Finally, the IT services industry has its own big merger to boast!

The acquisition of EDS has been speculated internally in HP for a very long time, ever since HP started becoming serious about services. When its effort to hire IBM employees to beef up its services business di not really get off the mark, HP actively looked out for EDS people. The first big catch was Steve Smith, who was hired in early 2005. Though he came from Lucent, he was an EDS veteran of 16 years. When HP hired John McCain (no, not the presidential candidate) later that year to lead consulting business, under Smith, internal speculations strengthened that HP was probably trying to acquire EDS. McCain, like Smith had spent 16 years in EDS. From 2005 onwards, a few more former EDS executives have joined at different levels, notable among them being Mark Fulgham, the current VP of IT outsourcing.

But after Smith left in the end of 2006, and McCain was promoted to the post of SVP to head HP services, the speculations almost ceased. McCain, despite his long EDS stint, is a proactive offshoring champion. So, many thought HP would go smaller acquisition(s) in India rather than a large acquisition like EDS. That was till reports came in that HP and EDS were in merger talks.

The Equation
For HP, the choice was hard. It had to grow the services fast to be a sizable competition to IBM. The trade-offs were three: size, quality/profitability, and cost of acquisition. Large Indian companies were clearly beyond its reach and have never showed any inclination to get acquired. The tier two Indian companies, though far more profitable and modern in their outlook, were small and costlier. EDS was not only large, it came cheap, even with a 25% premium to its quoted stock price. As many analysts have rightly descried it, it was a successful bargain hunting. However, the value of the company is only quarter the story. The two bigger challenges remain.

Successful integration is of course a challenge. HPs service offering is far more sophisticated, high value, quality-driven, tool-based (It is a leader in ITIL) and consulting-led much like IBM, Accenture, and the Indian firms. EDS is the anti-thesis of that. Despite its breadth and the strength in details of execution, it has not kept pace with changing times. To marry the two cultures and hoping that the whole will be greater than the sum of the two will be a Herculean task. Many analysts have also pointed out that it is a distraction when HP was finally stabilizing.

The other challenge is EDS expensive manpower. One sizeable acquisition of Mphasis in India notwithstanding, most of the 140,000 employees of EDS are in the United States. Compared that to IBM, which has more than one-third of its employees in India or Accenture, whose India manpower just surpassed its US manpower. John McCain will have to balance between the EDS integrationwhich will most likely come his wayand offshore ramp-up.

The other challenge, though not quite of the same magnitude as the above two, is to decide whether to continue with the low-end BPO business of EDS, including that in the public sector, which none of the major outsourcing firms target.

On the positive side, at least theoretically, it gives two advantages to HP. One, EDS is a huge channel for its big boxes, storage and all that big hardware to many traditional segments where EDS is strong. And two, it simply brings with it customers, many of which have not changed EDS as a vendor considering the cost of switching but are not too happy with it either. HP can add a lot of value in those deals and make them long-term customers. You just have to ask Ralph Szygenda, the GM CIO to gauge what that could mean for him!

Last but not the least, it upsets the strong Dell-EDS partnerships which will hopefully be a boost for HP PC business. But the caveat there is that, if HP tries to do that, it will severely impact its reputation as a serious services player.

On paper, the merger will create the #2 outsourcing player in terms of revenue. But it will not shift any boundaries. It will not affect IBM as the Big Blues new focus on strategic outsourcing has no threat from EDS. Ditto for Accenture. The rising Indian firms compete with different strengths offshore execution and nimbleness. That is not exactly familiar phrases for EDS.

In the long run though, it may create another major global players if HP manages to marry the complementary strengths successfully; if it manages to rationalize its onshore-offshore mix; and if it manages to turn EDS customers to long-term strategic clients for all its business. That is a lot of ifs.

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