HP Outsources Outsourcing To EDS

It was to have been the deal that would vault Hewlett-Packard into IT services' big leagues: A 10-year, $3 billion contract to manage tech operations for no less a customer than global consumer products giant Procter & Gamble. "We're popping a few bottles of champagne around here," HP services chief Ann Livermore told InformationWeek in 2003, when the deal was struck. That was five years ago. HP has had little success since then parlaying the victory into more big contracts. It turns out the company's legendary garage shop DNA didn't come with an outsourcing gene. CEO Mark Hurd tacitly admitted as much Tuesday when he announced plans to abandon efforts to grow HP's also-ran services business internally and buy Electronic Data Systems for $13.9 billion. "This fulfills our strategic objective of expanding in the services area," said Hurd, during a conference call. Under the merger plan, EDS CEO Ron Rittenmeyer would lead a new organization called "EDS -- an HP company" and report directly to Hurd. Livermore would continue to oversee what's left of HP's Technology Services Group, but she's not likely in a mood for more bubbly. In one stroke, the deal would create the world's second largest IT and business services company, next to IBM. The combined services revenue for EDS and HP last year was $38 billion, compared to $54 billion for Big Blue. HP's EDS unit would house 210,000 employees. The deal "gives us scale," said HP chief technology officer Shane Robison, in an interview. "One of the things you need in the services business is people with a lot of vertical expertise and operational expertise," Robison added, noting that EDS has a strong presence in lucrative industries such as financial services, energy and health care, as well as government services. EDS would also give HP blue chip customers like American Airlines, Bank of America, and Royal Dutch Shell. But can the combination of a PC and printer company with a history of treating services as a poor relation and an outsourcer that some view as an old school advocate of stadium-sized data centers staffed by legions of techies yield an organization capable of embracing new wave IT trends like cloud computing and software-as-a-service? Hurd is optimistic. "We think the fact that we bring a $4 billion R&D stream and a research stream from HP Labs brings leverage into the business on a number of fronts," he said. And Robison insists that EDS isn't all that sclerotic. "[EDS executive VP] Charlie Feld has been talking a lot about software-as-a-service and how to deliver more of their capabilities through SaaS and cloud-based infrastructures," Robison said. HP's hope: That big multinationals will look to outsourcers more than ever to collect, vet, and integrate software pulled from the Web and guarantee "five 9s" service levels as they move to the cloud for critical applications. Critics of that view contend that SaaS and cloud computing could make big system integrators like EDS obsolete. Architectural debates notwithstanding, the proposed merger is mostly about HP's desire to squeeze more profits from a vendor that's got too much overhead in a market that perennially coughs up low margins but still has lots of steam left and offers predictable, long-term revenue streams. In its most recent fourth quarter, EDS posted an operating margin of 7.3%, compared to the 11% most recently reported by close rival Accenture. The campaign to make EDS more profitable would inevitably include job cuts. "There's always job adjustments" during a merger, Rittenmeyer said Tuesday. The axe will likely fall in other areas, as well. "We know a lot about how to look at overhead and how to look at costs that result from overhead," Hurd said. "So think of us trying very hard to run the playbook that we think we know how to run very well." That playbook includes data center consolidation -- a cost cutting strategy that's been championed by HP CIO Randy Mott. Under Mott's direction, HP has been using virtualization, automation, and other new technologies to reduce the number of data centers the company needs to operate from 86 to six. Hurd says he's committed to maintaining EDS' operations in the Dallas area, but there's likely a plan in place to pare down the number of peripheral centers it operates around the country and worldwide. But EDS has already been through several rounds of consolidation in recent years, so achieving savings without cutting too deeply into bone could be tricky. If Hurd goes too far, customer service could suffer. Speaking of customers, the proposed deal is unusual in that clients of the acquirer, HP, might feel more of an impact than EDS customers. That's because HP would effectively hand off its outsourcing unit to EDS rather than pull EDS into its operations. "This is a reverse merger of our outsourcing business into EDS's outsourcing business," says Robison. So far, HP's largest outsourcing customers aren't going beyond politically correct niceties in assessing the deal. "We believe this will be very positive," says Procter & Gamble CIO Filippo Passerini, in an e-mail. "EDS has tremendous capability which can help P&G improve its business processes and IT infrastructure." In negotiating P&G's landmark outsourcing deal in 2003, Passerini nixed giving the business to EDS -- in part due to concerns about the outsourcer's financial health. Under HP, EDS will have a healthier bottom line. But P&G and other big customers can ill afford service disruptions during the integration process. "The challenge for HP and EDS is to stay focused on the customer and to continue to deliver with excellence in plans and projects underway," says P&G infrastructure solutions director Jim Fortner, also in an e-mail. "Integration is going to be a challenge," said analysts at Technology Business Research, in a note on the deal. Still, the analysts said Hurd is up to the integration task, having "proven his strength in operations." Another question is whether EDS's roster of multinational customers would be comfortable handing off vital IT work to a vendor steeped in a consumer PC and printing business that accounts for about half of its revenues. It could be difficult for HP to convince potential outsourcing customers that their needs would not be ignored by an upper management team obsessed with the cutthroat retail markets. Robison insisted such worries are unfounded. "Mark [Hurd] is very active with our customers. I don't think there's going to be any concern about their not having the CEO's ear," he said. Still, uncertainty over the merger could boost IBM and also help India-based outsourcers, including Wipro, TCS, and Infosys, that are expanding their presence in the U.S. market. On the other hand, HP, with EDS in tow, could rightfully claim that it's the sole vendor capable of furnishing business customers with the entire spectrum of IT products and services -- from PCs and servers to middleware and global outsourcing services. Hurd called the mix "one of the broadest, most competitive portfolios of products and services in the industry." Indeed, the big loser in all of this could be EDS' so-called Agility Alliance -- a collection of hardware and software vendors that provide the company with bulk rate products for installation at customer sites. If the merger goes through, HP would be in a position to substitute its own wares into EDS accounts, replacing those made by partners like Sun, EMC, and Dell (which is no longer a formal alliance member but remains a preferred partner). The stakes are high: One recent deal called for EDS to install 41,700 Dell PCs at U.K. financial services group Barclays. Robison insists EDS will remain technology neutral under HP. "We're going to listen to our customers and support the Agility Alliance as it is today," he said. At the very least, however, HP will add its own products to the Alliance menu. Hurd says any sales boost HP realizes as a result of acquiring EDS would just be gravy. "We did not bake in a lot of revenue synergies," he said. Both companies' outsourcing customers hope the recipe includes more services and no disruptions. The transaction, which values EDS at $25 per share, is expected to close in the second half of 2008. The deal remains subject to regulatory approval and a nod from EDS shareholders.