InformationWeek

January 5, 1998

Surge In Services

Year 2000, labor shortages, and profitability goals drive services demand

By Bruce Caldwell and Marianne Kolbasuk McGee

Services his year is likely to be even more stressful for CIOs than the last. CIOs are under the gun from year 2000-imposed time constraints and labor shortages, just as demand is rising for IT to contribute more to the company's bottom line.

Services companies say that means surging demand. Outsourcing vendors, systems integrators, and IT staffing companies all see business booming in 1998, driven largely by demand from compan ies that are behind on their year 2000 projects.

Consultants are also gearing up to advise clients on how to improve profitability through IT in call centers, customer management, and data mining. Another hot area is integration of legacy systems with Web-based transactions. Emerging areas in outsourcing include business process outsourcing and shared services, in which outsourced business-process operations from several companies are combined to produce economies of scale.

The labor shortage will only get worse as year 2000 conversion projects close in on deadlines, creating explosive demand for contract staffing services. When it comes to year 2000 projects, "the sense of urgency is beginning to peak," says David Wright, CEO at Amdahl Corp. Amdahl's year 2000 services revenue reached $100 million last year, and Wright says that could double in 1998.

Services vendors have been gearing up through acquisitions to deal with that demand. While some companies look to add year 2000 expertise, other systems implementers seek expertise in package software implementation to capitalize on the growth in enterprise application packages. "That's driving a lot of mergers and acquisitions," says Karl Keirstead, an equities analyst with Lehman Bros. in New York.

There's big demand for staff in other areas, too. Affiliated Computer Services Inc. recently boosted its resources available for government contracts by purchasing Computer Data Systems Inc., an IT services provider to the federal market with about 2,500 programmers.

Unlike some services companies, ACS is steering away from the hot growth market, year 2000. "We view it as a bubble business, here and then gone in a few years," says Jeff Rich, president and chief operating officer of ACS, in Dallas.

Consolidation is occurring even among the Big Six professional services firms, expected to become the Big Four this year. In today's services market, those with the most skills win. But Big Four competitors are not quaking in their boots-yet. Most expect that the mergers of Ernst & Young with KPMG Peat Marwick, and of Price Waterhouse with Coopers & Lybrand, will take several years to have a significant impact on the market. And right now, there's plenty of work for everyone.

Demand for services is so high that vendors based overseas, such as Cap Gemini, Logica, Origin, and Sema, are making inroads in the United States. They're injecting new blood into a market where the biggest players are struggling to find the human resources to fulfill existing contracts. Emerging and second-tier vendors such as AnswerThink Consulting and SMS are acquiring the resources to compete nationally.

"We're excited that this next wave of suppliers is developing," says Dennis McGuire, president of Technology Partners Inc., a Dallas outsourcing consulting firm. "A lot of the big guys have to focus on their existing customers."

Computer Sciences Corp., for instance, has limited its year 2000 work to existing clients for the most part, and to the assessment a nd planning stages. It's forgoing the code conversion and testing work rather than divert employees' careers and hire staff that would eventually have to be let go or retrained. "We will pass on that opportunity in order to meet what we feel are our obligations to our people," says James Saviano, president of CSC Consulting Group in Cambridge, Mass. "It's a very real issue: What happens to us after year 2000?"

With demand for package implementation and systems integration soaring, CSC has begun a college-recruitment program and expects to hire 350 people in March. Even so, Saviano says, "We will not have enough people to meet all the opportunities."

Despite the flood of existing work, new services and different forms of vendor relationships are attracting strong interest. Demand for business process outsourcing and shared services-for functions ranging from insurance claims processing to back-office accounting-is up, as companies see a way to cut costs, focus on core competencies, and make a buck by turning over cost centers to vendors that can develop them into profitable businesses.

Profit Generators
Shared services, in particular, is a hot topic. Instead of just outsourcing a business process and forgetting about it, companies are looking for ways to generate ongoing profits from those outsourced operations. The outsourced operations may not have the scale to produce profits by themselves, but when they're combined with others, the business case becomes stronger.

"There is a huge momentum toward shared services, and toward sharing business units in various countries," says Roger Nelson, deputy chairman in charge of consulting at Ernst & Young, in New York. The firm has a joint venture for IT support and SAP R/3 implementation with Farmland Industries, a $9 billion agricultural co-op headquartered in Kansas City, Mo., and recently formed a joint venture for back-office accounting services with London-based Shell International Ltd.

But some industry observers, including Lehman's Keirstead, are skeptical about the highly touted prospects for business process outsourcing, noting that few large deals of that kind have taken place yet.

That may be true, but the vendors are certainly gearing up for it. "A lot of new companies are coming into the market for business process outsourcing, and we're seeing some nontraditional competitors," says Allie Young, principal analyst for outsourcing services at Dataquest in San Jose, Calif. "That's where the Big Six will play-that's probably going to be one of the hottest areas in outsourcing."

To take the best path-and cut the best deal-when considering outsourcing, it's important to get a clear idea of what your IT assets are worth. Investment bankers are trying to play a part in that process. They aim to help create profitable relationships between IT organizations and services vendors.

Last spring, Don Kane, managing director for the financial institutions technology practice at Goldman Sachs in Chicago, began looking at the possibi lities. "Our objective is to illuminate strategic business issues for clients from the IT perspective," he explains. "There may be technology issues in some companies that suggest [they should] sell it, buy it, whatever. At some companies, we may be able to spin it out into a new business, like American Express did with First Data," a credit-card transaction processor.

Determining the market value of IT assets is also a specialty under development by James Burns, a partner at CIS, a San Rafael, Calif., consulting firm. Formerly chief operating officer for Swiss Bank Corp.'s SBC Warburg investment banking unit in North America, Burns helped craft the equity swap and outsourcing deal between Swiss Bank and Perot Systems Corp. in 1995.

"There will be a war for talent," says Burns. Stock options in an IT services company through a joint venture can be a potent incentive for IT professionals to stay put, albeit in a joint venture, instead of taking an offer from another IT vendor.

Outsourcing D ilemma
The choice of whether-and how-to outsource has become increasingly controversial, despite the continued growth in the outsourcing market. Some companies, for example, are bringing IT back in-house after becoming frustrated with the results of their outsourcing deals.

"There is a big trend in companies recognizing the value of IT, and that recognition is earned," says James Infinger, CIO at Raytheon in Littleton, Mass. For that reason, and because, he says, the technology has arrived to ease in-house management of networked systems, Infinger expects that other companies will bring outsourced operations back in-house.

But Paul LeFort, CIO of United HealthCare Corp., says outsourcing frees in-house staff to work on emerging strategic technologies. "The big issue for systems integration in 1998 will be related to electronic commerce and how to make money with the Web," says LeFort. The Minneapolis health-care provider has already outsourced most of its data centers, telecommunications , and networks to AT&T Solutions, IBM Global Services, and Unisys.

Most CIOs still opt to use in-house talent rather than outside service providers when it comes to key areas such as data warehousing, knowledge management, intranet, electronic commerce, year 2000, call centers, and customer management. According to a recent Dataquest survey of 100 IT executives with active or planned projects in these areas, 80% are not willing to entrust data warehousing projects to service providers; nearly as many said they wouldn't use service providers for knowledge management.

While users do use outside service providers for these hot technologies, most turn to software vendors because of their product expertise, according to Dataquest. Vendors with emerging technologies in data mining, for example, are most likely to win services business at MasterCard International Inc., says Anne Grim, senior VP of global information services at the credit-card company, in Purchase, N.Y.

Large professional services f irms are second in popularity to software vendors in call-center and knowledge-management initiatives, while specialist firms are second in intranet and Web-page projects.

Linking Old And New
One of the hottest areas in 1998 will be at the intersection of new and old technologies: the World Wide Web and legacy systems. USAA, a financial services provider for military personnel, has hired CSC to help as it continues to wrestle with providing client-server access to its massive, mainframe-based IMS and DB2 databases and prepares to begin integrating its client-server setup with new Internet-based systems.

"Moving from the mainframe to client-server has been driving us nuts for the past four years," says William Burrows, assistant VP of application delivery environment at USAA, in San Antonio. "We are one of the premier IMS shops in the country, and bringing that down to the client, with security controls, is a problem."

USAA recently selected Forté Software Inc.'s toolset for use in the integration projects and in application development. After prototyping a project using CSC's Forté Lynx, a set of components that links to Forté-built applications, USAA hired CSC to help. "We want to build a common platform for all Internet stuff and client-server," says Burrows. "A lot of the transaction services, security, and legacy database will be needed, whether for client-server or Internet," he explains. The first target for the tools and new integration processes is USAA's systems for claims handling, policy services, and other functions in its property, casualty, and life insurance businesses, according to Burrows.

While Burrows is using about 30 full-time and 20 part-time professionals from CSC, Andersen Consulting, SAIC, and other firms to supplement his staff of 30, he doesn't expect to see those numbers increase as the client-server and Web project gets under way, because the vendors will be transferring skills to his staff. But because of regulatory changes that hav e produced a backlog of projects to modify legacy systems, he expects that "for the next couple of years, we will be buying more services."

Though Burrows wants to hire staff to reduce his dependence upon service providers, the IT labor shortage is as grim in San Antonio as it is elsewhere. Pressures to cut costs make it difficult to compete for IT staff-and argue for the use of contract employees because of their flexibility and the absence of expensive benefits.

Burrows' problems are typical of those facing many IS executives. Experts agree that challenges such as staff shortages and the rate at which new technology is introduced are not going to go away. Executives need to get ready to take a long, hard look at the numbers and cut some deals, end others, and maybe deliver some profits to their companies. Vendors are also busy figuring out new ways to do business.

The opportunities are there, whether in a partnership with a vendor or in the IS organization's blood, sweat, and tears.

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