From F.T.
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HP must turn away from print and towards PCs
PC maker is targeting more direct sales model, says Scott Morrison
Published: December 13 2001 08:40 | Last Updated: December 13 2001 08:42
With many investors unconvinced by Hewlett-Packard's controversial $23.4bn bid for Compaq Computer, one recurring concern is that the deal would increase HP's exposure to the troubled personal computer business.
To many observers, the PC industry's best years are in the past. The high growth era came to a halt in 2001, which marked the first annual decline in PC sales. The sector is now characterised by slow growth, aggressive pricing and low costs - and the HP-Compaq deal is designed as a consolidation play.
"The shock of the deal was something that people took a while to get over," says one person close to HP. "It has taken people in Silicon Valley some time to get used to the fact that parts of high tech are a consolidating industry."
HP and Compaq say they intend to transform their loss-making PC businesses once they are combined. But they have yet to provide a clear indication of how they would restructure their ailing PC operations. Instead, they have tried to focus on how the combined company would be more competitive in a wide range of markets, such as enterprise servers, data storage and services.
However, that is not what many sceptical investors and industry analysts most want to hear. Walter Hewlett, son of one of HP's co-founders and a member of the company's board, says one of the main reasons he opposes the deal is that he believes it would dilute HP's highly profitable printing business by increasing its exposure to the increasingly commoditised PC market.
This market is increasingly dominated by Dell Computer, which this year took over the top spot worldwide with a business model that enables it to make desktops more cheaply by building and selling over the telephone or internet.
Some analysts have suggested that a merged HP-Compaq could spin off its PC business, which would appear to address Mr Hewlett's concerns. But such a standalone PC maker would have difficulty attracting the capital it would need to transform into a leaner, more competitive company.
While HP has not ruled out such an option, the company clearly intends to press on with its initial plan. Spinning off PCs is "not on the table right now - the company is going forward with the deal as it is", says one person close to HP.
The combination of HP's consumer PC operation with Compaq's strong commercial desktop business would, in theory, enable the enlarged company to achieve critical mass and generate annual savings of $250m for the merged operations. It also expects to eliminate overlap and move toward a "more direct sales model" to reduce expenses.
But HP and Compaq are in a bind. Additional details of their plans might help soothe investors' nerves, but regulatory constraints prevent them from outlining their product roadmap.
In addition, HP has not said how it would operate its distribution and sales channel - in part because it might alienate the distributors on which it depends to sell not only desktop computers, but servers and printing equipment as well.
This is a key issue because of the significant cost advantage Dell has due to its direct sales model. Distributors and retailers are concerned that HP-Compaq could use its critical mass to undercut the middleman to offer more competitive prices or boost profit margins. Resellers and retailers generally add 1 per cent to 10 per cent to final sales prices, according to one industry insider.
Despite those concerns, a person familiar with the proposed transaction says HP intends to move "aggressively" to a more direct sales model for PCs if it clinches the Compaq deal.
"This is clearly an opportunity to change the distribution model of the PC business," he says, adding that HP will move "quite aggressively and substantially to a direct model that would bring [it] close to Dell".
Compaq, which headed by Michael Capellas bought a PC distribution and custom-configuration business about two years ago, already achieves about 65 per cent of its North American commercial desktop sales through quasi-channels. Compaq's strategy includes direct online sales, but it also encourages resellers to refer customers to the PC maker, which then sell directly to the buyer. The reseller, of course, would still get a cut for sending the consumer to Compaq. A third "direct" sales method is for resellers to sell equipment, which Compaq would then ship direct to the customer. The goal is that an aggressive push into direct sales would enable the combined company to bolster PC operating margins to about 3-5 per cent. Additional reporting by Richard Waters in New York |
