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IBM services to the rescue
July 23, 2001 12:00 AM ET
by Michelle Rushlo
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The dismal news about hardware and software is well chronicled by now: Economic conditions worldwide have soured, battering sales numbers and squeezing profits.
The news at IBM (IBM) was no different during the second quarter -- except that it has a giant services business, one that posted 7 percent growth in revenue and helped meet earnings expectations.
For years, IBM has proclaimed itself "a services-led company." And now, it literally is.
IBM Global Services accounted for the largest share of the mammoth company's revenue in the second quarter, garnering $8.74 billion in sales. That compared to Big Blue's hardware business, which declined from last year to $8.65 billion.
Services bigger than hardware
Analysts say IBM's results bode well for other major services organizations, like outsourcing leader EDS (EDS). It is scheduled to report earnings on Wednesday.
Jim Corgel, general manager of the e-business hosting services division of IBM Global Services, said the economic necessity of looking to outsourcing for cost savings combined with the desire to improve websites and e-business as a whole has converged.
"All that coming together is why for the first time in history services surpassed hardware, and that was all by design," he said. "We'll continue to lead with services. We knew this day would come."
Analysts say the weak economy has given businesses renewed incentive to outsource traditional information technology functions.
"Companies are realizing they need to focus on their core competency" and are turning to outsourcing services to free them from IT obligations, said Gartner Dataquest analyst Allie Young.
Keeping up with the fast-paced change of technology and the growing demand for IT workers has been difficult, she said.
IBM services to the rescue
page 2: Outsourcing gains momentum
Jay Stevens, an equities analyst at Buckingham Research Group, said IBM's services unit has benefited because customers still need to maintain, integrate and train workers to use equipment they already have, even if they are not investing in new products.
"There's always a need to maintain what you have. Even when you don't buy a new car, you still have to maintain the old car. It's the same thing," he said.
Money-making maintenance contracts
Gary Helmig, an analyst at Wit SoundView, said the company also has a good services revenue stream to build from because about a third comes from maintenance contracts, and every price increase drives up total sales.
About 40 percent of Global Services revenue comes from outsourcing, which thrives in a weak economy, he said. Companies trying to manage through a tough economic cycle are finding they can't retain good IT workers and are under pressure to save money, so many are reaching the point where they say, "Just have IBM do it," Helmig said.
During the second quarter, IBM's services contract backlog rose to $95 billion. Three contracts worth more than $1 billion each were signed.
"Outsourcing is the heart and soul of what IBM Global Services does and will continue to do," Corgel said.
But the outsourcing business also gives IBM the opportunity to sell a mix of services, including hosting and integration.
Those additional sales -- coupled with the added hardware and software deals -- can help make services a more lucrative business than straight outsourcing contracts.
For example, IBM has seen strong growth in its hosting business, which covers both website hosting and design services along with the hosting of e-business applications.
"Other then 'how much does it cost,' people say 'how fast can you do it?'" Corgel said.
Hosting and integration
Being able to offer that one-stop shop has helped Big Blue win a lot of business that more-limited hosting businesses have been unable to attract, he said.
Young said IBM's name and long-standing reputation don't hurt either.
"There's an element of trust, of a commitment," she said. "Don't think for a minute that these deals aren't sold at the very high level of companies. A lot of these deals are sold at the executive level."
She points out that many companies still have a long-running preference for IBM technology, which helps the services division.
Big Blue is in a good position because its technology is already in so many IT operations, Young said.
"They also have a global presence. Let's face it. They are also a very aggressive company."
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