Hewlett-Packard, Long a Major Competitor

Hewlett-Packard, long a major competitor in the computer hardware industry, has in recent years undertaken a massive repositioning as an IT company. Central to this move has been a focus on data storage and information management solutions. In some ways, this is a natural extension of the firm's traditional hardware role, albeit on an enterprise-wide scale. Taking another perspective, the move is the manifestation of the major shift that Hewlett-Packard undertook in the wake of the Board's removal of Carly Fiorina from the CEO post.

The seeds of that move were planted when she spearheaded the acquisition of Compaq against the wishes of the Hewlett family. While at the time the move seemed to have some logic, given that both firms were computer makers faced with an adverse operating environment (Taylor, 2001), when the Compaq deal proved more expensive and less valuable than expected, the company was set to change its course. Today, the company's shift in focus seems to have been prescient.

HP has become a multi-service vendor of IT solutions and consulting, splitting this enterprise from its consumer electronics (PC hardware) business, a move many in the industry felt was necessary in the wake of the Compaq failure (Gaitonde, 2005). The move has been built upon HP's wide range of business service solutions, including the rapidly expanding data storage and retrieval function; and printing-related businesses, long an HP strength. Since Fiorina was deposed in 2005, Hewlett Packard's revenues have increased 48% and its profits increased 138%. This success has not been without its challenges, however.

The company's balance sheet position has deteriorated over this time as its debt has increased. HP's liquidity position has weakened significantly. In the latest quarter (Q1 F2009), HP saw a year-over-year decline in profit (MSN Moneycentral, 2009). The company has done well during the past four years, but now is faced with the challenge of positioning itself for the next five years. Hewlett Packard must decide if they are to continue along their present course, focused on enterprise solutions, or if they need to reposition again.

If they choose their present course, they must then decide how to restore growth and profitability. This paper will explore the options that Hewlett Packard now faces, and will develop conclusions regarding strategy for HP over the next few years. As an indicator of future strategy, HP has recently acquired EDS, an information technology specialist, with an eye to being a more formidable challenger to IBM (Crum & Kennedy, 2008). Current Environment Hewlett Packard has a strong market position.

The company's multitude of competencies and strong businesses has been supported by an enterprise-wide culture of innovation. Hewlett's positioning is a barrier to entry for most potential competitors and therefore can be viewed as a sustainable competitive advantage. There are other firms in a similar business, however, such as Microsoft and IBM, and these are also industry giants. Many HP dominates many of the sectors in which it competes, there remains substantial competition in most of those markets.

The company's main source of strength has traditionally been its Imaging and Printing Group (Gaitonde, 2005) and today this remains a strong business, generating 43.8% of the company's profits on 24.8% of the revenues. Other strong businesses are Enterprise Systems and Storage, which generates 24.6% of HP's profits on 16.3% of its revenues; and HP Services, which generates 18.9% of the company's revenues and 23.7% of its profits (HP 2008 Annual Report).

The biggest growth segments by revenue were HP Services (a function of the EDS acquisition), HP Software, and the Personal Systems Group (Ibid) although the latter has struggled since the end of the last fiscal year (Goldman, 2009). In the external environment, the most significant impacts are felt in technological and economic shifts. HP has long been a technological innovator, but they are not the only firm to claim this distinction. Most of their major competitors are also firms driven by innovation.

Shifts in the IT industry are typically driven by innovation, which is the primary source of competitive advantage. HP's technological leadership in imaging, for example, is one of the main reasons that it is able to command a strong market position in that highly-competitive category. With respect to the economic environment, HP is subject to economic fluctuations because of its broad-based corporate customer base.

Firms curtail IT spending during economic downturns, which impacts the top line at a company such as HP, especially when the company is forced to cut prices to reduce inventory, as HP did with servers late last year (Botelho, 2008). The company has hedged this to some degree in its service contracts. However, this does not hedge against the impact of a protracted economic downturn such as the one we are currently experiencing.

Thus, HP needs to develop a strategy to not only maintain its technological leadership, but reduce costs to defend against falling revenues. However, it must keep in mind that it wants to maintain its market position and more importantly its technological capabilities to take advantage of the eventual restoration of strength in the economy. Recommendations For the most part, HP's current path is congruent with its external environment. It is recommended that the company undertake the follows strategies in the next few years.

The first is that HP should continue to absorb EDS before undertaking any other similarly large acquisitions. The second is that HP should improve its margins, which have remained essentially unchanged since the Fiorina years. The third is that HP should work to improve its balance sheet, in particular with respect to the legacy debt of the EDS acquisition. The fourth recommendation is to divest the personal computer business.

The EDS acquisition has strengthened Hewlett Packard's position in the enterprise IT services business, such that it can rival IBM and other major players. Over the past year, HP has consolidated a significant amount of EDS' operations (2008 HP Annual Report). This has generated some cost savings. However, the cost savings have not been sufficient to offset the impact of the economic downturn. Therefore HP should accelerate the pace of EDS consolidation.

If HP can bring administrative costs down to pre-merger levels, this would allow the company to maintain its current R&D levels. The EDS business was valuable for its market position and some of its R&D capabilities, but ultimately the value HP expected to derive from EDS was in cost-reduction and leveraging the EDS client base for cross-marketing opportunities. While pursuit of the former seems reasonable in the long-run, the economic situation makes that option less likely as a source of short-term success.

The margin structure overall needs to be reduced at HP. In many of the company's businesses, it is able to command high margins because of its technological superiority. Hewlett Packard should undertake differentiation as a strategy in general, allowing it to improve its margins across the board. The gross margin was 24% last year, compared with 23.8% five years ago. The industry average gross margin is 37.4%; IBM's is 44.5% and Microsoft's is 79.7%. These should be the metrics by which HP gauges its own margin performance.

If HP's products are sufficiently differentiated, the company should increase its margins; if they are not then HP should place more emphasis on technological innovation in its largest revenue segments. The third recommendation is to improve the balance sheet. With the acquisition of EDS, Hewlett Packard's debt to equity ratio has increased significantly, from 130% to 191%. The firm's liquidity position has worsened as well. The current ratio was 1.2 before the acquisition and is now just 0.97. This will have negative implications for the firm's credit rating and cost of capital.

Given the degree to which HP relies on capital investment, there are adverse consequences to increasing the cost of capital in this way. While it can be argued that its revenue streams are relatively steady because of its long-term contracts, evidence from the most recent annual and quarterly reports appears to indicate that there is significant variability in the firm's cash flows -- the steadiness of revenues between this year and last is a major downturn in revenue given the EDS acquisition.

Therefore, in order to lower the cost of capital and increase HP's operating flexibility, it needs to focus in the next couple of years on shoring up its liquidity and debt positions. These should be brought back to pre-EDS levels. It would be understandable if there were concerns with a plan to pay down debt at a time when revenues are suppressed and for an industry in which a reduction in R&D could mean a reduction in competitiveness for years to come.

Indeed, it is critical that Hewlett Packard maintain its strength in research and development. There are more ways than one to pay down debt, however. In this case, capital can be raised by divesting the personal computer business. If the dismissal of Fiorina did not signal a move out of this business, surely the EDS acquisition did, since HP spent $13.9 billion to improve its capabilities in the IT services sector. The truth is that computers have long been commoditized.

HP's strengths in innovation are no longer relevant in the personal computer business. Moreover, the degree to which the PC business supports the other HP business lines is debatable. Competitor IBM got out of hardware years ago and the Compaq merger itself was driven by the recognition that this struggling business could only be salvaged through consolidation. Hewlett Packard has done all it can do in the computer hardware business. The hardware business is still growing -- a sign of the brand strength that HP and Compaq enjoy considerable equity.

Growth last year was 16.2%. Margins, however, were slender. At just 5.6%, the operating margin for computer hardware was by far the weakest in the company. The best time to divest a business, though, is when it still has some value. The size of the business (nearly $43 billion in revenue) and its growth means that there is substantial value HP can extract. The company will then be able to better focus on its various enterprise services lines.

The result of this move will be to focus HP on business where its innovation credentials mean something; on businesses that support one another; an increase in margins; and cash to pay down the debt acquired with the EDS purchase. The net result of these tactics will be a Hewlett-Packard company that operates in a clearly-definable sphere with a distinct strategy, one of differentiation. Hewlett Packard will then be playing to its.