Computer Services for Hire : ‘Outsourcing’ Thrives as Firms Shed Data Processing Chores
Most of the gleaming white buildings at Electronic Data Systems’ lush new headquarters here aren’t ready for occupancy yet, but one windowless, low-slung structure hums with the arid sound of huge mainframe computers crunching through billions of calculations every second.
This building, the size of eight football fields, is command central for EDS, the locus of an international network of computer and telecommunications facilities that handles information processing for parent General Motors Corp. and hundreds of other companies and government agencies.
There’s nothing particularly special about the technology being used here. But EDS and its competitors represent the future of the information technology industry, one in which building computers will be less important--and less profitable--than providing computer services.
Indeed, farming out computer operations to third-party service companies--a practice commonly called “outsourcing”--is one of the hottest trends in corporate computing. While computer vendors struggle with slumping sales and price wars, computer services specialists such as EDS, Computer Sciences Corp., Andersen Consulting, Perot Systems and a subsidiary of International Business Machines Corp. are enjoying torrid growth.
“Outsourcing . . . is rapidly developing into a tidal wave,” says Stephen T. McClellan, an analyst with Merrill Lynch. Information technology departments at large companies, he says, have become “like the motor vehicle fleet or the cafeteria--you can farm it out and get it done better and cheaper.”
For a long time, however, most corporations saw a big difference between hiring someone to make cheese sandwiches and turning to an outside supplier for computer services. The company’s computer files were just too critical and confidential to be entrusted to others.
And there was also a certain amount of pride at stake: Real Men Don’t Outsource was a common, if unstated, credo. Through the 1960s and 1970s, government agencies led the way in hiring service companies to operate computer systems under so-called “facilities management” contracts.
By the late 1980s, though, the corporate mind-set toward third-party services had begun to change. As computer departments grew larger and more expensive to operate, senior managers began looking for innovative ways to cut costs. And information systems managers had a lot to fret about: Constantly changing technology promised continued expense and uncertainty, and then there was the problem of finding and keeping skilled technicians.
The dam broke in 1989, when Eastman Kodak Co. agreed to have IBM, Digital Equipment and Businessland take over all of its internal computer operations. That deal gave a blue-chip seal of approval to the outsourcing concept, and now there’s hardly a corporation in the country that hasn’t at least considered the alternative.
EDS, founded in 1962 by a maverick IBM salesman named Ross Perot, virtually invented the concept of outsourcing and has been the biggest beneficiary of the recent boom. The company had about $750 million in revenue when General Motors purchased it in 1984, and by last year sales exceeded $7 billion. For the first time since the acquisition, less than half of EDS’ business last year came from its corporate parent.
But a growing pack of competitors is trying to grab a share of the spoils. Computer Sciences Corp., an El Segundo company whose traditional business is managing computer systems for the military and other government agencies, is now aggressively pursuing commercial customers. Aided in part by 15 acquisitions since 1986, annual revenue has swelled to more than $2 billion. Last year, CSC signed the biggest commercial outsourcing contract ever--a 10-year deal with General Dynamics that is expected to be worth more than $3 billion.
Andersen Consulting, split off last year from the accounting firm Arthur Andersen, is parlaying its expertise in consulting, computer systems design and programming into a broader computer services role. IBM is also trying to expand its computer services operations through its Integrated Systems Solutions Corp. subsidiary. Setting up ISSC as a separate subsidiary has helped allay customers’ fears that the IBM unit would be biased in favor of IBM equipment.
Ross Perot, who left EDS in 1986 after his harsh criticism of General Motors management led the auto maker to buy out his stake in the company for $700 million, is taking aim at his former minions with Perot Systems, a private firm that is already generating an estimated $200 million a year in revenue.
A growing legion of specialized computer service companies has also gained a foothold, offering a range of services tailored to industries such as banking, health care and transportation.
And new players are getting into the game all the time.
Rod Canion, ousted last year as chief executive of personal computer titan Compaq Computer, recently joined a former Perot Systems executive to form Insource Management Group. The Houston company won’t be a direct competitor with the big computer service companies but instead will offer companies a blend of technology and management consulting services designed to erase the need for an outside computer service supplier.
These challengers will have their hands full keeping up with the EDS juggernaut. Once known mainly for its militaristic, starched-shirt culture and expertise with large mainframe computers, the company is cultivating a kinder, gentler image. It’s positioning itself as a business partner that understands the customer’s operations from the ground up and can address all technology needs.
Lester M. Alberthal, the sober, consensus-oriented EDS veteran who succeeded Perot, prides himself on having overseen the cultural shift that he believes was essential to the company’s growth.
“As a service company, size is the issue that you deal with,” he says. “You are what your people are, and the more people you have, the more the environment of the company is critical. The environment for 70,000 people today is very different from an entrepreneurial start-up company.”
A key step was a 1989 reorganization that split the company into more than 35 quasi-independent business units, each focusing on a particular industry.
Alice Lusk, who joined EDS 17 years ago and now heads the health care business unit, says she is given considerable autonomy by top management. She goes to the management committee only for approval of major investments.
EDS has traditionally specialized in the most comprehensive type of computer services, taking over all of a company’s computer systems and either operating them on the customer’s premises or moving the functions into a centralized data processing center. (The Plano facility, overseen by Hartmut Burger, has four such centers, as well as a network management facility that controls EDS’s global telecommunications network.)
But there are infinite variations on computer outsourcing, and other vendors have different specialties. Andersen, for example, has typically focused on so-called systems integration work, in which it helps design and program a computer system but leaves ownership and most operations to the customer.
No two customers have exactly the same reasons for hiring an outside supplier for computer services. Ace Hall, a corporate vice president at defense contractor General Dynamics, said he began looking at outsourcing as part of a broad review of the company’s operations.
The data systems division that Hall headed was a large company in its own right, with more than 4,000 employees and an annual budget exceeding $500 million. But Hall and his bosses recognized that running a computer company didn’t fit very well with General Dynamics’ core defense businesses.
“We thought it was a pretty good organization, but we were not marketing services outside and it wasn’t creating any value for the company,” Hall said. So the company began looking for ways to get a financial return from the operation. One alternative was to sell the division to an outsourcing company.
At about the same time, Computer Sciences Corp. was setting out to reduce its reliance on government contracts by expanding its commercial business. Last September, CSC and General Dynamics cut a deal in which CSC bought the data services division for $200 million and signed the 10-year agreement. Hall says it was a “gut-wrenching” decision, but that the arrangement has worked smoothly thus far.
For National Car Rental, it was concerns about its ability to sustain innovation and assure the reliability of its computer systems at a reasonable cost that led it to an outsourcing deal with EDS. In the late 1980s, recalled chief information officer Jack Livingston, “we had implemented a number of innovations (such as automatic car-key dispensers and express service lanes) and we had increased our dependence on technology.
“The decision was: How much further did we want to take the technology given the number of risks? We knew this area was getting much more complicated.” With EDS, Livingston says, the company now has a “technology partner” whose enormous pool of computer equipment and skilled personnel can meet all of its needs quickly and cost-effectively.
At Westmoreland Coal Co. in Philadelphia, a desire to cut costs was behind the decision to hire EDS to run its computer operations. “We’re in a very competitive industry, selling a commodity, and we were doing everything we could to lower our costs and remain competitive,” said Ron Rominiecki, the company’s controller.
“Information technology costs had grown to a level that we thought was unacceptable, and the services they were providing internally were insufficient.” The outsourcing deal enabled the company to get more services for less money.
For all the successes, however, the computer services industry faces important challenges. Many big companies, especially those in information-intensive industries, continue to regard their computer systems as too strategically important to entrust them to outsiders.
Sometimes outsourcing can create bad feelings among employees, as in a recent case in which EDS took over the troubled computer operations of Blue Cross/Blue Shield of Massachusetts. Though Blue Cross initially implied that all the computer department employees would be offered transfers to EDS, 92 of the 570 workers were laid off.
Further, the shift away from big mainframe computers and toward powerful personal computers and workstations could eventually hurt EDS and other companies that specialize in running mainframe computer operations for multiple clients. Running complex networks of small computers has not been the forte of most computer service firms.
“They recognize that mainframe computing is not where the future is going to be, and they have to develop other solutions,” says Perry Harris, a consultant with the Yankee Group, a market research firm in Boston.
There are also fears that the federal government--a heavy user of outside computer services--may be moving away from the use of computer contractors. The Environmental Protection Agency last month canceled a $1-billion computer contract with CSC after government auditors said the company had too much control over agency operations.
Executives and analysts involved in federal contracting say it’s too early to tell whether the EPA decision will prompt other agencies to re-evaluate their computer services contracts. But concerns about potential conflicts of interest between computer contractors and its customers will likely remain an issue.
For now, though, the computer services industry remains strong. “Outsourcing is now acceptable--there’s no longer a stigma,” says Merrill Lynch’s McClellan. “It’s a locomotive picking up steam.”
Understanding Outsourcing As computer systems become more complex and difficult to manage, many companies are turning to outside contractors to handle some or all of their information systems requirements--a practice known as outsourcing. Here are some of its various forms:
* Contract programming: An outside vendor develops and maintains specialized software for coporate or government computer systems.
* Facilities management: An outside vendor operates the client’s computer systems, either at the client’s location or at the vendor’s data system.
* Systems integration: An outside vendor designs and helps install and maintain a complex corporate computer system, usually involving equipment from several vendors.
* Other: Includes third-party equipment maintenance and disaster recovery.
Sending Out for Computer Sources Total revenue from outsourcing is expected to continue growing strongly as more companies go outside for services including contract programming, facilities management and systems integration. Year: Estimated revenues (in billions) 1989: $25.60 1990: 29.28 1991: 33.48 1992: 38.01 1993: 43.25 1994: 49.33 Source: Yankee Group
