Two outsourcing deals closed within the last week — one on Monday between J.P. Morgan Chase & Co. and International Business Machines Corp., and the other on Dec. 24 between ABN Amro and Electronic Data Systems Corp. — seem similar but could indicate a strategic shift between two of the top IT services vendors.
By securing a seven-year contract worth more than $5 billion with Morgan Chase yesterday, IBM could be cementing its position as one of the leading suppliers for large-scale information processing capabilities. In contrast, despite the $1.3 billion, five-year Christmas Eve deal with ABN Amro, EDS has announced plans to refocus on deals that generate revenue quickly and don’t require large up-front expenditures.
Michael Sztejnberg, the managing director for enterprise technology services at Morgan Chase, called its arrangement with IBM “the largest IT outsourcing agreement in the financial community ever.” The deal calls for IBM to take on the bank’s data processing infrastructure, including data centers, help desks, and data and voice networks. Within six months, roughly 4,000 Morgan Chase technology employees and contractors will be receiving paychecks from Big Blue.
Mr. Sztejnberg said IBM, which focuses solely on developing and deploying technology systems, could do a better job managing the bank’s networks at a lower cost. “As information technology become more of a commodity, I think the outsourcing model becomes more attractive,” he said. “We’re looking for a significant value-add to come from this agreement.”
IBM’s deal with Morgan Chase will require a good amount of up-front investment on the vendor’s part. But Mr. Sztejnberg said this was not what prompted Morgan Chase to knock EDS out of contention last month and start holding exclusive negotiations with IBM. He said his group was particularly attracted by IBM’s utility-based model, which lets the bank pay for only the processing services it actually uses and permits significant variability in response to changing business conditions.
Given the large scale of Morgan Chase’s IT demands, Mr. Sztejnberg said, only a few companies could take on such a contract. At first the bank contacted only IBM, EDS, and Computer Sciences Corp. CSC was pared from the list first.
Bruce Caldwell, a senior analyst for the market research house Gartner Dataquest in Stamford, Conn., said Morgan Chase should see some significant cost reductions. “I think $1 billion in savings over the life of the contract is not an unreasonable figure,” he said.
He said that, according to Gartner’s research, there were 14 outsourcing contracts worth more than $1 billion 2002, and that IBM had won seven of them on its own and an eighth in partnership with another vendor. Mr. Caldwell estimated that over the past 10 years IBM has secured as many of these megadeals as CSC and EDS combined. “IBM is really locking up the majority of these large agreements,” he said.
EDS landed its share of big accounts in 2002, including the ABN Amro deal and a $4.5 billion deal with Bank of America Corp. announced earlier in December. But it was also plagued by financial problems, said Howard Lackow, the senior vice president of the Jericho, N.Y., trade group The Outsourcing Institute. EDS lost money when some of its customers, notably U.S. Airways and Worldcom, filed for bankruptcy, and its third-quarter results disappointed investors.
Steve Smith, the chief sales officer at EDS, said it is refocusing its sales energies in response to its cash crunch. “We are paying a lot more attention to free cash flow and the amount of capital,” he said in an interview Monday.
Though EDS still wants to land the largest deals, it is now more selective about where to allocate its resources and which deals to pursue, he said. Part of this strategy involves looking at the short term, at deals that would generate revenues quickly or would not require a large up-front investment.
The Bank of America agreement, for example, calls for EDS to manage the company’s telecommunications networks and requires initial capital outlay of $100 million, a relatively manageable figure. “We are looking for the opportunity to generate revenue faster,” Mr. Smith said.
However, the Morgan Chase contract may not have been something that EDS was in a position to pursue. “This is a very large-scale deal, and it will take a significant investment to get started,” said John Lutz, managing director, financial services, IBM. “We made it clear that we had the capability to deliver and that we would do whatever it took to get it started.”
Mr. Caldwell of Gartner said that this partnership would clearly take some cash to get off the ground. For example, IBM will need to install a new fiber-optic link between data centers in the United States and the United Kingdom. “There will be some investments required,” he said.
David Grossman, a senior analyst at Thomas Weisel Partners in San Francisco, said EDS’ financial situation has been a burden. “Clearly, you are encumbered if your balance sheet is weaker than your peers’; it weakens your ability to compete,” he said. “EDS is a good company with some strong customer relationships, but they aren’t as broad and far-reaching” as IBM’s.
In the 12 months through September, sales of IT outsourcing services declined 14%, but IBM’s rose 2% as EDS’ plummeted 29%, Mr. Grossman said. IBM’s strong balance sheet and in-house financing company make it economically appealing for potential customers, he said, and the company has been able to leverage these attributes to attract business.
“IBM has been gaining market share for some time, while EDS has lost share in the last 12 to 18 months,” Mr. Grossman said. “It’s pretty clear that EDS has had some issues.”
