|BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE|
Meet the "Completely Different EDS"
Despite a drastic reorganization and suddenly satisfied customers, skeptics remain
When Electronic Data Systems Corp. (EDS) landed the U.S. government's biggest-ever technology outsourcing deal--a $7 billion contract to build and maintain computer networks for the U.S. Navy and Marine Corps--Champagne corks popped and Sousa marches played over loudspeakers at the sprawling EDS headquarters in Plano, Tex. For CEO Richard H. Brown and his team, the surprise win over three rivals was proof positive that the once foundering technology-services giant was back. Wall Street was impressed, too. The company's stock jumped nearly 10% after the Oct. 6 announcement.
But for many investors, it's too soon to celebrate. Despite nearly two years of painful cost-cutting and reorganizing and six consecutive quarters of rising profit margins, EDS still must prove that it can reignite its sluggish top-line growth. Brown has done ''an exceptional job'' of restructuring EDS and boosting profitability, says analyst David M. Togut of Morgan Stanley Dean Witter. ''But [revenue] growth is much more difficult than restructuring.''
TRAILING THE FIELD. Indeed, despite seven quarters of record contract-signings totaling nearly $42 billion, EDS's third-quarter revenue was virtually flat from a year ago. If you strip out revenues from former parent General Motors Corp. (GM)--a flat-to-declining business that makes up 18% of EDS's sales--and exclude the effect of divestitures and currency swings, the growth was a healthier 8%. Still, that's well below the market rate of 14% growth for the businesses that EDS is in--everything from its strategy consultancy, A.T. Kearney, to managing data centers and creating electronic marketplaces. With investor expectations outstripping results, the stock now trades at about $56--well below its 52-week high of $76 in February.
The unflappable Brown, former chief of Cable & Wireless PLC (CWP), counsels patience. ''We're still extremely confident that the revenue is there to get,'' he says. With most of the restructuring completed, he says the recent contracts and improved customer renewal rates--86% now, vs. an abysmal 70% in 1998--will produce faster growth in the fourth quarter and double-digit gains in its non-GM business next year. ''There is absolutely no flaw in the performance of EDS,'' insists Brown, pointing to a $70 billion-plus backlog of contracts and a rich pipeline of potential deals.
Brown, a New Jersey native who joined EDS in January of '99, isn't the only IT-services chief struggling with sluggish growth. Computer Sciences Corp. (CSC), Perot Systems (PER), and other industry players have had similar disappointments. Heavy spending on Y2K fixes and frenzied Net initiatives in 1999 dampened sales earlier this year. And the strong dollar is pinching international players such as EDS, which gets 42% of its revenues from overseas.
Still, EDS faces some self-made hurdles. As part of Brown's $1 billion cost-cutting effort, the company terminated about 125 contracts and sold units with subpar profits. That left a $600 million hole in revenues to fill this year. Brown let a third of his salesforce go to make room for better performers but only recently staffed up to prior levels. And a massive shuffling of executives followed some 13,500 layoffs and early retirements, hurting critical sales relationships with existing customers.
Brown's drastic medicine was sorely needed. The scrappy business founded by Ross Perot and sold to GM in 1984 had grown fat and complacent. Some 48 ''strategic business units'' operated as separate fiefdoms, bloating costs and confusing customers. By the mid-'90s, EDS was an also-ran in the budding world of the Internet--and had ceded leadership in services to a revitalized IBM (IBM). In 1996, EDS was spun off by GM and forced to cut prices for its former parent to lock in a new, long-term services deal. EDS quickly found itself struggling to meet sales and earnings targets.
Brown hit EDS like a neutron bomb. Only 10 of the 37 top officers who were there when he arrived remain. The 48 fiefdoms have been streamlined into four business divisions. A weekly report ranks the top 40 managers against their sales targets and is shared with all of them. A computerized ''service excellence dashboard'' shows how more than 1,000 contracts are performing--with red highlights on the trouble spots, as ranked by customers and EDS executives. Brown regularly visits customers and employees and responds to the hundreds of e-mails he gets monthly from workers. ''There's a sense of urgency that hasn't been there before,'' says EDS Vice-President Robb R. Rasmussen.
Pleased customers have taken notice. William C. Van Faasen, CEO of Blue Cross & Blue Shield of Massachusetts Inc., says Brown stopped by for a visit to hear his concerns within two months of taking the top job at EDS. In seven years as CEO, it was the first one-on-one meeting Van Faasen had had with an EDS chief. ''They listen better'' now, he says. Jack Sandner, CEO of FreeDrive Inc.--which offers data storage services via the Net--was astonished at EDS's newfound focus. In more than a decade as chairman of the Chicago Mercantile Exchange, Sandner had worked with EDS and found the experience to be ''like rowing a boat in mud.'' But less than two weeks after Sandner and Brown chatted at a White House dinner in August, EDS teams were combing through FreeDrive. Ten days later, EDS had agreed to invest in FreeDrive and to provide Web-hosting and data-storage services to the startup. ''This is a completely different EDS,'' marvels Sandner.
EDS has no choice but to be faster and nimbler. Even its bread-and-butter outsourcing business--handling data centers, networks, and other tech chores for customers--is rapidly changing. Outsourcing chief Douglas L. Frederick says such deals, still 75% of EDS's revenues, are getting smaller and shorter than the 10-year megacontracts typical a few years ago. And profit margins are getting slimmer as competition heats up. Customers are looking for outsourcing deals built around specific technologies or business processes, like taking over the management of the human resources or accounting department, says IDC analyst Traci Gere. That kind of flexibility ''has not been a hallmark of EDS in the past,'' she says.
NEED FOR SPEED. EDS will need to be even speedier if it wants to be a big player in e-business services, the fastest-growing tech-services market: Research house GartnerGroup expects it to increase more than sixfold by 2004, to $158 billion. EDS's e-business customers often cite the company's good work, but give it mixed reviews when it comes to providing ''really innovative, cutting-edge types of solutions,'' says Gartner analyst Frances Karamouzis.
To improve on that score, EDS in November launched bluesphere, a new unit to offer customers Web design integrated with back-end applications, such as billing and procurement. Analyst Karl E. Keirstead of Lehman Brothers Inc. figures giants like EDS and IBM are well positioned to take market share from e-business niche players such as Sapient and Razorfish. ''The projects that are left are larger, more complex deals'' requiring global companies with experience integrating heavyweight computer systems, Keirstead says.
With most of the jolting changes behind it, will EDS finally take off? Merrill Lynch & Co. analyst Stephen T. McClellan thinks so. He figures non-GM revenues--the number most analysts follow--will grow 11% next year, after a paltry 4% increase in 2000. Earnings should jump 15%, to $1.3 billion. Still, he admits, profitably implementing these complex deals is where the real risk lies.
Even EDS executives concede they've done the easy part in pruning costs. Now, they've got to deliver on their growth promises to reap their rewards on Wall Street. Until then, they'd do best to turn down the Sousa and keep those Champagne flutes in storage.
By Wendy Zellner in Plano, Tex.
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Meet the ``Completely Different EDS''
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