2025 Analyst Survey: The upside of Japan's digital cliff

A successful leap over Japan’s so-called “digital cliff” in 2025 would supercharge overdue upgrades – and growth at the most resilient IT service companies.

Originally published on January 22, 2025, by Fidelity International.
Written by Noriyuki Takizawa, Research Analyst.
Noriyuki Takizawa is an equities analyst focusing on Japanese IT companies.

 

It is an often-cited paradox that as the leader in robotics, Japan is also one of the few countries that still embraces the fax machine. Home to the world’s largest technology-focused venture capital fund, corporate Japan scarcely invests in its own tech talent. Cloud penetration lags far behind the U.S. and Europe. The country’s digital infrastructure has been in such a state that the government fears the economy could lose 12 trillion yen (US$77 billion) a year if it fails to catch up in digitization by 2025. But I believe it will be IT services companies, which have long been the speedbumps to digital upgrades, that will benefit the most from this catch-up trade.

The problem can be traced back to a complex web of contractors. Unlike in most other developed markets, Japanese businesses prefer to outsource IT tasks to so-called “system integrators,” vendors who delegate everything from hardware manufacturing to software development to subcontractors. While this model relieves big corporates of troublesome tech projects, it has also driven up costs in the long run, hollowed out in-house tech talent and created a “band-aid” approach to IT systems.

The irony is that Japan needs these IT services vendors now more than ever as it races to catch up in digitization. Heeding the government’s call, businesses rushing to digitize are turning to the vendors for big-ticket transformations, such as cloud transition. In response, IT services vendors are starting to act more like consultants with wholesale solutions, rather than fixing one bug at a time – a change that gives them greater access to management teams and, ultimately, more commercial opportunities. The impact is immediate and apparent. Nomura Research Institute (NRI), a leader in digital transformation with a strong consulting unit, has expanded return on equity from 11% in 2017 to 20% in 20241. Fujitsu, which is even more well-known, is also improving operating margins, from 4% in 2024 to an estimated 12% in 2026, after implementing a strategy akin to NRI’s.

There is, however, no quick fix to the shortage in tech talent. The government warned in 2019 that Japan could face IT staff shortages of up to 800,000 by 2030. Some projects could get pushed back due to a lack of engineers. More likely is an incremental rise in wages in 2025 as the country approaches its digital cliff, which would favour bigger players that are able to pass on additional labour costs to clients. The fact that big companies and the government – at both central and provincial levels – are bearing the brunt of this digital upgrade will benefit larger contractors that have the scale and resources to take up such projects. The money is already trickling through. The Bank of Japan’s Tankan survey shows software investment by companies has grown by double digits in 2022 and 2023 and is estimated to have expanded another 14% in 2024.

But it’s also worth watching smaller players, some of which are likely to start looking attractive for acquisitions. Value stands to be unlocked where there are clear advantages – for example, in the recent purchase of Net One, a cloud network integration specialist, by system integrator SCSK.

Smaller companies with strong management also have the potential to grow faster than more established competitors. The rapid growth of a new digital consulting unit at Simplx, which specializes in financial markets trading systems, has helped the company deliver a 32% compound annual growth rate over the past five years, a pace that larger players can only dream of. Engaging with companies will be critical to capturing these event-driven opportunities in the sector, which could be some of the most rewarding in Japan’s 2025 transformation.

 

 

1 Financial years, which end in March in Japan.

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