BT Global Services grapples with cost demons

BT’s third-quarter results contained few surprises according to Ovum; the bad news was communicated in an earlier profit warning. Whilst the group reported positive revenue growth across the business, the focus is on the poor performance in BT Global Services, which took one-off charges of £336 million as a result of the financial and contract reviews.

BT Group earnings (EBITDA), down by 9% to £1,336 million before write-offs, suffered after one-off charges at BT Global Services, which has become the primary cause for concern, said David Molony and Richard Mahony, principal analysts at Ovum.

The pair commented: “We have suggested in our previous commentaries that the deterioration of the performance of BT Global Services is down to slower than expected delivery of cost savings. Today’s presentation made it clear that BT Global Services is still grappling with cost demons in its network operating review.
In fact, operating costs at BT Global Services were 10% higher in the third quarter of the current year.

“Management said that while some of this cost was in people (where a divisional reduction of 2,500 jobs has been made already), most was in increased access lines and network costs, such as daily operational buying costs rather than structural or financial items.

“This may seem surprising given price conditions for bandwidth in the global market, but it makes sense that with a fast growing order book and contracts to fulfil, the global services division should be spending to build the networks its customers want.”

The surprise is that it took so long for the business and group managers to figure out that the cost equation of building and funding five- to seven-year network contracts would require more upfront spending, said Ovum’s analysts.

Scott Morrison, Gartner analyst, added: “Overall, BT’s results show that tighter financial controls are having a positive impact on the majority of the business. Although, as Global Services continues to become a more significant part of the total business, what happens there will impact the business as a whole.

“As pre-announced on 22 January, BT Global Services is paying the price for poor decisions made in the past. The desire of the new management to reach a clean slate by the end of the current financial year has led to some re-engineering of current contracts, and while some costs have been taken out of Global Services – notably a reduction in total staff numbers – the underlying cost base has continued to rise.

“We would expect to see further cost cutting here in the future, not just in people but in systems consolidation and rationalisation,” continued Morrison. “This will not just impact the market unit – the back office will also need to reduce costs. In addition to being more picky about projects it goes after, we would expect to see a rationalisation of types of products and services Global Services brings to the market, and the way in which it supports customers internationally, focusing more on the service layer where it can control margins, and less on the underlying ‘plumbing’ of the network, where it is beholden to third party suppliers,” concluded Morrison.

CEO Ian Livingston said he was putting an end to surprises and insists that: “Global Services is an operational problem with operational solutions. Full stop.” But the operations review, which BTGS chief executive Hanif Lalani said three months ago would take 90 days to reach step-change, is ongoing.

The contracts review is expected to conclude in the fourth quarter. Of 17 major customer contracts selected for review, 15 have been concluded with mostly no changes in agreements, according to the CEO.

The two outstanding contracts are bigger and more problematic, said Mahony and Molony. Whether the savings or additional cash flow that could be realised are worth the trouble that may be caused for customer relationships is another matter. Clearly these contracts have outstanding issues which are under review and probably re-negotiable and we will watch with interest how deep the write-offs are against the remaining contracts.

“However, BT has a good track record in managing major accounts and in our opinion has done contract reviews consistently well,” they continued. “While BT Global Services’ performance has been disappointing, the financial rigour being applied now is clearly the best policy going forward. Our observation about BT Global Services is that enterprises generally – and the customers we have engaged with – have by and large remained positive about BT Global Services. It seems that for the moment there is goodwill towards BT Global Services, which is serving the business well. As a result, we do not sense that enterprise sentiment is turning against the business.

“We would also report that our impression of BT Global Services’ market presence is that it has not diminished – its pipeline is plump and it continues to bid for and win contracts at a similar rate against its peers. We have not seen BT Global Services execute on the re-focus on the large enterprise but it is perhaps a little early to see the fruits of the strategy to pursue the fatter margin business here.”

They summed up: “Today’s presentation frankly was short on evidence that BT is making significant cost savings at Global Services, although the management was clear in November that it would take the rest of the current financial year to clean up accounts and get the business back on track.”