Virtual Datacenters and The Services Chasm

Previously, I wrote about product companies that find themselves in a precarious place known as the services chasm. This is where the services strategy does not align with market realities. For those of you that are skeptical this chasm is engulfing more and more historically product-centric companies, please read the article that just hit the streets:

Cisco, EMC May Offer IT Services

Both Cisco and EMC offer hardware products that are the building blocks of corporate datacenters. Those building blocks are usually consumed in a traditional “CPE” or “customer premise equipment” model. In other words, the hardware is sold and installed on the customer’s sight. The transaction is a product sale. However, if datacenters begin to virtualize and customers begin subscribing to “datacenter services”, the CPE model collapses. Product companies like Cisco and EMC will need to sell their products to DCO service providers, OR they will need to provide these services directly to enterprises.

Obviously, IBM with its extensive heritage in services is well positioned for a world of virtualized datacenters. HP, with its acquisition of EDS, now has a shot. But what about product-centric companies like Cisco? Can they afford to simply resell through IBM, HP, or some other services provider? I don’t know.  Optimizing go to market channels is not my specialty. However, tracking and analyzing the balance of product and service revenues in technology markets is my specialty.   If datacenters go virtual, that marketplace takes a hard shift from product transactions to service transactions. I would argue that companies that can provide those services directly are much better positioned to succeed in that type of market. Perhaps this article hints that Cisco and EMC have already come to the same conclusion.

Billed but not Charged

I love discussing and debating the intricacies of services strategy within product companies. However, the most popular blog entry I’ve written to date is the one that defines a standard method for calculating utilization for delivery staff. It has generated several comments and questions—a majority made directly to me. A question that came in last week concerns hours that are billed to a customer but not successfully charged. The question had two parts:

1. Where should hours that were billed but not charged be categorized using the schema provided in calculating utilization?
2. What is a reasonable target for the number of hours billed but not charged?

Let’s explore both of these questions.

Who Else Has Been in the Services Chasm?

Last week there was a comment on my entry Dell Hits the Services Chasm:

Interesting observations about Dell. Could you elaborate further on the mantra of ‘aligning service strategy to the overall company strategy’. What examples have you seen where companies have failed due to a mis-alignment?

There are multiple examples of companies that have misaligned their services strategy. Several company examples are included in Bridging the Services Chasm: Aligning Product Strategy to Maximize Product Success (Professional Services Press, Sep 2009).  Before commenting on other classic examples of misalignment, let’s discuss the four factors that drive services strategy.

HP, WSJ, OMG

I just reviewed HP’s earnings release. The company met Wall Street expectations but both product revenues and net operating profits were down. This trend is right in line with what we saw in the Q2 snapshot of the Service 50, so HP’s results are clearly not atypical. I also scanned the rash of articles that came out from the business press discussing HP’s numbers, including this gem from the Wall Street Journal:

Good Question: How Has EDS Helped H-P?

These articles agree that services was THE ONLY business line to grow for HP over the past year. However, the business press is bemoaning the fact that it is difficult to compare service revenues from one year ago because of the EDS acquisition. There is also some question about the profitability of the overall service business for HP and how it compares to IBM’s services business.

I’m sorry, as product revenues take a double digit hit and product margins get skinnier (think netbook margins vs. laptop margins), I would argue there are three key facts that are most relevant when discussing the impact of services on HP:  

1. Services revenues are 93% larger than they were one year ago
2. Services now represent 31% of HP’s total revenues.
3. Services are responsible for 40% of HP’s total earnings from operations.

Clearly, the future of HP services includes improved profitability.

Hopefully for HP, EDS services can open doors for HP product sales.

Maybe, somewhere in the future, all of the products “HP invents” will be consumed through service transactions such as software as a service, cloud computing, managed services, or outsourcing services.   

For the here and now, if services would have followed the same trajectory of the product revenues, HP’s top line revenues would have been $22.8B this past quarter, not $27.9B. This means instead of hitting 98% of revenues compared to one year ago, HP would have only captured 80% of revenues compare to one year ago. If that was the case, the headline in the business press would have been much more direct:

HP REVENUES DECLINE 20%

What does services mean to HP? Many things, including keeping the above headline out of the business press.

Three Great Excuses Why You Missed Your Number

In the past several entries on this blog, I have been hammering on the migration from brute force sourcing models to more sophisticated tactics for optimizing the PS delivery resource pool. I’ve realized these discussions may be becoming too academic for the PS leaders out there that are slugging it out day to day, trying to meet a quarterly nut. As I’ve heard Paul Hofstadler, who sits on the TPSA Advisory Board, state many times: “PS is a game of nickels and dimes.” And so it is. And if you are struggling to collect those nickels and dimes this quarter, I want to leverage some industry data to provide you three killer excuses.

Sourcing Services: Projects vs. Skills

In my post on The Science of Sourcing, I referenced a book by John Ricketts that applies the theory of constraints to the world of sourcing services. Since that post, several folks have commented on the challenges of applying this approach to their service organization. In my next post, I will discuss five specific reasons the next generation of sourcing process are challenging for embedded PS organizations to adopt. In this post, however, I want to reply to this great comment made by reader Richard Augugliaro:

“The obvious question is, how do you make sure that you know which skills are demanded? Again, doesn’t that have the same problem of relying on a Sales forecast as does the “Hire-to-Plan” model?”

The short response, is that there is no free lunch when working to optimize service sourcing. The more nuanced response is that forecasting skill requirements should involve less volatility than forecasting deals.

Ericsson: Shifting Services Strategy Profile

In 2003, Ericsson reported that 17% of total company revenues came from project based services. Check out the headline this week:

     Ericsson: Q2 net profit drops, but service demand rises

     July 27, 2009 — 9:13am ET | By Sean Buckley

The article contains the following paragraph:

In addition to broadband, professional services were a bright spot for Ericsson. The company reported that services accounted for about 38 percent of the company’s total revenues. Buoyed by large contracts from major service providers such as Sprint, Ericsson said professional services revenues totaled $1.89 billion, while “network rollout” services accounted for $790 million. Svanberg stated that the company has dedicated 7,000 employees to “consulting and integration.”

Project based revenues have more than doubled for Ericsson over the past six years. How important was that $1.89 billion in services revenue to Ericsson this past quarter? And remember, this was “heavy” services revenue. A large percentage of those project margin dollars dropped directly to the bottom line.

I highlight this little industry data point because it is 100% in line with the overall industry trends we saw in Q2 that will be reviewed in The Service 50 webcast on Thursday. I have said it before in this forum, but let me say it agan: In a slow economy, service dollars matter.

The Service 50 Webcast

I promise I will return to the topic of sourcing, but I am hip deep in reviewing the Service 50 data for our upcoming public webcast this Thursday. Follow this link to register (open to all):

http://webcasts.tpsaonline.com/event/7×9537s98t4y

For those readers that have not attended in the past, I host a webcast every quarter that reviews the financial performance of fifty of the largest providers of technology services. The analysis is designed to answer the following questions regarding trends in tech services:

1. Who are the best performing providers of technology services?
2. Are technology service margins trending up or down?
3. Are net incomes trending up or down?
4. Are hardware and software companies becoming more or less service intensive?
5. What is the product service mix for the most profitable companies in the Service 50?
6. What is the product service mix for the largest companies in the Service 50?

As I review the data, I can tell you the impact of services revenues on product companies continues to be incredibly positive during this downturn. The image below is one I will cover in the webcast. As can be seen, product intensive companies with limited services revenues continue to suffer more than companies that have a healthy balance of products and services. Tune in Thursday for the complete analysis.

The Service 50 Q2 2009

The second half?

Where are TPS revenues and profits heading the second half of this year? The TPSA quarterly PS tracker trends three leading metrics PS organizations can view to understand where the indsutry will be heading in the second half of this year:

• Bookings
• Backlog
• Hiring

To find out how these key leading metrics are trending for TPS businesses, by geographic regions, participate in the TPSA PS tracker survey this quarter:

http://www.tpsaonline.com/member_surveys.asp#pstracker

Dell Hits the Services Chasm

I need to alter the entry I had planned for today because of a compelling headline that hit the news wire this week:

Dell’s Customers Are Becoming Its Biggest Foes

The article makes the following observations:

• The behavior of Dell’s customers is forcing the company to lower prices to protect market share at the expense of gross margins, a measure of profitability. Earlier this week, Dell warned investors its gross margins will slip slightly in the quarter ending this month, even though it also said revenue will be more than expected. That means Dell will likely keep less of every dollar in revenue it gets.
• The squeeze could jeopardize Dell’s financial performance. It said it’s hoping to post operating margins – another measure of profitability – of 7% over the long term on revenue growth of between 5% and 7% over each of the next few years to achieve that goal. Last quarter, Dell’s operating margin was 4.7%.

I have to admit, this article is a blaring endorsement for the book I am just finishing: Bridging the Services Chasm (Professional Services Press, September, 2009).  Here is an excerpt from the Chapter that explains the services chasm Dell now finds itself falling into.