Ursula M. Burns, the chief executive of Xerox, declared on Monday that the company’s plan to buy Affiliated Computer Services, an outsourcing services company, for $6.4 billion would be “a game-changer” for Xerox.
That could be standard business hyperbole, of course, and only time will tell whether the deal proves to be a winner for Xerox. But the game is indeed changing for big technology suppliers catering to corporate customers as they shift to depend less on products and more on services.
And technology companies, like Xerox, are often buying services companies to accelerate the transition. Only last week, for example, Dell announced that it would buy Perot Systems for $3.9 billion. Last year, Hewlett-Packard bought another large technology services company, Electronic Data Systems, for $13.9 billion.
The shift to services is being fueled by financial and strategic considerations and by the evolution of technology itself. Services businesses tend to be steadier sources of revenue and profit than product businesses, which are more susceptible to peaks and valleys of economic cycles. Services businesses also foster closer relations with corporate customers and often yield higher profit margins.
The cost and complexity of computing, analysts say, has led many corporate customers to conclude that owning and operating their own hardware and software is an expensive, distracting burden. So customers are pressing suppliers to not just sell them technology but to make it work for them to streamline business tasks like procurement, customer tracking, record handling and product design.
“For a lot of these companies, there is a real blurring between what is a product and what is a service,” said Christine Ferrusi Ross, an analyst at Forrester Research. “The concept of what a product company is anymore really has to be rethought.”
Xerox and other technology companies that are expanding their reach in services are following a model that I.B.M. pursued more than a decade ago and General Electric even earlier.
They recognized that to compete in an increasingly competitive global marketplace, companies needed to move into higher-value services, which are less vulnerable than product businesses to being undercut by low-cost manufacturers abroad.
Technology advances are making it easier for suppliers to provide computing as a service, delivered over the Internet from remote data centers in the so-called cloud computing model. Software can move off desktop personal computers to become a Web-based service, like Google’s e-mail, word processing and spreadsheets, and the online customer-relationship management software of Salesforce.com.
The digitization of all kinds of business records and documents also opens the door to automating business tasks and mining business data for everything from customer-service problems to sales opportunities.
The share of corporate technology budgets spent on hardware and software, which are capital expenditures, has been declining in recent years. That percentage fell to 28 percent this year, from 36 percent in 2004, according to estimates from Gartner, a research firm. The rest is spent on operational expenses, including services.
The trend is not a matter of rising labor costs at corporate technology departments, because headcounts have not increased, said Peter Sondergaard, senior vice president in charge of research at Gartner.
“The shift toward external services is quite pronounced,” Mr. Sondergaard said.
Analysts say the weak economy promises to accelerate the tilt toward spending on services as companies resist bigger capital budgets or adding workers to their payrolls.
In an interview, Ms. Burns said the Affiliated Computer deal was largely a matter of following her customers. “They want us to intelligently knit together all this stuff — the information that makes their businesses run,” said Ms. Burns, who took over in July with the retirement of Anne M. Mulcahy.
Xerox said that the combined company would have $22 billion in revenue and that nearly 80 percent of that total would be recurring revenue based on services and equipment contracts. The company’s services business would triple, to $10 billion.
In an interview, Lynn Blodgett, chief executive of Affiliated Computer, said that his company would certainly benefit from tapping into the Xerox worldwide sales force. But he also emphasized that it would benefit from the Xerox research in imaging and text-recognition technology. Affiliated Computer handles and processes back-office documents like loan-processing papers for banks and Medicaid claims for health care providers and states.
Xerox, Mr. Blodgett said, has technology that can begin to scan patient claims, for example, searching for patterns in the data that could suggest the best therapies for managing chronic diseases like diabetes. “It allows you to look at claims and reach conclusions,” he said. “It’s technology we just don’t have.”
The Xerox cash-and-stock offer was valued at $63.11 a share, based on the closing price of Xerox shares on Friday. Shares of Affiliated Computer, which closed at $47.25 on Friday, rose 14 percent on Monday, to $53.86. Xerox shares fell 14 percent, to $7.68.
Affiliated Computer, based in Dallas, was founded in 1988 to handle data-processing chores for banks and has grown steadily since. Today it has $6.5 billion in revenue and 74,000 employees.
Indeed, the company is sizable, with 20,000 more employees than Xerox, and analysts say the challenge of integrating the two companies may have contributed to the fall in Xerox shares. “Xerox has not done a lot of big merger deals, so one concern is that A.C.S. may not be easily digestible,” said Peter Falvey, managing director of Revolution Partners, a small investment bank that specializes in technology companies.
Affiliated Computer has also been a subject of inquiries by the Securities and Exchange Commission and grand jury proceedings in recent years, focusing on stock option grants and the accuracy of some customer records. The inquiries and repeated changes of chief executives and chief financial officers over the last five years prompted Disclosure Insight, an independent research firm, to rate the company a high risk. There are no current investigations, said Kevin Lightfoot, a spokesman for Affiliated Computer. “It’s all been put behind us,” he said.
Analysts say other services companies that might be takeover candidates in the wake of the Xerox-Affiliated Computer deal include Computer Sciences Corporation, CGI in Canada and a few Indian outsourcing companies like WNS and Patni. Several of the largest remaining independent technology services companies like Accenture or the leading Indian outsourcers like TCS, Infosys and Wipro, analysts say, are probably too costly and unwilling to be acquired.
“The merger trend isn’t over, but you are running out of companies that are small enough to reasonably acquire and yet large enough to make a difference,” said Rod Bourgeois, an analyst at Bernstein Research.
30/9/09
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