Internal Cisco Memo: HP PC Spinoff Will Result In Margin Loss, Weakened HP Brand

Cisco said in a hard-hitting internal memo that rival Hewlett-Packard's plans to spin off the HP PC business could result in "lower gross profits, price increases" and a weakened brand that will make it difficult for HP to compete in its remaining hardware businesses, including networking.

Cisco in the document maintains that HP's plans to spin off or sell its Personal Systems Group will result in lower margins for the HP channel, a sharp decrease in the size of HP channel deals and a drop in HP’s channel funding efforts.

"We believe that the negative supply chain implications could generate 2 - 5 percent margin loss, which HP would have to absorb in the form of lower gross profits, price increases passed on to customers or lower margins for channel partners," according to an eight-page internal document obtained by CRN.

The document, titled "HP's PC Business Divestiture - Cisco Internal Perspective," was written by Cisco's Strategic Marketing Team and sent to Cisco's global sales force on September 29 by Rob Lloyd, Cisco executive vice president, worldwide sales operations.

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In a letter to the sales force that accompanied the document, Lloyd rallies his sales troops to pounce on "the confusion in the marketplace around HP" in the wake of a "radical shift in strategy toward software and services that impacts both its short term and long term businesses."

That strategy has left HP "struggling to provide a clear direction and strategy, leaving employees, customers, financial markets, industry influencers and their channel thoroughly confused," Lloyd said in the letter.

Cisco declined to comment on the internal memo, but a spokesman acknowledged that the Cisco sales team is increasing its competitive intensity toward HP.

"Consistency and predictability are the hallmarks of any successful channel strategy," said a Cisco spokesman in an e-mail to CRN. "At Cisco we’ve been driving a value-based channel strategy since 2001 and are committed to earning our partners’ loyalty each and every day. While many of our competitors’ partner strategies remain unclear, Cisco is doubling down on the channel by investing $75 million in our new partner-led sales model.’

HP declined to comment.

NEXT: Cisco Claims HP PC Divestiture Would Harm HP Channel

The memo represents what may well be the most detailed financial and business analysis yet on the impact that a spinoff of HP's $42 billion PSG business could have on the Palo Alto, Calif.-based company’s remaining businesses.

It's also the most direct salvo against HP yet from Cisco.

Cisco sees significant competitive advantages as a result of a radical shift away from the HP strategy pursued by former HP CEO and current Oracle Co-President Mark Hurd. "Under Mark Hurd, HP's success was driven by efficiencies of scale: lower expenses through supply chain efficiencies and increased volumes via cross-selling and broad market coverage," the memo states. "Without the PC business, there is very limited supply chain or go-to-market commonality between the remaining parts of HP (printers versus servers/DC networking/software/services), which breaks this virtuous cycle and will require a new, still undefined strategic approach."

"By removing PCs, HP has effectively become a conglomerate of unlinked businesses -- a direct reversal of the integrated strategy established under Mark Hurd," Cisco said in the memo.

As for new HP CEO Meg Whitman, the document states, "as of today [HP's new CEO] has reaffirmed her support for this abrupt change in strategic direction, acknowledging that she thinks the 'strategy is right.' She stated that she is 'excited' to close the [$10.3 billion] Autonomy acquisition and intends to continue the strategic review of the PC business."

The memo also details the negative impact that a PC spinoff could have on HP's channel partners. Cisco estimates that HP's PC business generates between "$600,000 - $1 billion in channel funding including channel promotions, market development and distributor co-operative funds."

"This channel funding has created relevance with sales and technical personnel and has been leveraged by HP, as well as the channel itself, to cross-sell networking, software and other more profitable HP products," the memo states. "Without PCs leading the sale, we expect HP's average channel facetime to decrease by approximately 50 percent, average transaction size to decline by 35 percent and channel funding to decline, making it more difficult and expensive to reach and serve the channel partners through whom HP currently sells the majority of its technology to small enterprise and public sector customers."

Cisco's position echoes the opinion of some of HP's own channel partners, whom have explicitly urged Whitman to reconsider HP's PSG spinoff plan and the acquisition of Autonomy as she takes HP's reins. Whitman replaced CEO Leo Apotheker, fired by HP's board, earlier this month.

Andy Cadwell, vice president of sales for INX, a Dallas-based solution provider and Cisco Gold partner, said Cisco's aggressive sales tactics will provide critical air cover for Cisco partners, especially when it comes to competitive situations with customers evaluating both Cisco and HP networking solutions.

"HP went after Cisco hard when they were down earlier this year, and was very quick to exploit the challenges Cisco was having," Cadwell said. "We felt it. Customers were listening to it and taking advantage of some of the HP-Cisco back-and-forth to have a price discussion, so it's good to see Cisco going on the offensive."

If customers perceive a weak Cisco, Cadwell said, the conversation isn't about Cisco's business architecture, but about how much the baseline networking gear costs."Perception is reality. If they perceive Cisco as coming from a position of strength, they're more apt to be receptive to their value proposition," Cadwell said. "If they see Cisco coming from a position of weakness, they focus only on price."

NEXT: What's The Future Of HP's Networking Business

The internal Cisco memo details in excruciating detail the exact toll that a PC divestiture the HP’s former strategy to wield its mind-boggling $70 billion supply chain as a weapon to drive down margins in an attempt to weaken HP rivals like Cisco.

The HP networking team has repeatedly stated its plan to leverage the worldwide HP supply chain to go after what it has called Cisco's 80 percent margins with a networking product line it has proclaimed as having double the performance at a 30 percent to 40 percent cost savings compared to Cisco.

The memo, however, sheds light on just how big an impact Cisco expects a PC spinoff will have on the rest of HP's hardware businesses, including networking.

"Divesting PCs will negatively impact server and other hardware competitiveness and profitability due to massively reduced purchasing power that the PC unit volumes generate in memory (where HP represents 25 percent of all purchases) and processors (17 percent of x86 processors)," according to the Cisco document.

Cisco expects the PC spinoff to set the stage for what it calls an "unclear future" for HP's networking business. Specifically the memo says that former HP CEO Leo Apotheker's attempt to move HP from a "commodity hardware player to a value player has created uncertainty for the [HP] networking business." The memo says the "loss of purchasing power and the ability to price lower as part of a larger campus bundle will make it difficult for HP to continue its low-margin strategy and 'Almost Good Enough' messaging" in the networking battle with Cisco.

Cisco maintains that HP is "unlikely to transition to a value player in networking, given the significant R&D investment required," proclaiming: "This lack of differentiation, combined with HP's weakened brand, will make it difficult for HP to compete in networking."

The Cisco attack comes with HP touting networking market share gains against Cisco. In July, HP cited a report by Dell’Oro Group, a Redwood City, Calif.-based market research firm, showing HP gained 2.5 percentage points worldwide for Layer 2/Layer 3 Ethernet switching revenue market share in the first quarter of 2011, while Cisco’s share fell 5.8 points in the same period. HP also pointed to a 2.5 percent gain in routers and a 2.2-point increase in WLAN revenue market share over the same period, while Cisco’s share declined by 3.1 points in routers and 0.4 points in WLAN, according to the Dell'Oro Group numbers.

Cisco sees a "post-PC HP" under attack from all sides. "We expect 'post-PC' HP to come under competitive pressure from low-cost manufacturers (for example, Dell and various Chinese companies)," the memo states."At the high end, focused technology and architectural leaders like Cisco and EMC will continue to out-invest HP by a wide margin to deliver product innovation."

"At the same time, HP will have a hard time winning share against established players in custom and packaged applications (for example, IBM, Oracle and SAP) outside specific product and vertical niches where it has some presence today,’ added Cisco.

NEXT: Partner Applauds Cisco's Aggressive Stance

A senior executive for a top North American partner that sells both Cisco and HP products and did not want to be identified, praised Cisco’s no-holds-barred attack on HP. "I'm glad to hear Cisco is standing up and saying, ’we need to address this,’" he said. "With HP potentially distracted at the moment with the 'in-or-out on PSG' question and the 'who's the leader' question, yes, it's a good time for Cisco to maintain and grow market share."

The solution provider said that Cisco's newly aggressive competitive tone reminded him, ironically, of how Hurd motivated the HP channel to go after Cisco. "I liked Mark Hurd's attitude when he was at HP -- I liked the aggression," said the partner. "I think that's something good for Cisco to say, let's go out and grow this market."