With EDS, HP Buys Its Way Into Outsourcing Big Leagues

It looked like the deal that would vault Hewlett-Packard into the IT services big leagues: a 10-year, $3 billion contract to manage tech operations for global consumer products maker 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. Since then, HP's services business has grown to $16.6 billion in annual sales, but it has had little success parlaying the P&G victory into more whopper contracts, leaving it an also-ran in the market. The company's legendary garage-shop DNA didn't come with an outsourcing gene. CEO Mark Hurd tacitly admitted as much last week when he announced an agreement to buy EDS for $13.9 billion. "This fulfills our strategic objective of expanding in the services area," Hurd said. Under the merger plan, EDS CEO Ron Rittenmeyer will lead a new organization called "EDS--an HP company" and report directly to Hurd. Livermore will continue to oversee HP's Technology Services Group, but EDS, still based in Plano, Texas, will lead the outsourcing charge. In one stroke, the merger will create the world's second-largest IT and business services company, with combined revenue of $38 billion last year, still far behind IBM, with $54 billion, but ahead of Accenture, with $21 billion. HP's EDS unit will employ 210,000 people--pending an inevitable downsizing. The deal clearly gives HP's services business scale, HP CTO Shane Robison notes. "One of the things you need in the services business is people with a lot of vertical expertise and operational expertise," Robison says, adding that EDS is strong in the financial services, energy, health care, and government sectors. EDS would also give HP blue-chip customers such as American Airlines, Bank of America, and Royal Dutch Shell. BRIDGE TO THE FUTURE But can HP's culture bridge a computer and printer company with a history of treating services as a poor relation, with an outsourcer not far removed from the old-school ways of cavernous data centers staffed by legions of techies? The new organization must be capable of embracing new-wave IT trends such as cloud computing and software as a service that call into question what outsourcers do. Hurd, of course, is optimistic. "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 at all sclerotic. He points to EDS executive VP Charlie Feld, a former Delta Air Lines CIO who, he says, "has been talking a lot about software as a service and how to deliver more of their capabilities through SaaS and cloud-based infrastructures." HP's hope is that big multinationals will look to outsourcers more than ever to collect, secure, integrate, and deliver software and other IT resources over the Web and guarantee "five nines" service levels. But true believers in SaaS and cloud computing envision those models making big system integrators like EDS obsolete, by removing complexity. Architectural debates notwithstanding, the proposed merger is mostly about HP's belief that it can squeeze out more profits by consolidating operations and reducing overhead. In a services market that perennially coughs up low profit margins, EDS has done worse than average. In its fiscal fourth quarter, for example, EDS posted an operating margin of 7.3%, compared with the 11% most recently reported by rival Accenture. The campaign to make EDS more profitable would inevitably include job cuts. "There are always job adjustments" during a merger, Rittenmeyer says. The ax likely will fall in other areas, too. "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." Hurd's credibility comes from the financial turnaround he has driven at HP, whose stock price has more than doubled over the last 18 months. HP's playbook includes data center consolidation--a cost-cutting strategy championed by CIO Randy Mott. HP has been using virtualization, automation, and other new technologies to reduce the number of data centers the company operates from 86 to six. Hurd said he's committed to maintaining EDS's data centers in Plano, but others it operates around the country and world will surely come under scrutiny. EDS has already been through several rounds of layoffs and facilities closures in recent years, so achieving savings without cutting too deeply could be tricky. If Hurd goes too far, customer service could suffer. Hurd maintains that automation tools for server and storage management, including HP's own Opsware, allow data center operators to get by with fewer staffers without hurting services levels. "The cool thing about a services business is that as you extract cost, you actually increase service levels as you automate," he said. WHAT CUSTOMERS THINK The proposed deal is unusual in that customers of the acquirer, HP, might be affected more than EDS customers. That's because HP would effectively hand off its outsourcing unit to EDS. "This is a reverse merger of our outsourcing business into EDS's outsourcing business," says Robison. At P&G, CIO Filippo Passerini actually nixed giving the business to EDS back in 2003, in part because of concerns about the outsourcer's financial health. He sees promise in this merger. "EDS has tremendous capabilities which can help P&G improve its business processes and IT infrastructure," Passerini says in an e-mail. Under HP, EDS will have a healthier balance sheet. 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 plans and projects under way," says P&G infrastructure solutions director Jim Fortner, also in an e-mail. Any slipups with performance or uncertainties caused by integration could play to IBM's hand, as well as to India-based providers such as Infosys, Tata Consultancy Services, and Wipro Technologies. A loser in all of this activity could be EDS's 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 passes regulatory muster, HP would have an inside track on selling its own systems and wares to EDS accounts, at the least neutralizing an advantage of alliance partners such as EMC and Sun Microsystems, and preferred partners like Dell. It's high stakes: A recent deal called for EDS to install 41,700 Dell PCs at 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 says. Hurd said the merger's success hinges on cost cutting, not on improving sales by pushing other HP products. "We did not bake in a lot of revenue synergies," he said. By adding EDS, HP could stake a claim that it's the vendor, with the possible exception of IBM, most capable of furnishing business customers with the widest spectrum of IT products and services--from PCs, servers, printers, and storage to infrastructure software and global outsourcing services. How they'll fit together is the biggest challenge. HP has a history of being more flexible than the "solutions in a can" big IT vendors, says Judy Poirier, VP of IT at Canadian electronics maker Celestica, who used to work at HP and for a few years was the lead delivery executive on the P&G deal. EDS brings experience managing megadeals that HP lacks, she says, but that could quash the flexibility and responsiveness that made HP different from the largest IT services firms. Still, Poirier says, "if I'm contemplating an outsourcing deal, I'll consider HP more, while in the past I may not have."