Big Blue to Meet Its Match in HP-EDS - TheStreet

Big Blue to Meet Its Match in HP-EDS

The merger is expected to create an aggressive competitor on IBM's scale.
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SAN FRANCISCO -- The repercussions from the merger of Electronic Data Systems (EDS) with Hewlett-Packard (HPQ) - Get Report will ripple broadly throughout the tech industry.

H-P announced Tuesday that it will

buy the outsourcing services company

for $13.9 billion.

The deal will be bad "for anyone that doesn't have H-P or

IBM

(IBM) - Get Report

on their business card," said IDC analyst Bob Welch.

Even IBM, the leader in the global services and outsourcing business, will ultimately feel the pressure. Gartner puts the worldwide market for IT services in 2007 at $748 billion. With $54 billion in services revenue, IBM had 7.2% of the market. At $22 billion, EDS had 3%, while H-P had 2.3%.

And the merger could throw a wrench into EDS's Agility Alliance, a group of vendors that regularly coordinate to supply hardware, networking, software and services to EDS's outsourcing clients. The partnership has been very effective for EDS and its partners, Welch said.

In the short term, IBM and

Accenture

(ACN) - Get Report

"are the standard" in global services outsourcing and will get a short-term edge in closing deals with potential customers who may be uncertain about EDS's ability to deliver services during the merger, Technology Business Research analyst Chris Foster said.

But eventually, the merger will mean more challenges for both IBM and Accenture, which had 2.8% of the market in 2007.

For IBM, the merger would create an aggressive, diversified competitor nearly on IBM's scale. IBM and EDS compete especially in the government sector. "There is now someone that is close to offering

IBM's comprehensive offerings," Foster said.

IBM delivers enviable profit margins on its services businesses: Its global technology services took in $35.1 billion in 2007, or 7% growth in constant currency, and had a pretax profit margin of 9.4%. Its global business services grew 9% to $18 billion, delivering a margin of 10.7%.

Those figures are well beyond a reported profit margin of 6% for EDS, although the comparison is not "fair," Foster said. "IBM is selling higher-end consulting, application-customization services where the margins are very good."

IBM's higher-end business transformation outsourcing (BTO), which dramatically reduces costs by restructuring the way outsourced business is performed, is growing at a hefty 50%. That service is not a specialty of EDS, which focuses more on BPO, or standard outsourcing in which the services are handled overseas.

"EDS is more BPO than BTO," Foster said.

"To succeed in today's services market requires investment in the high end," IBM spokesman Ian Colley said in an interview. "It's no longer a labor-based proposition," he added, taking a swipe at EDS's outsourcing model.

H-P may ultimately sell more middleware through EDS than otherwise, enabling it to take software market share from IBM, Foster said. H-P also will sell more hardware through EDS. "But more importantly, it will pull through software, where the real margin is," he said.

Welch said the merger poses "strong competition for Accenture," the No. 1 applications integrator.

In recommending equipment, Accenture, a competitor of IBM, has been more H-P-centric, perhaps preferring to steer business toward a noncompetitor. Now, H-P is also moving in on its territory.

Storage hardware and software vendor EMC may also be faced with more competition. The company may see some EDS equipment sales displaced by H-P, but will stand up to the competition.

"EMC in the short term has enough best of breed and differentiation in their systems to stand alone," Foster said. But it should consider acquiring a provider of hardware integration services, he added.

EDS's Agility Alliance hardware members --

Cisco

(CSCO) - Get Report

,

EMC

(EMC)

,

Sun Microsystems

(JAVA)

and

Xerox

(XRX) - Get Report

-- may also feel left out in the cold if EDS customers are steered toward H-P equipment.

But the hardware vendor with the most to lose is former Agility partner

Dell

(DELL) - Get Report

, which still counts EDS as a chief customer.

Dell left the alliance in June 2007 "after customers appeared to be focusing more on software and networks than on PCs," a spokeswoman said in an email.

H-P CEO Mark Hurd said on a conference call Tuesday that the alliance would continue and his company will join it. EDS Chairman and CEO Ron Rittenmeyer suggested that H-P will have the edge: "The H-P process ... will be to play a large role in that with us."

The company must balance between pushing the H-P logo and fostering the successful alliance, Welch said. Disintegration of the partnership "would not be an effective strategy."

If H-P continues to let competitors play in the Agility sandbox, it would signify a broader industry trend toward cooperative competition, says Foster.

Still, the acquisition of EDS blurs lines where standalone integrators were once hardware agnostic, Foster added, referring to the practice of allowing clients to choose their preferred equipment brands. "The smaller, standalone companies in services and software are going to feel more pressure" from both H-P and IBM to align themselves. And that runs counter to what is best for clients, who want choice.

Yet the market is far from a duopoly. Price competition comes from several large, unaffiliated integrators and outsourcing firms, such as

Infosys

(INFY) - Get Report

,

Tata

and

Satyam

(SAY)

, Foster said.