EDS, Navy Get Back on Course

Outsourcer gives up $680M to gain 3-year extension on intranet contract.

Electronic data systems earned redemption on one of the largest and perhaps most troubled contracts in the history of outsourcing, signing a three-year, $3.1 billion extension on the Navy Marine Corps Intranet contract March 24.

But the win came at a price. To cement the deal, the Plano, Texas, outsourcing giant had to renounce $680 million in claims for work performed, as the Navy agreed to pay only $100 million of $780 million worth of work for which EDS had billed the government.

"This takes care of past history," said Rear Adm. James Godwin of the Navy—the top military officer overseeing the huge deal. "The new provisions will hold both the government and contractors accountable, with incentives and disincentives for good performance or lack of performance. We never had that before."

EDS has declined to comment on the terms of the deal until its next quarterly earnings statement, which is expected May 2, a company spokesperson said.

The NMCI project now has nearly 300,000 installed user workstations and another 58,000 to go before it is complete, said Godwin in Arlington, Va. Most of the as-yet-unfinished installations will be for the Marine Corps, recruiters and a classified network, he said.

Signed in 2001, the original $7 billion contract for the worlds largest intranet was set to expire in September 2007; with the extension, it will continue until September 2010, subject to the availability of funds. The Navy did not consider competitive bids in granting the extension to EDS, Godwin said.

"Its intriguing that the difference [between EDS $780 million bill and the Navys $100 million compromise] was that large, but look at the exit costs for both parties," said Julie Giera, an analyst at Forrester Research, of Cambridge, Mass.

Giera said the cost for the Navy to dump EDS and find another provider would have been far greater than the cost of ironing out differences with the company. Further, the cost to EDS of walking away from five years of investment in the NMCI project similarly would have outweighed the benefits of continuing, she said.

"Its great news for both of them. It would have been a disaster for the Navy to try to make a change," Giera said.

In another deal—announced earlier this year—that proves how difficult it is to sever an outsourcing relationship once its in place, EDS held onto the bulk of its work with troubled automaker General Motors. "Its like marriage and divorce," said Giera. When a new provider is brought in, it often takes six to 12 months for [that] provider to get to a level of competence, she said. "If youre a customer, you can find yourself facing interruptions in service," she added.

As for the NMCI contract, Godwin said the government has established how much the massive intranet is worth at present and can therefore calculate how much it will be worth in 2010 when the extension expires. At that time, the Navy may purchase the network from EDS or put it out to bid among other contractors, he said.

"We needed to know what it costs," Godwin said, "so at the end of this contract, we can rebid it." He said he compared an estimate from EDS with one done jointly by Booz Allen Hamilton and Gartner. "When we put the RFP [request for proposal] on the street, for EDS, IBM or CSC [Computer Sciences Corp.], well know what the price is. We could buy the network back from EDS," Godwin said.

The original NMCI deal included a provision that the cost per user seat on the intranet decrease every year. That condition appears in the extension as well; over the additional three years, the cost of a seat is scheduled to drop 15 percent.

Although heralded with much fanfare at first, the NMCI contract went south quickly for both parties. The Navy suffered as desktop systems remained uninstalled, sitting in a warehouse for months as EDS tried to figure out how to get them to the right offices, while EDS piled up losses as the Navy declined to pay.

In an interview earlier this year, Mike Kuehler, who is in charge of the project for EDS, said that keeping the contract within the EDS fold was a top priority when he was assigned to the project in 2004. According to the terms of the contract, EDS could not be paid by the government until a system was installed and running. "This was a going-out-of-business strategy," said Kuehler.

At its low point, the contract was costing EDS $800 million annually and led to a Securities and Exchange Commission investigation of the outsourcer.

But the problems werent entirely EDS fault. In some cases, EDS workers would show up at a building ready to install systems and networks and find the occupants of the facility had been ordered elsewhere. "There was government responsibility," said Godwin. "For example, EDS cant deliver a seat to a place that doesnt have the authority to operate."

In the end, EDS got the Navy to agree to revised terms that made it more likely the company could fulfill the contracts provisions and get paid.

In the meantime, EDS has turned things around and is looking forward to positive cash flow this year of about $140 million from the deal.