Two of the three titans of the asset-intensive infrastructure services business are merging. What does this mean for the services industry?
Let’s start with why they’re merging. Clearly, the space that they occupy is a mature space. It has been undergoing tremendous competitive pressure from the Indian firms with their Remote Infrastructure Management (RIM or RIMO) offerings. After losing some initial share to the Indians, the three titans – CSC, HP and IBM – seem to have righted their ship. HP had a one percent increase in sales and IBM had a three percent increase in sales. So the space seems to have adjusted to be able to meet the Indian RIM challenge.
In addition to continuing to meet the RIMO challenge from India, the three firms dominating the space also face the issue of work migrating out of legacy into the cloud. I think we haven’t yet seen the effect of this migration hit the market in a significant way. But it’s coming.
So there are three competitive challenges causing this merger to happen:
- Mature state of the market
- Existing RIM challenge
- Future challenge of cloud
It’s a win-win
Therefore, the merger makes sense. As in other mature industries, it makes sense to drive industry consolidation where a scale player can better manage the transition in a maturing market than individual players. This merger is straight from that playbook.
Therefore, the merger makes sense. As in other mature industries, it makes sense to drive industry consolidation where a scale player can better manage the It also makes a lot of sense for each entity. HP can divest itself of this mature space and focus on the faster-growing server and networking space. It frees Meg Whitman and the HPE franchise to focus their attention on the growth segment of the marketplace. So I think it’s a good play for that. It allows CSC to consolidate the infrastructure space and now positions them at the same scale as IBM with similar economies of scale and global reach. So I think both parties win. in a maturing market than individual players. This merger is straight from that playbook.
But it faces big challenges
The challenges for the leadership team under Mike Lawry are twofold:
- Capturing synergies to achieve cost reduction
- Making strategic investments in areas where the merged entity can grow
A significant challenge will be to achieve the cost reductions without affecting customer service and disrupting the customer base.
The merged entity is estimated to have $1 billion in synergies in year one – in other words, duplicate cost that can be eliminated. That’s about six percent of their cost base and seems like a reasonable going-in assumption. However, in this case I think it will be challenging, given that both CSC and HP are coming from having recently aggressively adjusted their cost bases to become competitive with the Indian challenge and therefore do not have large inefficiencies or fat that is available to cut without adversely affecting customer service. This will focus the synergy exercise on duplication of resources, which makes the billion-dollar target more difficult.
In addition to improving margins through these cost-cutting exercises, the merged entity will have to make strategic bets to invest in critical market segments and industries that will allow it to grow and offset the ongoing challenge from the India-based RIM players as well as the workload migration out of legacy and into cloud.
Net-net, I think this merger is good for CSC and HP. I also think it’s good for the industry in that the combined entity is better able to manage this transition than they would have individually. But substantial challenges remain for the combined entity to continue its cost reductions as well as invest in growth areas. Mike Lawry is an old hand with experience at this type of game and has had ample time to perfect his strategies from when he took over CSC. Now he has a bigger field to play on.