“The entire Bulgarian IT industry depends on business from abroad”: Is the national sector in crisis?

The more - the merrier. Winnie the Pooh’s famous mantra has perfectly described the Bulgarian IT industry for more than a decade. Rapidly growing revenues and profits. Business record after business record, and then more records. All this coupled with an insatiable hunger for new personnel, growing salaries and all kinds of social benefits. That seemed to be the case until recently, when the clouds of economic uncertainty came to loom over and the bubble began to deflate— just like that of other booms pumped up by cheap money during the last decade.

Now the sector, which has profited hugely from the pandemic-induced digitization boom, has been struggling in the most recent financial quarters as customers cut spending amid inflationary pressures and recession fears. The slowdown has generated some bold headlines, but how are the economic shocks actually affecting the Bulgarian IT industry? Is it really in crisis and what are the more important long-term questions for its future?

Dissection of the Bulgarian IT industry

Let's start with the concept of the IT industry, whose wide scope suggests that there is no way to talk about it one-sidedly. As noted by Lyudmil Stoychev, managing partner at CBN Panoff, Stoycheff & Co. – the company which has been doing detailed analyses of the tech sector for three decades, it includes more than one or two types of businesses. The Bulgarian tech sector consists of:

• hardware wholesale and retail,
• IT services,
• the software market,
• telecommunications,
• e-commerce,
• web services including hosting.

These are all different branches that run on different tracks. The hardware market, for example, is going down very noticeably, while the software market is growing, although not too much," Lyudmil Stoychev explains to Economic.bg.

According to him, wholesale sales are under huge pressure at the moment, while no significant changes are noticeable in IT services. He is mostly surprised by telecommunications, where revenues follow a distinctly upward trajectory. The Bulgarian Commission for the Regulation of Communications data shows that in the first half of 2023, the turnover of the three leading companies in the country, A1, Vivacom and Yettel, respectively reached EUR 340 million (20.6% growth compared to a year earlier), EUR 302 million (+9%) and EUR 237.5 million (+12.5%).

However, global financial uncertainty has deepened in recent years, investors and IT company customers have tightened their belts, orders are falling, the demand for staff has taken a U-turn, and the technology industry across the Atlantic has already set in motion a wave of mass layoffs. When asked how this situation reflects in Bulgaria, Ludmil Stoychev says:

The clients’ orders have decreased a bit - especially for companies that work in foreign markets. The domestic market is not very sensitive to what happens abroad, however, it is also many times smaller."

He gives an example with hardware sales, 95% of which are oriented to local customers - and digitalization in the country is moving at too slow a pace to generate more tangible demand.

Taken as a whole, the IT industry reports relatively good revenue levels in 2023, with the first and second quarters having performed very strongly.

The slowdown came in the third quarter. We'll see what happens in Q4 as a whole."

What keeps the entire Bulgarian IT industry going are client orders from abroad – the software industry, for example, relies on exports for 85% of its turnover. Although as a result of the international economic shocks, demand in the second half of the year has fallen, the market is still doing well. As is clear from the forecast in this year's "BASCOM Barometer" prepared by CBN - Panoff, Stoycheff & Co., revenue growth for 2023, specifically in the software sector, is expected to slow to just over 12%.

There is no danger of anything bad happening in general. Things are normal, there is just some reduction in the growth."

The staffing issue

In the words of Ludmil Stoychev, already this past spring, "one of the big companies had apparently made layoffs, although there was no official confirmation." According to market signals, there has been a cut in the workforce, for example, in the ranks of Crypto.com. There will also be resizing in VMware, sold to Broadcom.

This is not good for anyone, because good taxpayers who provide significant revenue to the treasury fall out of the system," the analyst notes.

He reminds me that, according to estimates, one full-time employee contributes annually about EUR 17,500 in net taxes to the Bulgarian treasury, and in addition to that, these people hardly use any resources from the budget.

Every single job loss costs the budget a serious amount."

According to Lyudmil Stoychev, people laid off in the second quarter quickly found a new job in the third. Underscoring the huge dynamism of the sector's labour market, he recalls the "cosmopolitan growth" of jobs in 2022, when more than 8,300 workers were hired in the software industry, and about 15,000 in the outsourced services sector. According to Lyudmil Stoychev, this significant increase comes somewhat as a result of momentum from 2021, when there was an acute hunger for specialists, and the IT sector is still on the rise given the digitization drive caused by the pandemic.

No one expected such a thing. And in practice, these people now have to provide themselves with new  orders, with new work."

The nature of the growth can also be judged by the Blue Card work permits issued to employees from non-EU countries, which in 2022 suddenly increased from around 400 to 1119. Interestingly, this happened even before the legislative relaxations that MPs passed at the beginning of 2023. In this connection, Lyudmil Stoychev spoke about the idea of issuing Blue Cards to students who can enter the labour market within 2-3 years and stay in Bulgaria.

According to the analyst, as far as the layoffs this year, this is not a good indicator that "the first wind that comes blows away a lot of jobs." With his comment, he opens the topic of the strategic place of this business for the Bulgarian economy and the lack of a clear vision and understanding, accompanied by the lack of state support in practice.

Data shows that the software sector is the number one employer by payroll. It is also the leader in terms of the number of foreign companies in the country – coming from 33 countries, and there are perhaps investors from more than 50 countries in the entire IT industry, notes Stoychev. A comparison can be made with the automotive sector, primarily composed of foreign investors.

In general, however, (the automotive sector has) around 300 – 400 companies operating, while in IT there are over 17 thousand, and only the software branch has over 5 thousand, which is exceptional in terms of size and positions."

It is also interesting that the IT industry is number one in the country in terms of R&D expenditure, which again makes it a key factor at the national level compared to the negligible funds that the Bulgarian state allocates to research.

This sector develops regardless of what the state does. However, we cannot step firmly and strongly on the European market", comments Lyudmil Stoychev and adds that "in the country there are very few companies with their own innovative products that can gain a foothold on the market".

At the level of state policy, Bulgaria’s weakness is very visible, especially if we look at the bright actions of neighbouring countries such as Romania and Greece. Greece, for example, quickly managed to attract billion-dollar investments from Microsoft, Amazon and Google, including data centres - the type of infrastructure where Bulgaria previously claimed to have a good position.

Bulgarian tax policy does not help

Frequent changes in tax policy are not a good signal for investors. Most recently, the Bulgarian MPs voted to raise the maximum social security monthly income for 2024 from EUR 1,700 to EUR 1,875. Even ignoring the negative indications from the fact that this was done without any dialogue with the businesses and at the end of the year, when companies, especially large foreign corporations, have already determined their budgets for next year, analysts point out another discrepancy:

a high-tech workplace brings the state benefits, which are many times larger than a simple increase in the social security income."

"If we look at how many jobs a change in the social security threshold could cost compared to the money that will come into the state budget - according to our estimates, about EUR 50 million will come from the entire IT industry - whereas the jobs that could have been created would bring EUR 70 million. We are talking about the number of jobs and the net income from each workplace - now these jobs will not happen, especially in this situation. The sensible policy observed in Italy and Great Britain is not to increase taxes, but to reduce them, so that they can do exactly that - open high-tech jobs that in turn bring revenue to the treasury," explains Lyudmil Stoychev.

Translated by Tzvetozar Vincent Iolov