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Tech Industry

Small firms shake up services industry

The once-sleepy industry got a makeover in 1998 and 1999 will likely bring more shake-ups, as big firms have to compete with smaller, more nimble companies.

A once-sleepy services and consulting industry woke up and got a makeover in 1998.

Within a two-month holiday season frenzy, IBM Global Services sold off its aging voice and data network to AT&T; Electronic Data Systems combed the industry to appoint a new CEO to fill its executive power vacuum; and Computer Sciences scooped up the biggest IT services contract of the year from the Internal Revenue Service.

The New Year will likely bring more shake-ups, as IBM, CSC, EDS, and the "big five" consulting firms are pressured to reinvent themselves to compete with smaller, more nimble firms for services contracts.

Expect more industry mergers and acquisitions to follow USWeb's, recent purchase of CKS Group, said Giga Information Group analyst Julie Giera. Together, USWeb-CKS is expected to take on bigger service firms to provide creative and back-end support to customers.

Giera said acquisitions could also help Keane, an IT services firm focused on Year 2000 consulting, and Cambridge Technology Partners, a fallen Wall Street darling still struggling to meet growth expectations. Cambridge Technology, which made its name in the industry for delivering IT services fast at a flat fee, has watched its stock droop over the past year as its large customers delayed new projects in favor of Year 2000 fixes, which is not the company's concentration.

Keane, however, has a different problem. The company's challenge in 1999 will be to continue cross-selling IT services to its Year 2000 customers as demand for millennium bug services levels off. Morgan Stanley Dean Witter expects Keane's fourth-quarter 1998 revenues from Year 2000 services to remain flat at $101 million--or 35 percent of total revenue. In the meantime, Keane's growth in non-Year 2000 application and outsourcing services is expected to increase from 28 percent in the third quarter to 33 percent of all revenue in the fourth quarter.

Worldwide, the market for enterprise resource planning services, a large hunk of the consulting business, is expected to grow to $48 billion this year, an increase of 17 percent more than last year, according to International Data Corporation in Framingham, Massachusetts.

With that in mind, traditonal ERP software vendors including SAP, Baan, and PeopleSoft are expected to continue making up lost software revenue by grabbing a bigger piece of the services pie. They are not alone.

"I cannot think of one services company that's not starting an ERP practice," Giera said. "They're all betting the farm on it." This could spell trouble for some firms depending on business from midsize customers. Drained from Year 2000 fixes, midtier customers aren't expected to be able to afford end-to-end ERP projects and will choose to work on piecemeal installations for specific needs--such as human resources.

"A crop [of service companies] will fail," Giera said.

Another market expected to balloon even more in 1999 is Web consulting. Among the new privately held firms hoping to become the next Andersen or EDS of the Web are iXL, Razorfish, and Proxicom. These upstarts pull together traditional strategic planning and couple it with Web site design, construction of a site that can scale to hundreds of users, and outsourcing capabilities to run the site for the client.

Big customers such as Charles Schwab, GE Corporate, and Mobil have picked these companies to plan and implement their Web strategies.

While a typical Internet consulting contract is worth $3 million to $5 million--a drop in the bucket for companies like EDS and CSC that typically ink multimillion-dollar contracts to build networks or run corporate computer systems--analysts say Web-based business is expected to grow quickly and larger firms can't afford to be left behind. That will lead corporate giants to continue buying smaller, creative consulting Web companies to tap what they need.

"There's been a continuing move of talent from the mega-outsourcing vendors to the new vendors," said Mark Wolfenberger, analyst at Credit Suisse First Boston.

Wolfenberger said the biggest story of 1998 is the market split that is driving more investors to bank on smaller, newer firms, such as software development and services company Sapient. Sapient is trading at higher gross margins than industry giants such as EDS that are fending off deteriorating profits, Wolfenberger said.