JP Morgan Chase To IBM: You're Fired!

While some observers believe J.P. Morgan Chase & Co.'s decision last week to scrap a 10-year, $5 billion services contract with IBM was driven by president and chief operating officer Jamie Dimon's aversion to outsourcing, spokesmen say the move actually was based on a desire to make full use of IT assets and processes the company acquired through its July merger with Bank One Corp.

The financial-services company will have access to a state-of-the-art data center that Bank One opened in Wilmington, Del., last week at a cost of $150 million, says Charles Costa, J.P. Morgan Chase's executive VP for global technology infrastructure. Among other things, the building features dedicated fiber-optic lines and new server and storage systems. "This didn't exist for us" when J.P. Morgan Chase struck its outsourcing deal with IBM in 2002, Costa says, adding that the company is better served assimilating Bank One's advanced IT assets than turning them over to IBM to manage. J.P. Morgan Chase was about 18 months into the 10-year deal.

Bank One's IT capabilities also will help J.P. Morgan Chase meet tech-driven business requirements, such as the Check 21 initiative that lets banks process checks using graphic images instead of paper. "That's a big priority that we need to be well positioned for," Costa says. Last year, Bank One rolled out a system that converts consumer checks into electronic debits for next-day settlements using high-speed imaging.

Bank One recently completed a $500 million initiative to standardize and centralize its IT systems, an effort that's expected to shave $200 million from its annual operating costs by, among other things, eliminating 600 software applications and reducing 11 loan systems to six. "The merger really changed the equation, and Bank One's technology infrastructure is a key part of that," Costa says.

For one analyst, the decision makes sense. "Bank One spent a fair amount of money building a very streamlined IT infrastructure that [J.P. Morgan] Chase would be foolish not to utilize," says Jeffery Harte, with Sandler O'Neill & Partners.J.P. Morgan Chase will continue to work with IBM on smaller projects and buy its hardware and software. But that may be small consolation for executives at IBM Global Services, who must have cringed upon hearing that J.P. Morgan Chase had tapped Dimon as its president and chief operating officer. As CEO of Bank One, Dimon scrapped a $2 billion IT outsourcing contract the bank had inked with IBM and AT&T in 1998. Dimon canceled that deal, known as the Technology One alliance, in 2002, explaining that Bank One's outsourcing experience "hadn't worked out," and it needed to "control its own destiny." Dimon joined J.P. Morgan Chase in the merger with Bank One.

J.P. Morgan Chase will adopt more and more Bank One-style operational practices, analyst Harte predicts. Former Bank One CIO Austin Adams now heads IT operations, while the architect of J.P. Morgan Chase's outsourcing strategy, former chief technology officer John Schmidlin, recently retired.

The bank is meticulously planning its transition back to an in-house operation to avoid operational disruptions. For instance, it's documenting all the processes IBM performs on its behalf in areas such as help desk and application support with an eye to replicating the procedures internally. It's also holding town hall meetings with employees returning from IBM in order to communicate roles and responsibilities through the transition. "It's relatively early in the deal, and a lot of employees didn't change locations or functions," Costa says. J.P. Morgan Chase will reel in most of the 4,000 IT workers it already had dispatched to IBM.

Careful planning notwithstanding, J.P. Morgan Chase's decision to terminate the agreement won't be painless, some experts say. Outsourcing contracts typically contain provisions that require the customer to pay a hefty fee to the vendor if it exits the deal before the contract's expiration date. Costa won't comment, but some believe J.P. Morgan Chase will pay IBM tens of millions of dollars in escape fees. "That would be a conservative estimate," says attorney William Bierce, who specializes in outsourcing negotiations. A former corporate client of his paid $60 million to exit an outsourcing contract that was significantly smaller than J.P. Morgan Chase's deal with IBM, Bierce says. He also expects that employees returning from IBM will want pension credit for time served outside the company.

For its part, IBM is looking to put a positive spin on the news, noting that the contract required substantial up-front investments that would have placed a slight drag on its earnings this year. However, $5 billion in revenue isn't easy to make up. One Wall Street watcher says the loss of the contract should cost IBM about 2 cents per share in annual earnings over what would have been its remaining years. Of course, trying to keep a reluctant customer happy for the next decade could have cost the vendor a lot more.0