Hewlett Packard and NEC, 2002 Joint Ventures in Outsourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Overview.
On December 12, 2002, Hewlett Packard and NEC announced a joint venture (“JV” or “alliance” for our discussion) with NEC to deliver managed information technology outsourcing services in Asia, the United States and Europe. The legal structure of the joint venture was not fully disclosed, but some guesses may be made. This case study explores business and legal issues frequently arising in joint ventures. We trace some of the prior relationship and the resulting economic, cultural and operational fit of the venturers.
Joint Venture as a Business Model in a Depressed Global Economy.
The joint venture starts with the realization that the resources of each joint venturer are insufficient to meet a particular market need. ( In a sense, a shared services center is a joint venture of the department or lines of business of a large enterprise.) This particular JV targets a need to serve global companies engaging in mergers and acquisitions. This view of the world suggests that increasingly, for the foreseeable future, consolidation and concentration of multinational enterprises will continue. In essence, the HP-NEC joint venture targets this wave of global consolidations across industries.
Prediction for Future Restructuring of the Joint Venture.
Business analysis suggests that, after NEC completes a spin-off of its semiconductor business, the new joint venture will be a candidate for merger into HP, provided that the joint venture achieves satisfactory performance goals. NEC’s Chairman and CEO, Koji Nishigaki, observed at the December 2002 news conference that “we have laid the foundations [for a merger], so the potential is there. Part of the companies could be merged. We will see many dynamic changes.”
Ultimately, like any joint venture, the potential for any merger and the success of the joint venture will depend on the joint performance of the JV partners, raising the issue of what commitments each is making to compete successfully in an increasingly competitive, increasingly concentrated market for outsourced international services in information technology management.
The joint venture presents a number of legal issues that are common to any international joint venture in information technology, hardware, software and managed services.
Geographical Scope.
The alliance will market to multinational companies that have offices in one or more territories. Initially, these territories are limited to China, Japan and the United States. As of 2004, the joint venture will expand the territory to South East Asia and Europe. The phased introduction of jointly-provided services into targeted territories should enable the parties to manage the inevitable transitional kinks in their relationship before taking the relationship to distant markets.
Service Scope.
The JV includes marketing, systems integration and customer support services.
Target Customers.
The JV partners intend to create a new market for IT outsourcing for customers that are not dependent on mainframes. They admit that IBM dominates the mainframe computer market. Rather, the JV will be targeting large global customers in the “post-mainframe-era market,” particularly the integration of computer systems after mergers of large global corporations that have disparate IT infrastructures. In Japan, the two have already worked on an integrated system for Sumitomo Mitsui Banking, which is the product of a recent merger of two banks. That deal not only inspired the joint venture, but probably will also serve as the “sweet spot,” template and benchmark for future joint venture service offerings.
Legal Structure.
The two alliance partners indicated that they will establish one or more joint ventures to provide a range of information technology services. The HP-NEC announcement did not elaborate on the terms or structure of the JV, so we will speculate.
Under a joint venture, there are basically two methods of developing a “joint venture”
- Contractual Joint Venture:
In a “contractual” joint venture, the two partners establish a business operation that is based solely on a contract. No new legal entity is formed. Such joint ventures were popular in East-West trade during the Soviet era. At that time, contractual joint ventures had several ideological and legal advantages for the Soviets. No one had to establish a legal entity that would have an existence independent of the joint venturers. The Soviets did not have to implement a capitalist tool of an entity owned by someone other than the State (the Fatherland). Accounting could be defined in the contract, leaving everything to negotiation and nothing to the application of capitalist legal systems. (Did you hear of Hollywood Accounting? It spawned many lawsuits. The Soviets had their own style of contractual accounting, too!). And termination could be achieved by contract termination, without transfer of any assets from an entity. We doubt that the HP-NEC deal was inspired by a contractual JV structure. - Entity Joint Venture:
In an “entity” joint venture, the joint venturers agree to form a new entity (the “JVCo”), which then serves as the focal point for the business operations. In an outsourcing JV, the joint venturers typically contribute cash to the JV Co. to conduct certain defined operations (such as its officers and key employees in administration and marketing). But, the JV partners rarely transfer ownership of intellectual property, operating employees, real estate or technology systems to JVCo. Instead, the JVCo takes licenses and leases from its JV partners, who also agree to provide defined services to the JVCo so that JVCo can, in turn, deliver the outsourcing package to the JVCo customers. A JVCo need not have much capital: any transitioning of customer employees and other resources under management could be made to either, or both, of the JV partners instead of to the JVCo. In fact, JVCo might have no assets at all, assuming that the JV partners each make available, on a “secondment” basis, its own employees performing functions in the name of the JVCo. Maybe the Soviets had a smarter idea, since at least the third parties dealing with the JV under a contractual JV could make a claim against some deep pockets!
Structure of Services to Target Customers.
Under the JV, the partners agree to establish a “joint sales force,” which might be under a JVCo. When a customer signs a contract with JVCo, the customer’s transitioned employees would probably be hired by a separate jointly owned entity (“JVServiceCo”), with services being provided separately and jointly by HP and NEC. The exact nature of the legal relationships between the service providers, as a team, the customer-specific JVServiceCo and the customer would reflect a number of legal and business considerations. The authors of this case study offer to provide details of such considerations, and related strategies, to their clients on request.
Scope of the JVCo’s Operations.
Under corporate law, the JV partners must carefully define the scope of the JV’s operations. Like lines in the sand, the scope defines the realm of business opportunities that each JV partner must bring to the JV, rather than perform on its own. Anything outside the defined scope does not involve any fiduciary duty of a JV partner to bring the corporate opportunity to the JV and to avoid competing with the JVCo for the opportunity.
Scope of Contributions in Kind.
In the HP-NEC deal, the announcement failed to mention anticipated financial contributions. This suggests that the two parties will minimize invested capital by allocating functions in a complementary, non-competitive, fashion. Such an allocation justifies a joint venture since the two companies might not have been able to offer or compete in the marketplace alone. See Antitrust in Joint Ventures in Outsourcing.
In the press conference, HP’s President, Carly Fiorina, said that HP “focuses on capability, invention and innovation,” while NEC “brings important capabilities in open mission-critical systems.” This suggests that NEC would be providing managed services for data centers operating legacy systems under Unix (or variants), and HP would be providing customer solutions design, project management and custom services in software development, product design, technology improvement plans and strategic consulting.
HP’s Contribution.
HP is already a leading outsourcing company in North America and Europe. In September 2002, Canadian Imperial Bank of Commerce awarded HP with a seven-year, $1.5 billion contract for the provision of IT services.NEC’s Contribution.
Customer Base.
NEC has an installed customer base in Japan’s financial and business markets, especially in telecom. NEC also has extensive business relationships with technology companies in China, which should help open the Chinese market for HP’s computers and, in combination, NEC’s and HP’s technology services. But, in the JV, new markets will be targeted, so the Japanese market will be only an incidental target market. Accordingly, the JV will allow NEC to enter new geographical markets using HP as a sales agent and distribution channel.
Technology Solutions.
NEC’s Solutions group offers custom consulting and systems integration services that could be used to provide back-office support in Japan. NEC Solutions offers highly reliable computing solutions to enterprise, government, and individual customers by providing software, hardware, and services necessary to design, integrate, and operate these elements. NEC Solutions focuses on customized solutions packages for new technology deployments for customers.In addition, NEC’s Systems Integration services group, which has approximately 13,000 systems engineers, provides end-to-end systems design, development, deployment, and systems operation solutions. System integration is provided directly and through NEC Soft, Ltd. and other subsidiaries. SI services consist of (a) systems design, development, and deployment services, (b) operational support services, including system problem diagnosis and correction, and (c) consulting services on systems architecture design and technology planning, including the evaluation and selection of technologies and platforms.
In software, NEC develops and provides software products primarily for use in its computers. Software products include operating systems, middleware for managing large-scale distributed data processing systems, and application software. NEC continues to further develop its capabilities in middleware to enable the more rapid, cost-effective integration of different systems, protocols, and software.
Rationale for a Joint Venture in Outsourcing.
Several key factors brought this joint venture into being:
Prior Collaborative Relationship over Many Years.
Since at least 1995, HP and NEC have been collaborating on technology other than services. They share mutual competitors, including Microsoft and IBM. Prior to the merger of Compaq into HP, HP had already established a series of joint activities in research and development, design, manufacture and distribution of computers and their components. The past relationship focused on combining mainframe technology expertise of NEC and, in at least one case, Hitachi, Ltd., with HP’s operating systems and computers.
In 1995, the two companies partnered in the Unix server arena, allowing NEC to purchase large-scale servers and related technology from HP on an OEM basis for resale in Japan. As a result, the NEC NX7000 product line is based on HP technology.
In 1997, HP became an OEM supplier to NEC and Hitachi, Ltd. of entry-level models in the HP 9000 D-class Enterprise Server family. Also, HP signed a multi-year software development agreement with NEC and Hitachi to integrate Japanese mainframe expertise into HP-UX operating system for grater modularity, scalability, performance, reliability and management by self-healing enhancements to detect and repair unexpected software problems in the HP-UX kernel. Incidentally, in 1989, HP and Hitachi signed a broad alliance including the joint development of HP’s Precision Architecture RISK CPU chips and the design and construction of HP’s PA-RISC systems. The two companies established a technical support center in Japan (the “HP-NEC Enterprise Solution Integration Center,” or “HP-NEC ESIC”).
In 1998, HP and NEC signed a development agreement to optimize HP’s HP-UX operating system to run on systems using the upcoming Merced 64-bit processor. As of 2002, the Merced processor has not generated widespread market demand.
In 1999, HP and NEC agreed to collaborate on what they called was the next generation of Japan’s Internet Protocol (IP) network. Under the 1999 agreement, NEC distributed IP servers using HP-UX (HP’s Unix-like operating system) and HP OpenCall (HP’s middleware) together with NEC’s application software and IP network equipment. On the R&D level, the two companies agreed to combine their computer and telecom technologies to provide real-time high performance for telecom carriers.
In May 2002, HP and NEC announced a strategic collaboration to deliver large-scale, open mission-critical solutions for targeted industries. They noted that, together, they had already jointly delivered several complex mission-critical solutions in the financial and telecommunications industries. This collaboration expressed an intention to target a number of U.S. financial services companies and a range of global Japanese companies. They intended to explore broader market opportunities worldwide, common systems integration and solutions, to leverage each other’s enabling technologies such as NEC’s OpenDiosa middleware for high-availability applications on non-mainframe servers and HP’s Utility Data Center and Integrated Service Management. The allocated roles for HP to provide IT infrastructure services and outsourcing capabilities and NEC’s systems integration and support technologies.
Common Technology Architectural Orientation.
While each of the JV partners has developed thousands of patents, every patent is subject to challenge and invalidation.
Concentration and Vertical Integration in the International Markets for Information Technology Outsourcing.
In 1997, Computer Associates reportedly offered to acquire Computer Sciences Corporation so to support distribution of CA’s software products. CSC successfully rebuffed the offer. But the dialogue raised the question of the viability of a future IT outsourcing business where the Service Delivery group was merely the distribution channel for proprietary software of Computer Associates and its favored channel partners.
Restructuring of NEC.
NEC has been hard hit by a combination of a decline in global demand for computers (and the computer components that NEC manufactures), falling prices for IT hardware, excess capacity in broadband telecommunications (and consequential decline in optical networking), and a general economic decline in Japan during the 1990’s and early 2000’s. As a result, NEC has restructured for cost-cutting, redirection of capital investment and supply-chain management to improve manufacturing efficiency. The restructuring includes closing of aging factories, layoffs, transfer of semiconductor business (including system LSIs, integrated circuits and discrete devices and compound semiconductor devices but not DRAM’s) to a new subsidiary that NEC intends to spin off in a public offering. Since 2000, NEC has also separated its plasma display panel division and merged several similar units at group companies.
In short, NEC has decided to slim down from its “giant” size into a series of separate companies, each with its own business plan. Development of an outsourcing business suggests a new business plan. In announcing the JV, NEC’s President and CEO Koji Nishigaki admitted that NEC had no experience in the full-scope type of outsourcing business, and hoped to learn from HP’s business model.
Restructuring of HP.
HP is the fish that swallowed the second fish that swallowed the third fish. HP merged with Compaq Corporation, a computer manufacturer and outsourcing services provider, after Compaq had acquired Digital Equipment Corporation, a computer manufacturer and outsourcing services provider especially for distributed networks of computers. As part of the post-merger integration, HP has shed thousands of workers and sought economies of scale and new channels for leveraging core competencies — including outsourcing — into new geographical markets.
Coopetition: Competition and Collaboration amongst Outsourcers.
“Coopetition” refers to the anomaly of companies that compete in one sector cooperating closely in another sector.
IBM.
In this case, HP, NEC and Hitachi, who have all worked closely to compete with IBM and other computer manufacturers, have joined IBM in the promotion of “open source” computing, to be supported by a non-profit Open Source Development Lab in Portland, Oregon, to test enterprise-class Linux.
Microsoft.
Microsoft licenses eHome technology to NEC and HP.
HP and NEC.
Each of HP and NEC sell computers, personal digital assistants / Windows CE devices and other technologies that perform similar functions.
Securities Law Disclosures for Joint Ventures.
Joint ventures involve significant risk to the business and reputation of each party. Formation and operation of a joint venture could require disclosure under securities laws, since a significant venture could have a material impact on the financial performance of either party. Each of HP and NEC has annual revenue in the neighborhood of about $35 billion to $40 billion. A venture that does put at risk 1% or 2% of that revenue stream (consisting of $350 million to $700 million) probably is not “material.”
On the other hand, such information might be disclosed generally in the issuer’s “management discussion and analysis.” This disclosure is much more general in nature.
As NEC said in such discussion in its Form 20-K filed in August 2002:
WE RELY ON OUR STRATEGIC PARTNERS, AND OUR BUSINESS COULD SUFFER IF OUR STRATEGIC PARTNERS HAVE PROBLEMS OR OUR RELATIONSHIPS WITH THEM CHANGE
As part of our strategy, we have entered into a number of long-term strategic alliances with leading industry participants, both to develop new technologies and products and to manufacture existing and new products. If our strategic partners encounter financial or other business difficulties, if their strategic objectives change or if they perceive us no longer to be an attractive alliance partner, they may no longer desire or be able to participate in our alliances. Our business could be hurt if we were unable to continue one or more of our alliances.
Under the Sarbanes-Oxley Act of 2002, joint venturers such as NEC and HP will probably need to disclose more information relating to joint venture operations. While that law generally does not change the definition of materiality, it does require disclosure of information the previously was ignored under former financial accounting principles. The act does require closer attention to disclosure of “off-balance-sheet” transactions. The SEC has issued a proposed rule on such disclosures.
Outsourcing Tools for Insourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Outsourcing Tools for Insourcing.
The typical outsourcer also provides a spectrum of support and consulting services compatible with a totally insourced environment. Thus, outsourcing is only one of the core service offerings. Enterprise customers now ask the question: why outsource when I can insource using the right tools? While there may be many reasons to outsource, there are equally many reasons not to outsource. The reasons relate to ERP, SCM, CRM and DRM solutions that can be used to keep customers loyal and flexibly prepared for a future outsourcing. Emerging BPM / business process management tools and software as a “service,” can likewise create opportunities for retention of functions in house.
Does your “outsourcer” also sell tools that facilitate insourcing? In this article, we take a quick look at one particular tool offered by the king of outsourcers for its enterprise customers’ data centers.
Panoply of Insourcing Tools.
Insourcing tools help a customer manage its technology and service delivery to its internal customers without dependence on a third party for design, maintenance and support. Let’s consider a few:
- Web-Enabled Self Service and the ASP Model.
Under the “Applications Service Provider” model, the external services provider hosts its own proprietary software solution. The customer enters data into the provider’s software by remote control, either using web-enabled services or high-speed link. - Web-Enablement of Customer’s Proprietary Software.
Companies such as Citrix have developed tools to allow a customer to place its own proprietary software on a secure Intranet, thereby reducing access costs, particularly for end-users who are traveling, home-based employees, or in a large complex organization with multiple offices worldwide. - Software Licensing Model.
Software that helps customers perform their own “managed services” has developed over time. In the “early days,” data base software such as Oracle and DB2 organized data. More recently, enterprise resource planning software (“ERP”), supply-chain management (“SCM”), customer relationship (“CRM”) and device-relationship management (“DRM”) software have enabled enterprise customers to harness a uniform set of business process tools across large organizations. Such more robust software serve as tools for reducing complexity, enforcing business process rules and showing transparency of data. Such software also can plan, identify and manage for business continuity in case of disasters. As an emerging insourcing or outsourcing tool, new software tools facilitate provisioning of resources. - External Benchmarking and Performance Metering Tools.
Service level agreements (“SLA’s”) define the various performance parameters that define the essential services under any outsourcing agreement. Enterprise customers have tools that measure the same operational data that the external service providers see at the service provider’s facilities. Customers now are demanding access to benchmarking and performance metering tools.
Why Outsourcers Might Offer Insourcing Tools.
There are many reasons why outsourcing might not be a proper solution for a client. Currently, IBM, Hewlett-Packard and Sun Microsystems all offer some form of tool to enable an enterprise customer to automatically provision server workloads based on supply and demand and network traffic. The same “silicon switch” that enables a customer to manage insourced IT resources could thus be used to transform to a hybrid insourced-outsourced combination or externalize the business process virtually.
Transitional Tools for Eventual Outsourcing of Process or Infrastructure, or for Provisioning of Services “On Demand.”
In such cases, the outsourcer should consider providing tools that retain customer loyalty and, like a Trojan horse, enable the customer to become an outsourcing customer “on demand.” The customer becomes trained in the service provider’s software, and such training might inspire confidence that, by using such tools, the customer can place more trust in an outsourced solution, either temporarily or on a continuous outsourced basis. These tools face the challenge of maintaining user control and limiting access to software applications while demand surges or subsides across a network of servers and data centers.
Infrastructure Support.
In fact, among others, IBM has adopted this strategy to service customers who might need hosted infrastructure and rapidly deployable additional server capacity. Its Tivoli “Intelligent Orchestrator” software will allow customers to convert a data center into an IT utility, where provisioning of network capacity (bandwidth), server processing capacity, storage and other computing resources are allocated dynamically in response to defined parameters of supply and demand. This resembles a “utility” because the “grid” operator may now anticipate demand and plan for allocation and reallocation of resources. In emergencies, the “grid” (data center with Intelligent Orchestrator (or competitive equivalent) could redistribute computing resources globally. But the challenge of dynamic global provisioning will remain daunting.
Pricing Challenges.
Tools for insourcing present challenges for the vendor. If the price of the tool is too attractive, the tool will sell and the services will not. If the tool is too expensive, outsourced services might be preferred, but only where the customer has no alternative. And by promoting tools, the vendor might cannibalize revenue from services, and vice versa. Pricing could be in the form of per-seat, per user, global site license, or site license by some other “line of business” demarcation.
Legal Issues in Dynamic Provisioning of Computing and Telecom Resources.
When we look at dynamic, rules-based provisioning of resources across international boundaries, we must remember that data transfers across borders remain subject to local legal controls. These include:
- data protection laws.
- privacy laws.
- export controls on military data or “dual use” civilian-military processes.
- license restrictions on authorized use.
- infringement indemnifications that may be territorially restricted.
- force majeure risks.
Transitioning from Software Licensing to Outsourcing.
Generally, a contract for a software license does not change when the parties enter into an outsourcing relationship. But customers should consider what changes should be made when this occurs, and what risks and assumptions have changed by virtue of the transition. By gaining the customer’s trust through a software tool, the vendor can thereby convert the customer to an outsourcing customer quickly, almost immediately. “Just sign here.”
We believe, in such cases, there could be significant business issues that need to be reflected in an appropriate contractual document. We recommend that an outsourcing lawyer be consulted in such circumstances.
More Information.
Bierce & Kenerson, P.C. does not provide any of the tools described above. However, we may be able to identify or comment on legal and practical issues of tools that may be of interest to the IT and technology-enabled services community. Please let us know if you have any questions about our experiences with particular vendors.