When one doesn't know the future or backgrounder on HP

In the aftermath of the .com bubble HP found itself looking for a viable alternative to its Unix architectures in the corporate server market. The Unix server market had enjoyed an extraordinary growth during the .com boom. Every company, including your cousin's, was planning to be the next Yahoo or Amazon, hence the (anticipated) demand for scalable and reliable infrastructures was nowhere in sight. Cisco, WorldCom, EMC, Sun, HP are just few of the names that stood to gain big from the never-ending Internet revolution. Yet, when reality was set for a comeback, these same infrastructure providers were among the hardest hit.

Indeed, Cisco wrote off about $2.25B worth of inventory in 2001, WorldCom and several in its category ceased to exist, Sun is still looking for a way out, while HP saw the light of a new day with a blind eye. In fact, Sun and HP had some things in common: great deal of reliance on Unix-based hardware revenue at the expense of software and services revenue. HP though had the advantage of a revenue stream diversified enough between corporate and end-user customers. EMC, another hardware star of the late 90's, has since set itself on the (right) track of complementing its hardware (revenue) with a string of inspired software acquisitions (e.g. Documentum, VMware.)

In the 2001 corporate server market, Intel based architectures were becoming more capable in reality and not only in the perception of the customers looking to shave costs. One could cluster enough Intel (multi-)processor based machines to serve webpages and applications, route email traffic, or even build a decent storage solution. While Sun had all inertial reasons to reject anything less than Solaris on Sparc, HP had already been a player (however minor) in the Intel based server architectures. Hence the logic of HP in acquiring Compaq: to become a credible player in the Intel based server market. The logic went on and stated that Compaq's weakness in the Intel server market, relative to Dell, was going to be addressed by demand consolidation (thus lower prices forced on suppliers), scale economies, and operational efficiency in the combined entity--estimated at, and later achieved, $2.5B.

HP failed on a couple of fronts. The most obvious is its competition with Dell. By choosing the better set of systems and processes from the two companies (HP vs. Compaq) and making it into the merged entity's standard, HP failed to acknowledge the intrinsic advantages in Dell's systems and processes. So instead of outdoing Dell, HP decided to add scale to an underperfoming set of systems and processes. In fact, the extent by which HP could outdo Dell's processes would have been a better metric associated with the acquisition. So, HP's server strategy failed due to a miscalculated objective and/or sloppy execution.

The second and more insidious development HP failed to fully consider was Linux's and the growth of the Lintel market. Around 2001, when Amazon and Google announced their adopting it, Linux was still relegated to the fringes of the corporate data center. So much has changed since that even Oracle and SAP run on Linux today. To its defense, HP could not have anticipated IBM's Linux moves, directed not only at Microsoft but at itself and Sun as well. It is through the IBM gifts that Linux has its place in today's datacenter. These gifts have been both direct, intellectual property, and indirect, corporate credibility. IBM has more than made up for the value of its gifts to Linux and forsaken revenue in its own Unix servers by selling services and/or a myriad of software applications on top of Linux. Arguably, IBM benefits now from an virtuous cycle it was instrumental in creating: Linux + services + Linux-applications + weakened competitors. If HP's Linux-delay could be half understood, Sun has no excuse for letting IBM steal the show. In conclusions, it is neither HP nor Sun that has capitalized on one of the most important trends in the server market: Linux.

One may add HP's loyalties to the company's problems. It could be viewed that staying for too long too close to Microsoft, Intel, and its own Unix, made HP less than prepared to capitalize on developments such as AMD's Opteron, and Linux.

On both accounts, HP failed for it did not know the future. In conclusion, one who doesn't know the future either stares at it and is condemned to reaction or creates it.


Anonymous said...

I agree with your basic analysis. The issue is aquiring an underperforming asset (plus a lot of really under perfroming assets (PC's etc.) and expecting it learn to compete rapidly.
The track record for large mergers is abysmal. One could speculate that even if the Compaq server business was first rate it would have failed because of the difficulty in larger corporate mergers. Wells Fargo was successful in its purchase of Croker because basically what it wanted was branch offices and it jetisoned the vast majority of Crocker management thereby avoiding the culture crash.
Read Jim collins - Good to Great. There are no quick fixes. Stick to your knitting and grow from within.

fCh said...

It was "grow from within" that Dell has done. Very few acquisitions and even those failed.

On the other hand, Cisco and even Microsoft at one time, however different their reasons to buy, were growing through acquisitions. Intellectual property (R&D) and putting potential competitors outside their markets...
In this second case though, there was clearly a dominant culture and size-differential between acquirer and its target.

Kozlowski's Tyco is a different type of acquirer, and failure one may add. It was all a game of numbers.

One can probably add more names from the list of the 30% successful M&A's, just to have a more complete picture.

Anonymous said...

Anybody would care to comment on this?


Free Advice from Wharton: Here's What Hewlett-Packard's New CEO Should Do

When it was announced on March 29 that the board of Hewlett-Packard had tapped Mark V. Hurd to be the company's new CEO and president, the most notable part of the deal was Hurd's relative obscurity. His low profile as a successful chief executive of Dayton, Ohio-based NCR, the former National Cash Register, stood in sharp contrast to the celebrity status of Carleton S. (Carly) Fiorina, who had been ousted by the board of the Silicon Valley technology firm just a few weeks earlier.

But in the weeks and months to come, Hurd, 48, will be front and center. His personality may be lower key than that of the flashy Fiorina, but Wharton faculty members say he faces tough strategic decisions that will raise his visibility at a company whose stock has plummeted in value in the last five years and whose culture was rocked by the tumult of Fiorina's tenure. He will have to move quickly to strengthen employee morale and convince Wall Street that positive change is on the way. Chief among the decisions facing Hurd: Should H-P, which acquired Compaq Computer in a controversial move by Fiorina in September 2001, be broken up?

Many industry watchers have been critical of the H-P/Compaq merger from the beginning. Although H-P enjoys international brand recognition and generates a lot of cash, the company faces a daunting problem: Large chunks of its business are being squeezed by two other behemoths. Dell, a direct-marketer, dominates the cutthroat, low-margin market for PCs, and IBM is king in the high-margin server, consulting and service businesses. IBM recently demonstrated its view that the PC is a dead end for firms seeking fat margins by selling its PC operations to Lenovo, a Chinese company.

Hurd's choices at H-P will set the stage for the company's performance for a long time. According to management professor Harbir Singh, Hurd will enjoy a quiet period while he gets his sea legs, but he will have to make key decisions before long. "I think he will get six months -- at least three, but probably six," says Singh, adding that Hurd must "closely examine the portfolio of H-P and use the window [of opportunity] that he has when people are open to significant change.... That could well mean selling the PC operation."

In interviews with the news media since his appointment, Hurd said he wants to improve the company's financial performance but has not indicated whether or not he plans to break up the company. Patricia Dunn, H-P's non-executive chairwoman, stated that H-P's board respects the work Hurd did in turning around NCR, where he had worked for 25 years and been CEO since 2003. NCR, a technology company whose tech businesses range from automated teller machines to data storage, is similar to H-P in that it has many business segments. But it is smaller than H-P, with $6 billion in annual revenue compared with H-P's $80 billion.

Picking a Team

Management professor Michael Useem, director of Wharton's Center for Leadership and Change Management, suggests that the first thing Hurd should do in his initial 100 days on the job is identify the executives within H-P whom he wants for his senior management team. Next, Hurd should waste no time deciding to what extent the company needs big changes in structure and organization. "At the time of Fiorina's departure, the board said the main challenge was not strategy but execution, yet news reports say Hurd has a pretty free hand to rethink strategy as well," Useem points out. "You can't change strategy on a dime, but in the next 100 days he should" pay attention to strategic issues.

Hurd also should give thought to H-P's culture -- a problematic area for Fiorina, who clashed with longtime H-P employees accustomed to the collegial, time-honored "H-P way." Says Useem: "Here, Hurd should take his guidance from the great Lou Gerstner [former CEO at IBM]. After two years of working to transform IBM –- in much the same way Hurd has to do now at H-P -- a barrier to the kind of performance Gerstner wanted was the inward-looking IBM culture. It had a resisting effect within IBM vis-a-vis the kinds of changes Gerstner sensed were critical to turning the company around. He worked hard on reconstituting the culture.... For Hurd, the question is going to be whether the H-P culture is where it ought to be to make it the kind of company he wants."

Fourth on Useem's list of suggestions for Hurd is that he quickly establish solid working relationships with the company's directors. "This board has become a hands-on board, so building confidence and creating trust on the part of directors in months ahead will be vital."

Management professor Saikat Chaudhuri has additional advice for Hurd: In the short term, he should address some concerns of two key groups of stakeholders: employees and investors. "He needs to convince people he is going to stabilize the situation, move things forward and prevent employees from leaving," says Chaudhuri.

H-P's stock rose 10% on the day of Hurd's appointment, a signal the market was happy that H-P had filled the CEO vacancy. But if the stock is to appreciate further, the market must see that Hurd is taking steps to juice H-P's financial performance. "Now investors will be expecting to hear what he will do. He needs to address these stakeholders very quickly," Chaudhuri says. "After that, he needs to do a careful review of the company. He has to see how he's going to better position the low-cost areas and get more traction in the higher-end businesses."

"There are huge issues for H-P," says Robert E. Mittelstaedt Jr., former head of Wharton Executive Education and now dean of the W.P. Carey School of Business at Arizona State University. "On the low end it is being beaten up by Dell, and on the high end it is being beaten by IBM, which has successfully made the shift from being a commodity business [PCs] to being a service and integration business. Even when Lew Platt was CEO at H-P [in the 1990s], H-P considered buying the PricewaterhouseCoopers consulting business, but H-P walked away because the price was too high. Later, IBM bought PwC at a much lower price. IBM has done well integrating consulting services into its other range of services. H-P had a good idea some time ago concerning services but couldn't quite execute on it."

Cartridges Are Key

Daniel A. Levinthal, professor of management and economics, says it may make sense for Hurd to retain H-P's PC business, but only if it significantly boosts sales of H-P's lucrative printing and imaging products. He notes that printer cartridges account for a huge percentage of H-P's earnings and provide much of the cash for other corporate endeavors. Levinthal says that H-P sells PCs and printers at close to cost in order to create demand for the cartridges. "At this point, if I were H-P, I'd think about the PC business only as a complement to my printer business. PCs are a digital repository of photo images...and a sponge for ink," he says.

Levinthal credits Fiorina with doing an exemplary job of integrating Compaq and H-P, but says the integration was not enough to offset the difficulties brought about by the acquisition itself, which he termed a "foolish" decision. "Joining forces with Compaq saved a few bucks, but operationally, in the long run, H-P has a basic position problem."

Another challenge Hurd faces is to make sure that H-P's coveted cartridge business remains a leader. Levinthal notes that H-P is so reliant on cartridges for profitability that it faces big risks if new printer technologies emerge or if competitors open up their technology to allow low-cost manufacturers to make cartridges for their printers. "As a long-term proposition, I'd be very concerned at H-P."

Mittelstaedt says H-P is not on the right track if it thinks it has to be a kind of one-stop-shop for consumers interested in PCs, printers and cartridges. "H-P is still trying to sustain the view that it has to be like a traditional full-service bank. Banks have long believed that if you don't offer full services, you don't get full access to customers. But the reality today is that markets are segmented and customers are so willing to split their business that there is little value added to offer everything. What's always confused H-P is if you sell printers, do you also have to sell PCs? The answer is absolutely not. So the company is going to have to look carefully at the lack of integration of its businesses. It's a journey. There's no obvious answer. But H-P is not going to be sustainable being in the high end and the low end and everything in between, and it can't avoid going more into services, like IBM."

Deleting the PC Business?

Like Singh, Mittelstaedt says there is a good chance that H-P will get out of the PC business. "I think you are going to see important moves in 90 days. I think you are going to see layoffs and consolidation inside the company and attempts to get some efficiencies. And I wouldn't be at all surprised to see it exit the PC business. If H-P were to put that on the block, there would be people interested in buying it, but it's a question of what the price would be."

H-P has a major challenge on its hands in trying to compete with IBM. "IBM is broadening the scope of its enterprise solutions business by trying to cater to small and medium companies as well as large ones," notes Chaudhuri. "That puts additional pressure on H-P to do this. H-P doesn't have infrastructure products that are the industry standard like IBM does -- servers or storage products that are setting new standards in performance. To get its innovative spirit back and get stronger competencies in-house, H-P has to invest on the enterprise side."

But this will not be easy. "The next five years will set the tone for the company," Chaudhuri adds. "H-P's basic culture is producing innovative products on the printing and imaging side. They are not the sales-consultant type of people that you see at IBM. IBM built itself around sales and services and started with mainframes. Since mainframes were complex to sell and support, IBM naturally built up a consulting division and sales division accordingly. Since H-P's history was different –- its products are relatively easy to use by customers -– it wasn't necessary for it to [develop] sales and solutions businesses in the same manner."

In the end, what Hurd does in the months ahead will go a long way toward cementing his own legacy. Says Useem: "The biggest decision of his career -- after the one he just took to become CEO -- is going to be what strategy to pursue at H-P. Does he break up the company? Spin off the printing and imaging business? Those decisions, just like Carly's decision to buy Compaq, will be a career buster or a career maker. After a honeymoon period, Wall Street will look at him in a hardheaded way and not give him any benefit of the doubt. Investors know it will take a few weeks or months for him to get up to speed. But they're going to be very unforgiving in their assessment of his decisions pretty quickly."