A New--But Not Necessarily Improved--HP

After Tuesday's watershed--and marathon,third-quarter earnings call, the newly merged HP-Compaq has a lot of questions surrounding its extensive product and services line. Several arms of HP's business appear to be in flux, while some are ailing so badly that some are skeptical about their survival. Most of the issues seem to be within HP's enterprise systems business, which includes storage, software, servers and PCs. This area took a dive as HP reported enterprise systems revenue of just $3.8 billion, down 8 percent from the previous quarter and a whopping 22 percent from one year ago.

Here's a breakdown of some of the New HP's major businesses such as storage, services and printer, and how they are faring in the new post-merger company:

Printing and Imaging
If there's one area HP has been strong in, it's printing and digital imaging technology; revenue was $4.7 billion, up 10 percent from a year ago. "Our printing and imaging business delivered an outstanding quarter," said Carly Fiorina, chairman and CEO of HP, during Tuesday's earnings call.

IDC reported that HP increased its printer market share in the United States in the second quarter this year, controlling nearly 50 percent of the market. In addition, HP said it passed Kodak as the top supplier of photo media in the retail space during the third quarter, with 37 percent of the market. Fiorina and Capellas said the recent quarter included the most ambitious launch of new products in the company's distinguished history, and much of the technology was in HP's strongest division.

Still, technologies such as the HP Photosmart printers and cutting-edge digital cameras, while impressive, are largely consumer products, not business solutions. Can HP translate the success of its printing division to its slumping enterprise business? Despite the high marks for the printing and imaging business, there are concerns. For one, Dell is intent on further damaging HP by launching its own printer product line, which could spell trouble. Perhaps worse is the fact that of all the integrated technologies and products between HP and Compaq, the printer and imaging business was virtually the only division unaffected by the merger, which suggests that the integration of Compaq is indeed taking a toll on HP. That doesn't bode well for HP's future.

Storage
One of the hidden gems of the Compaq deal was storage. In the complicated merger, storage seemed to be overlooked, despite the fact that the addition of Compaq's StorageWorks product line made HP the primary challenger to storage king EMC. One of Compaq's strongest areas pre-merger was storage, leading worldwide sales for disk-based storage and shipments for SANs in 2001, according to Gartner Dataquest. The former computer maker was especially strong overseas in Europe and Asia.

Pre-merger HP was no slouch in storage, either. Gartner Dataquest reported that HP was number one in Linear Tape Open-based tape technology shipments in 2001. The report also named HP the number two player in the overall tape market last year. With the combined market share, the new HP now claims that it, not EMC, is the number one storage provider worldwide.

While storage is one of the few bright spots in HP's enterprise business, the division has still taken a hit. Storage revenue for the third quarter was down 15 percent year over year, and down 10 percent from the previous quarter. Still, Capellas emphasized that HP storage hadn't fallen as greatly as EMC, the company's closest competitor. "We believe we grew or maintained share," Capellas said Tuesday.

The company still has work to do in merging the Compaq StorageWorks technology with HP's Enterprise Network Storage Architecture initiative. But despite the slide, storage is still a powerful part of HP's product line and offers enormous potential for a company struggling in the enterprise market.

Software
"The strategic choices and investments we made in this business two years ago are paying off," Fiorina said during the earnings call Wednesday.

Bluestone Software, however, was not one of those investments. Hewlett-Packard got into the middleware game somewhat late, acquiring Bluestone two years ago for $450 million. The aim was to capitalize on the growing middleware market with Bluestone's middleware platform, which became the basis for Net Action. However, HP was never able to make significant gains with Net Action against market leaders such as BEA Systems and IBM.

It's no wonder HP Software is at the bottom of the product listing on HP's Web site. Software revenue dropped more than 20 percent year over year, thus the writing was on the wall for HP's software business. The company decided to ax much of its software business and discontinue its Net Action application server product line. "We knew we were going to do radical surgery on the software business," Capellas said.

The winner of HP's decision to drop middleware is clearly BEA Systems. BEA, the market leader for Internet application server software, struck an alliance with HP earlier in the summer to integrate BEA's WebLogic application server platform with HP servers. BEA proved to the best partner for HP, since it has no competing hardware or middleware products, unlike IBM and Sun Microsystems. BEA scores big here as HP's preferred middleware platform, and HP gets new doors opened with BEA, which has captured more than one third of the application server market.

Microsoft also emerges as a winner, as HP officials say they plan to leverage the software giants growing middleware business as well. While BEA is largely strong in the high-end enterprise, Microsoft is dominant in the mid-range and SMB market with products like Exchange Server. Thus, HP gets balanced coverage in both ends of the market for middleware. In addition, both BEA and Microsoft get an edge in the Web services game against Sun and IBM. Capellas said HP will support both .Net and J2EE Web services as part of the expanded alliances with Microsoft and BEA.

Despite dropping its application server and Web services platform, Capellas said HP is committed to software. "This is a very strategic business for us," he said. Going forward, Capellas said HP will concentrate on three key areas for software: HP Openview infrastructure management software; HP Utility Data Center for data center management; and HP Opencall, a voice and data convergence software platform for the telecommunications industry.

HP's operating system line, HP-UX, may benefit from the addition of the Compaq hardware lines. The open source community will also continue to benefit from HP, as the company has emerged as a staunch Linux supporter and a major driver of the Apache Web server.

Services
IT services saw a 7 percent drop from last year, primarily from weak demand for integration and consulting services, according to HP. Capellas said the company saw good demand for storage and Microsoft-related services, but managed services surprisingly emerged as the strongest area. "We're seeing the fastest growth in managed services," Capellas said.

Therefore, HP has split services into three key areas: customer support and maintenance, integration and consulting, and managed services. While the merger has gone smoothly in the services division, according to HP officials, the company faces increasing pressure from IBM Global Services, by far the largest IT services firm in the world. Big Blue plans to add PricewaterhouseCoopers, which HP once angled to buy. Yet Fiorina said that since the IBM announcement to buy PwC, more system integrators have shown interest in partnering with HP. "If anything, IBM's planned acquisition has intensified others' interest in doing business with us," she said.

HP Services revenue may be down, but the winner here may be HP VARs. As IBM Global Services grows larger, so does the potential for channel conflict. With HP clearly limiting itself to three core practices, opportunities may open up for solution providers to work alongside HP Services and cover non-core areas for the company.

Servers and PCs
"This is our biggest integration challenge, not only from product mix but because this business includes our sales force," Capellas said during the earnings call. "At the same time, the enterprise business represents one of our best opportunities."

Capellas believes HP now has the most powerful enterprise product line-up in the industry. So why is the one area that had the most to gain from the Compaq merger fairing the worst these days?

For one, HP's sales model is going through a difficult identity crisis. Compaq was embroiled in a direct sales war with Dell before the merger, a battle that Compaq lost, costing the now-defunct computer maker its reputation in the channel.

HP also retired its popular "Hard Deck" policy recently, which helped reduce channel conflict by naming enterprise accounts for HP to take direct. The jury is still out on the new PartnerOne channel program at HP, and the company will have to figure out a way to make the system work for all segments of HP's business. In a recent interview with VARBusiness, Kevin Gilroy, HP's vice president and general manager of North American channels, said the Hard Deck, while a success in most product areas, was undone because the uniform policy simply didn't work in the PC market, where HP continued to lose money and market share.

The benefactors of HP's struggling enterprise business are none other than archrivals IBM and Sun. HP's Unix servers struggled, but HP's Superdome servers shipments were up 9 percent in the third quarter, providing much needed good news for the struggling server business. But HP clearly needs to improve sales for the Proliant server line.

While HP is now the number one PC maker in the world with the addition of Compaq, the company's PC business is perhaps the most struggling division within HP. And while Dell trails in market share, it's beating HP in nearly every other area--sales, pricing, marketing, and branding.

Capellas said HP will emphasize improving supply chain and manufacturing operations to better compete against Dell. But HP executives have finally recognized an edge against troublesome Dell, and it's as simple as HP's "Invent" marketing mantra; HP must make new and innovative computers. For all of Dell's success, the company is a manufacturer, not a technology innovator. Dell leverages Intel and Microsoft Windows to fill out its boxes, while it enters new markets by piggy-backing partners such as EMC.

HP seemingly has realized this advantage and decided it must distinguish itself from Dell and produced new and innovative PCs and servers to outshine its strongest competitor. With a rich history of innovation, HP should be able to pull it off. The question is when. "There are only two world-class competitors in the [PC business. HP and Dell," Capellas said. "You'll see us be ever more price competitive and we will launch some exciting new products that will push the limits of what you think of as the typical PC."

And of course, HP will have to develop an efficient channel program that won't be undercut by direct sales. Whether PartnerOne is the answer remains to be seen.