Services megadeals not quite so mega
Published: 05 Sep 2003 12:35 BST
Neither ABB nor IBM would provide information on the annual expense of those employees. But ABB spokesman Wolfram Eberhardt indicated that shifting workers to IBM is a big reason the company expects to save $50m annually over the next decade. "Most of these costs are labour costs," Eberhardt said.
The deal doesn't guarantee the affected workers a job with IBM for the next 10 years, Eberhardt said. And it's possible IBM will use some of those workers to generate additional revenue by putting them on other client accounts, suggested Michael Melenovsky, analyst with market research company IDC. What's more, Melenovsky said, some of ABB's IT work now done in Europe could be transferred to India, which could shave costs.
However, megadeals like the ABB contract can trigger costs beyond labour. Garrity said that in most outsourcing deals, service providers face capital expense costs in equipment and connectivity charges of 5 percent to 10 percent of the face value of the contract. IBM may be avoiding a big hit in this area, because ABB was already leasing equipment from IBM.
IBM declined to disclose the amount of profit it expects from the ABB deal.
Overall, megadeals generally are less profitable than smaller ones because of stiff competition in bidding, Garrity said. He pointed to Affiliated Computer Services, an IT and business-process outsourcing company whose contracts usually do not break the hundred-million-dollar barrier. ACS' operating profit margin tends to be higher than that at EDS, Garrity said.
Meanwhile, megadeal profit margins are under pressure. IDC's Melenovsky said it's more common now for clients to renegotiate long-term deals with their service providers, for reasons including bankruptcy filings and company reorganizations. He said client restructurings are likely the cause of EDS's admitted "under-performing contracts." If a client sells a division, "it means EDS has to go in and figure out how that division can be torn out of the deal," Melenovsky said. That can translate into less revenue for EDS.
In this climate, service providers are being more careful not to suffer in the initial phase of a big contract, Melenovsky suggested. "Back in the mid-'90s, it was very common for a company like IBM or EDS to lose money in the first 18 months," Melenovsky said.
Contract clauses calling for "benchmarking" also are squeezing margins, Garrity said. Benchmarking allows the client to check its fee rate in an outsourcing deal against current market rates, and push the service provider to lower its rate if market rates are substantially lower, Garrity said. Unfortunately for providers, "it doesn't go in the other direction," Garrity said.
Still, clients have an interest in not squeezing too hard. After all, they don't want their provider to go out of business and suddenly leave vital computer operations in limbo. EDS's drastic earnings shortfall last year raised fears it could be in trouble, Melenovsky said. "The issue starts to become, We want the service provider that we're outsourcing to, to be healthy financially," he said.
EDS reported net income of $138 million for the June quarter of this year, and met analysts' average expectation for earnings per share. Since posting earnings well below expectations for the third quarter of 2002, EDS has replaced its CEO and announced a focus on outsourcing services.
Outsourcing megadeals may not be as glorious as their lofty revenue values suggest, but they have advantages. One is recurring revenue that's generally stable over the course of several years. Another is the chance to gain additional work beyond that specified in the original contract. "It's not out of the question to see the size of the engagement crop up 5 percent to 10 percent," Garrity said.
There, Garrity said, the benefit of the megadeal is that the service provider knows what's going on in the client's business before potential competitors. "You've got your foot in the door," he said.
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