HP's Next CEO Should Throw Back EDS

Deposed HP CEO Mark Hurd bought outsourcer EDS two years ago for $13.9 billion. The deal made Hurd and his executive team richer, but only made the company a bigger player in tech services—not better.

Contrary to Hurd's promise at the time, HP's takeout of EDS has proven to be a classic "bolt-on" acquisition, where one-plus-one equals two, or maybe one-and-a-half. The deal has yielded little in terms of value creation, innovation, or customer benefits. Indeed, CIOs now have fewer outsourcing vendors to choose from in the wake of the merger.

As for shareholder value, the card most frequently played by Hurd's defenders, one share of HP was priced last week (before Hurdgate took down HPQ) about the same as when the company closed the EDS deal on August 26, 2008. You could call it a wash, were it not for the almost $14 billion in investment capital HP could have put to better use elsewhere. Oh, and the 18,000 tech services jobs that will be lost by the time all's said and done.

In fact, "wash" may be too optimistic. There's evidence EDS suffered significant customer attrition following its acquisition by Hewlett-Packard. HP's service revenues in the twelve months before EDS bolstered its books were $18.2 billion. In the first year with the Texas outsourcer fully in the fold (fiscal 2009), its services sales jumped to $34.7 billion, an increase of 91%. But that's not as impressive as it sounds.

EDS's services revenues, mostly from outsourcing, in its last full year as an independent company, 2007, were $21.2 billion. So if HP had only managed to maintain EDS's prior sales levels, its revenue from services after year one should have been in the neighborhood of $40 billion. In other words, the combined services businesses of EDS and HP shrank by about $5 billion after the deal.

To boot, HP's share of the worldwide tech services market fell from 7.8% in 2008, to 7.3% in 2009, according to Gartner. That's probably not what Hurd had in mind when, in a press release heralding the buyout, he proclaimed that, "The combination of HP and EDS will create a leading force in global IT services."

The shrinkage shouldn't be surprising, given the turmoil generated by the deal. HP whacked 9,000 services employees at the outset, and just two months ago said it planned to eliminate another 9,000 services jobs as part of a plan to "invest" $1 billion in its outsourcing business.

In a brilliant example of the biggest knock against Hurd—that he's big on cutting and small on driving organic growth—HP in this case literally defined "investment" as the charge against earnings it will take over the next several quarters to cover the cost of the layoffs.

Services employees also complain that Hurd instituted policies that had a disproportionate drag on morale given the relative pennies saved. One insider told InformationWeek that staffers recently forced into home offices by facilities consolidations must pay for their own Internet services. The kicker: they can't save by purchasing "triple play" plans because HP does not consider the VoIP service typically bundled with such packages secure enough for business calls.

But beyond anything Hurd could have done (other than passing on EDS to begin with), the deal's biggest drawback—one that will remain when the new CEO takes charge--is that it stripped EDS of its biggest advantage against its largest competitor—IBM.

Just like there are singing hobos and stabbing hobos (according to The Simpsons), CIO's generally fall into two camps—the one-stop shoppers and the best-of-breeders. The former tend to favor Big Blue and its broad, integrated portfolio. The latter usually went with EDS, formerly the largest pure-play outsourcer in the business.

As an independent, EDS could draw on a range of suppliers to assemble bespoke systems tailored to customer request. Under HP, EDS (rebranded last year as HP Enterprise Services) can no longer promise vendor neutrality when it hauls in servers and other gear on behalf of a customer. Odds are there's a ProLiant somewhere on the back of that truck.

All the same, HP-EDS is no IBM Global Services. IGS has been managing strategic outsourcing engagements for some of the world's biggest companies for more than a decade. At IBM, services is now the big dog wagging a long tail of R&D, product design and engineering, consulting, sales, and marketing. Indeed, IBM has become a services company that also sells enterprise hardware and software.

HP, even with EDS, is a PC, server, slate, phone, camera, scanner, monitor, printer, and ink company that also sells services. To whom would you rather hand off your multi-billion dollar, global IT operations?

That, more than anything, is why buying EDS did little to help HP establish itself as a real player in the strategic ITO game. Since 2003, the company has spotlighted its $3 billion mega-contract with Procter & Gamble as proof that other breakthrough deals were on the horizon. Two years after the EDS deal closed, HP can still only point to P&G as its prized reference account.

Most of the major services deals HP has won of late, like a $2 billion pact, disclosed last month, to support vehicle and design production at General Motors, are deals EDS would have secured on its own. EDS's strongholds were in the auto industry, airlines, and state and local governments. The vast majority of engagements HP has announced since gobbling up EDS have been in those same sectors.

That shouldn't be surprising, but Hurd promised synergies that would make the company a contender for megadeals in other markets—those dominated by IBM and, to a lesser extent, CSC and Accenture. It didn't happen---and for all the reasons above it isn't likely to regardless of who replaces Hurd.

The next incumbent's first job, therefore, should be to spin the EDS services organization back into an independent company. That, as Hurd was fond of saying, would unlock some real shareholder value.

For Further Reading

Should HP's Next CEO Buy More Software?

Global CIO: Burying Mark Hurd: Hewlett-Packard And Its Future

In Cutting Off Hurd, Is HP Spiting Its Face?

HP CEO Mark Hurd Resigns

Ellison Slams HP Over Hurd Ouster