Cap Gemini's $11 billion (€12.4bn) takeover of US-based Ernst & Young's consulting business in May 2000 was arguably the right acquisition, at the wrong time. The goal was certainly strategic: to turn the largely European IT services group into a truly global player. However, the merger also created a host of problems that have left the company searching for a new set of priorities.

Above all, it inflated Cap Gemini's already strong orientation towards high-end consultancy work – an area hard hit by slashed IT budgets. Since then, Cap Gemini Ernst & Young (CGE&Y) has failed to match its competitors' more aggressive push into relatively buoyant areas such as outsourcing and applications management. At the same time, it has moved into areas that are yet to fulfil their potential, such as collaborative commerce.

As 2001 drew to a close those factors showed in the company's financials. While margins at Accenture, CGE&Y's nearest competitor, remain around 9%, CGE&Y could only muster half of that. And while most large services companies were reporting growth of 10% or more, CGE&Y revenues were shrinking by about 2%.

The response has been measured. In December, CGE&Y's chairman Serge Kampf installed a new CEO, Paul Hermelin, former COO and "the main initiator of the union between Cap Gemini and Ernst & Young Consulting". His predecessor, Geoff Unwin, has already done much of the necessary cost-cutting, reducing headcount over 2001 by 5,400 jobs, or 9% of CGE&Y's workforce. Now, Hermelin plans to revive the company's fortunes through two main initiatives: a sharpened focus on outsourcing and a push into the mid-market through the formation of a new subsidiary, Sogeti.

Sogeti will offer "local professional services", as distinct from services related to multi-national projects. It will rent out manpower on a ‘time and materials' basis, as well as catering for small IT projects in the €100,000 to €500,000 range. That differs markedly from the multi-million euro deals Cap Gemini generally chases. Analysts have applauded the formation of Sogeti as a means of generating business in a suppressed market.

Sogeti will operate as a wholly owned subsidiary, initially opening offices in the US, France, the Netherlands, Germany, Switzerland and Belgium. It is thinking of rolling out services in several other European countries by the second half of the year, says Luke François Salvado, Sogeti's chief operating officer. Sogeti is also looking to make acquisitions in the US, but has no plans to open in the UK.

According to Salvado, this is because the UK market is well catered for by staffing agencies and freelancers, and the UK's employment laws allow the level of flexibility required for smaller projects.

But moving into that segment of the services market is not without risk. In each country, the area is already populated with scores of indigenous players and projects are usually less strategic and deliver lower margins. Sogeti executives, however, claim that its operating costs will be lower than those of its parent company due to reduced administrative layers, allowing it to achieve margins similar to those of CGE&Y.

But the push downmarket is not the only aspect of the revival strategy. CGE&Y wants to embrace outsourcing in a much more aggressive fashion. As IT budgets have come under pressure, more and more organisations have decided to pass parts, or all, of their IT operations – and even key business processes – to third parties. And CGE&Y has had to watch as rivals have grabbed the lion's share of that demand. The goal is ambitious: CGE&Y achieved 16% of its revenues through outsourcing in 2000, and Hermelin says this figure will rise to 30% over the next few years.

In doing so it wants to join the ‘big four' of outsourcing, putting it head-to-head with Accenture, IBM, Electronic Data Systems and Computer Services Corp. CGE&Y has not specified in any detail how it will achieve that goal, but analysts expect it to focus on applications management and ‘business transformation outsourcing'. Hugo Mills, an analyst at Société Générale believes that CGE&Y will focus on areas "where they can use their consulting skills", rather than more capital intensive areas such as business process outsourcing (BPO), which require hefty upfront investment in both hardware and employees.

Jason Brueschke, a senior analyst at investment bank Robertson Stephens, agrees, and believes that CGE&Y has "a very good opportunity to succeed in the applications management arena" where the demand is for handling organisations' packaged applications such as Siebel and SAP R/3. Today, CGE&Y's outsourcing deals are relatively large – around the €500 million mark – but the company is not winning the larger, longer term deals of €1 billion and above, contracts that differentiate the market leaders in this space, says Brueschke.