Shifting the burden

EDS shares NMCI risks with subcontractors

It is no secret that for the past several years, the Navy Marine Corps Intranet project has been a fiscal millstone around the corporate neck of lead contractor EDS. The company has lost hundreds of millions of dollars, largely because of increased expenses for building, populating and running the network throughout the Navy Department.

In addition to the losses, the company has more than $2 billion invested in the

4-year-old program.

EDS officials are looking for ways to cut costs. Company officials took the first step in mid-May, when they notified several of their subcontractors that they would slash the fees the company pays to them.

An official at one subcontractor, who spoke on the condition of anonymity, said the average cut was about 35 percent of the rates EDS had been paying its subcontractors, and some companies received notice that their rates would be cut by as much as 45 percent.

EDS officials would not comment extensively because the company is now in what is generally known as a quiet period before its earnings forecast is due in late July.

EDS spokesman Kevin Clarke said company officials re-evaluated their NMCI subcontracts to assess how the company can save money, and they adjusted the rates where appropriate. Clarke said he could not comment on the amount of money EDS officials hope to save through the maneuver or how many of their subcontractors received notice. However, he did say that not all of the subcontracts were reduced.

Clarke said company officials did not arbitrarily reduce rates. Instead, they contacted the subcontractors whose rates were deemed uncompetitive. "We contacted the folks who we felt were charging us rates that weren't competitive and told them their rates would have to be reduced," Clarke said. "It's a standard business practice and part of doing business today."

Navy Capt. Chris Christopher, staff director of NMCI, said Navy officials cannot comment on the inner workings of EDS. How the company deals with its subcontractors is an internal corporate manner, he said.

"But we are applying more and more technology to the system, so it's entirely possible that fewer people are going to be needed to perform work," Christopher said.

The Navy will continue to rely on the service-level agreements to hold EDS accoutable for meeting the contract, he said.

"If we don't receive the services we're supposed to — regardless of the reasons why — EDS doesn't get paid," Christopher said. "We have mechanisms in place to ensure we get the services in the contract. But if there are fewer people to provide them and those service levels are not met, EDS and the Navy suffer together. The Navy suffers operationally, and EDS suffers financially."

Companies were notified in mid-May that the reduced rates would take effect June 1, but some companies received extensions to later this week.

EDS officials admit, however, that they are trying to shift some of the burden of the NMCI contract to the companies that help provide services. Mike Koehler, NMCI enterprise client executive for EDS, said EDS officials reviewed several issues to determine the best changes to the contracts with their subcontractors.

"I realized that the only person at the table who would be penalized [if services aren't delivered] would be me," Koehler said. "I need the companies that want to work with us to put their revenue at risk for the service-level agreements. And if you don't, I'll find someone that will."

As a result, Koehler said he will change the way EDS works with subcontractors. Instead of paying a company upfront for services that will be performed during a contract's term, EDS officials are adopting more of a pay-as-you-go approach.

"I want to buy from [subcontractors] the same way my customer buys from me," Koehler said. "We're four years into this now, and we're much smarter about it. Instead of writing big capital checks upfront, we're going to change the way we do it. We're not going to engage in the old way going forward."

An industry insider who works for Hewlett-Packard Co., and is not affiliated with EDS or NMCI directly, said EDS' move could signify that EDS officials are mandating that contract rewards and risks are equal.

"There's got to be a shared risk in this as well, and I'm sure EDS is thinking that [the subcontractors] need to assume some of the responsibility," the industry official said.

Another industry executive, who previously worked as a vice president at Northrop Grumman Corp., said he was surprised that EDS didn't adopt this strategy earlier.

The change will likely produce one of three results, the former Northrop official said:

Subcontractors will produce less because they will be forced to place fewer people on the project.

Subcontractors will produce less because people with knowledge will leave and be replaced by workers with less experience.

Subcontractors will produce less because they can't afford to put resources on the project.

"So we're either going to see delays in producing services, or [we're] going to see a lowering in the quality of work that the subcontractors are producing," he said.