HP Case Study Report

Why HP should sell off its hardware division

Dennis Cattel, Ashank Gupta, Chin Hon Ben Leung, Gene Tabach, Pravar Vijayvargya

HP Case Study Report

Contents
Case Description ........................................................................................................................................... 2 Our Objective ............................................................................................................................................ 2 1 Introduction of Hewlett Packard (HP) ........................................................................................................ 3 History ....................................................................................................................................................... 3 Mission ...................................................................................................................................................... 7 2 Situation Comparison with IBM ................................................................................................................. 9 The Situation ............................................................................................................................................. 9 The Deal .................................................................................................................................................... 9 The Aftermath ........................................................................................................................................... 9 Similarities between IBM and HP: .......................................................................................................... 10 3 HP Situation Analysis (SWOT) .................................................................................................................. 11 4 The Five Forces Model ............................................................................................................................. 12 The Five Forces in Software Industry ...................................................................................................... 12 The Five Forces in Hardware Industry .................................................................................................... 13 5 Conclusion on HPs Analysis ..................................................................................................................... 14 6 SpinCo Competitive Analysis .................................................................................................................... 15 7 Reference20

HP Case Study Report

Case Description
Hewlett Packard got into the PC business with its purchase of Compaq in September of 2001, and has grown to be the largest supplier of the machines in the world, selling $38B worth of PCs and related equipment each year. In 2010, the company paid $1.2B to acquire mobile phone maker Palm and its nascent operating system webOS. In March, 2011, rumors from Asia surfaced that HP was planning to sell the PC business to Samsung. HP runs the worlds largest PC business and it is core to HPs strategy for the connected world, the company said at the time. In August, 2011, HP announced that it would sell or spin off the Personal Systems Group.

Our Objective
Assume that the company is going to be spun out and operated as a standalone business. We have been asked to lead the new company, cleverly named SpinCo Personal Computing. Our product line includes laptops, desktops, monitors, printers, phones, and webOS.

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1. Introduction of Hewlett Packard (HP)
In 1935, HP was founded by Bill Hewlett and Dave Packard, two electrical engineers from Stanford University with an initial capital investment of US $538. Their first product was precision audio oscillator, the Model HP200A. One of the HPs earliest customers was Walt Disney Productions. It had expertise in electronic test equipment. HP gave a new dimension to measurement range and accuracy. Most of the HP instruments were sensitive, accurate and precise than other comparable equipment. It shows that HP started as a technology company. They never compromised on the quality but rather made quality their core competency. Lets discuss the chronology of HP.

History
The 1960s In this decade HP was focusing on collaborating with different companies to bring up new technologies. In early 1960s HP collaborated with Sony and the Yokogawa Electric companies in Japan to develop several high-quality products. The critique rated them as the most advance product available in the market. Though commercially it couldnt become a big hit because of high cost involved in building HPlooking products in Japan. This collaboration was very successful in developing new products. In mid 1960s, HP spun off a small company, Dynac,in order to specialize in digital equipment. In 1966 HP entered the computer market with the HP 2100 / HP 1000 series of minicomputers. The 1970s In early 1970s HP revolutionize server business. The HP 3000 was an advanced stack-based design for a business computing server. This product played an important role in increasing HPs sale. It didnt take much time for HP to surpass IBM as the worlds largest technology vendor. Another success for HP came in 1968 with HP-9100A. According to Wired magazine, HP is given credit for the world's first marketed, mass-produced personal computer. HP avoided to call it a computer in order to remain far from competing with IBM. They called it calculator and priced it at $5000.

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Figure 1 The new Hewlett-Packard 9100A personal computer

This was a golden era for HP. They earned global respect for a variety of products. Given below is the list of some advanced product launched under HPs banner: first handheld scientific electronic calculator in 1972 (the HP-35), the first handheld programmable in 1974 (the HP-65) the first alphanumeric, programmable, expandable in 1979 (the HP-41C) and the first symbolic and graphing calculator, the HP-28C.

HP computers were similar in capabilities to the much later IBM Personal Computer. Unfortunately they couldnt compete with IBM on the same ground because of high price. The 1980s In 1980s, HP forayed into Printer business and expanded their line of product. In 1984, HP introduced both inkjet and laser printers for the desktop. Along with its scanner product line, these have later been developed into successful multifunction products, the most significant being single-unit printer/scanner/copier/fax machines. The product became a big success but the HP was dependent on Canon and Xerox for technical issues. The print mechanisms in HP's tremendously popular LaserJet line of laser printers depend almost entirely on Canon's components, which in turn use technology developed by Xerox.

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The 1990s In 1990s, HP again focused on their computer portfolio. They expanded their computer product line, which initially had been targeted at university, research, and business users, to reach consumers. They also acquired few firms in order to gain technological and workforce edge over competitors. Deal of Apollo and Convex Computer is one of the examples. Later in the decade, HP opened hpshopping.com as an independent subsidiary to sell online directly to consumers. In 2005, the store became so huge that they had to rename it as "HP Home & Home Office Store." They also got involved in sports to create their brand equity. From 1995 to 1998, Hewlett-Packard were sponsors of the English football team Tottenham Hotspur. In 1999, all of the businesses not related to computers, storage, and imaging were spun off from HP to form Agilent. Agilent's spin-off was the largest initial public offering in the history of Silicon Valley. The spin-off created an $8 billion company with about 30,000 employees, manufacturing scientific instruments, semiconductors, optical networking devices, and electronic test equipment for telecom and wireless R&D and production. The 2000s In 2001, HP made a big leap into acquisitions. They finalized a deal with Compaq to merge both the firms. There were lot of conflicts at the time of proposal but in 2002, the deal was made official. This deal made HP a major player in desktops, laptops, and servers for many different markets. After the merger with Compaq, the new ticker symbol became "HPQ", a combination of the two previous symbols. In 2004 HP released the DV 1000 Series, including the HP Pavilion dv 1658 and 1040 two years later in May 2004. In the same year HP spend millions of dollars for their campaign, The Computer is Personal Again. The campaign was designed to bring back the fact that the PC is a personal product. The campaign utilized viral marketing, sophisticated visuals, and its own web site. HP hired some famous personalities to make this project successful. Some well-known personalities were Pharrell, Petra Nemcova, Mark Burnett, Mark Cuban, Alicia Keys, Jay-Z, Gwen Stefani, and Shaun White.

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In the same decade, they changed their logo which lasted for more than 50 years.

Figure 2 Hewlett-Packard logo used until 2008

Figure 3 The current two-dimensional HP logo used on corporate documents, letterheads, etc.

In 2008, HP and Electronic Data Systems announced that they had signed a definitive agreement under which HP would purchase EDS. In September 2009, EDS was known as HP Enterprise Services. EDS was re-branded as "EDS an HP company. In November, 2009, 3Com and Hewlett-Packard announced that Hewlett-Packard would be acquiring 3Com for $2.7 billion in cash. The acquisition was one of the biggest in size among a series of takeovers and acquisitions by technology giants to push their way to become one-stop shops. Since the beginning of the financial crisis in 2007, tech giants have constantly felt the pressure to expand beyond their current market niches. The 2010s In April, 2010, Palm, Inc. and Hewlett-Packard announced that HP would be acquiring Palm for $1.2 billion in cash and debt. The addition of Palm brings HP a library of valuable patents as well the mobile operating platform known as webOS. The purchase of Palm, Inc.'s webOS began a big gamble to build HP's own ecosystem. On July 1, 2011, HP launched its first tablet named HP TouchPad, bringing webOS to tablet devices.

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Mission
Hewlett-Packard's Mission Statement: Customer loyalty To provide products, services and solutions of the highest quality and deliver more value to our customers that earns their respect and loyalty. Underlying beliefs supporting this objective: Our continued success is dependent on increasing the loyalty of our customers. Listening attentively to customers to truly understands their needs, then delivering solutions that translate into customer success is essential to earn customer loyalty. Competitive total cost of ownership, quality, inventiveness, and the way we do business drives customer loyalty.

Profit To achieve sufficient profit to finance our company growth, create value for our shareholders and provide the resources we need to achieve our other corporate objectives. Underlying beliefs supporting this objective: Profit is the responsibility of all. Balance of long-term and short-term objectives is key to profitability. Profit allows us to reinvest in new and emerging business opportunities. Profit is highly correlated to generating cash, which brings more flexibility to the business at a lower cost. Profit enables the achievement of our corporate objectives.

Market leadership To grow by continually providing useful and significant products, services and solutions to markets we already serve-and to expand into new areas that build on our technologies, competencies and customer interests. Underlying beliefs supporting this objective: There are more places we can contribute than we will be capable of contributing: We must focus. To be average in the marketplace is not good enough, we play to win. We must be No. 1 or No. 2 in our chosen fields.

Growth

To view change in the market as an opportunity to grow; to use our profits and our ability to develop and produce innovative products, services and solutions that satisfy emerging customer needs. Underlying beliefs supporting this objective: 7

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Growth comes from taking smart risks, based on the state of the industry-that requires both a conviction in studying the trends, but also in inducing change in our industry. Our size (and diversity of businesses) gives us an ability to weather economic cycles and turn them to our favor.

Employee commitment To help HP employees share in the company's success that they make possible; to provide people with employment opportunities based on performance; to create with them a safe, exciting and inclusive work environment that values their diversity and recognizes individual contributions; and to help them gain a sense of satisfaction and accomplishment from their work. Underlying beliefs supporting this objective: HP's performance starts with motivated employees; their loyalty is key. We trust our employees to do the right thing and to make a difference. Everyone has something to contribute: It's not about title, level or tenure. An exciting, stimulating work environment is critical to invention. A diverse workforce gives us a competitive advantage. Employees are responsible for lifelong learning.

Leadership capability To develop leaders at every level who are accountable for achieving business results and exemplifying our values. Underlying beliefs supporting this objective: Leaders inspire, foster collaboration and turn vision and strategies into action-with focused, clear goals. Effective leaders coach, relay good news and bad, and give feedback that works. Leaders demonstrate self-awareness and a willingness to accept feedback and continuously develop. Leaders speak with one voice and act to eliminate busy work. It is important to measure people on the results they achieve against goals they helped to create.

Global citizenship Good citizenship is good business. We live up to our responsibility to society by being an economic, intellectual and social asset to each country and community in which we do business. Underlying beliefs supporting this objective: The highest standards of honesty and integrity are critical to developing customer and stakeholder loyalty. The betterment of our society is not a job to be left to a few; it is the responsibility to be shared by all. This objective is essential to delivering on the brand promise. 8

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2. Situation Comparison with IBM
In analyzing HPs strategical decision to its Personal Systems Group, we found that it shares lots of similarities with IBMs situation when it faced difficulty to generate profit with its PC division. So we provide below a thorough analysis on IBMs case as a reference to HPs case analysis.

The Situation
When IBM decided to spin out its PC division in April 2004, its motivations were clear: the division recorded a net loss of $258 million in 2003, $171 million in 2002 and $397m in 2001, and had required a total parent company equity infusion totaling nearly $1 Billion as of June 2004. IBM's summed up the PC unit's performance nicely in the filing. "The Business has a history of recurring losses, negative working capital and an accumulated deficit. The ability to settle obligations as they come due is dependent on IBM funding the operations on an ongoing basis."

The Deal
In 2004, IBM sold off its PC division to Lenovo. As consideration for the transaction IBM received at least US$650 million in cash and up to US$600 million in Lenovo Group common stock, subject to a lock-up period expiring periodically over three years. IBM became Lenovo's second-largest shareholder, with an 18.9 percent interest in Lenovo. Additionally, Lenovo assumed approximately US$500 million of net balance sheet liabilities from IBM. Lenovo funded the cash portion of the consideration through internal cash and debt. The transaction was completed in the second quarter 2005 and required the approval of Lenovo's shareholders and review by relevant regulatory organizations.

The Aftermath
IBM has undergone profound changes over the last 10 years. For example, in 2000, IBM made almost as much money selling hardware ($2.7 billion in pre-tax income) as it did selling software ($2.8 billion). By 2009, the profit mix had shifted dramatically, with software and services each bringing in $8.1 billion in pre-tax income (and accounting for 84 percent of overall profits). Meanwhile, hardware profits plummeted by almost 50 percent in 2009, to $1.4 billion, and accounted for just 7 percent of overall company profits. Top-line revenue (excepting those divested businesses mentioned above) rose from about $75 billion in 2000 to $104 billion in 2008. IBM's bottom-line profits increased at an even faster pace, growing from about $10 billion in 2000 to about $18 billion in 2009.

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This growth allows IBM to tout some pretty impressive figures to shareholders. Earnings increased at a double-digit pace during the last decade, rising from about $4 per share in 2000 to more than $10 in 2010. The company returned almost $100 billion to shareholders through dividends and share repurchasing programs, while $65 billion was spent on more than 100 acquisitions, and $56 billion went into R&D.

Figure 4 IBM's improved profit margin since the IBM-Lenovo transaction

Similarities between IBM and HP:

1. HP is cutting its losses early on WebOS because it couldnt compete with Apple. IBM had to acknowledge its OS/2 wasnt going to compete with Windows. 2. HP plans to shed its PC unit because of margins. IBM withdrew from the PC market in steps. First, IBM pulled away from the retail market and then sold its PC unit to Lenovo in 2005 3. HP is betting on software and services. HP CEO, Apotheker, is focused on making HPs services more strategic to customers and buying Autonomy for $10 billion. IBM CEO in 2005, Gerstner, focused on services, moved into high-end consulting and current IBM CEO Sam Palmisano doubled down on software. 4. Both companies have research and development arms that can be leveraged. Hence it is evident that if HP goes the IBM way by selling off its Personal Computing Division and focusing on developing software and services, it can increase its operating margins in the same way as IBM has been successful.

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3. HP Situation Analysis (SWOT)
Strengths Market share Brand recognition Global company Reputation for quality

Weaknesses No innovation Lack of technical expertise Poor leadership / direction No integration of acquisitions Empire-building (Palm, Compaq) Maintained status quo Opportunities Threats Low profit margins Innovative competition Commoditization of personal computers Substitute products (iPad, tablets) Possible software/hardware integration Using acquisitions to make a comprehensive product Undiscovered product applications Creating a new market segment

While HP has many strengths in the hardware industry, such as dominant market share and superior quality, the industry is threatened by low profit margins and substitute products. The emergence of smartphones and tablets is causing the threat of substitution to grow. If there is the possibility of losing market share to substitutes in an industry where the profit margin is already low, it would be prudent to decrease investments in that industry, or get out of the industry entirely.

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4. The Five Forces Model and Value Chain
We also used the Five Forces Model by Michael E. Porter to analyze the competitiveness of the software and hardware industry, thus providing a big picture for the perspective of HPs long-term development.

Figure 5 The Five Forces Model for industry analysis

The Five Forces in Software Industry

Barriers to entry- The barriers to entry of software development are very low. The cost of developing a product is low, and overhead is negligible. Production facilities and large amounts of startup cash arent required. Threat of Substitutes- There is a high threat of substitutes in the software industry. Due to the low barriers of industry, almost any company with innovative employees can produce quality software. There are many similar solutions to any problem or need a user may have, so for any particular product, a software company is competing with multiple similar companies. Bargaining power of consumers- There is a dependent bargaining power of consumers. If your consumer is a low-end user, like a small business or a personal computer user, then they do not have too much bargaining power: they have to purchase the software you are selling them. However, if your business caters to large corporations, they have more say in the product you are giving them. Thus, the bargaining power is variable, depending on your consumer base. Bargaining power of suppliers- There are basically no suppliers in this industry, since there are no supplies that are necessary for software production. As long as a company has computers that code can be written and compiled on, and possibly servers to run online components, suppliers are not necessary.

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Competitive rivalry- Due to the high threat of substitutes, and the low bargaining powers and barriers to entry, the software industry is fiercely competitive, leading to very high competitive rivalry

The Five Forces in Hardware Industry

Barriers to entry- The barriers to entry in the computer hardware industry are very high. Facilities are required to assemble desktops, laptops, and other hardware. In addition, bulk discount rates with suppliers are necessary to stay competitive in the industry, and a new business will not move enough inventory to qualify for such bulk rates. Threat of substitutes Due to the high barrier of entry, the threat of substitutes is mitigated.. There are few competitors in the computer hardware industry, and their offerings are different enough that it would be difficult for a consumer to substitute one for another. However, substitutes to traditional hardware like laptops and desktops are growing in the form of smartphones and tabletsthis causes the threat of substitutes to be high. Bargaining power of consumers- The bargaining power of consumers is low. Most consumers of computer hardware do not get customized equipment and have to buy the stock items the manufacturer is selling Bargaining power of suppliers- The bargaining power of suppliers is high. There is a duopoly on processors, hard drives, and video cards. Due to this, suppliers are able to dictate prices, which in turn dictate the prices of the finished product. Competitive rivalry- There is a low competitive rivalry in the computer hardware industry, due to the high barriers to entry, high bargaining power of suppliers, and relatively low competition. However, a recently rising threat of substitutes may be cause for concern.

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5. Conclusion on HPs Analysis
Although HP has a rich history of dominance in the hardware industry, it is an obvious trend that its profit margin is shrinking and the hardware market is in its declining stage. While on the other hand, the global demand and development of the software industry is booming, and HPs software division is also taking shape in the recent years. It is known that the average net profit margin of the software industry is 23.4%, which is more than twice that of the computer hardware industry. In our detailed analysis on the industries using the Five Forces Model, the structure of software industry clearly indicates that it has a higher profitability. Furthermore, in the IBMs case with its PC division struggling to make a profit, the decision to sell it to Lenovo had been proved well made as IBM now generates a 19.7% profit margin as of the end of 2010, as compared to just around 10% before the sell-off in 2004. To sum up our analysis, we support the notion that HP should spin off the Personal Systems Group. The hardware industry may be high in revenue, but it is low in gross margin due to the nature of the business. If sales drop drastically, as they may, due to the high threat of substitutes, hardware will become a money sink for HP. Considering that Hewlett-Packard CEO Leo Apotheker is more focused on the software and services business, we further propose that HP look to sell its hardware division and utilize the capital to invest in the more profitable software industry in the long run. This will serve as an effective long-term strategy to promote sustainable profitability.

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6. SpinCo Competitive Analysis
As we consider taking the job in leading SpinCo, several important factors would come into play and a full SWOT analysis should be done looking at these product lines in their current setup within HP. (Please note this SWOT analysis has been done in the previous section, however we will highlight key points in this section.) The fact that HP would consider spinning off a portion of their product line that accounts for about one-third of its revenue shows that there must be some internal weaknesses and external threats present. First, the internal weaknesses must be addressed. HP has had a lack of innovation, technical expertise, and leadership. In the Saturn case study last week, the ultimate failure of Saturn was deemed by our group to be primarily a management problem. In this weeks case, there are certainly many parallels and similar points that can be made. HPs leadership has lacked direction and foresight starting with the CEO. Carly Fiorina arrived at HP in 1999. Previously she had a successful career at Lucent and AT&T, mostly in sales and marketing. She was an outsider to the company and also, unlike the company's founders, she was a marketer, not an engineer. She oversaw the acquisition of Compaq, despite the objections of the son of company cofounder William Hewlett and many other stockholders. The hope was to merge these two large companies together to let economies of scale create profits. However, she underestimated the power suppliers would have in HPs profit margins. Intel and Microsoft controlled the components which made it more difficult to achieve a scale advantage. Fiorina also cut R&D and new product development in favor of seeking market share with largely undifferentiated products. This was a very short-sighted approach that led to some moderately successful quarters after the merger as HP focused on commoditization and volume. However, the lack of investment in new markets and lack of innovation have ultimately hurt HP in the long run. In 2005 Mark Hurd became CEO and quickly started aggressive cost-cutting. This continued to hurt innovation as R&D expenditures went from 9% of revenues of new products to under 2% and patent applications fell by 2/3. (Figure 6) Again, these trends continued in 2010 when Leo Apotheker was named CEO. Apothekers comfort was in software, having spent 20 years at SAP. The announcement to either sell or spin-off the PC business and focus on higher profit-margin areas such as software would seem to indicate that he is investing in what he knows from his past.

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Figure 6 Number of patents applications filed per year for HP

Chart Source: AllThingsD.com Is Innovation Dead at HP?, http://allthingsd.com/20110822/isinnovation-at-hp-dead/ Cutting R&D and patent applications highlight the larger problem of innovation. Throughout its early history, HP was always known as an innovative company. In recent years that simply has not been the case. HP might have come up with the slogan HP Invent, but instead it should have considered the slogan HP Acquire. (Figure 7) Under the CEOs of the past decade, HP has not been proactive in understanding important market trends, connecting to the evolving marketplace, fulfilling unmet consumer needs, and migrating customers to new solutions. Instead it has continued to acquire companies, often for a premium price, with little long-term planning and a poor job of execution. While HPs leaders have spent their time figuring out how to compete in old markets with old solutions, Steve Jobs has led Apple to unprecedented success in todays highly competitive environment. When Apple was struggling in the late 1990s, Steve Jobs didnt just invent new computers, he repositioned Apple products such as the iMac toward internet use and mobility. He also helped invent a new industry with its iTunes services and iPod, which paved the way for many of Apples other products. In short, he helped launched organic products that were differentiated from competitors in the PC industry. Apples next step could come with Cloud computing, with Apples iCloud scheduled to be released this fall.

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Figure 7 HP Invent or HP Acquire?

Ultimately, we think there are opportunities available for SpinCo. SpinCo can build on the strengths of HPs strong, global brand that is recognized for quality. HP spread its reach across a large number of areas through the acquisition spree of the past decade. A separate SpinCo would allow for a more focused approach. Assuming a new management team could be brought into place, we would target a mix of individuals with previous corporate experience in efficiency and execution in the hardware business (to help the short-term strategy as discussed below) as well as people known for thinking outside the box (to help long-term growth). These solutions will not occur overnight. That is why the PC and printer business is so important in the short-term. Although the profit margin on these products is fairly low, the huge volume combined with a high market share will allow for a revenue stream that should be relatively stable for at least the next few years. HP is by far the market leader both in the U.S. and worldwide in printers with 44% market share worldwide and 55% within the U.S. (Figure 8) In 2010 it was estimated that HPs printers and ink cartridges business constitutes 25% of the price estimate for HPs stock while the companys notebook and desktop PC business accounts for only 14%. (Figure 9) Although printers themselves are low margin products, HPs high margins on printer ink result in overall margins that are higher than that of the PC business. It is estimated that HPs printers and cartridges EBITDA margin has risen consistently from about 17% in 2005 to 22% in 2009. As Vyomesh Joshi, the MP imaging and printing groups (IPG) executive vice president stated, at a conference just a few weeks ago, "We have doubled profits in the last ten years. This is a $26 billion business with operating profits of over $4 billion annually.

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Figure 8 HP's leading position in Hardcopy Peripherals Market as of 3rd Q 2010

Figure 9 HP's business portfolio mix

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Figure 10 HP 's printer & cartridge EBITDA margin

While relying on PCs and printers for short-term revenue, we would invest heavily in innovation. Acquisitions have become an important part of many large companies growth and innovation strategy. Certain strategic acquisitions could still be considered, but ideally we would try to improve upon the lack of organic growth that HP has experienced recently. One way to help grow organically would be to go back to the HP Way which had been largely abandoned by recent CEOs. Open offices, open collars, and open lines of communications between management and employees will foster a culture of innovation and creativity. Additionally this will help improve employee morale that had taken a significant hit with the cost-cutting of Mark Hurd. One direction for this innovation would be delivery of Cloud-led and Web connected innovation for consumers and businesses.

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7. References
http://www.itjungle.com/tfh/tfh032210-printer03.html http://findarticles.com/p/articles/mi_m0EIN/is_2004_Dec_8/ai_n8550653/pg_2/ http://www.zdnet.com/blog/btl/six-reasons-why-hps-ibm-moment-will-prove-elusive/55483 http://www.forbes.com/sites/adamhartung/2011/08/25/why-leo-apotheker-is-no-steve-jobstoo-bad-for-hp/ http://seekingalpha.com/article/195935-hewlett-packard-printers-more-valuable-than-pcs http://news.idg.no/cw/art.cfm?id=276CF570-1A64-6A71-CEFBC2DE48B32580 http://www.businessinsider.com/hp-employees-react-to-new-ceo-2010-10

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