Hewlett-Packard’s acquisition of EDS to change supplier landscape

Hewlett-Packard's aim in purchasing outsourcing supplier EDS is to reposition itself as a strategic business partner instead of simply being a technology supplier in enterprise accounts.

Hewlett-Packard's aim in purchasing outsourcing supplier EDS is to reposition itself as a strategic business partner instead of simply being a technology supplier in enterprise accounts.

The goal is to gain more influence in the boardroom in a similar fashion to IBM, rather than being confined to the CIO level as is currently the case. The ultimate prize is winning higher-margin deals with greater recurring revenues.

As Clive Longbottom, a service director at Quocirca, says, HP envisages itself helping companies "in the technology field from soup to nuts. It wants to be able to get in at the top, helping companies decide their strategy, design and implement that strategy and then run it for them".

Before its proposed £7bn purchase of EDS, the supplier was already one of the top 10 services providers worldwide and, if the deal goes through, it would more than double its services business to £19.7bn in revenues. This would make it second in size to only to IBM in this area.

But as Longbottom points out, services has not been an integral part of HP's brand image to date. "What do you think of when someone mentions IBM? Probably not hardware as such but business solutions, services and so on. Think of HP? Printers, servers and the like. It is a different value proposition," he says.

Therefore, Longbottom says that the point of the proposed purchase is to try to "level the playing field to ensure that HP and IBM will always be on the same shopping lists when it comes to the biggest projects".

What the deal does not provide the supplier with, however, is high-end business consulting expertise in the mould of either IBM or Accenture, even though this amounts to the biggest play in the boardroom.

As a result, says Allie Young, a research vice-president at Gartner, although it may be a while yet, "you cannot rule out future acquisitions by HP to fill things in at the top end as that is their exposure."

But according to HP's 2007 annual fiscal report, there are currently three key areas that it wants to focus on in project terms during the years ahead: "The explosion of digital information and content the growing need for technology that enables people to create, store, share and print that content and the rapidly growing demand for information technology in emerging markets around the world."

Dealing with all of this data, however, it says, will be a "huge and disruptive challenge for our customers and their IT environments and a major opportunity for HP". This is because it will put "pressure on businesses to rebuild, retool and deploy a flexible infrastructure so they can get the right information to the right people at the right time".

But the challenge ahead will create an addressable market worldwide of £600bn as customers will need "systems, software and services to create, store and analyse content PCs and handheld devices to access and share it and monitors, TVs and printers to view and print it." And, of course, HP considers itself best placed to provide these offerings.

There were clear impetuses behind HP's moving quickly to achieve its aims. According to Euan Davis, a principal analyst at Forrester Research, the market is starting to splinter into two distinct factions, each with its own set of providers: low-margin general market IT services and high-margin business-centric services.

Where EDS has traditionally generated the bulk of its £11bn sales from the latter along with a smattering of business-transformation work, HP has to date operated firmly in the technology-services camp.

This means that it has specialised in areas such as product support and maintenance - not necessarily the optimum focus for achieving its stated aims - although IT infrastructure consulting, integration and outsourcing services have also been on the menu.

A second driver for change is again referred to in the supplier's annual report. The document indicates that, during the 2007 fiscal year, the technology services, IT infrastructure consulting and integration businesses were "under significant pressure as our customers have reduced their IT budgets".

This trend, on the other hand, "has benefited the outsourcing services business as customers look at reducing IT management costs to enable more strategic investments". With this in mind, it becomes obvious why EDS might start looking attractive to HP.

As to which areas of EDS's business HP is likely to concentrate on to help it achieve its goals, Young says that its "very respectable application development and integration business" is a logical place to start because of the "tremendous opportunities" it offers.

But creating a more "industrialised model" in order to make "infrastructure and business processes into repeatable technology solutions" or pre-packaged offerings also has potential, Young says. This is not least because it is an area in which IBM has made little headway despite "aggressive" attempts to do so.

Davis agrees. "HP has made some significant progress in its service delivery model and is starting to build an industrialised service portfolio and centre of excellence around applications modernisation. Whether it really needs EDS to push that forward, I am not sure, but it provides massive scale and will give HP the ability to compete for deals in the large IT services space," he says.

A challenge, however, is that many organisations are opting less for the once-popular mega deals that EDS has traditionally engaged in and are moving instead towards shorter, leaner contracts with a range of suppliers.

Nonetheless, because EDS has also started devising "modular service platforms", Davis says HP could derive value from building on its existing work. It will also benefit from EDS's strong vertical market focus in sectors such as government, healthcare and manufacturing, an area in which it currently has little expertise.

But it is also important not to underestimate how useful EDS's large customer base will be in driving technical sales, says Phil Codling, a principal analyst at Ovum's IT services practice. "EDS is already an important partner for HP products, and although it will need to profess technical agnosticism up to a point, ultimately HP will expect it to drive product sales as well as services. But it is a tension that HP is already living with," he says.

Longbottom says that there is more to the acquisition than just this, however. Under the leadership of chief executive, Mark Hurd, the supplier has been growing quickly and, because the markets expect to see such growth continue, "acquisitions are a good way to do this in an immediate sense".

"EDS makes HP 30% larger than IBM - something that Wall Street and many customers will like," Longbottom says.

On the down side, "Acquisitional growth looks good on the books until the second year, when the problems come through. If the deal was not totally synergistic, there will be a slowdown or drop in growth," he says. And the danger then is that Wall Street "may take against it".

There are other risks, not least because HP still has to fully bed down its 2006 purchase of management software company Mercury Interactive. "We are at the start of an economic downturn, so the deal will be under stress. There is the pressure [from the customer base] to bring things back in-house and major infrastructure projects may be put off for a year or more," says Longbottom.

As a result, HP's Hurd will be under pressure himself "to show shareholder value within six months - or to start making major changes, including major layoffs, to improve performance," Longbottom says.

Another challenge relates to EDS's existing technology suppliers, which are now bound to worry about "how much HP is going to get in the way, particularly around the hardware side".

HP has indicated that EDS will continue to be run as a separate entity under the auspices of current president and chief executive, Ron Rittenmeyer. Its technical services business, meanwhile, will remain under the command of Ann Livermore, head of the supplier's £19bn technology solutions group.

But this act of keeping the two organisations running separately "will confuse people mightily" Longbottom says. Therefore, the situation is unlikely to last forever, with increasing amounts of convergence taking place over time.

In the short term, however, HP will require strong and charismatic leadership to avoid unsettling customers. "The deal has to go very quickly and smoothly. They cannot waste much time here as any long-term or prolonged integration is only hurtful to clients and prospective clients, who'll say that they don't want to get involved right now," Young says.

This means that, during contract negotiations, both suppliers will need to reassure prospects about future "vision, where it is going to be and why it will be better in the end. And that is a real challenge for the leadership," Young says.

As a result, existing customers are being advised to seize the opportunity to negotiate better deals for themselves. Davies says, "Sales people have quotas that they have got to hit, so that can be useful in leveraging a deal. For users, it can be quite useful to have a bit of uncertainty around their suppliers because if they want to keep the business, they have to lower prices."

Although Codling indicates that customers are not "panicking by any means", he says that they are inevitably voicing "concerns" about such a large deal. Xerox, which has been an outsourcing customer of EDS for 14 years, is reserving judgement on the situation for the time being.

Earlier this year, the document management systems and services provider extended an existing deal with EDS. The new £133m, six-year contract involves the provider supporting approximately 40% of Xerox's internal IT systems, including its desktops, service desk and mainframes.

Xerox said in a statement, "Our contracts with EDS include a change-in-control clause that gives Xerox flexibility in how we manage this business going forward. It is premature for us to speculate on what next steps we will take. Xerox relies upon other technology service providers for the management and support of its IT systems, including IBM, Tata Consulting Services and Wipro among others."

As for the impact on the wider market, commentators expect the move to kick-start wider market consolidation as smaller players attempt to bulk themselves up to compete.

"HP plus EDS creates a player of significant scale in an industry that is used to having IBM as the global leader by a long way, and that creates a longer-term threat to smaller companies. It is not an immediate threat, but it may make them reassess the scale requirements of the business," Codling says. HP declined to comment on the situation.

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