In 2004, JPMorgan Chase & Co. (NYSE:JPM) CEO Jamie Dimon raised plenty of eyebrows when he abruptly canceled a $5 billion outsourcing contract with International Business Machines Corp. (NYSE: IBM), arguing that the Wall Street firm could do the work more cheaply itself. Tech companies are continuing to feel the impact of Dimon’s decision today.
These days, customers are not shy about demanding steep discounts, free training and whatever else they can think of, in exchange for buying hardware, software and services. The impact of these deals is clear in recent tech earnings reports.
For instance, Hewlett-Packard Co. (NASDAQ:HPQ) yesterday disappointed investors by reporting weaker-than-expected consumer PC sales and a decline in profit margins in its services business. Last month, concerns about lackluster service signings dampened the enthusiasm for IBM’s otherwise strong quarter. Dell Inc. (NASDAQ:DELL), though. gave a bullish outlook based on the strength of its enterprise business. (Corrects an earlier version of this story that said Dell gave disappointing guidance.) Wall Street, however, found its results more impressive than H-P’s and thinks that its strategy to focus on corporate customers seems to be paying off. Though Microsoft Corp. (NASDAQ:MSFT) posted strong third quarter results, analysts remained concerned about the drop-off in Windows sales and the decline in the PC business.
These companies are betting that their best hope for growth lies with businesses rather than consumers because the potential for profit can be larger than focusing on commodity businesses such as PCs. H-P CEO Leo Apotheker was quoted as saying the company wants to go further “up the value chain’” in services, and who can blame him. H-P acquired EDS for $13.9 billion in 2008, to gain market share from IBM, which entered the business in 2002 by acquiring PricewaterhouseCoopers’ consulting arm for $3.5 billion. IBM got the better deal. Revenue at both Big Blue’s Global Technology Services and Global Business Services businesses rose more than 6% in the last quarter. Meanwhile, H-P’s Services business revenue gained 2% to $8.97 billion.
The money to be made in services is huge. IDC estimates that companies spent $69.1 billion in 2010 on business consulting services, considered by many firms to be the icing on the IT cake because it is so profitable. Enterprise tech spending is expected to be lackluster ths year, rising worldwide in U.S. dollars between 3.5% and 5.1%, according to Gartner.
“Lest we get over-excited, it’s worth noting that much of this rise is down to currency exchange rate fluctuations that are routinely factored into our forecast,” wrote Gartner analyst Richard Gordon in January. “Looked at another way, in constant dollars we have actually reduced the forecast for spending growth in 2011 from 4.7% to 4.3%, which is a 0.4 percentage point drop.”
CEOs and CIOs know the trends in the tech industry as well as the companies themselves. They know they are in the driver’s seat. To them, the most important thing a vendor can tell them is how quickly a product or service will add to their bottom line. These executives pride themselves at being immune to the gee-wiz sales pitches that stress technological prowess over financial practicality. The results of a recent Gartner survey of CIOs found that almost half expect to run their applications and infrastructure through clouds over the next five years.
“This change will necessitate that CIOs reimagine IT and lead their organizations through a process of creative destruction,” according to Gartner. “CIO IT strategies for 2011 focus on creating infrastructure while streamlining costs and operations. Based on the strategies reported in the figure below, CIOs intend to redefine the essential elements of IT — from infrastructure, to cost structure, to people, to processes. Moreover, they see each of their strategies as intimately connected with business strategies, a reflection of their desire to get closer to the business.”
That means convincing large companies to buy technology products and services will get more difficult for years to come.