Services megadeals not quite so mega

Companies like IBM, Hewlett-Packard and Electronic Data Systems love to trumpet computer services contracts worth hundreds ofms or evenbns of dollars.

But what's hiding behind the big numbers are the costs involved in following through on those megadeals -- costs that can be substantial.

IBM, for example, recently boasted of a $1.1bn (£0.7bn), 10-year information technology services contract with Swiss power and automation technologies company ABB.

 Big Blue said that, along with roughly $600m generated by two other contracts signed in late 2001, its revenue from ABB will approach $1.7bn over 10 years. But IBM isn't likely to rake in profits anywhere near $170m a year, at least initially. Because it is hiring nearly 1,300 ABB employees as part of the deals, IBM is looking at yearly personnel expenses that probably top $90m.

Analysts say the IBM example is typical of large IT services contracts. Services providers frequently have to make substantial investments in IT equipment and personnel. What's more, clients are renegotiating contracts along the way, which can trim profits further, said analysts.

The real value of the deals may be long-term relationships and repeat business years later.

"What's being acquired here is really a client relationship," said David Garrity, an analyst with equity research company American Technology Research.

That could explain the spate of big deals announced in recent months, and an overall growth in the number of billion dollar-plus contracts being signed by services companies.

In May, HP said it finalized a deal worth $3bn over 10 years to manage Procter & Gamble's overall IT infrastructure. In August, Computer Sciences boasted it won a 10-year, $342m IT outsourcing contract with Malaysian banking group Malayan Banking.

IBM, meanwhile, announced a seven-year IT outsourcing contract with beverage company Diageo. Analysts familiar with the deal estimated its value at $400m to $500m.

Megadeals are usually IT outsourcing arrangements lasting for at least several years, where services companies take over tasks such as developing software applications, running data centres or managing desktop computers. Last year was a big year for the biggest deals. There were at least 14 IT infrastructure outsourcing deals worth $1bn or more in 2002, compared with nine such deals in 2001, according to researcher Gartner Dataquest.

TPI, a consulting company that helps arrange outsourcing contracts, said that in 2002, the total value of all IT-focused outsourcing deals worth more than $200m added up to $41.4bn, versus $38.8bn in 2001. Including "business process" outsourcing deals, which involve farming out business tasks such as call centre operations or accounting, the total value of outsourcing deals worth more than $200m rose from roughly $46bn in 2001 to about $50bn last year, according to TPI.

The number of big deals will most likely decrease in 2003, TPI has predicted. But Garrity is bullish about big outsourcing deals over the next three to five years. Businesses can use megadeals to cut costs, and may see outsourcing as an attractive option as they look to upgrade their computer gear, he said.

The emergence of so-called utility computing initiatives, which aim to convert computing to a pay-as-you-go service such as electricity, also could spark big deals, Garrity said. The overseas market in particular is fertile, he said. "You may see more megadeals coming out of Europe, and you may see more megadeals coming out of Asia," he said.

Read the fine print
Still, the deals may not be as sweet as they seem. IBM's contract with ABB is a case in point. Under the new agreement, announced in July, IBM said it will take responsibility for the operation and support of information systems infrastructure in 14 countries in Europe and North America--representing some 90 percent of ABB's IS infrastructure.

IBM is taking on about 780 ABB workers, on top of 510 ABB employees absorbed from the two earlier contracts. Forty-four of the already-transferred ABB employees were from India. Garrity estimates that the annual cost of European and North American workers is roughly $75,000 to $100,000, while the Indian workers probably set back IBM $15,000 to $25,000 a year. Thus, a conservative estimate for the annual personnel costs Big Blue is picking up in the deals is about $94m.

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