Convergys reported 2006 results that were slightly below many analysts expectations. Revenue grew 8% driven primarily by the employee care segment's 30% growth followed by customer care's 10%. The information management segment was a drag as the top line shrank about 1%.
Despite revenue gains, profitability in employee care (8% of revenue) continues to disappoint. New contract implementations with DuPont and Boston Scientific led the impressive top-line growth. However, operating losses were more than expected because of difficulties implementing certain contracts and reserves relating to issues with Convergys' contract with the state of Florida, where there is some concern that the relationship is not in the best interest of Florida taxpayers. Employee care (the human resource outsourcing business) has proved to be a tough business for both Convergys and its competitors. Most analysts expect to see margin improvement in coming years but are less optimistic than management on this segment's long-term potential.
Strong demand for call center outsourcing led to solid growth in customer care (64% of revenue). In addition, expenses in this segment grew only 8%, leading to a nice operating margin boost to 11% from 9% a year ago. The customer care business is Convergys' core competency, and solid results are expected to continue.
On the other hand, the information management segment (28% of revenue) struggled as it deals with the migration of its Sprint and Cingular business to competitors. This segment's primary function is data processing, which is a business that thrives on scale. As these large customers exit Convergys' platform, expect to see revenue decline and margin compression to continue. The next couple of years will be especially challenging for this segment as management tries to minimize the impact of lost business with new contracts and cost-cutting.
Economies of scale and high switching costs in Convergys' outsourcing businesses have helped create a narrow economic moat for this firm. However, this moat has thinned in recent years due to consolidation in the communications industry and startup costs in employee care. In time, though, profitability should improve.
Convergys has achieved economies of scale that individual clients could not create on their own. The customer care segment (64% of revenue) provides customer service, technical support, and account management to businesses in several industries through 60,000 employees who are spread among 65 contact centers. Nearly 30,000 of these representatives reside in countries such as India and China, which allows Convergys to offer services at a reasonable price around the clock. The information management segment (28% of revenue) has similar advantages.
Long lead times and large up-front investments lead to high-switching costs for customers. To protect the interests of both parties, Convergys generally obtains multiyear contracts that penalize either party when a contract is broken. In addition, once a customer changes from in-house processing to outsourcing, it loses competency in that function, creating dependence on the service provider. Convergys' employee care service could prove especially sticky to customers because of implementation periods that last up to two years.
Source(s): Morningstar, Convergys