In the services business, it's starting to look like d¿j¿ vu all over again.

Back when IBM ( IBM) and H-P ( HPQ) realized PCs were turning into so many commodity boxes, they seized on services as one of the next growth engines. Big Blue, an early evangelist, now pulls in more than half of its sales from the market; H-P, which lags behind, still drew a sizeable 17% of revenues from services in the April quarter.

But now, with potential customers shrinking their IT budgets while competition heats up from Dell ( DELL) and upstart Indian players, the services business is falling prey to some of the same pricing pressures that have bedeviled hardware.

"Markets for things like consulting and systems integration actually declined last year, for the first time in living memory," says Ben Pring, a research vice president at Gartner.

"There's been a huge rush at tech companies to have some sort of services presence, which has created overcapacity," he explains. "The paradox is that services for a lot of companies have been seen as the future for their business. But the future is perhaps not quite as rosy as some people think it is who may be coming from another space, imagining this is the next green field."

Last week H-P said operating profits in its services arm fell 1.6% from the prior quarter to 9.9%, partly due to pricing pressure in everything from low-end customer support services to IT outsourcing and consulting. "Pricing pressure is pervasive in the IT economy in general and in IT services, so we see it in all parts of the business," explains Mike Rigodanzo, a senior vice president of operations at H-P.

H-P CFO Bob Wayman has said he'd like to see margins climb to around 13%.

H-P isn't the only one to suffer. IBM's pretax margin in services in the first quarter fell to 9% last year from 12.1% the year before, partly because of its acquisition of PricewaterhouseCoopers, whose consulting business has suffered from the broader slump.

"The good news is that IBM finally is perceived as a services company; the bad news is that now investors are worried about services rather than mainframes," summed up Merrill Lynch analyst Steve Milunovich in a recent note. Merrill has done recent banking for IBM.

A Market Up for Grabs

In competitive terms, the services market still looks like a free-for-all -- a far cry from computer hardware, now dominated by a handful of burly veterans.

Consider that IBM, with a massive $39 billion services business and the number-one global share, owns a mere 7.5% of the total market. Number-two player EDS holds only 3.9%, according to Gartner. The $540 billion global services market is still up for grabs

Service Share
IBM leads an increasingly competitive field
Company 2002 Market Share (%) 2001 Market Share (%)
IBM 7.5 7.5
EDS 3.9 3.8
Fujitsu 2.6 2.6
H-P T 2.3 2.4
Accenture 2.1 2.1
Others 81.5 81.4
Source: Gartner DataQuest, May 2003

Small-fry providers, which still account for more than three quarters of the rest of the market, remain a force to be reckoned with -- especially those in low-cost countries like India.

Indian players like Wipro ( WIT), Infosys ( INFY) and Tata "are a big concern in Europe already," says Humberto Andrade, director of professional services business quarterly at Technology Business Research, a market research and consulting firm. "They have quality, they have price, they have scale. They're gaining a lot of contracts from European companies and the U.S. market is definitely the next step."

Big Blue's head of global services Doug Elix has admitted 40% of its business consulting services arm is exposed to offshore competition.

Though the Indian players haven't made inroads into high-level business consulting, focusing more on outsourcing IT projects, H-P's Rigodanzo acknowledges, "Just like everybody else, they're looking for ways to expand." To better compete, H-P has built up its own staff in India over the past five years from a few hundred to around 3,500.

In another competitive twist, Dell -- long viewed as a plain-vanilla hardware jockey -- has upped its profile over the past year as it has built a new-managed services business.

Dell draws most of its services revenue from low-margin break-and-fix business, but higher-end offerings are growing more important, generating around $500 million in the latest quarter, says SG Cowen's Richard Chu. "That's still a drop in the bucket relative to $9 billion and change in total revenue, but the area grew about 45% year over year," he points out. SG Cowen hasn't done recent banking for Dell.

Chu describes Dell's approach as "productivation" -- the idea of hawking services as a product, complete with a fixed price. It's not yet clear how much of the services market could fall prey to the trend, though for now, he says, "Complex enterprise installations are certainly not Dell's sweet spot."

Still, knowing Dell's genius at commoditizing, execs at other services outfits would have to be a little unsettled by its take on the industry. "Services really isn't all that different from any other technology," shrugs Kevin Soelberg, vice president of services marketing at Dell. "It is people- and tools-based as opposed to hardware-based, of course. But beyond that, it follows a standardization or commoditizing curve just like products do."

He says Dell doesn't aim to compete with an H-P or IBM in services; rather, its services arm is intended to complement its highly successful core hardware business.

H-P agrees. "Their offerings tend to be on the low end and fairly specific to Dell technology, not multi-vendor," says Rigodanzo. Dell can't offer the same geographic and technological breadth, he adds.

Nevertheless, it's clear IBM and H-P will need to lean more and more on R&D to set themselves apart. Both have been talking up the growth prospects of utility computing, a recent advance in high-level services that lets customers tap into extra computing capacity at peak periods and only pay for what they use.

Right now, sums up Andrade, commoditization of the services business is still at an early stage, "probably like hardware was 10 years ago." Back then about a dozen high-end hardware players competed; today, only three or four have survived.

"Over the next five years we'll see increasing consolidation and commoditization in services," he predicts. "How high in the stack can you commoditize -- that's a big question."

The answer will determine whether IBM and H-P stave off the same painful margin slides that have humbled the hardware business.