Big Blues Big Bet: Services

New challenge for former IGS head Palmisano: Maintaining margin growth.

In the early days of IBMs Services Organization, executives such as Sam Palmisano brashly claimed that their unit would someday make up half of IBMs revenues. Now, with services veteran Palmisano taking over the companys top spot next month, that lofty goal is well within sight.

However, new pricing pressures and other market shifts could make maintaining the services position as difficult as it was to attain it.

Few IBM Global Services watchers expect Palmisano to make many changes to the $35 billion services unit in the short term, but that is not a sign that the outsourcing and consulting arm of IBM is without its challenges.

Palmisano, who had a strong hand in crafting the IGS growth strategy still in place today, did much to create the healthy margins for IBMs services business that are the envy of the Armonk, N.Y., companys rivals.

"Sam really knows how to manage the earnings equation," said Frank Dzubeck, president of Communications Network Architects Inc., a Washington consulting firm. "He knows how to get profits without bleeding anyone."

But maintaining such margins in the face of increasing price competition—especially with the movement toward less expensive, offshore consulting—will be increasingly difficult.

"In this market, they have to do a lot to prove [return on investment]," said Stephen Lane, an analyst at Aberdeen Group Inc., in Boston. "How to keep the worlds biggest IT organization going in the face of price competition will be an interesting challenge. When youre the biggest, the challenge is staying there."

IGS managed to get to the top of its industry through a combination of hard work, organic growth, an acquisition strategy for filling skills gaps and a concerted effort to keep the consulting arm technology-agnostic, according to a former IGS executive, who asked not to be named.

But the divisions legacy of healthy margins and premium prices has largely kept IGS out of the midmarket, an important omission, said Julie Giera, an analyst at Giga Information Group Inc., in Cambridge, Mass.

"They have been schizophrenic about the midmarket over the last few years," Giera said. "They refused to even bid on outsourcing or managed services deals below a certain size. For IBM to continue the success theyve had, they have to find a way to address the midmarket at a price they can bear."

At the same time, IGS has not created significant mind share in high-end strategy consulting or in business process outsourcing—both areas of high growth, Giera said.

"We think business process outsourcing will lead the industry," Giera said. "IBM does both of those but in pockets. There is not one central group they can point to, and that is a hole for them. Electronic Data Systems [Corp.] has it, PricewaterhouseCoopers has it, IBM has to get it."

In fact, business process outsourcing for functions such as human resources, billing and payroll are areas into which Palmisano may move IGS.

"They have to be willing to do services that dont have to do with technology, such as strategies and process re-engineering," said Dean McMann, CEO at The Ransford Group, an outsourcing consulting company in Houston. The wild-card challenge for IGS may come from shifting demands in the IT outsourcing space toward utility computing. If the nascent market takes off, the move to utility computing could threaten IGS ability to maintain its healthy margins, industry sources said.

"If utility computing really takes off, IBM and EDS have skills around managing data centers, but they dont own the networks to do the remote delivery, and telcos have a lot of experience in selling utility services," said Doug Chandler, an analyst at International Data Corp., in Framingham, Mass.