Outlook for the IT service sector 2025: Growth will kick off again at the end of the year
Translation: Original published in Finnish on 03/27/2025 at 09:07 am EET
We expect the performance of the IT service sector to improve as a whole in 2025. However, due to the more challenging Q4 and the 2025 guidances, our estimates decreased slightly for 2025. We now forecast revenue to be broadly at comparison period levels and profitability to improve clearly. However, we expect intra-sector dispersion to be clear and company-specific earnings improvement to be driven by revenue growth or efficiency measures. This year, as the market decline presumably stabilizes/turns back to growth, we should be able to see which companies have adapted to the changing market situation and whose strategy is working. In the short term, we expect the competitive situation to remain tight, but the expected strengthening of the general economic development in Finland and Europe and lower interest rates will create the conditions for a gradual improvement in the demand outlook. Measured by the Rule of 20, we expect one company to achieve excellent performance and one to achieve good performance, while last year none of the Finnish listed companies achieved this.
Source: Inderes
We expect revenue to be at the level of the comparison period as a whole in 2025
Source: Inderes
Our revenue estimates for 2025 decreased further following the Q4 reports (~2 percentage points). In 2025, we estimate that the sector's organic revenue as a whole will be at the level of the comparison period, as the median revenue decreases by 1.4% and the average increases by 0.7%. In terms of revenue, there is exceptionally little divergence in the mix of companies, with Digital Workforce standing out with strong 14% growth and the others being in the +/- 4% range. The M&A front has been record quiet, so inorganic support for growth remains low given the current data. Thus, we expect organic revenue development to be at the level of 2023-24. Relative to the five years preceding the weak cycle (2018-2022: 8-16%), however, the development is very subdued. We expect the companies most affected by the decline in demand for custom software development (Witted, Silicon, Vincit, Solteq) to continue to underperform.
Source: Inderes
We estimate that there is more capacity without projects ("benched") than usual at the moment and professionals are highly available in the big picture. Significant year-on-year growth would require aggressive hiring, which we do not believe will occur in the near term. Therefore, our growth expectations are clearly concentrated on H2'25. In our estimates for the entire sector, the first positive organic growth figures will not come until Q4. We closely monitor the quarterly development of the number of personnel, as this indicates the development over the next 12 months.
We expect profitability to improve driven by cost savings
Source: Inderes
In 2025, we estimate the median EBITA margin of the companies in our coverage to rise to 6.0% (2024e: 3.9% and 2018-2023 average 7.5%). The mean provides a better picture of the sector's average profitability trend, which rises to 7.2% from 6.3% in the previous year. Profitability is supported by company-specific savings measures taken last year and this year, better billable utilization and/or gradually increasing revenues. It now appears that the sector’s profitability bottoms were hit in 2023-2024, when the decline in demand suddenly materialized for most and continued last year. We believe profitability challenges will continue to arise from the difficult management of billable utilization, as project starts are postponed and growth is difficult to achieve. In addition, wage inflation will remain moderate, but price competition continues to put pressure on profitability. Staff turnover has not been a challenge in recent years and will not be as long as customer demand remains weak. Pricing pressure remains our biggest concern in the industry and has already poisoned the order books of several operators, making the return to better profitability levels slower than previously expected. The longer the downward pressure on prices continues, the weaker the order book structure of the entire sector will become and the slower the turnaround will be. However, several companies have adjusted their cost structures in the weak cycle, which means that profitability could return to much better levels, at least temporarily, as the market improves.
A comprehensive summary of the IT service sector and the whole year 2024 is available here.
Source: Inderes
The guidance expects revenue to be at the level of the comparison period and profitability to improve clearly
The IT service sector's guidance for 2025 roughly expects consolidated revenue to be at the level of the comparison period. Of the companies, 4 expect revenue to increase, 4 to decrease and 2 do not provide guidance for the current year. In terms of profitability or earnings, 6 companies expect it to improve, 1 to decrease and 3 do not provide guidance. Thus, in terms of profitability, the companies expect a clear improvement. The guidances are naturally relatively well in line with our expectations discussed above, as we expect revenue to be at the level of the comparison period and profitability to improve by about 2 percentage points from 2024.
Source: Companies and Inderes, *Inderes' interpretation of the guidance, **prior to the divestment of Tech Services
The quarterly decline in the number of employees continued (-1%) in Q4 but has slowed compared to the turn of last year (Q4’23: -4% and Q1’24: -2%). This gives some confidence that the bottom of demand is near.
Source: Inderes
At market level, general economic development is a major determinant, but differences between companies are pronounced
At the market level, we see the general economic situation as the most important driver for IT service companies in the short term. As long as customer budgets are on the decline and earnings performance is weak, it is difficult to see a clear market-wide recovery in demand for IT service providers. However, investors should be aware that there are significant differences between companies in the IT service sector, which has been highlighted in this cycle.
The adjusted EBIT growth estimates of Inderes' entire coverage (only positive results) is 10% this year. Last year, the earnings increased by about 4%, but it should be noted that there were quite a lot of adjustments in the earnings. All in all, however, earnings turned back to a growth track. This year, earnings growth is also expected to be distributed across a broader range of sectors and be less dependent on cost-cutting measures, although they still play a reasonably significant role. The turnaround in earnings is a positive for IT service companies that live and die by their customers' IT budgets.
Predicting the sector's performance around the current inflection point remains very difficult. We expect fierce competition from overcapacity to continue this year. As is typical, many projects ended at the turn of the year, and competition for new projects has been tight. However, in our view, companies have been more optimistic overall compared to last year, and more have commented on slightly recovering sales activity. In the private sector, we believe that the toughest cost-cutting measures have already been taken among customers at market level, assuming the economic forecasts hold. We believe a key trend next year will be the continued consolidation of private-sector IT providers. Long-term strategic partners, companies with industry expertise, players with strong critical capabilities, and companies with a broad range of services are strong. So far, it seems that, in the light of the figures, Gofore and Digia have been the winners in this trend.
Austerity measures in the public sector are muddling the entire picture for market demand forecasting. In the public sector, the need to evolve IT systems in the coming years remains evident and will continue to drive operational efficiency. At the same time, the need for savings is clear, which makes it difficult to predict demand development. We expect the public sector as a whole to be sluggish compared to previous years, and continued pricing pressure is likely to make operating in this sector challenging. We believe that companies that do well in the public sector have the potential to continue to do good business there, although growth is likely to be more constrained. A key variable in the attractiveness of the public sector is private sector demand, as overcapacity drives price competition in large public sector tenders. Selling at a low price is often a better option for the company than doing nothing, at least in the short term.
In the coming years, the ability of companies to continuously innovate, which we often highlight, will be key as many companies are amid change processes and seek to position themselves in highly attractive service, market and customer sectors.
Valuation levels expect weak development in the coming years
Earnings performance is a key driver of stock prices, but a third important component of expected returns, in addition to capital allocation, is the level of valuation at the time of purchase. We believe that the valuation level has already reversed to a very attractive position in a historical context. Historically, valuation levels have not recovered without a turnaround in the business and the start of earnings growth.