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When IBM (IBM
) scooped up PriceWaterhouseCoopers Consulting in October, 2002, Big Blue bet that the $3.9 billion deal would help solve its long-standing challenge of sluggish revenue growth. The consulting business itself seemed to offer bright growth prospects, and PWCC's 30,000 whip-smart consultants were supposed to help drive sales of IBM's other products and services.
But on Jan. 15, IBM's Business Consulting Services, which includes the PWCC consultants, stumbled. While the rest of IBM's financials for the fourth quarter were strong, revenues for the BCS group fell 2%, to $3.25 billion, compared with expected growth of 3%. The news was enough of a surprise that Merrill Lynch & Co. (MER
) analyst Steven Milunovich slashed his revenue prediction for the consulting group from 10% growth in 2004 to a 4% decline.
Big Blue's big push into strategic consulting is proving to be one of the thorniest challenges in the young tenure of Chief Executive Samuel J. Palmisano. While Palmisano and his top lieutenants have managed much of the PWCC acquisition smoothly, they've been confronted with a consulting industry that's more troubled than most anyone anticipated it would be two years after the U.S. recession officially ended. A glut of capacity and the rise of offshore competitors have led to brutal competition. The result is that many IBM consultants are sitting on the bench, dragging down revenues and profit margins. "They're probably a little bit behind where they were hoping to be," says analyst John B. Jones Jr. of Soundview Technology Group.
Even as tech demand recovers, Palmisano will need to move IBM up the food chain faster than rivals nibble away at the bottom. Competitors from India and elsewhere are aggressively moving into services like call centers and maintenance that IBM has long offered. At the same time, players such as Hewlett-Packard Co. (HPQ
) and Accenture Ltd. (ACN
) are stepping up their capabilities in traditional IBM strongholds like outsourcing. Rivals openly question whether the PWCC deal will offer IBM any competitive advantage. "Time will tell with that acquisition. So far, they've had virtually no growth," says Carleton S. Fiorina, CEO of Hewlett-Packard, which considered acquiring PWCC before IBM did. "Relationships are nice, but in the end, do they bring business in the door?"
So will the PWCC deal pay off? The evidence suggests that it will, over the long term, though 2004 will be challenging. Already, the collaboration between PWCC's consultants and IBM's techies is resulting in a range of high-end services that rivals will be hard-pressed to match. More than ever, the company's consultants are helping top execs plot strategy and plan business initiatives -- and then offering the services and gear to make it happen. Sanford C. Bernstein & Co. estimates the growth rate for BCS will average 12% in 2005 and beyond, faster than any other group at IBM. "Having started from nowhere, we've made a lot of progress," says Virginia M. Rometty, head of the BCS group.
Whether Rometty's group thrives will depend in large part on how it performs in the market for what's called "business process outsourcing." In these deals, companies hand over management of an entire corporate function, like finance, to an outsider. IBM's strategy is to develop expertise in four processes -- human resources, customer care, procurement, and finance and accounting. It has attracted an anchor customer in each segment, and now it's marketing its skills to other corporations.A VALUABLE PARTNER. IBM landed Procter & Gamble Co. as its anchor client in the human-resources market last September. The 10-year, $400 million deal calls for IBM to take over administration of the consumer giant's payroll, travel expenses, and other tasks, while P&G reaps big cost savings and improved service levels.
For IBM, the P&G deal is even more significant. Under a typical outsourcing contract, IBM would acquire the people and computing systems of a customer. In the P&G deal, IBM is picking up technology assets, too. It purchased a business software program from SAP that P&G had customized and P&G's Net portal technology, which lets employees manage their expenses and benefits. Now, IBM plans to meld those assets with its own and market them to other customers. "We want to take the best practices from both organizations and make something stronger," says Bill Matson, general manager of IBM's HR consulting practice.
Still, IBM will have plenty of competition in the market. Business process outsourcing is expected to grow 9% annually over the next two years to $143 billion in 2005, according to researcher Kennedy Information Inc. That has attracted a host of rivals, including Affiliated Computer Services Inc., and prompted HP to enter the market for the first time. "There's more competition," says Brad Smith, vice-president at Kennedy, "[though] I think IBM is on the right track." There is evidence of that: In the fourth quarter, IBM notched $2.8 billion in business-outsourcing deals, nearly $2 billion more than Goldman, Sachs & Co. had predicted. And on Feb. 4, IBM won a $2 billion deal to take over Sprint Corp.'s customer-service operations.
The PWCC consultants have made IBM a more valuable partner in plotting strategy, too. Consider the tale of LAM Research Corp. (LRCX
), which makes equipment for semiconductor manufacturing. CEO Stephen G. Newberry wanted to make the Fremont (Calif.) company's expenses more flexible so that it could cope with the extreme cycles of the chip industry. IBM consultant David Lubowe worked with Newberry to develop a solution. Big Blue took over LAM's tech infrastructure, and now LAM pays for computing power only as it needs it. What's more, IBM consultants helped create an online marketplace of suppliers for LAM and 23 other companies. By pooling their buying power, the companies receive cost savings of up to 30% on back-office services such as benefits administration. The result? Even when LAM's revenues hit $160 million a quarter in 2003, off 50% from 2001 levels, it turned a profit.
With competition increasingly fierce, IBM's ace in the hole may be its vaunted research group. In the past, IBM researchers would work with customers on an ad hoc basis. But in late 2002, IBM for the first time created a formal group of about 200 researchers specifically to work with consultants and clients and began holding them responsible for meeting financial goals. Now, IBM's researchers are working on 75 megaprojects, the largest effort of its kind in the industry. They're expected to bring in $200 million in contracts this year, double the total in 2003, says IBM research head Paul M. Horn.
BostonCoach is one customer that expects to benefit from this cross-fertilization. The limousine company wanted to increase its fleet productivity. So early in 2003, IBM consultant Steve Manni brought in a group of researchers who built a program to crunch data about geography, travel times, and passenger importance. BostonCoach expects the tool to yield a 15% to 20% rise in fleet productivity, leading to $10 million more in sales with the same labor costs. "[No other company] had the R&D depth of IBM," says BostonCoach Managing Director Pat Hillman.
IBM will need every weapon it can muster as it struggles with overcapacity and increased competition in the consulting business. But over the long term, Big Blue's bet on PWCC seems likely to pay off. By Spencer E. Ante in New York