Monday, June 06, 2005

After Fiorina left HP, what’s next?

For almost two decades, the printer business of Hewlett-Packard has sailed along on a river of ink-cartridge profits, dominating rivals with a market share of more than 50%. The $24 billion-a-year division accounted for 76% of HP’s $4.2 billion in earnings for fiscal 2004. It has remained blissfully detached from the problems at HP’s computer units, created by the high profile, $19 billion acquisition of Compaq in 2002. But with overall growth in printer demand slowing and margins tightening in the face of an assault from Dell and others, HP has realized there is no room for complacence. After a recent reorganization that merged Imaging and Printing Group and Personal Systems Group to form the HP Imaging and Personal System Group, chief Vyomesh Joshi, who has been executive vice president of the imaging and printing unit for past three years, is planning a knee-deep “transformation” to ensure HP’s dominance in printing and imaging. Joshi is to refocus on the biggest opportunities while lowering costs to maintain profit and margins amid falling printer prices. The plan will involve 10% or more head count reduction and streamlining the cluttered portfolio of businesses in the division.
Hewlett-Packard was reinvented by Carleton S Fiorina via her “big-is-better” strategy since she took the helm in 1999. HP has doubled its sales in the past five years and become a competitor in an unrivaled number of markets, from $100 digital cameras to billion-dollar tech-services deals. Yet in too many of the businesses, HP is losing stream. Except for the printing division, the crown jewel, the rest of HP is an underachiever. Investors are not impressed, they want a far simpler solution: break the company up. Fiorina insisted that HP needs the broadest reach possible to capitalize on her vision of technology’s future and believed that spinning off printer business would destroy shareholder value. However, when shareholders are asked, they have different opinions about the spin-off. "I would like them to spin off the printer business," says Kenneth A. Smith, senior portfolio manager at Munder Capital Management, which owns about 2.9 million HP shares. After the ouster of Fiorina in February 2005, observers say HP could be edging closer to spinning off its cash-cow printer business from the rest of the sprawling company. The shares of HP surged $1.40, or 7 percent, after Fiorina’s announcement. Although HP declined this idea, investors believe that Fiorina’s departure makes such a move more likely. But they were disappointed again when the new CEO Mark Hurd said at a press conference on March 30 that it is too early to consider spinning off HP’s printer business.
HP says that combining the groups internally will foster greater efficiency and help the company to bring products out more quickly. The synergies between the two groups are believed to help HP drive its consumer electronic effort. This is supported by some HP’s customers who like to have access to PCs, printers, servers, storage and networking devices all from one company. "Our commitment has increased. We've purchased a full server infrastructure through HP, and desktops, they should not spin off any part of the business" said Paul Cullen, Macquarie Textiles IT manager. Others think that the cash flow of printer business put HP in a much better shape than those that have to rely on the computer business for cash flow. One of the oddities of modern business is that companies often seem to feel compelled to spin off their best performing businesses on the idea that in selling it out, they can get a better return on the standalone business than when it's saddled with other businesses that are dragging it down. That's why AT&T spun off AT&T Wireless a few years back, despite how obvious it was that having a wireless component was going to be a necessity in the future.
We believe that the key question here is what is the benefit and cost of synergy. To some extent economies of scale exist between the printer and PC businesses due to the similarity in the manufacturing process. A single sales force can sell bundled products to end customer and brings economies of scope. But will these two business lines reinforce each other? Will any consumer buy a HP PC because he prefers a HP printer, or vice versa? Not necessarily in a commoditized market where cost often plays bigger role. First, in the PC business, the direct-sale, build-to-order model is crucial for HP to compete with Dell. At the same time HP has to keep thousands of traditional retailers and resellers, who help HP sell its printers and ink, happy. These two systems often operate at odds with each other and operating in both worlds leaves HP doubly exposed. HP failed to match Dell’s scale and efficiency in the direct system. As a result, HP PC slipped to No. 2 with 15.7% share, behind Dell and operating margins in 2004 were a meager 0.9%, miles behind Dell’s 8.8% margins. A break-up would help resolve this dilemma, freeing the computer division to adopt the Dell approach. Second, most of printer business’ profit comes from selling high-margin consumable – ink cartridges and installed base is the key in this business. The printer business could expand its market and partner with HP’s computing rivals, including IBM and Dell – once it was unhitched from the computer company. Analyst Steven Milunovich of Merrill Lynch & Co. estimated that the total value of HP’s businesses could increase by 25% to 45% if it were split into printing and nonprinting operations. Lastly, HP’s push for synergies has gotten in the way, say insiders. To pull off a big sales deal at HP these days often requires delicate diplomacy. Putting together a package involving servers, printers, and software, a sales rep has to hammer out an agreement with each division. If one unit is concerned about financial targets and unwilling to bend its price, the whole deal can fall through. The company lacks an effective process to resolve conflict and motivate cooperation.
With all above, is it the right time to spin off the printer now? We don’t think so. It is hard to see how a separate HP PC business would be any stronger or more profitable on its own. HP should work on getting the computer business profitable without spinning of the printing operation. This would mean that HP must get its own business settled down. There has been enough wrenching of the culture at HP/Compaq that time still needs to be taken for a new cultural equilibrium to congeal. Furthermore, the market is still unsettled and unclear so it may not be the best time to spin-off. They should maybe explore and experiment with its current configuration along the lines of a 3M “make a little, sell a little” model, rather than lurching around in search of a radically different structure, or seeking to imitate IBM or Dell too closely.

Evrim Erdem
Kathy Liao
George Maurice

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