Executive summary

Business overview

Base provides outsourced software development services, leveraging the strengths of Japanese and Chinese IT engineers. Founder Katsunari Nakayama, originally from China, has identified software production (specifications design and programming) and operation/maintenance as two segments of the market that require the most man hours. The company he founded has focused exclusively on building a base in these areas, and its name derives from this objective. Today, Base specializes in outsourced development for system integrators as well as IT divisions of corporate customers.

Fujitsu is one of the company’s main customers (generating 19.5% of revenue in FY12/21) and a major shareholder (8.6% stake at end-FY12/20). Base has conducted business with Fujitsu since its inception, and its Chinese subsidiary BCH is a joint venture established with Fujitsu. Base is also a certified Core Partner of Fujitsu. It has in the past invited Fujitsu officers to serve as external directors on its board, and accepts personnel seconded by Fujitsu, all of which attest to the strong relationship between the two companies.

At the parent level, the company generates roughly 52% of its revenue from system development, 16% from Operations & maintenance, 12% from Staffing service (dispatch of staff to customers mainly under worker dispatch contracts), 17% from ERP solutions, and 3% from Other solutions. On a consolidated basis, offshore system development mainly by Chinese subsidiary BCH is added to the lineup. Base also sells to local Chinese companies, but it refrains from actively expanding in China where competition is fierce. BCH only contributes about 6% of consolidated total revenue (Consolidated/Non-consolidated ratio: 1.06) and lags the parent company in profit margin.

Nearly half of Base’s revenue comes from system development for the financial industry (particularly, securities companies). In recent years, revenue from the manufacturing industry has shown rapid growth, making it the second largest customer industry by revenue share, followed by logistics. Trends such as investment in digital transformation and labor shortages in the IT industry have been tailwinds for the company, driving demand for its services.

For Base, revenue is a function of the engineer rate, project duration, and number of engineers, but can also be expressed as the product of revenue per customer, project duration, and number of customers. Base’s engineer rate is on par with that of its competitors, so its revenue growth hinges on engineer deployment capacity (number of deployable engineers x deployment speed). The company hires college graduates and mid-career engineers in Japan and China to raise its number of deployable engineers, and delegates decision-making authority to on-site managers to improve deployment speed. This approach allows the company to respond rapidly to customer needs, setting it apart from its competitors. Base uses a proprietary man-hour management system to manage and maintain systems, allowing it to visualize the work hours of all its teams. Based on collected data, the company aims to effectively allocate resources by redirecting manpower from teams with spare capacity to those carrying heavy workloads.

Revenue growth is driven by increases in the number of engineers, the number of customers, and revenue from major customers. The company has increased its number of employees (engineer-to-all employee ratio of 95%) by 2.4x from 372 (non-consolidated basis at end-FY12/16) to 890 (consolidated basis at end-FY12/21) over five years (external contractors up about 5x from just under 90 to just under 450). Revenue from top customers Fujitsu, Mizuho Securities and Nomura Research Institute has remained stable at just over JPY2.0bn each (48.3% of total revenue from these three companies in FY12/21), but revenue from NTT Data continues to expand. The four major customers generate approximately 59% of total revenue. Base sees ample room for further growth by cultivating new customers and expanding business with existing customers. It estimates the work it undertakes for the major customers represents less than 1% of their total outsourced project costs.

The company balances one-time revenue businesses (mainly system development) and recurring-revenue businesses (Operations & maintenance and Staffing service). Both have the same level of profitability, but recurring-revenue businesses deliver steady revenue that solidifies the company’s earnings foundation. Base plans to continue balancing the revenue shares of its one-time and recurring-revenue businesses in line with economic trends.

The company regards operating profit growth as its most important performance indicator. In FY12/21, it reported operating profit per employee of JPY3.4mn, and OPM of 22.6%, which is higher than the 7.6% average for software companies and the 6.5% average for data processing and provision service companies (source: Ministry of Economy, Trade and Industry's 2021 Basic Survey on the Information and Communications Industry). The high OPM level reflected a combination of strong GPM (29.3% in FY12/21) and a low SG&A-to-revenue ratio (6.7% in FY12/21). By expanding its revenue from existing customers and reducing its dependence on outsourcing, Base builds in-house expertise, reduces loss-making projects, and raises its gross profit. It recovers cash efficiently by using short-term contracts (renewed within three to six months) for system development and by increasing revenue from recurring-revenue businesses (Operations & maintenance and Staffing service). It has reduced its cash cycle from 48 days in FY12/16 to 27 days in FY12/21 by shortening its accounts receivable turnover days.

Earnings trends

In FY12/21, Base reported revenue of JPY13.3bn (+7.2% YoY), operating profit of JPY3.0bn (+23.1% YoY), recurring profit of JPY3.0bn (+24.0% YoY), and net income attributable to owners of the parent of JPY2.1bn (+22.0% YoY).
While the company resumed a project that had been suspended in FY12/20 due to the spread of COVID-19, some projects were either delayed or downsized as a result of repeated states of emergency declarations by the Japanese government. 

In FY12/22, the company forecasts revenue of JPY15.0bn (+12.8% YoY), operating profit of JPY3.6bn (+20.0% YoY), recurring profit of JPY3.6bn (+19.9% YoY), and net income attributable to owners of the parent of JPY2.5bn (+16.1% YoY). While noting that the situation remains uncertain, especially in light of the sudden rise in the number of COVID-19 infections in January 2022, the company generally assumes that the economy will gradually return to normal. Management expects IT investment demand, especially for DX, to remain strong.

Base plans to step up recruiting in Japan, China, and the rest of the world, and continue to add at least 100 new employees per year (net increase after offsetting departures). It aims to rapidly establish a team of 1,000 employees (with a full-time employee to external contractor ratio of 2:1).

Strengths and weaknesses

The company’s strengths: 1) its ability to deploy a large number of qualified engineers thanks to access to both Japanese and Chinese labor markets and internal system of continuous learning, 2) rapid and flexible decision-making by front-line project managers, and 3) consistent focus on high profitability.

Its weaknesses: 1) susceptibility to structural shifts in the software industry due to focus on outsourced projects, 2) challenges with succession planning due to uniform approach toward executive development, and 3) high dependence on certain industries and customers.

Key financial data

Trends and outlook

Quarterly trends and results

Consolidated results for Q1 FY12/22 

• Revenue:           JPY3.9bn   (+27.3% YoY; 26.2% versus full-year forecast)
• Gross profit:       JPY1.1bn   (+24.7% YoY; 24.7% versus full-year forecast)
• Operating profit: JPY924mn (+31.4% YoY; 25.7% versus full-year forecast)
• Recurring profit:  JPY932mn (+33.1% YoY; 25.9% versus full-year forecast)
• Net income:       JPY639mn (+33.0% YoY; 25.9% versus full-year forecast)
  

Highlights

Q1 consolidated revenue of JPY3.9bn was up JPY843mn YoY. Equal to 26.2% of the company's full-year target, this represents a good start for the year. The company reported solid order flows for offshore systems development projects at its subsidiary in China from not only Japanese companies but non-Japanese companies as well.

Q1 gross profit of JPY1.1bn was up JPY225mn YoY. This represents a gross profit margin of 28.8%. The SG&A expense ratio of 5.3% was down 1.3pp versus 6.6% in Q1 FY12/21. 

Q1 operating profit of JPY924mn was up JPY221mn YoY. This represents an operating profit margin of 23.5%, up 0.7pp versus 22.8% in Q1 FY12/21. 

Company forecast for FY12/22

For FY12/22, the company forecasts full-year consolidated revenue of JPY15.0bn (+12.8% YoY), operating profit of JPY3.6bn (+20.0% YoY), recurring profit of JPY3.6bn (+19.9% YoY), and net income attributable to owners of the parent of JPY2.5bn (+16.1% YoY). The company has not changed its stance of targeting an annual increase in operating profit of at least 20% YoY. It targets an operating profit margin of 24.0%, up 1.4pp from FY12/21.

Sales strategy

Market forecast

While noting that the situation remains uncertain, especially in light of the sudden rise in the number of COVID-19 infections in January 2022, the company generally assumes that the economy will gradually return to normal. Management expects IT investment demand, especially for digital transformation, to continue to increase and expand the market.

Major clients (3 systems integrators, Fujitsu Group, NRI Group, NTT Data Group)

The forecast for each company for FY03/22 in its related segment is expected to exceed the FY03/21 results (NRI Group and NTT Data Group increased 10% YoY) due to increased digital transformation and SAP-related demand.

Sales strategy

Obtain projects with a high degree of certainty

The company focuses on projects with high certainty, particularly digital transformation and SAP-related projects, as well as aggressively promote the acquisition of Application Management Outsourcing (AMO) services, a recurring revenue business that provides applications operation and maintenance.

Strengthen sales structure

The company's executives, department heads, and leaders, regardless of their positions, promotes on-site sales. The Business Promotion Department covers the areas that cannot be covered by on-site work.

Customer growth

The company aims to continue steadily increasing transactions with the four major customers. For developing its fifth and sixth pillars, it steadily expands transactions with several major systems integrators and build relationships of trust by leveraging its sales know-how.

Organization/human resources strategy

Organization strategy

The company intends to move the organization from the traditional vertical customer-specific organization to a cross-functional services organization. The systems headquarters will be reorganized from two divisions to three divisions, and the systems divisions will be reorganized from 22 divisions to 28 divisions.

Human resources strategy

The company's policy of recruiting a net increase of 100 employees per year remains unchanged. However, it will shift from traditional mid-career hiring to new graduate hiring, and referral recruitment will also be strengthened. In addition to stepping up the recruitment of foreign nationals at Japanese offices, the company will also expand its recruitment channels. The company also plans to strengthen communications through initiatives such as holding partner meetings in order to actively utilize external partners. This should increase the number of external partners from an average of less than 450 per month in FY12/21 to around 600 per month.

Medium-term outlook

Base does not disclose medium-term management plans. Below, we discuss the company’s medium-term outlook based on the views of company founder and Representative Director Katsunari Nakayama.

Pursuit of new value

President Nakayama established Base in January 1997. He had previously worked as an engineer in China and Japan, and felt that, contrary to its high-tech reputation, the Japanese software industry had undergone little change from its early days, and continued to be closed and suffer from outdated business practices (chief among which was the ambiguous designation of responsibility). President Nakayama believed that the industry lagged other industries in terms of productivity, and that it would ultimately become unable to compete on the global stage if it continued to drift along the same path.

The Japanese software development industry currently has a multi-layer subcontracting structure. User companies fully delegate the software development process to large system integrators, which outsource the various stages of the development process (design, development, testing, and operation) to a series of vertically integrated subcontractors (first-tier, second-tier, third-tier, etc.). This approach is problematic as it depresses the prices that can be charged by lower-ranked subcontractors in the vertical hierarchy, and leads to structural issues such as inefficiencies stemming from intermediary margins and bottlenecks. President Nakayama concluded early on that these problems stemmed from a failure to clearly designate responsibility, and believed this weakness of the existing pyramid structure could be exploited to generate business opportunities.

Base aims to create new value and increase customer satisfaction by enhancing productivity and clearly attributing responsibility in its projects. It is always exploring how to realize the values of its customers, and aspires to be an enterprise that continually provides new value for the customers, says the company.

Serving as a “base” for the IT industry

President Nakayama believes developers should take more pride in outsourced development. In system development, he sees software production (activities such as specifications design and programming) and operation/maintenance as two segments of the market that require the most man hours, and believes it is critical for Base to solidify its foundations in these areas. The company ultimately aims to serve as a base for the IT industry (hence its name), and wants Base to be the top-of-mind brand when it comes to software production. 

Anticipating transformation in software industry

Comparison with pioneer in quality assurance for outsourced software testing

Another company that aims to create new value for its customers and, like Base, specializes in a single business field is leading software testing company SHIFT (TSE1: 3697). SHIFT believes the software industry will increasingly adopt a horizontal business division like other industries, where specialist vendors at each development process have autonomy. In this model, SHIFT aims to take on the role of managing such multi-vendor projects by providing quality assurance through software testing. Base, on the other hand, aims to be the first-tier subcontractor in the multi-layer subcontracting structure, and create new value in software production (specifications design and programming).

Successful transformations in the semiconductor and mobile phone industries

The transition to a horizontal business division is already underway on a global scale in the semiconductor and hardware (smartphone) industries in the form of foundries and outsourced electronics manufacturing services (EMS). The companies that dominated the semiconductor industry in the past, such as IBM and Japanese semiconductor manufacturers, were all vertically integrated. Over time, the production process (where cost is key) have been supplanted by foundries such as Taiwan-based TSMC. Companies such as Apple have shifted their focus to product design, product requirement specifications, and specifications design, and fully outsource manufacturing to EMS providers such as Hon Hai Precision Industry (Foxconn Technology Group), which operates mainly in China. This is because a horizontal business division is ideally suited for industries that require massive capital investment (semiconductors) or substantial parts supply (smartphones). The semiconductor and smartphone industries are therefore prime examples of how structural transformation can create new value by improving productivity, introducing new technologies, and clearly designating work responsibilities.

Investment in human resources 

Whereas the semiconductor and smartphone industries are equipment-centric, the software industry is labor-intensive. In other words, semiconductor and smartphone manufacturers invest heavily in equipment, while software developers mainly invest in human resources. Base is no exception, and the company has increased its hiring budget in an effort to recruit over 100 people per year (net increase after offsetting departures). However, excessive hiring tends to increase the company’s training burden and depress productivity per employee, so Base tries to maintain a balance between personnel increases and productivity per employee.

In order to maintain cutting-edge technology and a high level of quality, the company is placing an emphasis on skills development, leadership development, and employee follow-up. In terms of skills development, the company is collaborating with customers and partners to provide training in the most up to date technologies. It is also focusing more on training in agile development, which is highly suitable for digital transformation. Regarding leadership development, the company is implementing an early selection and training system and developing the next generation of departmental managers through a dedicated training curriculum.

Revenue correlated with number of employees

The company’s revenue has more or less expanded in tandem with the number of employees. The employee count and revenue per employee have concurrently increased since FY12/17. Its revenue and employee count plateaued temporarily in the wake of the global financial crisis and the Great East Japan Earthquake, but have trended up since around 2017 as the push toward DX resulted in severe labor shortages in the IT market. The Japanese market for outsourced software development is valued at just under JPY9tn, so the company has ample room for further expansion in this industry. 

Base will continue to strengthen recruitment of human resources in Japan and China, as well as from the rest of the world, and it plans to add at least 100 new employees per year (net basis). The company’s organic growth can be expressed using the following formula: revenue (operating profit) = number of employees x revenue (operating profit) per employee. Assuming productivity per employee holds steady, revenue should rise in tandem with growth in the number of employees. The company aims to rapidly build a team of 1,000 full-time employees. 

Base regards M&A as one path to secure human resources, but it is currently taking a wait-and-see approach as deals have become expensive. In January 2017, the company added about 60 people to its workforce when it acquired Goto Software. This, coupled with a move to a new management structure, drove a decline in revenue and operating profit per employee in FY12/17, but both bounced back to pre-acquisition levels by FY12/19 as synergies from the acquisition began to emerge. According to Base, obtaining new manpower and customers through acquisitions would be a viable option from the standpoint of capital efficiency, if the company were to rapidly increase its revenue to several times the current level. 

Business

Business model

Business fields (consolidated, service lines)

Base provides outsourced software development services to its customers by leveraging the strengths of Japanese and Chinese engineers. It operates in four service lines: SI Services, ERP Solutions, ICT Solutions, and Japan-China Solutions. SI Services include system development as well as operation and maintenance. ERP Solutions mainly covers SAP integration and maintenance support. ICT Solutions includes electronic Know Your Customer (e-KYC) solutions, online ID confirmation services, and ICT-powered BPO support. In Japan-China Solutions, the company provides offshore solutions and also sells to local Chinese companies, mainly through its Chinese subsidiary Base (Wuxi) Information Systems Co., Ltd. (“BCH”). BCH only contributes about 6% of total consolidated revenue (Consolidated/Non-consolidated ratio: 1.06), and lags the parent company in profit margin. Base has refrained from actively expanding in China, where competition is fierce, and considers Japan its main target market.

The company discloses revenue data by core businesses of the parent, which divide into System development (Development [narrowly defined], Operations & maintenance, and Staffing service), ERP solutions, and Other solutions (BPO and OCR). The relationship between the core businesses (parent) and the service lines (consolidated) are shown in the following table.

Main businesses

Revenue shares (parent-only basis)

Base discloses parent revenue shares for the following businesses: System development, roughly 52% of revenue; operations & maintenance, roughly 16%; staffing service*, roughly 12%; ERP solutions, roughly 17%; and Other solutions, roughly 3% (BPO and OCR).

^*Staffing Service entails fixed-term deployment of staff to customers mainly under worker dispatch contracts.

In relation to the service lines, the Staffing Service business belongs to SI Services. The Other Solutions business (parent) includes Base’s proprietary corporate services (yet to account for a material portion of revenue) that fall under the consolidated service line of ICT Solutions.

Development (roughly 52% of revenue)

In the system development business, Base mainly develops open-source-based systems (which run software on top of an open-source operating system on a server) for the financial, logistics, and manufacturing industries. It has a particularly strong track record in building systems for the financial industry such as securities companies, banks, and credit card companies.

The company offers comprehensive services that span all aspect of the system development process ranging from defining requirements, basic design, detailed design, programming design, and programming to various types of testing, migration and release, and post-launch operation and maintenance. In an effort to improve quality at an organizational level, the company (1) manages projects meticulously to avoid delays and/or rework, (2) conducts third-party quality control checks through a specialized department, and (3) stringently follows and works to enhance its plan-do-check-action (PDCA) cycles.

Operations & maintenance (roughly 16% of revenue) 

In this business, Base’s staff are stationed at customers’ IT/helpdesk divisions to operate and provide maintenance services to new and existing systems. The company focuses on educating these staff with knowledge of customer businesses, thereby building their non-technical skills. Further, engineers who were involved in the development phase of these systems are often included in the staff members to have in place a team that can meet customer needs promptly. This setup also allows Base to keep track of customers’ organizational changes, addition of new products, or modification of business processes, which enables the company to win development assignments (such as systems enhancement, functionality expansion, and UI improvements) for core and peripheral systems.

In systems management, Base uses its proprietary man-hour management system b.mat (which tracks man-hours per project to visualize engineer deployment) to ascertain the hours worked by each team. This allows the company to effectively allocate resources by redirecting manpower from teams with spare capacity to those carrying heavy workloads, thus contributing to cost reductions. From a customer perspective, this normalizes the workload of related divisions, reducing peaks (busy periods) and troughs (downtime), and thus contributes to efficient utilization of resources.

Staffing service (roughly 12% of revenue)

In the Staffing Service business, Base dispatches systems developers and operators to customers as a service accompanying system development. Sharing a common viewpoint with the customer, these staff mainly engage in systems planning, requirement discussions with end users, project management, and problem solving. For development or operation/maintenance projects mandated to Base, the company’s dispatched staff often collaborate with its systems developers (assigned to the project) to ensure greater mutual understanding of the requirements and systems specifications, which leads to more secure and efficient development work.

ERP solutions (roughly 17% of revenue)

In the ERP solutions business, Base mainly provides ERP, CRM, and BASIS (business application software integration systems) solutions centered on SAP SE products. Leveraging its experience and expertise gained in ERP-related services, the company provides consulting, development, and operation/maintenance services associated with implementation, upgrade, and migration projects.

Other solutions (BPO and OCR) (roughly 3% of revenue)

In the Other solutions business, Base leverages its experience in development projects to build proprietary solutions, which it proposes to customers. The company’s solutions for NISA* (setup) and the My Number** system have been adopted by multiple customers. Base also proposes ways to support customer operations through business optimization and workflow improvements using cutting-edge technology. The adoption of OCR-based card number recognition system in account setup operations at customers (applicable to a variety of cards including driver’s licenses, My Number cards, and credit cards) is one such example.

* NISA, short for Nippon Individual Savings Account. Individual investors (limited to residents of Japan) with a NISA account are offered a certain amount of tax exemption for small investments.
** My Number: Japan’s social security and tax number system comprising a unique 12-digit number allotted to each registered resident in Japan.

Accompanying these solutions, Base also provides BPO services. While BPO services generally entail the outsourcing of administrative functions, the company goes a step further to combine administrative tasks with IT solutions in its offerings. 

System development (one-time revenue business)

Overview of system development

System development refers to the process of designing, programming, and testing to develop IT systems for corporate operations. The process is divided into two stages handled by different professionals. Systems engineers oversee outline design, specification of requirements, and basic design (sometimes collectively referred to as upstream processes). Programmers engage in subsequent detailed design, programming, testing, and deployment support. In addition to defining requirements and creating systems design, systems engineers generally handle operation and support, while programmers focus on writing codes based on the design specifications provided by the systems engineers. The system development flow and an estimated share of allocated work hours are shown in the following diagram and graph.

Within system development, Base sees software production (design and programming) and operation/maintenance as two segments of the market that require the most man hours. Detailed design and programming account for 44% of Base’s total man hours (person/month), and this goes up to 58% if adding in basic design. The company derives 59% of its revenue from its four major customers, and we estimate projects undertaken for these customers concentrate on the production phase of the overall system development process. 

Technological advances drive increase in outdated (legacy) systems

Amid accelerated digital transformation initiatives, in recent years, the IT industry has seen an increase in investment projects that involve advanced technologies such as IoT, cloud, robotic process automation (RPA), and fintech. However, according to the Nikkei xTech investment survey conducted in FY2012, companies on average manage to allocate only 24.3% of their IT budgets toward new development, compared with 44.9% for operations and management and 30.8% for maintenance-related development. The “Domestic IT Investment Trends” survey conducted by ITR in 2017 puts new development at only 31% of IT budgets (of which investment to support business growth accounted for 32%, operational efficiency 37%, and business continuation 31%).

Industry observers have warned that Japanese companies are being held back by so-called legacy systems that are outdated, bulky, complex, and closed (“Digital Transformation: Overcoming of ‘2025 Digital Cliff’ Involving IT Systems and Full-fledged Development of Efforts for Digital Transformation,” METI). In Japan, where 70% of the IT engineers are employed by vendor companies, it is not uncommon for such companies to undertake outsourced development that starts from the specification of requirements. Base aims to secure orders and steadily expand its business by identifying the challenges and needs of its customers and providing corresponding solutions.

Characteristics of Base’s system development

Base’s core business is the system development business and because it focuses on outsourced development, success in this business hinges to a large extent on building close relationships with customers. To maximize the value it provides to customers, Base pursues a growth strategy underpinned by advanced technical capabilities, quality, and rapid personnel deployment. The company says it maintains access to world-class technologies through its long-term relationships with major customers (large system integrators such as Fujitsu), and provides quality solutions underpinned by its training system that starts at an early stage.

In terms of rapid personnel deployment, the company is able to deploy a roughly equal number of Japanese and Chinese engineers, which results in twice the engineer deployment capacity and speed of many of its rivals. Against the backdrop of growing shortages of IT personnel and hiring difficulties in recent years, Base’s capability to instantly and flexibly deploy employees has been a competitive advantage in securing customers, according to the company. 

Base also subcontracts work (to several dozen companies at the parent level, over 100 companies at the consolidated level) as necessary, but it ensures quality control by maintaining a high share of in-house development (full-time employee to external contractor ratio of 2:1). The company also encourages its employees to obtain various qualifications, not only related to IT but also in fields such as finance. It believes these can contribute to a deeper understanding of customer operations, and therefore prove useful in cultivating new customers or expanding business at existing customers. Base’s subcontracting ratio (number of external contractors [monthly average] / full-time employees [average for the fiscal year]) has increased in recent years, rising from roughly 25% in FY12/17 to about 44% in FY12/18, roughly 56% in FY12/19, about 60% in FY12/20 and about 69% in FY12/21. As labor shortages persist while orders continue to climb, its subcontracting ratio may increase further, but the company thinks it can maintain high quality by improving the development capabilities of its subcontracting partners.

Types of outsourcing contracts and risk control (based on Japanese law as of March 2020)

“Ukeoi” and “jun-inin” contracts

Japanese law distinguishes between two broad types of outsourcing contracts: “ukeoi” (contracts for work) and “jun-inin” (quasi-mandate) contracts. Under contracts for work, remuneration is contingent upon completed work (that is to say, the objective of the contract is work completion), whereas under quasi-mandate contracts, remuneration is based on the actual amount of work performed. In other words, contractors have a responsibility to deliver a completed product under a contract for work, but not under a quasi-mandate contract. 

Responsibility to complete work

Under contracts for work, outsourcing parties can delegate part of the development work to a contractor, thereby transferring responsibility for the allocated work (including management and education of personnel necessary to complete the work) and the accompanying risks to the contractor. They can also expect to ultimately receive a completed product. At the same time, these contracts impose a completion responsibility and defect liability on contractors. The completion responsibility means contractors have an obligation to deliver a completed work product to the outsourcing party. The defect liability requires contractors to fix any defects discovered in the completed work product without additional charges (however, this liability only applies during a predetermined period, which is typically one year following delivery).

Additional charges, additional work hours incurred

Generally speaking, it is difficult to accurately define the completed product for a system development project in the initial stages of the project. If work that was not included in the original scope of the contract emerges, the contractor will bill additional charges to the outsourcing party, resulting in additional expenses at the latter. Conversely, if the contractor is unable to complete the product by the agreed deadline, or if defects are discovered in the product, the contractor will incur additional work hours, which will depress its own profit. Because IT systems have become increasingly complex in recent years, it is often not possible to discern detailed requirements at the time an outsourcing agreement is concluded. 

Contract types employed by Base

Base’s contracts vary according to its business areas. The company generally concludes contracts for work and quasi-mandate contracts in the system development business. For the Operations & maintenance and Staffing service businesses, it either enters into a quasi-mandate contract or a worker dispatch contract. In the ERP solutions business, it principally uses contracts for work. Base mitigates risks specific to outsourced development by renewing its contracts every three to six months. 

Multi-layer subcontracting structure

The Japanese software development industry currently has a multi-layer subcontracting structure. User companies fully delegate the software development process to large system integrators, which outsource the various stages of the development process (design, development, testing, and operation) to a series of vertically integrated subcontractors (e.g., first-tier, second-tier, and third-tier). This approach is problematic as it depresses the prices that can be charged by lower-ranked subcontractors in the vertical hierarchy, and leads to structural issues such as inefficiencies stemming from intermediary margins and bottlenecks. Within this structure, Base operates as the primary vendor or first-tier subcontractor for many of its customers.

Expansion of industry coverage

Financial industry as the pillar

Base offers outsourced development services to roughly 70 (large) companies operating in a broad range of industries including financial, industrials, logistics, telecommunications, public services, and infrastructure. The company’s strength has been in outsourced development for the financial industry (specifically securities companies), which accounts for roughly half of the company’s revenue. In recent years, the company has seen a rapid increase in revenue from industrials, which now brings in revenue on par with logistics.

Base sees expansion of business with existing customers as a top priority. It also aims to venture further into new customer fields such as industrials and insurance, and capture major projects related to retail brokerage in the securities field. The company’s major trade partners are industry-leading companies such as the Fujitsu group, Mizuho Securities, Nomura Research Institute, and NTT Data. Turning to sales channels, Base approaches customers either by using system integrators as an intermediary or via direct sales. 

Development of three key industries (financial, logistics, industrials), and cultivation of new fields 

Base has undertaken outsourced development for a variety of companies in the financial industry (securities companies, banks, non-life insurers, leasing companies, and credit card companies), ranging from the development of core systems such as investment trust backbone systems (maintenance and management), time deposit systems for megabanks, and securities account systems, to non-life insurer call centers (with Computer Telephony Integration [CTI] support) and compliance systems for securities companies. In the distribution industry (retail, wholesale, transport, warehousing, e-commerce), the company has delivered systems for a wide array of backbone operations such as retail sales management systems, transport management systems, and call center systems. While Base does not yet have an extensive track record in building industrial systems, its outsourced development in this field has increased rapidly in recent years, growing into a third pillar on par with logistics. Compared to the financial, logistics, and industrials industries, the company has a relatively small presence in the public sector (social security, government agencies, postal services, and government-controlled competitive sports), telecommunications (cable TV, telecom carriers), and infrastructure (infrastructure construction, operation, and monitoring); it sees plenty of room to expand in these massive markets.

Prime vendor of IT services to securities companies

Base’s principal field of expertise is IT services for securities companies. As a prime vendor, the company provides IT support services tailored to the management themes of major traditional and online securities companies, leveraging its accumulated expertise in front, middle, and back-office IT systems and operations. Its engineers have securities sales representative qualifications, and can offer IT support underpinned by business and technical knowledge, says the company. Base has accumulated a track record as a prime vendor in the field for more than 10 years, and has developed relationships of trust with customers. The company is using the expertise gained from working with four securities companies to cultivate new customers in the field. It also provides BPO services for administrative operations related to account setup, NISA, My Number, and various notifications.

Expanding business with major customers

Sustainable business relationships with major customers 

The company’s four major customers (Fujitsu, Mizuho Securities, Nomura Research Institute and NTT Data Global Solutions) account for a high and stable share of total revenue, at about 59%. That share rises to roughly 75% if adding in Fujitsu and Nomura Research Institute group companies and the NTT Data Group. Base has long-term relationships with its major customers. It has conducted business with Fujitsu since its inception in 1997, with Mizuho Securities since 2002, with Nomura Research Institute since 2013, and with NTT Data since 2017. Base continues to focus on order expansion at NTT Data, which it looks to develop into a fourth major customer. At the same time, the company aims to leverage its experience to date in the securities space to cultivate new end users as customers.

Fujitsu is one of the company’s main customer (generating 19.5% of revenue) and a major shareholder (with a stake of 8.6%). Since the company’s establishment, Base has conducted business with Fujitsu, and its Chinese subsidiary BCH is a joint venture with Fujitsu. Base is also a certified Core Partner of Fujitsu. It has in the past invited Fujitsu officers to serve as external directors on its board, and accepts personnel seconded by Fujitsu.

Expanding revenue per major customer

Base is recognized as a first-tier subcontractor by departments of its three major customers for which it has previously undertaken system development projects. However, it thinks there is plenty of room to further expand orders from these accounts. The company estimates the work it handles for the three companies corresponds to less than 1% of their total outsourced project costs. It therefore looks to expand revenue from each customer by capturing new orders from departments with previous dealings, as well as orders from other departments. For example, once the company develops logistics and/or manufacturing-related systems for a major customer, it will not only pursue vertical expansion but also seek to leverage that expertise horizontally to secure projects related to finance, public services, or other fields. In line with this strategy, the company undertook its first systems maintenance and management project (Operations & maintenance business) for Mizuho Securities in 2009.

Developing NTT Data Group into fourth major customer

NTT Data Group has been established as a major trading partner of the company. In FY12/21, revenue from NTT Data Global Solutions doubled from 5.5% in FY12/20 to 10.2% of total revenue. NTT Data operates across a range of industries, which opens the door for outsourced development projects in fields such as finance, logistics, social infrastructure, manufacturing, and SAP. Base has gone all out to deploy engineer resources to NTT Data and its group companies in fields in which it has a proven track record. 

Operations & maintenance and Staffing service (recurring revenue businesses)

Operations & maintenance, management

Base offers systems maintenance and management services in a broad range of fields. Thanks to its operational knowledge on specific businesses and its technical knowledge on system development, the company is able to complement its operation and maintenance services with management services. Base has served as the project management office (PMO) and conducted testing for large projects, and has built favorable relations not only with the IT divisions of its customers but also with divisions that use its systems as well as with other vendors. In addition, the company has experience in system risk management, including compliance with the Sarbanes-Oxley (SOX) Act, audit support, project risk monitoring (PRM), and cybersecurity.

Recurring-revenue businesses provide solid earnings foundation

Base takes measures to anticipate customer needs so that it can rapidly respond to unforeseen events while providing quality assurance. The Operations & maintenance and Staffing service businesses generate stable recurring revenue, and thus solidify the company’s earnings foundation. Base aims to keep a balance between its one-time revenue businesses (mainly system development) and its recurring-revenue businesses, which presently account for roughly 40% of revenue.

IT staff dispatch and RPA integration support

By dispatching its staff to customer sites, Base accumulates hands-on experience in customer operations, remains informed of project progress, and familiarizes itself with customers’ internal rules and procedures. In addition, the company employs a large number of engineers who can program RPA bots, and offers RPA integration support to IT and other departments that handle administrative work.

ERP solutions—core business areas

Provides comprehensive services

Base relies on the expertise and knowledge of its certified SAP consultants with 10 years plus industry experience to provide comprehensive solutions for SAP package integration, ranging from conceptual planning of systems to business design, system development, infrastructure construction, testing, migration, and post-launch support. When it comes to implementation of ERP systems such as S/4HANA and Hybris, the company leverages its advanced technical capabilities and mobility to offer optimized solutions in response to customer needs. Base shines in technical services that combine ERP and open-source systems, and the construction, quality control, and operation/maintenance of world-class systems by a team of multi-national engineers. 

Focus areas

While ERP software giant SAP has thus far mostly offered traditional ERP solutions, its focus has been shifting to the succeeding S/4 HANA and innovation systems. SAP Leonardo is an innovation system that offers a portfolio of emerging technologies such as machine learning, blockchain, big data, Internet of Things (IoT), and analytics. Base provides comprehensive implementation support services for the SAP ERP platform, the SAP Cloud platform, and open platforms.

KPIs

Growth in operating profit as first priority

Operating profit over revenue

Base has regarded growth in operating profit as its most important KPI over the last 10 years. Because it prioritizes absolute levels of operating profit over revenue, the company has been able to avoid risky projects driven by a revenue-centric approach. Throughout its history, Base has undertaken very few projects that resulted in losses, and it has operated consistently in the black since its establishment. In FY12/21, Base reported OPM of 22.6%, which is higher than the 7.6% average for software companies and the 6.5% average for data processing and provision service companies (source: Ministry of Economy, Trade and Industry's 2021 Basic Survey on the Information and Communications Industry). The company also managed to ride out the global financial crisis with minimal impact. Base reduces the risk of contingencies and rework by using short-term contracts that are renewed every three to six months. 

High profitability and productivity

Base’s operating profit corresponds to revenue minus manufacturing costs and SG&A expenses. The company boasts a high productivity per engineer (operating profit per employee of JPY3.4mn in FY12/21 compared with an average of 1.7mn at four competitors), which is a reflection of the skill levels of its employees and a relatively high in-house development ratio (full-time employee to external contractor ratio of 2:1). Base reduces rework through the conclusion of short-term contracts that are renewed every three to six months, which effectively lowers its production costs. In addition, its high engineer employee ratio has kept its SG&A-to-revenue ratio down to around 10%. The company stations on-site managers with decision-making authority, and Shared Research believes this approach not only minimizes indirect expenses (because only decisions on high-risk projects are escalated to the headquarters), but also reduces the number of lost orders compared to rivals where all decision-making power is vested in the headquarters. 

Engineer deployment capacity, spend per customer, and number of customers are key

Base’s revenue is a function of its engineer rate, project duration, and number of engineers, but can also be expressed as the product of revenue per customer, project duration, and number of customers. Its engineer rate is on par with that of its rivals, so revenue growth hinges on engineer deployment capability (number of deployable engineers x deployment speed). To expand the number of deployable engineers, Base hires college graduates and mid-career engineers in Japan and China. To increase deployment speed, the company delegates decision-making authority to managers stationed at customer sites, allowing it to rapidly respond to customer needs without having to wait for sign-off by the headquarters, which sets it apart from competitors. Base also uses a proprietary man-hour management system (b.mat) that helps it maintain and manage systems by visualizing the work hours of each team. Based on collected data, the company effectively allocates resources by redirecting manpower from teams with spare capacity to those carrying heavy workloads.

Revenue growth is mainly driven by increases in the number of engineers, the number of customers, and revenue from major customers. The company increased its number of employees 2.4x (engineer-to-all employee ratio of 95%) from 372 (non-consolidated basis at end-FY12/16) to 890 (consolidated basis at end-FY12/21) over five years. Revenue from top customers Fujitsu and Mizuho Securities has remained stable at just over JPY2.0bn each (reflecting revenue shares of just under 20%), and revenue from Nomura Research Institute and NTT Data continues to grow rapidly. The company’s top four customers (Fujitsu group, Mizuho Securities, Nomura Research Institute group, and NTT Data group) generate roughly 75% of total revenue. Base sees ample room for further growth in revenue by cultivating new customers and capturing new orders from existing customers. It estimates that the work it handles for its major customers corresponds to less than 1% of their total outsourced project costs.

Japanese-Chinese collaboration boosts synergy and recruiting capabilities

Roughly equal number of Japanese and Chinese engineers

Base has leveraged the networks of its founders—President Katsunari Nakayama and Senior Managing Director Yoshimitsu Ito, who are Chinese IT engineers—to develop strong ties with reputable universities in China and thus gain access to Chinese engineers. President Nakayama believes the company’s growth is driven by synergies derived from the combined strengths of its Japanese and Chinese engineers, with the former contributing an emphasis on quality, strong team harmony, and an understanding of Japanese customs, and the latter an interest in new technologies, work speed, and a strong appetite for growth. According to the company, the Japanese and Chinese staff complement and inspire each other, and this international collaboration gives rise to added value and synergies. Base maintains an even balance between Japanese and Chinese employees in both regular and management positions. The key benefits of working with a mixed team are: (1) different value systems promote mutual encouragement and autonomous growth, (2) a balanced work environment increases motivation, and (3) access to job markets in Japan and China doubles the company’s recruiting capacity.

In addition to China, Base also recruits human resources in South Korea, Bangladesh, and India. However, it currently has few non-Chinese foreign nationals among its employees, and Shared Research believes the company could reap many benefits from further opening its doors to talented human resources from around the world. 

Status of foreign nationals employed in Japan (Chinese nationals account for just under half)

As of end-October 2018, the Japanese information and communications industry employed 57,620 foreign nationals, with Chinese nationals making up just under half (27,088). The company says Base is naturally an attractive prospective employer for Chinese engineers who wish to work in Japan, since it offers a balanced work environment comprising a roughly equal number of Japanese and Chinese employees. the company is making headway in global recruitment, and in this sense resembles Tata Consultancy Services Japan, Ltd., the Japanese arm of India-based Tata Consultancy Services Limited. 

China’s share of worldwide college students 

China has the highest number of college students in the world at 37mn, according to the Chinese Ministry of Education. As the global college student population stands at 290mn, this means that one in seven or eight college students in the world (share of nearly 13%) studies at a Chinese university. Japan currently has 2.9mn college students, equivalent to a global share of only 1%. The university advancement rate in China appears to have increased from 40% in 2015 to 50% in 2019. Over the last 16 years, 678 new university faculties and graduate schools (including independent graduate schools) have been established in China, which is half of the total number of such institutions in the country. China has 339 prefectural-level municipalities (administrative unit that ranks somewhere between a province and a prefecture) and much larger number of cities. University faculties and graduate schools have now been established in 196 cities (coverage ratio of 57.8%), correcting the past overconcentration of such institutions in megacities such as Beijing and Shanghai. Meanwhile, industry observers have indicated that students graduating from Chinese engineering schools, which are closely tied to the development of the Chinese manufacturing industry, lack in the capacity to resolve complex problems and in work ethics.

Revenue composition

Since Base operates in a single segment of Outsourced Software Development, it does not release information by segment. However, the company discloses revenue for major customers with a revenue share of over 10%. Revenue from Fujitsu (the company started transactions in 1997) accounts for about 20% of Base's revenue, while Mizuho Securities (started from 2002) accounts for roughly 14%. The revenue share for Nomura Research Institute has increased each year since transactions began in 2013, and currently stands at around 15%.

Fujitsu is one of the company’s main customers (accounting for 19.5% of revenue in FY12/21) and a major shareholder (8.6% stake at end-FY12/20). Base has conducted business with Fujitsu since its establishment, and its Chinese subsidiary BCH is a joint venture with Fujitsu. Base is also a certified Core Partner of Fujitsu. It has in the past invited Fujitsu officers to serve as external directors on its board, and accepts personnel seconded by Fujitsu, all of which attest to the strong relationship between the two companies. Base regards Fujitsu as a top-priority customer, and feels indebted for the support it received since its early years. Base has similarly had a long business relationship with Mizuho Securities. This account started to contribute to Base’s earnings stability and earnings growth from 2009, when the company was mandated a systems maintenance and management project (Operation & Maintenance business) in the wake of the global financial crisis. The project marked the true beginning of the company’s recurring-revenue businesses, and the resulting earnings stability has allowed it to mitigate the negative impacts of the global financial crisis and Great East Japan Earthquake.

Base conducts business with over 60 other trade partners. Among these partners, NTT DATA that the company started business with in 2017, is rapidly increasing its presence as a new pillar. In FY12/2021, revenue from NTT Data Global Solutions rose to 10.2% of total revenue. Shared Research believes Base’s dealings with industry-leading companies continue to enhance its reputation in the IT space, creating a virtuous circle.

Main group companies

Base has two consolidated subsidiaries: Base (Wuxi) Information Systems Co., Ltd. (commonly referred to as BCH; 59.8% of voting rights) and BCH Japan Co., Ltd. (59.8%). BCH, a Chinese subsidiary established in October 2008 with investment from three Fujitsu group members, develops systems as offshore solutions and for local Chinese companies. BCH Japan is a wholly owned subsidiary of BCH. 

The original objective of offshore development was to reduce costs by leveraging price level differences in Japan and China. Today, offshore development is used not only to achieve cost reductions, but also to compensate for the shortage of systems engineers in Japan.

Base established bbc Co., Ltd. in July 2011, and made Goto Software Co., Ltd. a consolidated subsidiary via a share acquisition in January 2017. It absorbed both companies in January 2018 via an absorption-type merger. The company expects BCH to operate as an independent company in the Chinese market in the future. BCH contributes several percent of consolidated revenue, and lags the parent company in profitability. Base has refrained from actively pursuing expansion in China, where competition is fierce, and considers Japan its main target market. 

Profitability analysis

Complementary effects of growth in operating profit 

Base considers operating profit growth its most important KPI. While this may appear to be a somewhat elementary indicator at first glance, concentrating on this KPI leads to improvement in other profitability metrics. Growth in operating profit tends to contribute to improvements in GPM and OPM. Cash and deposits and capital stock have increased following Base’s listing, as the company has no major capital needs aside from investment in recruiting. Although the equity ratio has remained at high levels, its ROE should continue to improve as long as its total asset turnover ratio and net income margin expand further (ROE improved from 24.2% in FY12/18 to 28.2% in FY12/21).

Contraction in cash cycle 

The company’s cash cycle contracted in the space of a few years from 48 days to 27 days in FY12/21. Shared Research understands that Base is able to efficiently recover cash because (1) it uses short-term contracts (renewed every three to six months) for system development, and (2) it is increasing earnings of recurring-revenue businesses such as the Operations & maintenance and Staffing service businesses. While the company’s inventory turnover days and accounts payable turnover days have held more or less steady, its accounts receivable turnover days have contracted.

Productivity gains lower cost ratio and SG&A expenses

The company boasts a high level of productivity per engineer (operating profit per employee of JPY3.4mn in FY12/21 compared with an average of 1.7mn at four competitors), which is a reflection of the skill levels of its employees and a relatively high in-house development ratio (full-time employee to external contractor ratio of 2:1). Further, Base has reduced its manufacturing cost ratio by concluding short-term contracts that minimize rework, and kept its SG&A-to-revenue ratio down to around 6.7% by maintaining a high engineer (to all personnel) ratio of 95%. It reported industry-leading OPM of 22.6% in FY12/21.

Market and value chain

Information and communications industry and market size

Below, we take a look at the results of the “2021 Basic Survey on the Information and Communications Industry” (as of March　31, 2021) conducted by the Ministry of Internal Affairs and Communications (MIC) and Ministry of Economy, Trade, and Industry (METI). According to the survey, in FY2020, Japan was home to 5,987 companies that engaged in information and communications-related operations (meaning companies that are engaged in the information and telecommunications industry in any small way, whether as a main business or not), with FY2020 sales of JPY53.4tn (JPY74.2tn including revenue in areas other than the information and telecommunications industry). A breakdown by specialization indicated that telecommunications marked the highest revenue, followed by software, and data processing and provision services. Together, they accounted for 79.4% of the total information and communications industry with 33.4% from telecommunications, 31.2% from software, and 14.9% from data processing and provision services.

Software industry market size

In FY2020, revenue from information services providers stood at JPY18.8tn down JPY205.6bn compared to 2019. This was largely due to a JPY287.1bn decline in the mainstay contract development software business. Revenue per company was JPY5.0 bn (-3.1% YoY). By industry sector, the game software industry showed significant growth (+16.7% YoY). By industry, outsourced software development also had the greatest number of companies with a 46.7% share, followed by information processing services with 24.4%. The two industries accounted for approximately 70% of the total.

Promotion of digital transformation and related challenges

METI has compiled a report, “Digital Transformation: Overcoming of ‘2025 Digital Cliff’ Involving IT Systems and Full-fledged Development of Efforts for Digital Transformation,” summarizing the Working Group discussions on the state and issues of software development in Japan that presents a hurdle for digital transformation (DX). The Working Group identified two structural problems unique to Japan that inhibit DX promotion: (1) existing systems being overly closed and complex, and (2) delays in upgrading the skillset of IT engineers. These problems are already manifesting as evidenced by the fact that major financial institutions are successively writing down system-related assets (examples include Mizuho Financial Group and Mitsubishi UFJ Financial Group’s credit card subsidiary).

The write-downs are mainly attributable to delays in post-integration processes, a worsening business environment, and slow adoption of new technologies. The rise of new technologies such as blockchain and fintech have turned traditional large systems into a “negative inheritance” for financial institutions. Enhancing the efficiency of system development has become a priority issue not only at leading financial institutions, where the sense of urgency is strong, but across all industries. Given this environment, vendor companies are called to provide value to user companies by leveraging personnel who can stay up to date with rapidly changing digital technologies.

Closed and complex nature of existing systems

Need for IT engineers to upgrade skillset

Shortage of IT resources

The Ministry of Economy, Trade, and Industry (METI) has warned the shortage of IT personnel while demand for IT is increasing over the long term: in its March 2019 Survey on IT Personnel Supply and Demand, the Ministry published a forecast for IT personnel shortages based on three scenarios (high, medium, and low level of shortage) for IT demand through 2030. According to the report, there will be a shortage of about 450,000 IT personnel in 2030 under the medium-shortage scenario and about 790,000 under the high-level shortage scenario. IT human resources include system consultants, designers, software developers, and data processing and communication engineers. 

Trends at competitors

Selection of comparable companies

Among the large number of companies engaging in outsourced software development, Base regards R&D Computer Co., Ltd. (TSE1: 3924), System Information Co., Ltd. (TSE1: 3677), and NSD Co., Ltd. (TSE1: 9759) as peers or rivals. Shared Research has also added outsourced software testing company SHIFT to the group below because it resembles Base in that it is a relatively young company (with a similar average employee age) that operates in a single segment.

System Information

An independent system development company. System Information competes with Base for orders from NTT Data. The main customers are Mitsubishi Electric Information Systems, Dai-ichi Life Information Systems, and NTT Data (as at September 2021). By customer industry, Base derived 33.3% of revenue from insurance, 2.0% from public insurance, 22.6% from logistics and services, 9% from finance, 12.7% from manufacturing, 12.3% from telecommunications, and 8.0% from public agencies. Base and System Information used to have capital ties through cross shareholdings.

R&D Computer

An independent systems integrator with three business segments: SI services (contract development), infrastructure solutions services (system infrastructure and network construction), and package-based SI services (software package products). Major clients are Fujitsu Group, Hitachi Group, and NTT Group (as of FY03/21). The revenue breakdown is SI Services (62%), Infrastructure Solution Services (16%), and Package-Based SI/Services (22%).

NSD

Base regards system integrator NSD as a benchmark company. NSD generates roughly 6x the revenue of Base, and boasts a comparatively high OPM of 14.9% (FY03/21). The revenue breakdown is System development (89%) and Solutions (11%). It employs some 3,000 engineers and leverages its engineer deployment capacity to provide services to the financial industry and a broad range of other fields. For FY03/21, it derived 31.4% of its revenue from the financial industry, 45.8% from manufacturing and social infrastructure IT, 12.2% from IT infrastructure, and 10.7% from solutions businesses.

SHIFT

SHIFT specializes in software verification testing. The third-party verification and quality assurance software testing business provides consulting, solutions, and a quality assurance platform to support customers' software testing operations. Its segments are enterprise (93%) and entertainment (7%). SHIFT continues to recruit personnel on a large scale (1,000 new hires per year) to increase its employee deployment capacity.

Comparison of financial indicators

Productivity per employee 

Revenue per employee tends to increase sharply with the deployment of external contractors. Base lags System Information, R&D Computer, and NSD in revenue per employee, but Shared Research suspects the divergence is attributable to a high reliance on subcontracting at the company’s three rivals (no related information disclosed in the securities reports of the three companies). Because subcontracting costs are included in cost of revenue, Shared Research believes operating profit per employee is a better indicator of productivity per employee. Operating profit per employee for FY12/21 was JPY3.4mn for Base, JPY2.8mn for NSD, JPY1.9mn for System Information, JPY1.2mn for R&D Computer, and JPY0.9mn for SHIFT.

OPM

Base’s OPM of 22.6% far exceeds those of the other companies. The company attributes this to its high engineer (to all personnel) ratio of 95% (compared to roughly 75% at the other companies), and the fact that it has managed to keep its SG&A-to-revenue ratio down to 6.7%. The SG&A-to-revenue ratio stands at 9.8% at R&D Computer, 6.3% at NSD, and 21.6% at SHIFT (all ratios based on most recent full-year results).

GPM

Base’s high OPM of 22.6% is a byproduct of its strong GPM of 29.3% (FY12/21). SHIFT has the highest GPM of 30.2% in our comparison group, but also the highest SG&A-to-revenue ratio of 21.6% due to heavy spending on recruiting and advertising, and this has kept its OPM down to 8.7% (FY08/21). Shared Research understands that Base’s GPM is higher than those of System Information, R&D Computer, and NSD because of a large percentage of major customers, low subcontracting expenses, and a low number of loss-making projects (the company’s engineer rate is on par with the other companies in our comparison group).

Strengths and weaknesses

Strengths

Ability to deploy a large number of qualified engineers thanks to access to both Japanese and Chinese labor markets and internal system of continuous learning

Base can efficiently increase the number of deployable engineers by hiring college graduates and mid-career engineers in Japan and China, and by keeping its engineer (to all personnel) ratio high (currently 95%). It has increased the number of engineers by 2.4x from 372 (non-consolidated basis at end-FY12/16) to 890 (consolidated basis at end-FY12/21) over five years. The company plans to rapidly establish a team of 1,000 full-time employees (with a full-time employee to external contractor ratio of 2:1) by adding at least 100 new employees per year on a net basis. Despite being a relatively young organization with a low average employee age of 36.8 years, Base has an average salary that is close to its competitors NSD and System Information, two companies with a longer history and an average employee age that is at least three years higher. The company says its salary levels give it a competitive edge in recruiting, which enables it to hire college graduates from 10 elite universities in China. The company encourages its employees to obtain various qualifications, not only related to IT but also in fields such as finance. It believes such qualifications can contribute to a deeper understanding of customer operations, help build relationships of trust with customers, and support sustainable business growth.

Rapid and flexible decision-making by front-line project managers

Base has captured major customers thanks to its decision-making speed and mobility. The company stations on-site managers at major customers who make frequent orders, and grants them decision-making authority. This allows Base to speed up decisions and capture projects ahead of competitors. Four major customers (Fujitsu group, Mizuho Securities, Nomura Research Institute group, and NTT Data group) generate about 75% of revenue. The company builds long-term relationships with its major customers. It has conducted business with Fujitsu since its inception in 1997, with Mizuho Securities since 2002, with Nomura Research Institute since 2013, and with NTT Data since 2017. It estimates the work it handles for these customers corresponds to less than 1% of their total outsourced project costs, and sees ample scope for further revenue growth at each by expanding orders in fields it has already built a track record in and capturing orders in new fields. For example, building on previous system development work, the company captured a system maintenance and management project (handled by its Operations & maintenance business) from Mizuho Securities in 2009. It also added NTT Data as a major customer a few years ago, and revenue from this customer continues to grow sharply. 

Consistent focus on high profitability

The company considers growth in operating profit its most important performance indicator. In FY12/21, it reported operating profit per employee of JPY3.4mn and OPM of 22.6%, which is higher than the 7.6% average for software companies and the 6.5% average for data processing and provision service companies (source: Ministry of Economy, Trade and Industry's 2021 Basic Survey on the Information and Communications Industry). The high OPM level reflects a combination of a strong GPM (29.3%) and a low SG&A-to-revenue ratio (6.7%) in FY12/21. We understand that the company improves GPM by expanding revenue from existing customers, eliminating loss-making projects, and reducing its dependence on subcontracting. Base is able to recover cash efficiently by using short-term contracts for system development (renewed within three to six months) and increasing revenue from recurring-revenue businesses (Operation & Maintenance, Staffing Service). It has reduced its cash cycle from 48 days in FY12/16 to 27 days in FY12/21 by shortening its accounts receivable turnover days.

Weaknesses

Susceptibility to structural shifts in the software industry due to focus on outsourced projects

As a management policy, Base aims to “earnestly push ahead with the plain but steady business of outsourced development.” The company has thus far succeeded in fulfilling another policy—“firmly maintain high profitability and high growth”—by avoiding unnecessary SG&A expenses and streamlining labor-related costs (accounting for the bulk of cost of revenue) and labor-intensive structures. President Nakayama believes the multi-layer subcontracting structure of the Japanese software industry is a weakness that can be exploited to generate business opportunities. The industry has long suffered from ambiguity in areas such as productivity and designation of responsibility, and Base’s approach is to clearly define these areas in its contracts. Thanks to President Nakayama’s foresight, Base has increased customer satisfaction, successively won new and follow-up projects, and achieved above-industry growth. The company’s solid position as a first-tier subcontractor in the old-fashioned Japanese software industry has been the driving force behind its growth. However, if the present multi-layer subcontracting structure of the industry were to collapse and give way to a horizontal business division, Shared Research believes the company would have to change course and take on a more aggressive stance toward building proprietary development projects. We also believe it is difficult for the company to set a medium-term business plan with quantitative targets because its focus on outsourced development leaves it susceptible to software industry trends or earnings trends at major customers.

Challenges with succession planning due to uniform approach toward executive development

Base has grown its revenue to over JPY13.0bn while operating in the single segment of Outsourced Software Development. However, the work it undertakes for major customers corresponds to less than 1% of their total outsourced project costs. This means its customers are only outsourcing a fraction of their software production (mainly, specifications design and programming) and operation/maintenance tasks for large system development projects to the company. Base has pushed ahead with a transfer of decision-making authority to on-site managers. It selects managers based on an election system where candidates nominate themselves to the posts available; about an equal number of Japanese and Chinese candidates (aged in their mid-thirties to early forties) have thus far raised their hands to run as candidates, according to the company. Still, since the main responsibility of on-site managers is to supervise front-line operations, they cannot gain the necessary management experience to develop into a leader of the caliber of President Nakayama, who can steer the company into the future. A charismatic founder who owns and runs a company is generally difficult to replace, and it is not uncommon for the successor to take heed of what the founder (often serving as the chairman) has to say when it comes to running the company. Base could conceivably increase its current revenue levels several times while continuing to operate solely in the Outsourced Software Development segment. If so, it may need another expert manager at the helm once (1) it starts to diversify its customer fields (as rival NSD has done) (for example, the company has managed to build continuous relationships with financial customers with relative ease, but this is more difficult to achieve when handling projects for government agencies or in other industries), or (2) M&A activity starts to increase the importance of consolidated management. In addition, structural changes in the software industry may force the company to overhaul its business model. If the cultivation of executive candidates cannot keep pace with earnings growth, Base may need to consider hiring its executives from outside the company in the future. With that said, from 2021, the company has elected a new managing director (positioned as COO) who has experience as a senior executive officer and two new executive officers who have experience as department heads. As such, Shared Research believes the company is beginning to address the succession planning issue.

High dependence on certain industries and customers

Base provides outsourced development services to around 70 customers (mostly large corporates) spanning a wide range of industries including financial, industrials, logistics, telecommunications, public services, and infrastructure. Meanwhile, the company says the financial industry (particularly securities), its area of strength, is the source of about half its revenue. By customer, about 59% of Base’s revenue comes from four major accounts (Fujitsu, Mizuho Securities, Nomura Research Institute and NTT Data Global Solutions), highlighting Base’s heavy dependence on a handful of large customers. That share rises to roughly 75% if adding in Fujitsu and Nomura Research Institute group companies and the NTT Data group. The company pushed forward business selection and concentration while taking into consideration its reliance on certain industries and companies, and this approach has indeed fueled Base’s growth. That said, it is also true that compared with independent system integrator NSD (a benchmark company for Base), the company’s operations are more heavily weighted toward certain industries. NSD, which boasts the ability to mobilize some 3,000 engineers, actively pitches for projects with companies across a wide range of industries starting with finance. A breakdown of NSD revenue by customer industry indicates that in FY03/20, 31.4% of total revenue came from the financial industry, 45.8% from manufacturing and social infrastructure IT, 12.2% from IT infrastructure, and 10.7% from solutions business. In order to be on par with NSD, we think Base will need to expand its customer universe for outsourced development by tapping into the non-finance space and public organizations.

Historical performance and financial statements

Income statement