Speaking at a Bank of America investment conference in San Francisco, Ron Vargo, EDS’s newly tapped finance chief, laid out the company’s near-term growth and profit strategy.
Following the rough years of 2003 and 2004, the company’s top-line growth for 2005 was flat to slightly negative as it took a lot of expenses out of its cost structure. But now in 2006 it is on track for revenue growth of around 7%, Vargo said. Several factors have buoyed sales, he explained, including the renewal of the UK Ministry of Defence contract, the extension of its once highly problematic Navy deal, its recent acquisition of a majority stake in mid-tier Indian offshore outfit Mphasis, as well as favorable foreign exchanges.
Vargo said the typical growth rate in the $600bn services industry now hovers around 6% to 8%. Because EDS does nearly 60% of its revenue in ITO, or infrastructure outsourcing – mostly the desktops and data center business, with a smaller chunk of networking services – which is growing at the low end of the overall industry rate, the company expects 2007 revenue growth to come in the low-to-mid single digits.
Vargo said a key driver of growth for EDS is operating margin expansion, which includes increasing productivity through steps such as better managing and reducing the number of its own suppliers. The company has loads of hardware and software partners, and outsources certain parts of its services business, such as break/fix for infrastructure deals, according to Rob Schilperoort, vice president of ITO product management, who sat down with Global Computing Services this week to talk about the ITO business.
Labor cost reduction is also a priority, through both offshoring and automating more delivery processes. More than 90% of ITO processes are fully automated and it’s actively working on turning its offerings into standardized processes that customers can simply check off on a list, Schilperoort said. And executing the megadeals, such as the $1.7bn contract it signed with first-time outsourcer Kraft earlier this year, will be another key metric of margin performance, according to Vargo.
As EDS continues to make the large capital investments required early on for these megadeals, and as it funnels cash to building out its own internal infrastructure, processes, and global services network that it has focused on for the past two years, capital expenses as a percentage of gross revenue will most likely stay around 8%, right in the middle of the historical range of 7% to 9%, Vargo said. But EDS is keen to see this figure drop as these internal initiatives are put in place, he added.
Competitively, Vargo said the final decision in many of the megadeals comes down to EDS versus IBM. Despite all the talk of the services business being characterized by multi-sourcing and smaller deal size, which likely means less business for a top global firm such as EDS, Schilperoort said the deals, at least on the ITO side, were actually staying at the same size if not increasing.
As for the low-cost offshore players, Vargo said that they are now indeed competing for a lot of the applications and BPO contracts. This is perhaps less of a concern to EDS, which does less than 30% of its business in applications and less than 15% in BPO, than some of the other established services giants. But the large Indian vendors are starting to get their feet wet in infrastructure outsourcing, Vargo said, and they’re finding the lower-growth, higher-capital infrastructure work to be a change from their mainstay high-growth, higher-margin and less capital-intensive BPO and applications business. Even as they enter the infrastructure space, they play mainly in the market for remote monitoring, Vargo said, which EDS also performs from some of its low-cost global centers.
