A Big Step Back For Big Blue

It was a notable upset. On Mar 11, Hewlett-Packard landed a $150 mn
outsourcing deal with Renault, snatching the plum contract away from archrival
IBM. HP's $14 bn tech services unit doesn't get much respect, but with last
quarter's growth rate topping 14%, it's looking a lot spiffier than the
industry leader.

IBM's sprawling $46 bn services division has certainly run into a rough
patch. Services have been the company's growth engine for a decade, but they
grew just 6% in the first quarter. That news prompted IBM's May 4 announcement
that it will take a restructuring charge of up to $1.7 bn and eliminate as many
as 13,000 positions, mainly in Europe, where demand was slowest.

Here's what's happening: While the company has been focused on its
future, the present is coming up and kicking it in the pants. IBM has been
investing rapidly in business consulting services to help companies transform
the way they do business, yet its less glamorous, traditional tech services
still pay a lot of the bills. Signings of short-term contracts for installing
computers and software and for systems integration were down 9% in the first
quarter. So services chief John R Joyce needs to shore up that end of the
business.

It's a surprising shift. The latest quarter is the first time in years that
this piece of IBM's business has fallen short of its targets.

IBM
vows to get back in the game. To boost sales to small and midsize businesses, it's
adding a tele-sales unit. It's eliminating the layer of management that
oversaw Europe, and assigning pricing and marketing decisions to the people in
individual countries-with the goal of closing deals more aggressively.

While the moves seem smart, they're not likely to deliver a major growth
spurt immediately.

For IBM's services strategy to succeed, it needs to maintain a balance of
multiyear outsourcing deals and short-term contracts. Industrywide, the length
of outsourcing agreements is declining, largely because customers don't want
to be locked in with a single supplier for as many as 10 years. Though IBM
remains the worldwide services leader, with its share holding steady at 7.8% in
2004, the trend toward shorter contracts caused its order backlog to drop 7.5%
last year and an additional 1% in the first quarter.

The company's European management reorganization likely won't help that
much. Starting three years ago, IBM began shifting its sales force to place
high-powered sales executives in direct contact with large customers. A new
category of employees, called managing directors, deals directly with a large
client or two, has authority over pricing, and coordinates all of the
salespeople from the company's divisions who deal with those clients. The
strategy hasn't delivered the stellar results IBM was looking for, especially
in Europe.

The smaller-business push doesn't seem like a quick game-changer, either.
The market for small and midsize business has long been seen as ripe for the
large tech outfits but has proved difficult to harvest. Two years ago, IBM began
creating services tailored for these smaller clients, and in the past couple of
months it launched 11 new offerings-including an e-mail security scanning
service that costs as little as $1 per user per month.

The trouble is, smaller businesses are typically more cautious than big ones
about adopting new technologies. Plus, IBM has to convince those local services
outfits, some of whom it competes with, that it really wants to be their friend.
That may be tough. "They have to get out of their comfort zones to boost
growth, but it requires a substantial change in how they do business," says
analyst Bob Djurdjevic of Annex Research.

There's another initiative that's intriguing-but still in the planning
stages. DeMarco has asked IBM Research scientists to take the knowledge and
technology developed for large consulting clients and design sophisticated,
prepackaged services for smaller customers. These bite-size services could be
delivered by IBM or by its regional partners.

When Joyce, formerly IBM's chief financial officer, took over as head of
global services a year ago, it seemed as if he had inherited a smooth-running
machine. Now it looks like he has something of a turnaround project on his
hands. Rivals Accenture, HP, and Dell will surely make IBM pay a high price if
he stumbles.

By Steve Hamm in New York in BusinessWeek. Copyright 2005 by The McGrraw-Hill
Companies, Inc