A Winning Bid--Then Billions in Unpaid Bills

Oct. 6, 2000, was a red-letter day for former Electronic Data Systems Corp. (EDS ) CEO Richard H. "Dick" Brown. The U.S. Navy awarded EDS the largest computer-outsourcing agreement the federal government had ever signed: an eight-year, $6.9 billion deal to merge more than 1,000 disparate Navy networks into one slick, Web-based intranet. Thrilled investors drove the stock up nearly 10%.

But 2 1/2 years later, no one's striking up the band. Only 60,000 of the roughly 400,000 computers that were supposed to be connected by now to the Navy Marine Corps Intranet (NMCI) are online. And EDS has yet to earn a cent, despite investing $1.9 billion. "We've learned some hard lessons," Brown admitted on Feb. 25, before he stepped down on Mar. 20.

The biggest: Keep a lid on sunny optimism when bidding for mega-outsourcing deals. Fighting IBM and others for the contract, Brown had EDS slice $1.7 billion off its initial $8.6 billion bid, say two former high-level executives. Brown agreed not only to a thin profit margin but also to terms that deferred payment for equipment and salaries until the Navy gave its O.K. For the first time, the government would require a tech outsourcer to meet stiff performance targets or not get paid. EDS also bet wrongly that the Navy's decades-old systems could easily be replaced with off-the-shelf gear.

It didn't take long for the project to hit rough seas. When EDS engineers began taking over the Naval Air Systems Command in Patuxent River, Md., in early 2001, they found a tangle of computer programs that wouldn't work with the Windows-based NMCI network. An analysis completed in February, 2002, pegged the number of incompatible programs at more than 100,000. Snafus mounted, and so did the finger-pointing. Navy leaders accused EDS of failing to plan appropriately. EDS executives felt the Navy's tech managers were more worried about protecting turf than finding solutions. After lawmakers got wind of the troubles, they demanded that EDS stop work while the network was put to tough performance tests.

The delays were disastrous for EDS. With no Navy cash coming in, EDS laid off 310 workers, about 10% of its NMCI staff, in late 2001. That year, NMCI drained $750 million from EDS's coffers, estimates Sanford C. Bernstein & Co. analyst Rod M. Bourgeois. An additional $850 million seeped out in 2002.

There is some good news, though. A survey released in March showed that 71% of Navy users were satisfied with the system. Rear Admiral Charles L. Munns, the Navy project director, says the digital transition is "like going from the Wild West to a planned community." And Congress gave EDS the go-ahead in February to hook up an additional 310,000 computers to the network. If EDS completes the job by yearend, as planned, NMCI could begin generating free cash flow of $500 million a year, starting in 2004, says Bourgeois. Still, EDS concedes that, too, is an optimistic goal, and the company still can't say when it will turn a profit on NMCI.

By Andrew Park in Dallas

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