HP and EDS in merger talks

Phil Codling, John Madden, Tom Kucharvy/Ovum
15 May 2008

It's become axiomatic to say that the IT services market is consolidating. In actual fact, in contrast to the software sphere, there have been very few large deals in recent years, with most of the merger activity confined to small and mid-sized moves (Logica buying Unilog, CSC buying Covansys, and so on).

The top ten or so of the IT services industry have barely changed places, let alone ownership, despite interminable rumours and private equity interest. But here comes a possible very big play indeed - big not just for HP and EDS, but also in terms of its potential to shake up the entrenched competitive landscape in global IT services.

Adding EDS (with revenues of $22.1bn in 2007) would more than double the size of HP's services business ($16.6bn in revenues). The resulting $39bn services operation would still be smaller than IBM Global Services (with revenues of $54bn). But in an industry where we've become accustomed to IBM holding a significant global lead over the rest of the competition, the merger would thus bridge this gap substantially and establish the merged entity as the clear no.2 in IT services.

Moreover, an EDS-HP combo should in theory be able to deliver greater global reach and economies of scale than either firm separately (with, potentially and eventually, cost and service delivery benefits for customers).

In terms of capabilities, EDS would bring depth and experience to HP's IT outsourcing organisation. Although HP has proved it can handle large-scale global outsourcing contracts (such as P&G), it has nowhere near the reach and customer base of EDS in some sectors and markets, particularly government contracts.

Such a combination could open up new avenues for HP to peddle its stable of software and systems management products, as well as hardware (although realistically many of EDS's clients already use HP gear).

A deal would also enhance, to a lesser degree, HP's Consulting & Integration unit. EDS, recognising its disadvantage compared to IBM, Accenture and others, has focused on beefing up its technology consulting capabilities, with an increased emphasis and investment on applications services/consulting - the company recently formed an SAP practice, for example.

What HP-EDS would still lack, however, is a business-oriented consulting capability that comes close to rivalling those of IBM or Accenture. In other words, EDS helps HP rise "up the stack" in IT services a little, especially in the applications domain, but there are still plenty of attractive engagements from which it might be excluded, not to mention the sales opportunities that business consulting can generate for an IT services firm.

All of this assumes that, if the deal goes through, HP succeeds with a massive integration programme. In hindsight, HP's integration challenges/successes with the huge Compaq merger (in 2002) were overshadowed by the blistering investor/management fight that preceded it.

It's difficult to comment on how an HP-EDS integration might theoretically proceed, but it would inevitably entail risks. Combining services portfolios and delivery platforms to maximize economies of scale would be a huge task. Of course people are the greatest asset of a services business and, despite HP's newfound organisational efficiencies under Mark Hurd, HP would need to move quickly to stem any potential "brain drain" from EDS.

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