A Defiant EDS

If EDS CEO Michael Jordan is sweating his company's comeback, he sure isn't showing it.

Leaning back in the deep, leather chair at the head of the long table in his conference room at the Plano, Texas, headquarters, Jordan proclaims confidently that EDS, the company founded by presidential candidate H. Ross Perot, "is alive and well and coming back like a storm."

An odd choice of words, perhaps, given the deluge of bad news this past year weathered by riches-to-rags EDS, the second-largest IT integrator in North America (No. 2 on the 2004 VARBusiness 500) after IBM Global Services. There have been contract write-downs, quarterly losses and major cost cuts. It's a far cry from its salad days just a few years back, when EDS posted 2001 earnings of $1.36 billion (it lost more than that just two years later) and its relationships with customers, like GM, were envied throughout the industry.

Jordan intends to restore that luster and to quell the critics who talk of the company's bad turn. The tall, easy-going, plain-talking CEO came out of retirement in March 2003 (after retiring as CBS chairman and CEO) to take over the storied company after the four-year roller-coaster tenure of his predecessor Richard Brown. His biggest challenge since coming aboard, he says, has been to re-create the highly disciplined old EDS organization that Perot started.

"Our company has been fragmented over the past 10 years; we [divided the company] into many different units," Jordan says. He believes that getting back to basics through a strong, two-pronged business approach will spur the turnaround he craves. The first imperative calls for the creation of industry-leading technology to be driven by an initiative that will embed 200 vendor-partner employees at the EDS campus. The second is to maintain a relentless pursuit of ongoing cost efficiencies.

While the average VAR will likely never face logistics the size of EDS, the integrator's strategies are still applicable. Everybody wants to bring back a win. And no one more so than Jordan. As he looks at the woodlands view through the outsized windows that line his conference room, Jordan stops for a second to order his thoughts, then turns and states simply, "My goal is to turn this aircraft carrier around."

Righting the Recent Past

By the time Jordan inherited the company nearly two years ago, EDS had become bloated. "The cost structure had careened out of line with the industry's economic realities. It was too high," believes David Grossman, a partner at equity research firm Thomas Weisel Partners, based in San Francisco. "Margins were coming down, but costs weren't."

So Jordan got to it with a plan to cut $3 billion, or 20 percent, of cost. Specifically, the reduction, which Jordan says is on schedule, is being achieved through a $1 billion savings through more efficient purchasing, a $1 billion savings through better capacity utilization and a $1 billion savings via reduced labor costs.

Critics think that previous management, eager to create footprints in new markets, took on contracts that have come back to bite them. That includes a contract with Dow Chemical and the mammoth Navy Marine Corps Intranet (NMCI) contract, which played a major role in the company's third-quarter $153 million loss.

EDS has been notoriously tight-lipped about the Dow contract, referring only to it officially as its "other commercial contract." In 2004, it said it resolved all outstanding claims and issues related to the contract and that it was terminated on Aug. 1. A source says the two parties were never able to resolve issues around not-specified terms of the contract. According to the company's 2004 10-K, as of December 2003, EDS had invested some $150 million in the deal that called for the provision of IT services by using both its legacy systems and new ones that it would develop.

The Navy contract, meanwhile, has likely been EDS' biggest source of embarrassment. Running for six years, from 2001 to 2007, it is the company's largest contract, valued at $6.9 billion at one point. It calls for the company to upgrade computer networks at 4,000 Navy and Marine locations, but has been plagued by schedule setbacks. It has, in fact, been one embarrassment after another, including a $233 million after-tax asset impairment charge in its 2004 third quarter.

So were those deals right at the time, or did previous management err by chasing them? Jordan declines to incriminate his predecessor, only allowing that "we've lost a lot of money--about $1.5 billion" and that "the Navy contract should turn around in 2005."

But contracts were only part of the cost crisis. Julie Giera, a vice president at Forrester Research, also has worked as an executive vice president for a larger outsourcer and as a bank CIO, so she has had a chance during the years to observe EDS as a customer, competitor and analyst. Her take: The company simply wasn't in step with a changing marketplace.

She faults it for saddling itself with 50-plus strategic units, each dealing with a specific area, like banking or utilities. "They started to compete with one another to justify their own P&L statements," Giera recalls. "They didn't care about the company as a whole."

To his credit, Brown whittled the number of units down to five from more than 50 and, in so doing, eliminated layers of corporate overhead. However, Giera says, he didn't tackle one of EDS' biggest issues--the company's infrastructure. It was still running some 30 databases internationally--a cost problem that the company is now solving by reducing the number of databases to three.

The Jordan Era

By the first quarter of 2003, it was clear that the EDS board had had enough of Brown. There were too many problem contracts--such as Enron, US Air, WorldCom--three companies that represented the worst excesses of the 1990s. Quarterly earnings disappointed: Wall Street was mortified by the startling announcement in the fall of 2003 that the company would miss third-quarter earnings expectations by 80 percent and that earnings would be down 60 cents per share.

After Jordan took over, one of the first things he did was bring in his own team, including EDS former vice chairman Jeffrey M. Heller, who returned as president and COO, and Jordan's old friend Charlie S. Feld. Formerly the head of the Feld Group consultancy, he is now executive vice president of portfolio management. Also from the Feld Group, where he was COO, came Steve Schuckenbrock, now EDS' executive vice president of global sales and client solutions.

Yet the fact remains, neither Jordan nor Schuckenbrock have ever worked extensively in IT services. Add to that a slate of top 50 managers, the majority of whom have changed job titles in the past two years, and you have a promising, though not battle-tested team. "These are fundamental changes. There is a fair amount of risk here. He has replaced hundreds of years of outsourcing experience," Giera says. "But Jordan couldn't have made the changes he needs to make without sweeping out that management."

There also has been a lot of bad press to spin in the past year: Moody's downgrading this past summer of its senior unsecured notes to junk status, the SEC inquiry into the Navy contract and a slashed dividend by two-thirds to conserve cash. That reduced dividend is part of an ongoing program on the part of Jordan, who is intent on slashing unnecessary expenditures and vows to eliminate 20 percent, or $3 billion, of the company's cost structure.

"We are on schedule. We took about a billion out [of our cost structure] this year," Jordan tells VARBusiness. "We took a lot of people out of our European surplus. And we think our early-retirement program will be people-friendly." In addition to already reducing its head count by 5,000, Jordan told a Smith Barney Citigroup technology conference he plans to lay off an additional 15,000 to 20,000 workers in the next two years, in essence, reducing head count that would wipe out the total head count of most solution providers.

As part of that drive, EDS this past fall extended an early-retirement program to 9,200 of its workers. The exact number to choose this option was slated to be released on Feb. 7, after this issue went to press.

Keep the Customer Satisfied

But containing costs is only half the battle. Keeping customers and winning new ones is the other, critical half. To that end, the company has created the "EDS Agility Alliance," a federation of vendor partners collaborating with the company to provide its next-generation enterprise solutions.

Its members include Cisco Systems, Dell, EMC, Microsoft, Oracle, SAP, Siebel, Sun and Xerox, and its goal is to develop cutting-edge solutions that beat the competition.

Heading up this new effort is Robb Rasmussen, vice president of global alliances. While alliance programs are not new, Rasmussen insists this one is different.

"There are 200 technology employees from these nine companies embedded at EDS. They will work as a [multicompany team] to develop offerings, not just one-on-one with EDS," Rasmussen says. "If you walk around, you can't tell who is from Cisco, who is from EMC or who is from EDS. This is unique from anything I've ever seen."

Rasmussen says it took eight straight months working with each partner to pound out their roles in helping build on the agile enterprise platform, specifically making sure there would be no overlap among solutions. In addition, the alliance will be supported by a firm governance structure with EDS executives meeting with "alliance top management, such as [EMC CEO Joe] Tucci and [Cisco CEO John] Chambers," he continues. "Meetings will alternate among EDS, alliance partner locations and video conferences. This allows us to be connected to [vendor] road maps."

Rasmussen says that among the solutions he is most excited about rolling out is hosting OS platforms with Sun, the No. 3 hardware player, and the global secure network EDS is building with Cisco. "I think the network is foundational for EDS," he says. "And whatever form utility computing takes on, the network is very important." Clearly, EDS intends to play in the on-demand computing space.

Indeed, wags say the alliance is a play to compete against IBM. However, Lorrie Scardino, Gartner research director, says the partnering alliance was a smart move. "EDS looked deep inside to see where they had gone wrong in the past. They had to align both internal sales and delivery sales to support the alliance partners," she explains. "I think they are embracing lessons learned."

Still, the jury is out on whether the alliance can yield strong results. Joseph Vafi, managing director of equity research for Jeffries & Co., places the alliance as simply one among many in the IT sector. "Let's see the results," he says.

"It remains to be seen whether it will produce," Scardino adds. "One of the things I like about EDS is that management is all walking the same walk, talking the same talk. I think Jordan is doing a good job. He is showing a level of articulation for a man who came into the business not knowing much about it. He has assembled a good management team."

The EDS Mother Lode

The dynamic technologies that EDS hopes the alliance will yield will then be employed by its core moneymakers--business process outsourcing (BPO) and IT outsourcing. The first must increase sales to drive company growth and the second needs to at least hold its own as rivals try to take its business.

BPO raked in $2.7 billion for EDS in 2003, mostly in finance, procurement and HR outsourcing deals, securing sufficient action for its 25,000 employees, says vice president Gil Marmol, who has led BPO since 2003 and was recently named division vice president. But it wants to get better than that.

"Jordan has made it clear that BPO is a priority for our growth," Marmol tells VARBusiness. Another newcomer to the EDS fold, Marmol from 2000 through 2003 served as the president of Marmol & Associates, which offered investment capital to early-stage tech companies.

Marmol says that previous management wasn't into driving BPO the way Jordan is. "We haven't aggressively pursued it," he acknowledges. Breaking down the market into its three specialties, Marmol predicts EDS will gain in the procurement BPO market, currently the smallest and youngest focus in the portfolio. In HR, he points to important gains made in the past year, including the extension of its contract with Canadian bank CIBC.

As for finance/accounting, although EDS does not currently have a BPO client in the United States, Marmol expects the alliance will announce an agreement with one of the Big Four accounting firms by the end of the first half of 2005.

"I expect BPO, which currently represents 13 percent of overall revenue, to grow to 20 percent of EDS' overall revenue over a five-year period," Marmol says. "We are well aware that the BPO market is growing faster than the IT market, and is more profitable. The biggest challenge for EDS is to successfully [marshal] its resources around driving results. If you look at the majority of people here, their personal history is on the IT side of the house."

Which suits Jeff Kelly just fine. Recently named interim account leader for its GM business, Kelly headed up EDS' infrastructure portfolio for the past two years, which incorporates hosting, networking and communications, desktop services and storage. Worth roughly $11 billion in annual revenue, management must continuously staff employees who can maintain enterprise clients' aging legacy systems, while also preparing for the new, specifically the company's agile enterprise initiative. Kelly also had to grow the business while keeping competitors from stealing his business--Dell, for example, has announced it's getting into managed services in the desktop space.

"I'm the outside-in guy, paying attention to the market first and what it needs, and then working backward to form a strategy," he says. "That means retaining the best of our culture and regenerating other aspects of it."

Kelly is eager to point out new company work, talking about client Bank of America's decision to roll out 160,000 VoIP phones. EDS has a similar deployment in progress at GM. He also is enthusiastic about working in the network space with Cisco and talks excitedly about the in-progress construction of a $100-plus million, next-generation network for virtualized utility computing. "This is a large, strategic investment," he says. "We are investing to take cost out of the process for our customers."

The Future

With the pieces and players now in place, the time has come for Jordan to make good on his plans, but he figures the fruits of his labor won't be visible until 2006. Next year, Jordan says, the company will be--at best--flat and focused on additional cost reductions. EDS' 2004 numbers came out in February, after this issue went to press.

Next year is also when EDS has to re-up its historical deal with GM, a "masters service agreement" generated by the two companies when EDS split off from GM in 1996. No one at this point knows for certain how much of the business it will retain. In 2003, the carmaker accounted for 10.5 percent, or $2.3 billion, of the integrator's total revenue.

"They won't lose all their business, but I do think GM wants to bring in a few more vendors. EDS will have to share," says Jeffries & Co.'s Vafi. "But EDS is preparing for it now by watching the cost structure. They want to be ahead of that." Accordingly, the company's entire cost-reduction program is proceeding on schedule.

Jordan says that his goal for 2006 will be an 8 percent increase in profitability and that, in fact, if the messy Navy and Dow contracts were subtracted from the final accounting, 2005 profits will show a 5 percent to 6 percent profit rise.

While the strategy is solid, no one can doubt that the speed of the turnaround is critical. Wall Street needs a reason to believe, as do enterprise customers. For his part, Jordan says that next year will see an accelerated rightsizing. "We have to address that and take into account severance," Jordan says, referring to its impact on earnings; he also plans to retrain hundreds of employees. "We clearly have a lot of skilled people on our customer's legacy systems. If we can move those customers into new technologies, that would be a significant part of our new strategy."

Evaluating the integrator's ability to rebound, Forrester's Giera says: "I think there are several milestones EDS has to reach. The fourth quarter will be important in getting the Moody's downgrade out of the way; it's a perception problem. And they have to show growth from new clients, continuing to win at the same time they are making [these] fundamental changes."

One important advantage EDS has over IGS, and one that might help it close the ranks, is its ability to leverage partner R&D dollars, she believes. Not being fettered by loyalty to vendor-specific hardware or software gives EDS a strong level of flexibility without destroying the brand, she says, a situation not readily enjoyed by competitors Hewlett-Packard or IBM.

Still, like most industry observers interviewed for this article, she says it's not whether EDS can pull off the change, it's, "Will the market give EDS the time it needs to complete this transformation?"

"Clearly, [EDS is] going to move forward. The question is, at what pace?" Vafi adds. "Can [it] really re-emerge as the clear No. 2 player? I think it will be slower than people think, [and] some investors get impatient."

Kelly acknowledges that "speed is important from a competitive point of view. But you want to make sure you are making investments in the right way."

Is all this adding up to a "For Sale" sign in the months ahead? Never, Jordan says flatly, although he does concede the stock is undervalued, which can make it attractive to suitors.

"The stock price can always be higher. [It was about $21 per share the day VARBusiness went to press.] We are undervalued--8 percent margin on $20 billion. That rolls up to a much higher stock price," Jordan says, a little annoyed. "For some reason, the rumor has gotten started that you can't trust the fact that EDS will be around five years from now. It's the Navy contract, and we'll get that off our back. I think the rumor got started in Westchester [N.Y., where IBM is based]. It's nonsense."