Here we are, well into the fall season. In Plano, Texas, temperatures are dropping, and so are the revenues, profits, and market valuation of the town’s most prominent corporate citizen, Electronic Data Systems.

EDS, the company that trail-blazed the outsourcing business model, has recently hit a very bumpy patch along the road. The company’s problems are seen by some as comeuppance for past arrogance and bravado, and by others as a cautionary tale of the challenges of managing large outsourcing contracts, especially in a depressed market.

In less than two months, EDS has endured a series of bad news events that has fundamentally shaken the confidence of Wall Street, and may also underscore the company’s increasing vulnerability to competitors for big outsourcing deals. The company’s woes also highlight some of the potential pitfalls of the outsourcing business model itself.

Just two days before the autumnal equinox and eight days before the close of its third quarter, the Big Fall officially took place at EDS. The House That Ross Built announced it would miss earnings estimates by an whopping 80%. Making matters worse, the company’s tough-talking CEO Dick Brown had just painted a rosy picture for analysts a month earlier. Talk about a credibility problem.

Needless to say, analyst and corporate debt ratings were downgraded immediately. Shocked investors dumped the stock en masse, resulting in a market valuation that was cut by more than half in a single trading day. Calls for an investigation of the company’s accounting practices were heard up and down Wall Street. Apparently the SEC did not require much prodding, and an investigation is now underway.

Actual third quarter earnings were only slightly better than the original profit warning, but even a tiny recovery in share price could not mask the fact that EDS stock had lost over 70% of its value since the start of 2002.

The bad news hasn’t ended with third quarter earnings report, either. EDS, which prides itself on its ability to close the really big outsourcing deals, has lost several high profile bids in the past couple of weeks alone. Just a few days ago, it was reported that J.P. Morgan Chase & Co. is nearing agreement with IBM on a seven-year technology outsourcing contract that could be worth more than $5 billion. EDS had also bid on the project. Less than a week earlier, consumer-goods company Procter & Gamble Co. said it had backed out of an $8 billion outsourcing deal it was negotiating with EDS. Reportedly, EDS's financial difficulties are the reason behind the P&G decision, and perhaps the J.P. Morgan move as well. P&G is concerned that EDS’s weakened financial condition would make the company a risky partner to entrust with the company’s IT infrastructure jewels.

EDS is not only facing increased competition from IBM for big outsourcing deals, of course. HP recently announced a seven-year outsourcing deal with Canadian Imperial Bank of Commerce worth about Cdn$2 billion. That’s the kind of big-time contract that EDS has traditionally assumed as its birthright.

According to a survey just released on November 18 by InformationWeek Research, EDS is not faring well in the eyes of the very customers it hopes to serve. Based on responses from 700 business-technology professionals, the survey ranked leading outsourcing vendors on such factors as trust, reliability, value, technical skills, industry knowledge and innovation. EDS ranked sixth out of nine vendors, only finishing ahead of IBM and its newly acquired PricewaterhouseCoopers (numbers seven and eight respectively), and last place Worldcom.

So what went wrong at EDS?
The company’s official explanation is it was surprised by a sudden and precipitous decline in discretionary spending by its customers. But the problems at EDS also beg the question: "What is discretionary and what isn’t?" Certainly the company’s management consulting subsidiary, A.T. Kearney, which it bought back in the mid-90s, has been in a world of pain, along with the rest its industry, as corporations pull back on consulting and new integration projects. But some analysts now say that far more of the company’s outsourcing revenues are variable than the company actually likes to think, or admit. In a stumbling economy, many of EDS’s customers are playing "Honey I Shrunk The Outsourcing Deal," turning profitable relationships into problems.

EDS has also been suffering from a bad case of indigestion with some of its largest outsourcing contracts, particularly a stalled outsourcing deal with the US Navy. The deal, reportedly worth $7 billion, was signed in late1999 and still has not turned a profit, in part because of delays due to software testing ordered by Congress. EDS says the Navy contract and another deal with the British Government cut cash flow by $1.8 billion in the past 18 months.

Add to that some large bankruptcies among its outsourcing clients, specifically WorldCom and US Airways Group, and you’ve got the makings of a very large problem.

Sources close to the situation say that EDS is now scrambling to right its ship by jettisoning people and costs wherever possible. "They’re looking closely at every outsourcing relationship and deal and trying to figure out how to make them profitable," according to one source. They are also looking over many of their assets for possible sale to raise cash. In fact, EDS announced on November 14 that it would sell its Consumer Network Services unit to Fiserv, Inc. for $320 million in order to meet upcoming pension costs.

According to some employees, EDS has been going through a "zero-based" employee valuation program in which every staff member needs to defend his or her job and the value it produces for the company. A couple of weeks ago, the company announced it would cut 3% to 4% of its workforce over the next several quarters.
Analysts are harshest towards Brown because they feel he waited far too long to come clean. "There was a time when he could have lowered his guidance, but he maintained it wasn’t happening to EDS," said one analyst. "There is a pretty big credibility chasm here," said another.

For EDS, it has been a very stormy fall. Among financial analysts, what winter will bring is wide open to speculation.