HP/Compaq: Facing the services music

In a tight economy there are two ways for a company to distinguish itself - by cost or by service.

In a tight economy there are two ways for a company to distinguish itself - by cost or by service.

For a combined Hewlett-Packard and Compaq that translates into either becoming the Tesco of high-tech, or creating a services business with clout.

Compaq is the current world leader in server sales and together the two companies would be the largest provider of desktops, but selling hardware is no longer a high-margin business.

"Why would they want to be number one in desktops? Selling commodity hardware is not what gets them where they want to be," said Amy Wohl, president of consultancy Wohl Associates.

Indeed, undercutting competitors in hardware may only serve to undermine the perception that customers have of their equipment, according to Michael Bauer, a partner at SCS Consulting.

To put the hardware business in perspective, Compaq made more than £350m last year in computer and enterprise systems, while HP lost an equivalent amount during 2001. Then there is the £1.3bn that HP made from its imaging and printing systems.

But in the services business, both Compaq and HP are widely perceived as playing catch-up to IBM's Global Services and Electronic Data Systems.

In its last accounts, Hewlett-Packard listed IT services as accounting for £5.3bn in revenue and £240m in operating earnings, while Compaq put its services revenue for the year at £5.4bn and its operating profit at £740m.

Meanwhile, IBM Global Services accounts for £23.9bn, around 40% of IBM's total revenue stream of £60bn. In the fourth quarter, revenue exceeded £6.3bn for global services, compared to £1.4bn for Compaq and £1.3bn for HP.

The services-only company, EDS, posted £15bn in revenue and £910m in net profit. HP services are at about 15% of its £31.6bn total revenue and Compaq at 24% of its £28bn revenue.

If HP and Compaq want to transform themselves into a global services giant, equal to the two market leaders, as their executives often state, they will have to increase their global services business by fivefold. It took IBM eight to nine years to get where it is today.

The question is whether customers and investors will give HP-Compaq that much time to grow their services arm.

"I'm not convinced it is doable. To me, if they get the deal to run then the question becomes, within some reasonable period of time - one to two years - can they execute?" Wohl said.

A survey of industry experts, from the ranks of competitors and disinterested third parties, reveals a mixed bag of reactions. None of the experts interviewed were overly optimistic about a merged HP/Compaq's ability to compete seriously with the industry heavyweights.

"Clearly, the merger would give Compaq better access to HP customers and Compaq would get better Unix skills from HP. But the Unix skills are nothing that in the course of a year or two they couldn't get for themselves," Wohl said.

According to Wohl, the major issue confronting both companies is that their service business is focused in large part on supporting their own hardware and software.

"I would expect the combined company to be substantially more important in service than HP would be alone, but not more important than Compaq is today," Wohl said.

The perception that both companies are too grounded in hardware and supporting their own equipment is a theme that an EDS spokesperson was quick to pick up on.

"We view this as a hardware-driven merger. The service is maintenance and pass-through hardware revenues," said an EDS spokesman.

Gordon Eubanks, the former 15-year veteran as chief executive officer at Symantec, and now CEO and president of Oblix, a company in the identification management business, is more optimistic.

"They're not going to become IBM Global Services overnight, but they are strengthening. You have to look at these things relative to where they are today and the options they face as individual companies. Together they are stronger," Eubanks said.

Whether a combined HP/Compaq succeeds comes down to market perception and execution, according to Dick Arns, the executive director of Chicago Research Planning Group, a US organisation of chief information officers.

"How many clients understand who HP is today? If you have a question about that it shows that the HP [marketing] message is flawed. If you feel the market understands them, then chances are you believe their merger will be successful. But if [not] it will fail before it even starts," he said.

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