2 stocks benefiting from Japan's digital revolution

Japan's tech sector is on the brink of a digital revolution, driven by a unique convergence of labour shortages, government initiatives, and a renewed focus on automation.

The team undertook a research trip to Japan a couple of months ago, meeting more than 50 companies. The sentiment was positive, with management teams excited about inflation returning and interesting anecdotes about how they can finally increase prices for their products and services. Moreover, salary inflation is becoming more widespread. Almost every company we met discussed hiring additional employees across sales, IT and engineering functions.

How they will all achieve this, given domestic labour shortages and ageing demographics, remains to be seen.

One thing that’s clear is that Japan’s technology sector is now undergoing a digital revolution aimed at combating decades of deflation and demographic challenges. This shift has been spurred by numerous government and private sector initiatives to modernise outdated systems. While some programs have buzzword names (“Society 5.0”), underlying it is a genuine push from the highest levels to integrate advanced technology across industries, creating significant opportunities in software, cloud computing, and IT services.

As Japanese companies ramp up IT spending to improve efficiency, and a labour shortage accelerates automation, the software market is projected to grow at 10% annually over the next five years. Cloud spending in Japan currently accounts for only 12% of total IT spending, versus 37% globally. Additionally, Japan’s e-commerce market continues to lag behind countries such as the US and UK, with e-commerce penetration at just 9%, compared to 26% in the UK and 15% in the US.

Japan’s cashless payment market has expanded from 13% of total payments in 2010 to 39% in 2023. That still substantially trails markets like South Korea (95%) and the UK (65%). Government policy is targeting 80% over the medium term.

The team took advantage of the Japanese market meltdown at the beginning of August to add two attractively priced investments well positioned to benefit from this growth.

As part of Japan’s digital transformation, organisations across many sectors have increased their IT budgets, fuelling a surge in software development. The Fund’s new position in Shift Inc. (TYO: 3697), a leader in domestic software testing and inspection services, benefits from this trend. The growing complexity of software development and Japan’s chronic shortage of skilled IT engineers is creating demand for testing and inspection services. The company has a track record of successful acquisitions, utilising them to improve its service offerings, attract skilled talent and expand its customer base.

OBIC Business Consultants (TYO: 4733) is a leading player in enterprise software, focusing on accounting and payroll solutions for small and medium-sized businesses— think of it as the Xero (ASX: XRO) of Japan. The company is well positioned to capitalise on the shift to Software as a Service and cloud solutions. The government’s push towards digital invoicing and receipts over the past few years provides an additional tailwind to OBC’s growth over the coming years. The company has significant cash reserves and has largely transitioned to a recurring revenue SaaS business model, with 76% of total revenues now recurring. OBC should have years of strong sales and earnings growth ahead of it.

‍This is an excerpt from the September 2024 quarterly report