IT services: A year of dramatic change

The IT services market changed significantly this year, sending vendors and clients scrambling to adapt to the new and sometimes...

The IT services market changed significantly this year, sending vendors and clients scrambling to adapt to the new and sometimes difficult terrain.

Some vendors expanded. The world's biggest IT services provider, IBM Global Services, for example, acquired PwC Consulting. Others disappeared, like accounting giant and IT consultant Andersen Worldwide.

Many struggled, the most notable example being Electronic Data Systems (EDS), the world's second-largest IT services provider, which lost business and invited a US government probe as a result of unmet financial expectations.

All vendors suffered from clients' conservative spending to some degree, and from the resulting price wars.

As providers grew, disappeared, splintered, scrambled and struggled, chief information officers (CIOs) and IT managers had to pay close attention to troubled vendors to make sure they complied with their contract provisions and maintained service quality levels.

CIOs and IT managers also had to understand the new realities and dynamics of the market to take advantage of new opportunities. These included the chance to rethink their services strategy, restructure engagements and renegotiate contract terms and prices.

Best consensus was separation of accounting from IT
One development that unfolded quickly and with earth-shaking consequences was the effect of the Enron scandal. Enron's relationship with accounting giant Arthur Andersen highlighted the conflict of interest problems that can arise whenever an accounting company provides both auditing and consulting - including IT services - to a client.

A consensus rapidly emerged that best practice required the separation of accounting firms from their IT consulting units. This process began before Enron's fall but significantly accelerated in 2002. Arthur Andersen's parent, Andersen Worldwide, sold its IT consulting unit in pieces before it expired from the damage caused by the Enron scandal.

PricewaterhouseCoopers announced plans to spin off PwC Consulting via an IPO - it even renamed the unit with the unfortunate moniker "Monday" - before IBM swooped in and bought it. And Deloitte Touche Tohmatsu grudgingly committed to spinning off Deloitte Consulting as a private and independent company, a process that has not been completed yet.

Even IT services companies no longer part of an accounting firm further distanced themselves from their former parents. Accenture, which had been spun out from Arthur Andersen years ago, repeatedly in the first half of the year explained it had no links to the embattled accounting firm.

Meanwhile, KPMG Consulting changed its name to BearingPoint, a rebranding campaign it estimates will cost up to £25m, to distance itself from its past as a former unit of accounting firm KPMG International, from which it was spun off in early 2001.

As the Enron debate raged on and accounting firms did their best to distance themselves from the IT services market, some predicted that traditional IT vendors such as IBM, EDS and Computer Sciences Corporation, would benefit from this shift.

'One of the most difficult years ever' for IT
But 2002 also proved difficult for traditional IT vendors, not least because hard economic times reduced their clients' willingness to spend on IT services.

The spending malaise lasted all year. In November, analyst group Gartner called 2002 "one of the most difficult years" ever for the IT services industry, and estimated that spending in this market would increase only 2.8% to £350bn compared with 2001.

Market researcher IDC, which measures the IT services market in a slightly different way, in October reported that the market was "facing a more difficult year than anticipated" and sharply reduced its growth rate forecast for the year from 10.6% to 6.7%.

However it is measured, vendors and analysts agree that consulting and systems integration have been two of the hardest hit sectors of the market.

The key factor for CIOs making IT services decisions in 2002 was to cut costs in the short term, leading IT service companies to shift their focus away from delivering services for long-term business results, said Lorrie Scardino, a Gartner analyst.

This short-term, cost-cutting approach to IT services isn't good for IT managers nor for vendors, because it could catch both camps unprepared when the economy finally recovers, she said.

"Enterprises have to get smarter about the options available to them," she said. "The enterprise that stands still and keeps the viewpoint of 'we like it this way' is going to be at a disadvantage."

Reduced spending by clients saw IT services providers lay off staff, with IBM Global Services, EDS and BearingPoint, formerly KPMG Consulting, making significant redundancies.

Harware vendors strengthen services offering
Another development during 2002 was that several big vendors whose core business is hardware, including Hewlett-Packard, Dell and Sun Microsystems, took steps to strengthen their services organisations significantly.

These vendors are convinced that beefing up their services teams leads to increased revenue and helps them woo enterprise clients that expect them to provide services beyond the traditional product support.

HP, for example, said that one of the main reasons for acquiring Compaq was to improve its services arm. Dell, meanwhile, said in August that it was "in a hurry" to bolster its professional services unit, as the PC giant continues expanding into enterprise areas such as servers, storage and networking.

Sun this month made a big services push, announcing a renewed interest in the sector and a restructuring of its services operation. Unisys, in the past primarily a hardware vendor, announced this year that more than 75% of its revenue now comes from services.

Two other issues that hit the headlines were problems at EDS and IBM's PwC Consulting acquisition.

The difficulties EDS faced during 2002, its 40th anniversary, were not limited to layoffs. Its business relationships with several big bankrupt companies, including WorldCom, US Airways and UAL, affected its image and earnings.

Its third-quarter revenue and earnings shortfall angered analysts and investors and hurt its stock price and the credibility of its top management. The timing of a profits warning could not have been worse. EDS was about to win what was said to be one of the largest outsourcing contracts so far, from Procter & Gamble, which then backed off from its decision.

That warning also prompted the US Securities and Exchange Commission to launch a probe. The press also questioned EDS accounting practices during the year.

December exemplified EDS's ups and downs all year. It announced UAL's bankruptcy would shave five cents a share from its fourth-quarter earnings, and that it had won a 10-year, £2.85bn outsourcing contract from Bank of America.

"EDS had a terrible year, but clients are still willing to take it seriously," Gartner's Scardino said. "EDS is going to come back because their clients never went away. They do good work, have good clients and they're a true services delivery company."

Finally, IBM's acquisition of PwC Consulting should help it strengthen certain technology areas, such as customer relationship management, as well as specific vertical industries, such as life sciences, as well as its business management consulting sector, according to analysts.

"PwC positions IBM, on scale alone, as a megaforce in the IT services market," Scardino said. "The integration seems to be going well, but there's little end-user feedback on it. The proof in the pudding will be the client feedback."

And, although IBM Global Services has put the PwC Consulting integration on a fast track, aiming for completion next year, the organic melding of the two groups could take two or three years, Gartner analyst Robert Goodwin said.

In all, as 2002 winds down, the industry is hoping 2003 will be a more stable and less dramatic year in IT services.

"It looks like the massive bankruptcies and vendor shakeout are mostly behind us, and that 2003 could be a calmer year. But you never know," Goodwin said.

Read more on IT outsourcing