HP/COMPAQ: Analysis - Facing the services music

In a down economy, most industry experts agree that there are only two ways for a company to distinguish itself: by cost or by service.

Reinterpreted to fit the combined Hewlett-Packard Co.-Compaq Computer Corp. business model subject to the critical shareholders vote Tuesday, it means either these companies become the Wal-Mart Stores Inc. of high tech, or together they create a services business with great depth.

Compaq is the current worldwide leader in server sales and together they would be the largest provider of desktops, but selling hardware is not a high-margin business.

"Why would they want to be No. 1 in desktops? Selling commodity hardware is not what gets them where they want to be," said Amy Wohl, president of Wohl Associates, a consultancy in Narberth, Pa.

Besides, undercutting competitors in hardware may only serve to undermine the perception that customers have of their equipment, according to Michael Bauer, a partner at SCS Consulting in Southfield, Mich.

To put the hardware business in perspective, Compaq made more than half a billion dollars last year in computer and enterprise systems, while HP lost an equivalent amount during its 2001 fiscal year. Then there is the US$1.9 billion that HP made from its imaging and printing systems.

But in the services business, both Compaq and HP are widely perceived as playing catch up to IBM Corp.'s Global Services and Electronic Data Systems Corp.

HP in its last Consolidated Condensed Statement of Earnings listed IT services as accounting for $7.5 billion in revenue and $342 million in operating earnings, while Compaq put its services revenue for the year at $7.7 billion and its operating profit at $1.06 billion.

Meanwhile, IBM Global Services accounts for $34 billion, or around 40 percent, of IBM's total revenue stream of $85 billion. In the fourth quarter, revenue exceeded $9 billion for global services, compared to $2 billion for Compaq and $1.9 billion for HP.

As a services-only company, EDS can claim that 100 percent of last year's $21.5 billion in revenue and $1.29 billion in net profit came from services. HP services are at about 15 percent of its $45 billion total revenue and Compaq at 24 percent of its $40 billion in revenue.

If HP and Compaq want to transform themselves into a global services behemoth, equal to the two current leaders, as their executives often state, they will have their work cut out for them, needing to increase their global services business by about five-fold. It took IBM eight to nine years to get where it is today.

With that in mind, the question becomes whether investors give HP-Compaq that much time to grow their services arm.

"I'm not convinced it is doable. To me, if they get the deal to run then the question becomes, within some reasonable period of time -- one to two years -- can they execute," Wohl said.

A survey of industry experts, from the ranks of competitors and disinterested third parties, reveals a mixed bag of reactions. None of the experts interviewed were overly optimistic about a merged HP/Compaq's ability to seriously compete with the industry heavyweights.

"Clearly, the merger would give Compaq better access to HP customers and Compaq would get better Unix skills from HP. But the Unix skills are nothing that in the course of a year or two they couldn't get for themselves," Wohl said.

According to Wohl, the major issue confronting both companies is that their service business is focused in large part on supporting their own hardware and software.

"I would expect the combined company to be substantially more important in service than HP would be alone, but not more important than Compaq is today," Wohl said.

The perception that both companies are too grounded in hardware and supporting their own equipment is a theme that an EDS spokesperson was quick to pick up on.

"We view this as a hardware-driven merger. The service is maintenance and pass-through hardware revenues," said John Clendening, a spokesman for EDS in Plano, Texas.

Gordon Eubanks, a long-time industry watcher, former 15-year veteran as CEO at Symantec Corp., and now CEO and president of Oblix Inc., a company in the ID management business, is more optimistic.

"They're not going to become IBM Global Services overnight, but they are strengthening. You have to look at these things relative to where they are today and the options they face as individual companies. Together they are stronger," Eubanks said.

Many believe that at the end of the day whether a combined HP/Compaq succeeds comes down to market perception and execution, according to the executive director of Chicago Research Planning Group, a national organization of CxOs based in Chicago.

"How many clients understand who HP is today? If you have a question about that it shows that the HP [marketing] message is flawed. If you feel they are understood by the market, then chances are you believe their merger will be successful. But if it is other than that it will fail before it even starts," said Dick Arns, executive director of Chicago Research Planning.

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