CSC – When All Else Fails, Split!

CSC – When All Else Fails, Split!

Information technology (IT) services company Computer Sciences Corporation (CSC) recently announced it is splitting into two separate companies.  One will “focus” on commercial markets, the other will “focus” on government contracts.  Ostensibly, as we’ve heard before, leadership would like investors, employees and customers to believe this is the answer for a company that has incurred a number of high profile failed contracts, a turnover in leadership, vast losses and declining revenue.

Oh boy.

After years of poor performance, and an investigation by the UK parliament into a failed contract for the National Health Services, in 2012 CSC brought in a new CEO.  Like most new CEOs, his first action was to announce a massive cost-cutting program.  That primarily meant vast layoffs.  So out the door went thousands of people in order to hopefully improve the P&L.

Only a services company doesn’t have any hard assets.  The CSC business requires convincing companies, or government agencies, to let them take over their data centers, or PC deployment, or help desk, or IT development, or application implementation – in other words to outsource some part (or all) of the IT work that could be done internally.  Winning this work has been an effort to demonstrate you can hire better people, that are more productive, at lower cost than the potential client.

So when CSC undertook a massive layoff, service levels declined.  It was unavoidable.  Where before CSC had 10 people doing something (or 1,000) now they have 7 (or 700).  It’s not hard to imagine what happens next.  Morale declines as layoffs ensue, and the overworked remaining employees feel (and perhaps really are) overworked.  People leave for better jobs with higher pay and less stress.  Yet, the contract requirements remain, so clients often start complaining about performance, leading to more pressure on the remaining employees.  A vicious whirlpool of destruction starts, as things just keep getting worse.

Immediately after taking the CEO job in 2012 Mike Lawrie declared a massive $4.3B loss.  This allowed him to “bring forward” anticipated costs of the anticipated layoffs, cancelled contracts, etc.  Most importantly, it allowed him to “cost shift” future costs into his first year in the job – the year in which he would not be fired, regardless how much he wrote off.  This is a classic financial machination applied by “turnaround CEOs” in order to blame the last guy for not being truthful about how badly things were, while guaranteeing the end of the new guy’s first year would show a profit due to the huge cost shift.

True to expectations, after one year with Lawrie as CEO, CSC declared a $1B profit for fyscal 2013 (about 20% of the previous write-off.)  But then fyscal 2014 returned to the previous norm, as profits shrunk to just $674M on about $12B revenues (~5% net margin.) For 4th quarter of fyscal 2015 revenues dropped another 12.6% – not hard to imagine given the layoffs and ensuing customer dissatisfaction.  Most troubling, the commercial part of CSC, which represents 75% of revenue, saw all parts of the business decline between 15-20%, while the federal contracting (much harder to cancel) remained flat.  This is not the trajectory of a turnaround.

CEO Lawrie blames the deteriorating performance on execution missteps.  And he has promised to keep his eyes carefully on the numbers.  Although he has admitted that he doesn’t really know when, or if, CSC will return to any sort of growth.

No wonder that for more than a year prior to this split CSC was unable to sell itself.  Despite a lot of hard effort, no banker was able to put together a deal for CSC to be purchased by a competitor or a private banking (hedge fund) operation.

If none of the professionals in making splits and turnarounds were willing to take on this deal, why should individual investors?  In this case, watching people walk away should be a clear indicator of how bad things are, and how clueless leadership is regarding a fix for the problems.

The real problem at CSC isn’t “execution.”  The real problem is that the market has shifted substantially.  For decades CSC’s outsourcing business was the norm.  But today companies don’t need a lot of what CSC outsources.  They are closing down those costly operations and replacing them with cloud services, cloud application development and implementation, mobile deployments and significant big data analytics.  Or looking for new services to solve problems like cybersecurity threats. CSC quite simply hasn’t done anything in those markets, and it is far, far behind.  It is a big dinosaur rapidly being overtaken by competitors moving more quickly to new solutions.

One of CSC’s biggest competitors is IBM, which itself has had a series of woes.  However, IBM has very publicly set up a partnership with Apple and is moving rapidly to develop industry-specific software as a service (SaaS) offerings that are mobile and operate in the cloud.  These targeted enterprise solutions in health care, finance and other industries are designed to make the services offered by CSC obsolete.

Although it may have had a huge client base of 1,000 customers.  And CSC brags that 175 of the Fortune 500 buy some services from it, exactly what does CSC bring to the table to keep these customers?  Years of cost cutting means the company has not invested in the kinds of solutions being offered by IBM and competitors such as Accenture, HP and Dell domestically – and WiPro, TCS (Tata Consulting Services,) Infosys and Cognizant offshore.  Not to mention dozens of up-and-coming small competiters who are right on the market for targeted solutions with the latest technology such as 6D Gobal Technologies.  CSC is still stuck in its 1980s consulting model, and skill set, in a world that is vastly different today.

csc_crime_against_humanityCSC has no idea how to “focus” on clients.  That would mean investing in modern solutions to rapidly changing client needs.  CSC failed to do that 15 years ago when most outsourcing involved heavy use of offshore resources.  And CSC has never caught up.  Leadership overly relied on selling old services, and discounting.  It’s model caused it to underbid projects, until the UK government almost shut the company down for its inability to deliver, and constantly hiding actual results.

Now CSC lacks any of the capabilities, people or skills to offer clients what they want. Its diffuse customer base is more a liability than a benefit, because these customers are “end of life” for the services CSC offers.  Years of declining revenues demonstrate that as value declines, contracts are either allowed to go to very cheap offshore providers, lapse completely or cancelled early in order to shift client resources to more important projects where CSC cannot compete.

This split is just an admission that leadership has no idea what to do next. Customers are leaving, and revenues are declining.  Margins, at 5%, are terrible and there is no money to invest in anything new.  Some of the world’s best investors have looked at CSC deeply and chosen to walk away.  For employees and individual investors it is time to admit that CSC has a limited future, and it is time to find far greener pastures.

 

Are American’s Abusing Social Security Disability?

Does anyone remember the 1990s?  Economic growth was robust, the stock market was exploding and unemployment was low.  Even though outsourcing was just emerging as a new business practice, there were more jobs than employees in America, and the Federal Reserve Board Chairman worried about "irrational exuberance."  If you had a degree you had a job, and you had a car (or 2) and a house as you awaited ever rising income and asset values.

Oh my, how times have changed.  A third of U.S. homes are worth less than the mortgage, auto sales fell off a cliff as GM and Chrysler filed bankruptcy, trust in banks has disappeared, savers earn nearly 0% yet investors shun stocks and laugh at declining values of IPOs.  And unemployment remains stubbornly stuck just below double digits as job growth remains anemic, despite reduced outsourcing and rising oversees costs. 

So how do Americans react to limited economic growth?  Apparently, increasingly, by feigning disabilities in order to create their own form of social welfare net similar to Europe.  Regardless of what Americans say, it is important to look at what they do

This week I am pleased to offer you a guest blog from Jack Ablin, Chief Investment Officer of Harris Private Bank, a division of BMO Financial:

Working conditions in the United States are getting downright dangerous if the Social Security disability statistics are any indication.  The number of Americans collecting disability is rising at an unprecedented and alarming rate.  This belies Bureau of Labor Statistics data that tells the story of workplace safety that is constantly improving.  Everyone knows that injury incidence rates have been in secular decline since, well, always. 

When thinking about worker-related risks, "Lunch atop a Skyscraper," the famous Depression era photo by Charles C. Ebbets immediately comes to mind.  What we once accepted at the workplace is now wildly unacceptable:


Steelworker lunch

In 2010, there were 3.5 total recordable cases of non-fatal occupational injury and illness per 100 full-time workers, down from 5.0 less than a decade ago.  In 1973 the rate was 11 per 100.  The net decline amounts to a 3.7 percent reduction in these hazards every year for four decades

Of course, not all injuries and illness are work related.  Then again, is there any aspect of our lives that has not become safer in the last two generations?  For example, auto injuries are always a factor.  But those risks have collapsed with the advent of airbags, anti-lock brakes and other technological breakthroughs. 
 
The Social Security Administration’s website cites two criteria for disability eligibility:
•      You must be unable to do any substantial work because of your medical condition(s); and
•      Your medical condition(s) must have lasted, or be expected to last at least 1 year, or be expected to result in your death.

Quizzically, from 1980 to 2002 there was no change in the percentage of the workforce claiming disability, yet the “disability participation rate” has embarked on a 4.5 percent ascent each year for the last decade.  There is now 1 person collecting disability for every 12 in the workforce

This occurred despite the evolution toward more of a “desk job” workforce.  The Bureau of Labor Statistics reports that today only 14% of working Americans are in goods producing jobs, down from more than 25% in 1973.  Yet, somehow, claims for disability benefits have headed in the opposite direction:

Disability Participation Rate
 
There are people out there that truly want to work but are too sick or injured to do so.  Sadly, many are unfortunately being branded with a stigma because of the legions that are out there gaming the system.  That is the only way we can explain how almost as many people collect disability (10.8 million) as there are working in the entirety of manufacturing (12 million). 

It is plain to see that permanently stagnant labor markets are making Social Security disability the new unemployment benefit.  
 
The impact of America's "no growth decade" from 2000-2010 is clearly impacting America.  I want to thank Jack for his analysis.  I urge your to sign up for Jack's newsletter, full of insight about the economy, interest rates, investing and jobs by contacting him at jack.ablin@harrisbank.com.  Jack is a graduate of Vassar and has his MBA from Boston University.  He is a CFA and frequent contributor to CNBC, Bloomberg, Barron's and The Wall Street Journal.

Outsourcing – Right or Wrong? 9 Key Questions


Summary:

  • Outsourcing has been very popular
  • Outsourcing removes management options
  • Outsourcing creates Lock-in, and makes it harder to deal with market shifts
  • Most organizations see long-term performance deteriorate as a result of outsourcing

Outsourcing has been extremely popular – ever since the early 1990s.  We know it has led to a lot of jobs moving out of the USA.  Outsourcing manufacturing has exploded employment in China and other parts of Asia.  Outsourcing information technology has exploded employment in India and parts of Eastern Europe. 

Economists tell us that outsourcing has driven down the cost of everything from the clothes and household items we buy at WalMart to the cost of social marketing, ad creation and even telephone services.

But has it helped businesses be more successful? As outsourcing popularity reaches 2 decades – both domestic and offshore – we now have a lot more insight.  And what we can see is that almost all outsourcing has been bad for the company that uses it! As things change, outsourcing has left them stuck competing the old way and further removed from market needs.

As my Sept. 29 column in CIOMagazineOutourcing for the Right Reasons” (also published in ComputerWorld online under the same title) points out, the vast majority of outsourcing was done for the wrong reason.  And the result has been deteriorating performance for those who outsourced.

Most companies outsourced to cut cost.  The problem is, this has led to even worse lock-in than normal.  Where organizations had options when they controlled the function – from manufacturing to janitorial serivces to help desks to datacenters – there were options to make changes.  But when something is outsourced the contract takes away most options.  The die is cast, usually for years into the future —- regardless of what might happen in the world!

Outsourcing can be used to create flexibility.  But, honestly, how often have you seen it used that way?  In well over 90% of cases the outsourcing is intended to cut cost – and lock-in operations.  It is meant to remove options from the management discussion.  Once outsourced, there is no consideration as to undertaking those efforts again.  And if the outsourcing is done when business results are poor, the intent is to never revisit doing those things again.  Under the banner of “outsource everything that’s not core” the management team is left with nothing to manage – except “core”!!!  But if core has limited value, how do you now create a healthy business?  How do you move to meet shifting needs?

Outsourcing has been a tidal wave for 15 years.  Things might be cheaper, but has it made business performance better?  Take a hard look at your company – and you may well realize it hasn’t helped you be a better competitor.  When you outsource, how often are competitors able to equally outsource and match your short-term cost reductions?  Things might be a penny cheaper, but the business is likely much less flexible, more vulnerable to market shifts, and far more locked-in to doing what it always did!

If you are seriously considering outsourcing, ask some simple questions:

  1. Am I doing this because I want to simplify my life, or offer the market something new?
  2. Am I doing this so I can “focus” on my “core” business?
  3. How will this advantage me versus competitors?  Would emerging competitors do this?
  4. Can competitors do what I’m doing?  Can this lead to a price war?
  5. How will this make me more competitive in 10 years?
  6. How will this make me more connected to markets?
  7. How will this make me more flexible to deal with shifting markets, and how will I exploit this flexibility?
  8. Am I doing this because I’m desperate to cut costs?  
  9. What could I be doing instead of outsourcing to be more competitive?

Who “gets it”? – Employment, investing and IBM

"IBM authorizes another $5Billion for share buybacks" is the Marketwatch.com headline.  This brings the amount available for buying the stock to $9.2billion – or enough to buy about 73.6million shares.  But it begs the question, what value will this bring anyone?

"The U.S. Workplace: A Horror Story" is the CIOZone.com headline. A survey by Monster.com and The Human Capital Institute of more than 700 companies (over 5,000 workers) discovered that by and large, employees are mad at their employersThey don't trust business leaders, and think those leaders are exploiting the recession for their own purposes (and gains).  79% of workers would like to find a better employer – to switch – but only 20% of employers have a clue how many workers have become disillusioned.

Simultaneously, "Many vanished jobs might be gone for good" is the Courier-Journal.com headline.  Historically, increases in manufacturing (usually led by autos) and construction (primarily housing) caused recessions to diminish.  But nobody expects either of those sectors to do well any time soon.  Manufacturing is showing no signs of improving, in any sector, as we realize that all the outsourcing and offshoring has permanently reduced demand for American labor.  And quite simply, very few investments are being made by business leaders that will create any new jobs.

"ALL BUSINESS:  Innovation Needed Even in a Recession" is the Washington Post headline.  The article points out that almost all recent improvement in profitability – boosting the stock market – has been through cost cutting.  But that has done nothing to help companies improve revenues, or improve competitiveness It's done nothing to bring new solutions to market that will increase demand.  Quoting the former Intel CEO Gordon Moore – "you can't save your way out of a recession" – the article cites several consultants who point out that companies which earn superior rates of return use recessions to invest in new technologies and innovations that create new demand.  And eventually new jobs.  But today's CEOs aren't making those investments.  Instead, they are taking short-term actions that dress up the bottom line while doing nothing about the top line.

Which brings me back to IBM.  Who benefits from $9.2billion being spent by IBM on its own stock?  Only the top managers who have bonuses and options linked to the stock price.  The shareholders will benefit more if IBM invests in new products and services that will increase revenues and drive up long-term equity.  Employees and vendors will benefit from creating new solutions that generate demand for workers and components.  Almost nobody benefits from a stock buyback – except a small percentage of leaders that have most of their compensation tied to short-term stock price.

What new innovations and revenues could be developed if IBM put that $9.2billion to work (a) at its own R&D, product development labs or innovation centers, or (b) at some young companies with new ideas that desperately need capital in this market where no bank will make a loan, or (c) with vendors that have new product ideas that could meet shifting markets? 

That's the beauty of an open market system, it supposedly funnels resources to the highest rate of return opportunities.  But this doesn't work if managers only cut costs, then use the money to prop up stock prices short term.  It's a management admission of failure when it buys its own stock.  An admission that there is nothing management can find worth investing in, so it will use the money to artificially manipulate the short-term stock price.  For capitalism to work resources need to go to those new business opportunities that generate new sales.  Money needs to flow toward new health care products and new technologies – not toward keeping open money-losing auto companies and failed banks that won't make loans.

If we want to get out of this recession, we have to invest in new solutions that will increase demand.  We have to seek out innovations and fund them.  We cannot simply try to Defend & Extend Success Formulas that are demonstrating their inability to create more revenues and profits. Laid off workers do not buy more stuff.  We must put the money to work in White Space projects where we can learn what customers need, and fulfill that need. That in turn will generate jobs.  And only by investing in new opportunity development will workers begin to trust employers again.    IBM, and most of the other corporate leaders, need to "get it."