9 / 5.8
Number of access providers / 18 / 23
Estimation of Internet penetration rate in companies / 18.0% / 34.0%
Estimation of Intranet penetration rate in companies / 2.0% / 3.0%

Several ISPs offer unlimited dial-up connections for fees (Ls 12-30) that are comparable to fees in other parts of Europe. The increasing use of the Internet in Latvia is encouraging some companies to make new investments in Web-related technologies. A joint project between BNS and MicroLink, for example, is aimed at developing a new portal in Latvia

The sale and servicing of hardware
Some 50 companies in Latvia sell and service computer hardware, and total sales in 1998 amounted to EUR 140 million. All of the world’s major hardware producers, including IBM, Dell, Compaq, Sun, Cisco, 3Com and HP, are represented in Latvia. Value-added retailers such as Fortech, Dati, SIMSS and VAR are offering design solutions and implementation.
The local assembly of PCs is a fairly developed segment of the industry, mostly at small companies. Firms are coming to recognize the importance of economies of scale, and mergers re taking place. Fortech, for example, has set up a joint venture with the Estonian company MicroLink to produce desktop computers in Rīga. The aim is to create a Baltic computer brand.
Several major hardware companies have also introduced servicing networks with small, regional outlets which cover most of Latvia’s territory. These networks make the maintenance of IT systems that are spread all over the country much simpler.