HP to Merge Server, Services Units?

by Timothy Prickett Morgan

The top brass at Hewlett-Packard held their security analyst meeting in New York last week, and chairman and CEO Carly Fiorina would not confirm that the company would merge its Enterprise Systems Group and its HP Services group into a single entity called the Technology Solutions Group.

A report in the Wall Street Journal suggests that Ann Livermore, who heads up the services unit and who hails from pre-merger HP, will be the executive vice president of the new merged unit. Peter Blackmore, who was the executive vice president in charge of the Enterprise Systems Group, which controls the development and marketing of servers, storage, and systems management software, will be put in charge of the sales force for the new Technology Solutions Group.

Blackmore is the most visible and highest ranking executive that remains from the former Compaq. Both Livermore and Blackmore report directly to Fiorina, and that is apparently not going to change. HP's Personal Systems Group and Imaging and Printing Group seem to be unaffected by the reorganization. HP's Financial Services unit, which has been part of the HP Services organization, will be part of the Technology Solutions Group. Based on fiscal 2003 numbers, the Technology Services Group would have had $29.6 billion in sales, about 40 percent of HP's total $73.1 billion in sales. The Personal Systems Group had $21.2 billion in sales and the Imaging and Printing Group had $22.6 billion in sales.

The merger of the services and server/storage units, which is almost certainly going to happen in the coming quarters, would seem to have less to do with personalities and the pressures of running the two most difficult and widely scrutinized business at HP than it has to do with trying to gain synergy and market leverage by combining computing platforms and services into a single offering for customers who have grown tired of system integration headaches. HP would be wise to continue to report separate profit and loss statements for enterprise systems (which includes servers and storage) and services units even if it does merge them. She did say that HP will start breaking out software sales and their profit and loss figures in coming quarters, which suggests that HP wants to demonstrate leadership in all categories it plays in. If HP does retain P&Ls for these units, it will be able to prove that the reorganization is not about masking the lack of revenue growth and dismal profits in the systems and storage area, but rather about changing the go-to-market strategy for HP as it attacks the enterprise and the small- and mid-sized business (SMB) markets. All Fiorina said in her presentation on the matter is that HP started in June to bring its services and systems units into closer alignment, and that this process was proceeding into future quarters.

Fiorina gave an overview of where each of the HP units are, and took issue with a popular characterization of HP as being in a pincher between rivals IBM and Dell in the IT sector. "It is popular these days to describe HP as being stuck between IBM and Dell," she said with a certain amount of disdain. "It is particularly popular for our competitors, IBM and Dell, to saw we are stuck between the two. Unfortunately," she said, and presumably she actually meant fortunately, "the facts do not support the thesis." To make her point, Fiorina showed a chart that demonstrated that HP was the number one leader in a number of key IT categories (data was from the third calendar quarter of 2003 only), and the market share that HP enjoys in each area:

• Disk storage, 50.7% share
• SAN storage, 31.4%
• External RAID storage 20.1% (number-two vendor worldwide)
• Unix servers, 33.8%
• Linux servers, 28.1%
• Windows servers, 28.1%
• Management software, 12.3%
• Handhelds, 25.9% (number-two again)
• Notebooks, 16.9%
• Desktops, 16.1% (neck and neck with Dell)
• LaserJets, 52.1%
• InkJets, 45.5%

These rankings are, of course, self-serving and they are only based on top-line sales, not bottom line profits (or losses). The rankings do not reflect the substantial declines in revenues that HP and Compaq have suffered in some sectors since the merger. But HP clearly feels like it has reached a new equilibrium from which it can start growing again.

In an interesting aside that is increasingly important in a Wal-Martized world, Fiorina made the case that HP has the IT industries largest supply chain, and that this would be a key deciding factor in HP's future fortunes. "The IT industry is a game of scope and scale," she explained. HP has a $37 billion parts supply chain, and it is the number one consumer of X86 processors, X86 chipsets, memory, disk drives, Windows operating systems, laser engines, optical disk drives, LCD display panels, and lots of other IT components. HP also spends $5 billion in contract manufacturing and is the top spender here. Perhaps equally significant is the fact that HP commands 10 percent of the world's retail shelf space. "Our supply chain has become a competitive weapon, particularly when an economy turns soft. It is always important, but is also particularly important during a recovery when supplies are constrained and prices go up."

She went on to characterize Dell as "low cost, low tech" and IBM as "high cost, high tech," and the clear implication was that HP would strive to be low cost, high tech to beat the two of them. She said that while IT shops were spending less on information technology than they did several years ago, management understands IT better than it did back then and they also understand an IT supplier who has faced some of the supply chain, merger, and integration issues that HP and Compaq itself have stared down.

It is all a question of wringing profits from the consumer, SMB, and enterprise businesses that HP plans to target. It is all well and good to talk about leveraging research and development spending by spreading it out across these areas, but some people on Wall Street are saying that HP would have been throwing off more profits if it had not merged with Compaq at all. That's why Fiorina's team is focusing on growing earnings per share in this fiscal year.

That will be accomplished with organic growth, not through the acquisition of a big consultancy, as IBM has done with the PricewaterhouseCoopers acquisition. Shortly after Fiorina took the helm of HP, the company tried to buy the IT consultancy of PwC and was snubbed. HP went on to buy Compaq and IBM bought PwC's IT unit, and the rest will be history. Over the long haul, she said that HP should be able to grow earnings at a rate of 20 percent a year, driven by IT sales that she expects to grow as twice the rate of growth in gross domestic product. In the short term, she said she is happy with consensus estimates for the current quarter. "Our quarter is clearly on track, and we've had good Christmas selling."

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