IBM’s $34 billion cash acquisition of Red Hat announced early this week has far-reaching implications for the IT services world. IT is modernizing, moving from a legacy world with data centers, proprietary operating systems and proprietary technologies to a digital environment with cloud, open-source software, a high degree of automation, DevOps and integration among these components. IBM’s legacy assets and capabilities are formidable, but the firm was not well positioned for IT modernization and struggled with digital operating models. The Red Hat acquisition is significant as it repositions IBM as a vital, must-have partner for enterprise customers in IT modernization and evolving digital operating models. This is a very intriguing acquisition for IBM. Let’s look at the implications for IBM and enterprise customers.
An interesting trend is developing in the services industry, reversing the trend we’ve seen for the past five years. I predict that this year, and for the next few years, we will see a modest rise in mega deals – deals with $500,000,000 or more in Total Contract Value (TCV). Where are those deals coming from?
At Everest Group, we watch services transactions closely. Over the last five years, the industry experienced a big move away from mega deals, preferring smaller and smaller transactions. This was then exacerbated by digital rotation where customers were interested in digital pilots – which are small deals. But this year we note a renewal of interest – in some specific situations – for large deals.
Here’s my take on three forces driving mega deals now.
Force #1: IP-Plus-Services Model
One force driving mega deals is where the service provider wraps services around the intellectual property (IP) platform the provider owns. TCS’s book of business of large deals is a good example of this. TCS has an IP platform around insurance and mega deals tied to that platform. The $2 billion-plus TCS transaction with Transamerica earlier this year is a good example. What makes the deal so large? The customer is modernizing its IT by jettisoning its legacy technology and transferring it to TCS for modernization through the TCS platform.
As the services industry pivots to digital models, IP ownership plays an increasingly important role. Automating work diminishes the importance of labor arbitrage, and the profit pool reconfigures around IP owners. The nature of the IP-plus-services model allows mega deals to happen. I expect more of this kind of deal to happen at TCS as well as at providers like Cognizant, which has a similar platform in the pharmaceutical healthcare space with TriZetto. Both TCS and Cognizant are using their investments in IP platforms to differentiate their offerings and capture large contracts.
Where service providers own important IP platforms, I see those as the basis for some very large deals.
Force #2: Leveraging the Balance Sheet
Another source for large deals is providers leveraging their balance sheet to finance a customer’s large-scale IT modernization. HCL and Wipro are good examples of providers using this approach to create very large deals. They use their balance sheets to fund expensive IT modernization deals, including taking over a customer’s legacy assets. This strategy accelerates a service provider’s growth, and I expect to see more mega deals using this strategy.
Force #3: Digital Transformation Programs
This year, we’ve seen digital transformation move out of the pilot phase into full-blown transformation programs. The amount of money customers spend on these transformations is staggering, often hundreds of millions of dollars. The large availability of enterprise funding for transformation is likely to encourage larger deals.
The net result of these three forces? I believe we will see a modest increase in mega deals, and in certain areas, larger deals for the remainder of this year and next year.
I’m not claiming the entire services market is moving to mega deals. In fact, two size-diminishing secular trends that were well underway continue: (1) decomposing the legacy, multi-tower deals to single towers and bidding those out (2) the move from managed services to systems integration and digital work. These trends will continue to create a fabric of smaller transactions.
However, some large deals are emerging. I believe the three forces I described are working against the well-established trends for smaller deals we saw during the last five years.
Disruptive technologies enable dramatic new ways of doing work and delivering value to customers. Understandably, companies are rushing to implement disruptive technologies to change their business so that they can better serve their customers, employees, partners with new value and lower their total cost of ownership. Achieving this goal necessitates assembling a digital platform. However, few companies have the resources to build and maintain a platform alone, so they need to contract with third-party service providers. Here’s the problem: the classic procurement approach for third-party services doesn’t work with digital transformation.
In meetings with companies undertaking digital transformation or IT modernization, I often hear executives talking about advice they’ve received from their consultants and advisors on how to plan and manage these initiatives. I consistently hear different versions of three points. “We must have a detailed road map of our transformation journey.” “We will need to replace most of our existing talent.” “We’ll need mountains of money.” Sound familiar? Consultants and systems integrators (SIs) consistently preach these practices, warning companies that their transformation won’t play out the way they hope unless they follow this advice. But compare that advice with the real-life experience of CIO Toby Buckalew.
Companies are on the horns of a dilemma. They signed long-term, managed service contracts for IT or business processes, which took advantage of the savings from labor arbitrage. But now they find that there is significant potential to leverage the new suite of digital technologies that promise improved performance and lower cost. The problem is that that their incumbent service providers often actively resist implementing these technologies, using delaying and obviation tactics, refusing to pass on the savings and/or demanding additional work or other concessions in return for complying. Now that I’ve identified this major issue that many companies face today, let’s look at how they handle this non-alignment situation.
Traditional change management practices weren’t built for digital transformation. Here’s how to rethink two key aspects of your approach
IT modernization and digital transformation focus on changing a business and creating new value. But investing in new technologies and changing processes do not change a business; they just give a company the ability to change the business. Unfortunately, traditional change-management techniques are not adequate to address the level of change in IT modernization and digital transformation.
Traditional change-management techniques may help a company implement digital technologies, but they won’t enable driving the necessary change to realize the full benefits of the technologies. How can your company determine if its change management plan is effective?
The first step in determining change management effectiveness is understanding that your company is changing its business model. The traditional mindset that change-management tactics will drive success in transformation initiatives understates the immense amount of change and the nature of the change that is required. Managing business model change is far more comprehensive than typical transformation initiatives.
Most large enterprises were on a journey for the past 30 years where a higher and higher proportion of the core systems driving the enterprises was software packages or software as a service. Traditional wisdom for companies was “don’t build – buy.” Then, again, as companies undertook digital transformation journeys, the prevailing belief was that the best way to do digital transformation is to get there as fast as possible by buying (not building) many components, using third-party software and SaaS products. Now, two disruptive forces are starting to shift the balance between build vs. buy in the IT world.
Many companies find they need to undertake IT modernization to support later digital transformation to create new competitive advantage. They recognize that IT and shared service groups must modernize so they can respond more effectively and quickly to the business needs. However, it’s a mistake to approach IT modernization with the same approach as traditional transformations. The changes to people/talent, processes, policies and philosophies are cross-functional and cross-departmental and cut deeper into the organization than many companies anticipate. Despite these hurdles, Novartis achieved great success in its multi-year IT modernization journey. I spoke with Scott Mason, Head of IT Operations at Novartis, about the company’s keys to success in IT modernization.
In 2011, Novartis faced a challenge of infrastructure instability and cost explosion. It’s a global healthcare company and recognized it needed to modernize its operations to prepare the infrastructure as the backbone for the company’s agile, digital business world. “We recognized that the modern technology landscape is about building the backbone operating model and competencies that prepare your platform for digital. That’s the foundation – without it, nothing can happen,” said Mason.
The term “digital transformation” is now ubiquitous. Nearly every company’s leaders and board of directors see the potential of digital transformation to create new value and improve their competitive positioning. They are investing in building out capabilities to transform their business. Unfortunately, some companies build digital capabilities but don’t generate value that changes their competitive position. So, are businesses really making progress in these investments? Where are we in efforts to succeed at digital transformation? Here’s my view and what I believe must happen next.
By its nature, digital transformation is difficult as it’s fraught with the complexities and magnitude of change. The reason so many digital journeys don’t succeed is because the company fails to implement the operating model necessary to make the digital platform work. By operating model, I mean organizational changes, policy and process changes, talent model changes and the go-to-market changes.
Why do companies often fail to implement the operating model that’s necessary for the digital platform they build? Simply stated, they take a fractured approach to the digital journey. Although the executives say the operating model is changing, they don’t build a common vision that allows it to happen.