Service Companies: Small Crumbs of Comfort
Are you being served by a UK company? It?s not likely as our services industry is dominated by the US. But dealers can still get in on the action in a small, but profitable way. Candice Goodwin reports
It?s hard to believe, in the late 1990s, that once upon a time the UK led the world in computer hardware development. But back in the 1940s, US marketing expertise in the form of IBM and others, rolled over the UK?s nascent hardware industry ? and then later on, the same thing happened in software as well.
Computer services, the argument ran, would be a different matter. ?Services always used to be considered a local game, it was the old ?you can?t export haircuts? argument,? says Rob Wirszycz, chairman of the Computing Services & Software Association (CSSA). ?What you can export are brands, so what we?re seeing is local delivery, but foreign branding.?
The UK service sector is now dominated by foreign-owned companies and UK service com- panies seem chronically unable to take advantage of what?s turning into one of the biggest money-spinners around.
In 1995, the UK IT services market was worth #9.2 billion, according to the latest version of The Holway Report, regarded as the definitive guide to what?s going on in the UK services sector. It?s also growing fast; Holway estimates that during 1996 it grew by 17 per cent, making the UK Europe?s fastest growing services market.
But Holway?s figures indicate that the companies getting most benefit from the UK services boom aren?t UK-owned, and many of them aren?t even from Europe (see table). And if the UK?s services don?t get much of a look-in in the UK market, they do even worse in Europe. There, the biggest all-UK-owned service provider is Logica ? which comes in at number 30 on the list of service companies ranked by revenue.
And more bad news from Holway for UK service providers ? since the very largest services players are not UK-owned ? is that the largest companies are increasing their share of the market. While the UK services sector was growing by 17 per cent overall, the share of the 10 biggest companies grew by 30 per cent, a trend that?s now been repeated for four years in a row.
The reasons for this aren?t hard to see. Large companies are more likely to be awarded large contracts, such as the #100 million a year outsourcing deals the Inland Revenue gave to EDS and British Aerospace gave to CSC. Outsourcing is the single biggest contributor to the rapid growth of the UK services sector; according to Holway, UK outsourcing market grew by 45 per cent to #1.7 billion in 1995 and is forecast to grow by 24 per cent a year between 1996 and 1999.
The second reason is that larger companies have more money for acquisitions to make them even bigger. Last year, for example, IBM swallowed up UK services company Data Sciences. France?s Cap Gemini Sogeti has successfully grown by acquisition, but there are few UK companies large enough to play this game. If BT?s takeover of MCI goes through ? and there?s no reason to suppose it won?t ? then the UK will for the first time have a service player large enough to be visible on a global scale. Only just, though ? the merged company?s service revenue will be something like $2 billion, whereas IBM ? number one in the worldwide services market ? has revenue of about $20 billion.
?US domination is a fact of life, I?m afraid,? says Wirszycz. ?The problem for UK services companies has been marketing, and a number of firms have laid themselves open to takeovers by US companies because their marketing was weak.? But does it matter that so many of the big services companies aren?t British? Wirszycz says not. ?Ownership of a company only matters insofar as whether the owner is going to continue that commitment. Our biggest concern is whether the UK?s technical base is declining. I?d suggest it?s as strong as it ever was. UK firms are clearly attractive, which is why they get taken over. We?re keen to see jobs created, the market growing, and foreign firms using the UK as a base for exporting overseas.?
In terms of revenue, Holway estimates that the top 10 services suppliers represent 36 per cent of the market, and the top 40 about 70 per cent. The good news, though, is that although the large, multinational companies? share of the market is increasing, there still seems to be plenty of room in the market for smaller players indigenous to the UK.
Only about 13 per cent of the CSSA?s current membership of 530 consists of large companies with over 500 employees. Firms with 20 or fewer employees account for 25 per cent of the membership, with the rest made up of medium-sized players. ?The big are getting bigger ? and the small are getting more numerous,? says Wirszycz.
Richard Holway, author of The Holway Report, predicts increasing polarisation in the services sector, with medium-sized firms getting squeezed out or taken over, while both very large and fairly small companies continue to flourish. ?Mid-size services companies are a bit like the dodo; they?re becoming extinct,? he says. ?When they get to a certain size, they tend to get acquired.?
As US service giants such as EDS and Andersen Consulting get fatter, Holway believes small companies ? overwhelmingly UK owned ? will make a good living taking on contracts too small for the giants to consider worth getting out of bed for, and providing specialist or local services which the larger players cannot deliver.
?Although the Inland Revenue has outsourced to EDS, it still buys a lot of services from smaller companies; in fact, you get a trickle-down of business from large companies to small ones,? he points out.
The size of the market opportunity in UK services now seems to have filtered through to the City, which is giving a warmer reception to UK service companies. ?Poor stock market sentiment in 1994 led to a year of no new issues. But the success of the CMG float in December 1995, and the realisation that the real top performers in the sector are service companies like Admiral and Capita, has resulted in a raft of new, high quality issues in 1996,? Holway says. He points to recent success stories such as SAP specialist Diagonal, which recently floated on the stock market and saw its share price rise from 275p to 315p in the first hour after trading opened.
Most computer dealers of any size have some kind of service capability, if only in installation and technical support. And with margins on hardware and software shrinking fast, there are plenty of reasons for dealers to look at moving into services, or expanding their existing service operations.
?Growth rates in hardware sales are only two to three per cent and in software sales only nine per cent, whereas pure services are growing at 20 per cent? argues Holway. Yet many UK suppliers still just see services as a way of adding value to hardware and software sales.
?All our services ? such as technical support, site visits, and consultancy ? are free, though we?ll probably move into chargeable services in the medium to long term,? says Alastair Laidlaw, head of marketing at Ideal. The company?s view is that because of the added value it provides, it?s in a position to charge higher margins on its products.
?Our margins are higher this year than last year because we provide service free of charge,? Laidlaw explains. ?We find there?s a relationship between customers who know what they?re doing, the margins they can make, and the margins we can make. Our prices may be one to two per cent higher than other distributors, but we?re cheaper to do business with overall, because we see products in the context of solutions.?
Holway is not convinced. ?The philosophy is to sell the product and give away the service ? it should be the other way round,? he says. While dealers aren?t yet going as far as to give products away, a number of them have started to build up their service operation.
?Back in 1988, we didn?t do services. Now they?re a key focus of the business,? says Nick Melvin, corporate marketing director at P&P. ?Over the past few years, we have very substantially increased the proportion of our services income. It now accounts for about 38 per cent of our profits, whereas two years ago it was about 10 to 11 per cent and, if you look at our employee mix, services staff made up 40 per cent of our workforce two years ago compared with 65 per cent today.
?Services are important to us for two reasons. First, they help us build a closer relationship with our clients; when we provide services we work more closely within their IT strategy and build a longer relationship. Second, the return on services is higher than on product alone. Increasing our focus on services has helped us to increase our profits steadily over the past few years, and for the future, our stated strategy is to carry on increasing the group?s skills-based revenues.?
P&P has developed its service business both organically and through acquisition. It has bought training company QA; Myriad, which specialised in IT personnel contracting and recruitment; Space Consultancy; and has acquired the franchises for Scottish Computerland, under the Computers for Business name. It has also restructured in order to provide a sharper focus on services. There are now three divisions: one specialising in desktop technology and services, one for mid-range technology and services, and one is purely a services operation.
Out of a total revenue of just over #800 million, Computacenter generates about #100 million from services ? but it has plans to change that. ?We?re having a tremendous push in services at the moment, with a view to growing services as a percentage of our business,? says marketing manager Peter Lorant. ?We?ve been investing in the services side of the business for the past few years; our main problem is in getting enough skilled people.?
Skills shortages are now one of the biggest problems for UK service companies looking to expand their business, but that in itself is a good indication of the current boom in UK services. It looks set to continue for some time, fuelled by technical drivers such as the opportunities arising from internet technologies and structural factors such as the need to ensure corporate systems are ready for 2000 and European monetary union. With the UK?s service market seemingly growing faster than any other in Europe, now is the time for dealers to get a piece of the action.