A Lull for Service Firms

FRAMINGHAM (07/31/2000) - A nervous investment fund manager called me recently, wondering whether demand in the IT services industry was slowing. Had the long-predicted post-Y2k crash finally hit? Several major systems-integration firms reported lower-than-expected second-quarter earnings. The stock market extracted its penalties for those failures to meet analysts' expectations. Then Computer Associates International Inc. announced "disappointing" results.

Whack: 42 percent off its share price in one day.

It seems strange to have a drop in the IT services business when Internet and wireless technologies offer such opportunity for growth. But I believe it's only a temporary slowdown, driven by a massive restructuring of the IT services and products industry. Here's why:

The lull isn't coming from the end of Y2k conversions - unless you're one of those companies that foolishly built a large practice or product set just for Y2k readiness. Rather, the slowdown comes from companies stopping to consider how the Internet will really affect their businesses and how their strategies and operations will have to change.

Most companies haven't figured this out yet and have become further confused by the e-commerce failures in many retailing ventures. Eventually, their legacy or infrastructure systems will have to go through another round of massive change to operate in electronic channels. But most companies are hesitant to spend on new ERP systems until they're more confident about what their businesses really need.

One sign that we're only in a temporary slowdown is that most IT services and product companies are still growing, but not as quickly as they did in the past couple of years. Every IT company and organization I know is still looking for good people.

Wall Street analysts had become used to growth rates of 20 percent to 25 percent a year - or even greater for some smaller startups whose businesses were based on Internet-related work, like Web-site design or Internet-strategy consulting. But many of these small companies - several of which had meteoric IPOs - won't grow much larger. And it's not because business isn't out there.

First, the market has become much more competitive, with lots of companies doing Internet-related work. Second, most small companies won't grow to any scale because they lack experienced sales and marketing capabilities and their service/product offerings are too narrow. For them, especially those that are publicly held, slow growth will mean consolidation.

The failure of these smaller companies to grow and the slowdown in the growth of some larger companies shouldn't disguise the fact that there's a huge amount of IT work to be done. There's too much firepower in the Internet and wireless technologies. Companies just have to figure out how to use it.

But how will that work get done? That's where industry restructuring comes in.

Once ERP work picks up, it will be done through application service providers (ASP). ASPs will offer new ERP capabilities at lower and variable costs. But it's naive to think that to be an ASP, all you have to do is offer old ERP systems on a different technology platform. I believe the winners in this part of the IT industry have yet to emerge.

There will also be many specialty firms offering low-priced telecommunications and computing services. But soon, these firms will be seeking content to boost their profits. Expect to see a lot more process outsourcing that includes embedded IT operations. For example, British aerospace company BEA Systems Inc. just formed a venture with a start-up, Xchanging, to do all its human resources work.

And will there be a role for systems integrators in what appears to be an emerging world of specialist players? You bet. Someone still must put all this technology together and make it work. The Internet hasn't made life easier yet.

It's just made more things possible. And a pause to consider those possibilities makes sense.

Champy is chairman of consulting at Perot Systems Corp. in Cambridge, Mass. He can be reached at jimchampy@ps.net.

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