Digital Convergence Leaves Room for Few Players
As communications technologies converge, so will systems integrators, management consultants, telecom providers and value-added resellers
he age of voice, data and video convergence has not arrived, but the business models that once defined groups of information technology suppliers have begun to blend. Information providers, ranging from entertainment producers to network equipment suppliers, last year generated $1 trillion in revenues. The business potential in the new age has forced traditional systems integrators, management consultants, telecommunications companies and hardware resellers to jockey fiercely for the few spots available on the digital dream teams.
The battle to reposition themselves finds management consultants now doing integration work, systems integrators offering consulting services, telecom companies expanding their infotech capabilities and resellers providing services and even performing small-scale integration tasks.
Research firm Dataquest estimates that the total domestic IT services market this year will generate $47 billion, up about 15 percent from 1994, and will maintain an annual growth rate of 15 percent between 1996 and 1998. Of the total services market, systems integration projects will total $7 billion this year, and consulting operations will provide $9 billion worth of services.
The profit potential has caused some blending of lines that used to differentiate IT providers. But business and technology revolutions play significant roles as well.
Relatively inexpensive products that become obsolescent in 18 months continue to flood the marketplace, leaving non-IT companies baffled and offering infotech firms a captive audience for their services. Although profit margins on hardware and software sales have dropped, the need for IT services has grown and made the systems integration business more competitive with new companies sprouting and older firms moving into the integration niche.
With the slow domestic economy, organizations have faced financial and personnel cutbacks that integrators believe they can offset with technology. Today's clients, more knowledgeable about the power of IT than those in the past, are more concerned about gaining competitive advantage in their industries through IT rather than the sophistication of the technology itself.
Customers want more than the technology; they want value. Many companies today also have begun to trade in their expensive, aging mainframes for cheaper client/server machines. This has forced resellers, who have built their businesses on selling hardware, to change their stripes and start providing services as well. Although integrators and manufacturers such as Digital Equipment Corp. will continue to use resellers to sell their equipment, analysts agreed traditional resellers will have a diminished role in the new age.
Finally, the anticipation of convergence has lured companies such as AT&T into the systems integration business. Can the market 10 years from now sustain the integrators that exist today? Industry analysts say no. Eventually, the integration industry will undergo a shakeout, leaving a few extremely large companies with global reach.
But David Toub, director of strategic planning and business development for DEC's systems integration division, believes the increased competition is an absolute good. He shuns prognostications of an industry shakeout. After all, when DEC was launched in the late 1950s, the pundits of the day predicted the worldwide market for computers might reach 50, he pointed out.
BPR Changes the Face Integrators Show Customers
The economic recession that spawned the business process reengineering revolution changed the way companies managed their IT assets. It also has forced integrators to revamp their strategy for gaining new business.
With companies struggling not only to stay alive but to lead in their industries, they unloaded their information technology headaches to integrators. Companies freed themselves from staying ahead of the rapid technology influx. Instead of managing networks or troubleshooting dead printers, they could concentrate on their own business and leave the headaches to the infotech experts.
Before BPR, large companies often had integration projects within certain departments, such as accounting or marketing. Reengineering has forced companies to think in terms of their entire organization or enterprise. Businesses no longer want pockets of integrated systems anymore. To stay competitive, they need all systems to talk to each other on an enterprise scale -- financial, sales, marketing and distribution.
A decision to build or buy that capability comes down to return on investments. Brand names and the latest widgets won't necessarily sell a customer. Companies no longer consider technology of paramount importance; they want quantifiable performance and productivity gains they will share with the integrator.
That has forced integrators to rethink their marketing and sales strategies. In the past, integrators, especially those that manufactured hardware, sold their technology prowess. They typically sent a technical guru to sell their solution to the head of a customer's data processing department. As IT resources have become a business issue for customers, integrators now send marketing teams to meet with a company's top executives or business unit managers. The integrator-client IT discussions have moved from the back room to the boardroom.
And the discussions these days sometimes do not even involve systems. With senior managers now overseeing IT decisions, integrators have a captive audience for some of their newer services. IBM Corp., Electronic Data Systems Corp. and Computer Sciences Corp. all offer management consulting services. Although the companies separate the consulting units from their development teams, industry analysts question the ability of an integrator's consulting team to remain
objective and recommend a competitor's solution.
Nevertheless, integrators see the business opportunities in management consulting as an entree that could lead to more lucrative systems development work. In the past, integrators had a large pool of low-priced technical people to write code for systems, but today, they require a greater number of more experienced, higher-priced consulting professionals, noted John Daly, associate service director at Summit Strategies Inc., a Boston, Mass., research firm.
The shift to IT as a business solution also has changed the way clients structure contracts. During the next 10 years, integrators will see customers move toward more price-performance contracts, predicted Rishi Sood, analyst at G2 Research in Mountain View, Calif. Integrators will have to learn to structure profitable solutions within those types of contracts.
Creates Romance of Client/Server
As companies restructure their business processes, they often find that their 20-year-old mainframes just aren't up to all that distributed processing and remote database access consultants recommend.
How and when companies move toward distributed computing with networked PCs or workstations does not matter. The point is they are. And integrators know it.
Dataquest said two-thirds of the Fortune 1000 companies have begun some form of restructuring, with one-third doing significant BPR projects. In the spring of 1993, 31 percent of the 1000 businesses began shifting from mainframe, data center-based processing toward client/server computing. By the fall of 1994, 61 percent were making their move.
"The thing that's growing the IT industry is change and the velocity of that change," said Bob Steinerd, Dataquest vice president. Systems integrators will drive the industry because they can take the technology and help customers apply it to their particular business problem, he explained.
Client/server computing has put mainframe processing power on the desktop, reshaping the systems integration industry. The technology has changed the types of skills customers want in integrators, the way integrators organize themselves and even the way systems are developed. Hordes of COBOL programmers won't do. Integrators must be adept in areas such as Novell Netware, Windows NT, Lotus Notes, or Oracle databases. They need to be able to get on the Internet, design home pages in the hypertext markup language, and set up firewalls. Mastering this range of skills will require resources and scarce talent. "The pendulum that had swung in favor of small, flexible client/server developers is beginning to swing back toward larger, established integrators that have proven skills in managing and maintaining large, business-critical client/server projects," Daly said.
Customers want integrators that work more as business partners rather than engineers. To reflect their expertise in solving a company's particular business problems, integrators such as IBM have changed their organizational structure along vertical industry lines while simultaneously leveraging their preexisting geographically aligned structure.
Despite the cosmetic changes an integrator might implement, ultimately, "technical competence continues to distinguish the leaders from the laggards in the industry," Daly said. Integrators, he noted, will have to change the traditional practice of producing unique code as quickly as possible and start building reusable software components that can be transferred from one application to another. Companies that cannot do this face severe risks, he predicted. Daly noted that BSG Consulting Inc. and SHL Systemhouse have emerged as some of the leaders in the client/server market. Canada's SHL has long cultivated a relationship with Steve Jobs' object-oriented programming leader NeXT Computer.
Where does that leave small and mid-sized integration companies? If they want to work with the Fortune 1000 companies, Steinerd said they will have to establish global presence. Companies such as Cambridge Technology Partners, who have focused heavily in the client/server market, already have stepped up to the global challenge, opening offices and acquiring firms worldwide. However, there still will be a lot of opportunities for smaller, regional integrators, he said.
Daly pointed out that small, niche-oriented integrators also could become prime targets for acquisitions or could start offering consulting services, much like their larger counterparts.
Lure of Convergence Brings in New Players
The $1 trillion generated last year by the information, telecom and entertainment industries has lured new entrants in the systems integration industry. Perhaps the biggest change -- actually it's been predicted for some time -- is the melding of computers and telecommunications. Sun Microsystems's CEO Scott McNealy gets credit for coining the buzzphrase "The network is the computer." That has made telecommunication service providers believe they own the strategic resource -- all those fiber optic wires, satellite links, telephone switches and high-speed data lines. They see that the market for systems integration will sooner or later be integrating all the set-top boxes, network connections and media servers that will pipe what consumers want in their homes.
In this sense, the business market may partly be a test of capabilities that will be essential when the much-touted information superhighway opens for consumer traffic.
AT&T Co. is likely to be a leader. Last month Ma Bell announced that its newly formed Solutions unit will provide voice and data integration to large corporations.
The new unit started with 5,000 employees and a backlog of work worth more than $1 billion. It recently added a $160 million contract with Great Western Bank, the nation's second largest thrift institution. AT&T will provide network design and management to connect more than 400 branch offices, 160 loan offices and 550 automatic teller machines.
Networks dominate the bulk of the infotech solutions sought by large businesses, and the network reach of competitors EDS and IBM have begun to approach the dominance of AT&T, said Alf Andreassen, client services vice president. "I don't think we have much of a choice."
In fact, AT&T is not alone. The regional Bell phone companies also have an interest in the potentially lucrative business emerging from the convergence of data, voice and video. "He who owns the network owns the world," Steinerd said. The telecom companies believe "they have a real jewel with their networks, and to a certain extent, they're right. AT&T will be a formidable force," he added.
Telecom companies face a big dilemma, however, in changing their corporate culture, Steinerd noted. "Information technology is much more sophisticated than telephony," he explained. Their success will depend on the ability to attract senior executives with infotech experience who can guide the firms through the change.
AT&T, in February, hired Victor Millar from Unisys Corp. to head the new unit. Millar led the worldwide expansion of the mainframe manufacturer's leap into the services business, which now represents Unisys' fastest growing segment. He also was one of the architects of Andersen Consulting and served as chairman and chief executive officer of Saatchi and Saatchi Consulting Ltd.
GTE Corp. has leveraged its telecommunications networks into the systems integration business and has been successful. But just as more telecom companies move into the data side of systems integration, integrator heavyweight EDS sees the value in exploiting the breadth of its networks.
The Texas company, founded by Ross Perot, boasts one of the largest privately run computing and communications networks. In the last two years, EDS has tried unsuccessfully to team with MCI Communications Corp. and British Telecom plc. Despite that, industry analysts said EDS has not given up.
Still, all this positioning is bound to create conflict. With integrators becoming consutants, telecom companies turning into integrators, and hardware and even software firms turning integrators and consultants, the potential for conflict of interest is everywhere. Caveat Emptor. EDS or CSC performing a consulting job will always raise doubts about whether the recommendation is rigged to help the integration units at their companies. Likewise, AT&T may not be eager to include MCI in its systems integration job, even if an MCI service would be cheaper. And don't forget, AT&T is a huge supplier to many integrators such as EDS.
Finally, IBM as an integrator will always prompt customers to wonder if IBM is able to recommend other companies' hardware and software -- whether or not that may be true.
Regardless of who moves in or out of the traditional data systems integration business, training and education will be the key to survival as technology becomes more complex. Convergence will require entirely new skills, said Joseph Kraemer, managing director of EDS' communications and electronic management consulting practice.
Integrators must invest heavily in their intellectual capital
because they will influence the way technology evolves, he said. Their professional staffs must receive continuous training, making the potential business from convergence an opportunity better suited for large integrators, Kraemer noted. "Little guys will finish last. In the end, the laws of scale will prevail."
Integrators Find Booming Business in Outsourcing
Once considered a desperate act for financially strapped companies, outsourcing has emerged as the hottest trend in systems integration. Outsourcing, the transfer of systems management and operations to an information technology contractor, has gained widespread acceptance during the last five years, according to a report from research firm Dataquest.
"Industry leaders, not laggards, are now looking at outsourcing," said Gail Rigler, director of corporate marketing for Electronic Data Systems Corp.
In the past, companies in financial trouble decided to divest themselves of their infotech assets, both equipment and people. Outsourcing got them quick cash and gave integrators a new revenue stream. Integrators buy the equipment up front and inherit the customer's IT personnel, which limits big outsourcing deals to companies such as EDS, IBM Corp. and Computer Sciences Corp. that have access to capital. The three companies combined do slightly more than half of the outsourcing business nationwide, according to Dataquest.
"I wouldn't say cost cutting doesn't play a part anymore, but there are many new business drivers that make outsourcing an alternative," said Dataquest analyst Allie Young. Companies view outsourcing as a way to gain a competitive edge because they can concentrate on their main business line and use the technical expertise of an IT service provider.
"As companies reengineer, they're looking for an IT company to run their infrastructure. But more importantly, they want a company to build new systems and run the infrastructure to support the reengineered processes," explained Rich Coyle, spokesman for IBM's Integrated Systems Solutions Corp. The wholly owned subsidiary, based in White Plains, N.Y., runs IBM's systems integration and outsourcing business.
Some notable companies that have chosen to outsource their IT operations include Xerox Corp., American Express Bank, Hughes Aircraft Co., General Dynamics and Dell Computer Corp.
Although integrators say outsourcing is a win-win situation, Rudy Hirschheim, professor of information systems at the University of Houston, disagrees. Based on a study of 22 companies, he noted that outsourcing agreements before 1991 have not had such positive results. "I am hard-pressed to justify why a company would outsource their information systems function unless they're really starved for cash," Hirschheim said.
Outsourcing simply restructures a company's cash flow, he added. Hirschheim has found that companies that let their internal IT department bid against vendors have achieved similar savings as those promised by integrators. He said companies have better luck when they outsource pieces of their IT assets instead of selling them wholesale in a long-term, multimillion dollar arrangement.
In fact, some are taking Hirschheim's advice. Young said some companies now just buy help desk, network management or distributed systems management services. "Over time, the hope on the integrator's part is that the customer will [become] confident with outsourcing, and maybe that will lead to something else."
The piecemeal approach also has allowed smaller, niche-oriented integrators such as I-Net Inc. and Systematics to do some outsourcing because they can apply their specific expertise.
- Joyce Endoso
Expert Organization, Not the Client, Assumes Risk
They are the special operations team of the systems integration industry. They pinpoint the problem and neutralize it -- all in nine months or less. And they do it at a fixed price.
Cambridge Technology Partners has skyrocketed since its 1991 launch when James Sims, president and chief executive officer, turned a training and consulting company into one of today's leading developers of client/server applications. The Massachusetts-based firm has defied industry averages, growing four times faster at 85 percent a year.
The Wall Street Journal rated CTP's initial public offering of 2.6 million shares at $5
each the most successful of 1993. Stock value
increased by 215 percent by the end of that year.
During the last year, the company's stocks, which have received strong recommendations from J.P. Morgan Securities Inc., have fluctuated between $14 and $24.25.
With $59.7 million in revenues in 1994, CTP reached a milestone. "By exceeding the $50 million revenue barrier, we have established ourselves as a long-term player in the systems integration market," Sims said.
The company has built its reputation and client base of more than 200 companies, ranging from financial institutions to aerospace companies, on a rapid application development method. How rapid? CTP shrinks the requirements definition stage of development from six months to three weeks through intensive workshops with customers. Fees generally range from $1 million to $3 million to design, develop and implement an application.
"We're experts at building systems in an accelerated period of time. Time, not the technology, is of vital interest to our clients," Sims said. In fact, "if clients want new functionality, they know they will have to give something up. They understand our process, and we're not delaying it," he explained.
The company has expanded its services to include client/server network integration and relational database management systems. CTP also has cultivated its object-oriented programming skills and created software libraries. Sims predicted that next year, the company will develop most of its applications in objects and reusable software code, accelerating the firm's already rapid development strategy.
In addition to boosting its technological capabilities, CTP has augmented marketing efforts overseas. "From the beginning, we looked at going international. We've given up two to four points in profits by doing that though," Sims said. International revenues made up 24 percent of CTP's total 1994 revenues.
The company has about 150 people abroad, with offices in the Netherlands and England. In early 1994, Sims led the acquisition of a Swedish infotech consulting and software development company.
CTP's success in application development proves the value of its fixed time, fixed price strategy. "If we're the experts, then we should take responsibility for it. We think risk should be assumed by the expert organization, not the client," Sims said.
- Joyce Endoso
FEDERAL IT PICTURE LOOKS FUZZY
The Republican pledge to give states block grants has put the federal information technology market on notice.
This year, the federal government will spend $27 billion, 5 percent of the total operating budget. Analysts conservatively put the growth rate at about 4 percent to 7 percent. State and local governments, on the other hand, will spend more than $34 billion on IT alone this year. "There is some question in my mind as to the continued growth of federal IT," said Bob Dornan, senior vice president of Federal Sources Inc.
If Republicans continue to hold their majority status in Congress for the next several years, integrators will see even more business move to state and local markets where the "old boy network" rules. Although states with large IT budgets such as California buy IT products and services more like Uncle Sam, most states prefer working with smaller companies with a local presence.
The transfer of money to the states spells good news for smaller integration companies. In this market, Dornan pointed out, "smaller opportunities are churning out more quickly to companies with local presence and knowledge."
Nevertheless, big integrators such as Electronic Data Systems and IBM Corp. already have made their inroads in the local markets. EDS has contracts in about 30 states, the District of Columbia and 100 local governments. The contracts cover health care claims processing, toll collection, law enforcement and education systems.
IBM Government Systems has contracts with Maryland to provide an imaging system and support for the state's child welfare information system. The group also is building a new tax system for New Brunswick, N.J.
The shift, however, could hurt companies such as Computer Data Systems Inc. The Rockville, Md., firm works almost exclusively on federal contracts. Although company president Gordon ("Stonie") Glenn acknowledged that he eventually would like to expand into the state and local market, he feels the federal business remains a viable business strategy.
Unlike their state and local counterparts, federal agencies sometimes can take years before awarding a contract -- six months is considered a fast-track procurement. Many of these contracts, however, are worth several hundred million dollars.
For years, federal agencies have used blanket contracts to buy IT products. Agencies now use this same method to buy services. The Defense Department two years ago awarded a multimillion dollar integration services contract to a handful of competing prime contractors. Although industry officials were skeptical of how profitable the contract would be, the companies did well overall. Each of the prime contractors made at least $20 million last year from that contract, said Maryann Hirsch, director of federal market analysis at Federal Sources.
For big system procurements, some agencies have chosen to break them apart into commodity pieces and hire an integrator to glue the pieces together. The General Services Administration, which is planning the government's telecom system for the year 2000 and beyond, could award multiple contracts for the communications circuits and a single integration contract to keep the network together.
Despite negative publicity that surrounds federal procurements, integrators will play because of the high dollar value of the contracts, something neither the state nor local governments can match -- even with the block grants.
- Joyce Endoso