'Fixing' HP With Strong Operations Strategy

Hewlett-Packard's interim leadership says HP had the right technology strategy but the wrong person to execute it, which is why CEO Carly Fiorina's tenure came to an abrupt end last week. Yet Fiorina's successor is sure to face hard choices about whether the Silicon Valley icon's plan to compete across such a broad range of technologies and services makes sense.

Although some critics believe Fiorina erred colossally in acquiring Compaq in 2002, most say that's not what led to her ouster. Rather, the consensus is that Fiorina couldn't effectively manage the combined companies. "She didn't deliver," says Ashok Kumar, an analyst at Raymond James.

Some customers agree. Jesus Capó, CIO at retailer El Dorado Furniture, which operates nine stores in Florida, says HP slipped. Capó was a satisfied HP server customer, but he's switching to IBM as the company consolidates systems. The decision had little to do with technology, he says.

"I was an HP customer, but I rarely heard from them; they took me for granted," Capó says. By contrast, he says, IBM sales staffers "were constantly calling on me, and I got the sense they really wanted to partner with me. We are a $150 million company and IBM treated us like we were a $1 billion company." Capó will spend more than $100,000 this year on an IBM Unix server and related network and storage systems.

HP's board believes the problems can be fixed and that a breakup of the company isn't necessary. Robert Wayman, HP's CFO, who was named interim CEO, and Patricia Dunn, an HP director since 1998 who was named nonexecutive chairman, insisted last week that a major restructuring isn't in the cards and the company will stick to the broad-based technology strategy it's been pursuing. "What needs to be done is achieving the opportunities present in a remarkable collection of businesses and assets that make up the HP portfolio," Dunn said during a conference call.

To do that, the company's next CEO must be strong on operations management. Under Fiorina, HP's profit margins were slipping, even though the company wasn't necessarily low-balling competitors to win business. A technology executive at a major New York financial-services company that's upgrading its Windows-based PCs and servers says HP's bid was significantly higher than quotes he received from IBM and Dell. "They're not even in the game," says the executive, who asked not to be identified.

To her credit, Fiorina oversaw growth in key areas. Worldwide sales of IT services increased 8.3% to $14.2 billion last year, according to research firm Gartner. And executives at HP's largest services customer, Procter & Gamble Co., give HP high marks for performance. "We're extremely satisfied," says Linda Clement-Holmes, P&G's director of infrastructure services, who manages the company's 10-year, $3 billion services deal with HP.

Clement-Holmes is confident P&G won't see any service interruptions caused by the leadership changes at HP. "I'm not expecting any impact," she says. Although Fiorina personally helped structure the deal with P&G, Clement-Holmes says that HP executive VP Ann Livermore was more involved in hammering out the details. "She's intimately familiar with our agreement. There's still a lot of consistency there," she says.

And while the Compaq merger didn't sit well with many HP shareholders, some customers believe they benefited from the move. Tim Kelly, director of distributed technology for Total System Services Inc., a provider of credit-card processing services, says it's the Compaq technology that keeps him as an HP customer. "Most of the resources [we use] came from Compaq and are now still within HP," Kelly says.

The question is where HP goes from here. Despite assurances from interim management that the company won't be split up, some analysts aren't convinced.

Richard Ptak of IT analysis firm Ptak, Noel & Associates says divestitures are likely. "They have to be thinking seriously about breaking things apart," Ptak says. The problem, he says, is that HP as presently constructed is equal to less than the sum of its parts.

HP has weaknesses to shore up in its product strategy. The company lags IBM in key areas such as server virtualization. IBM's Power5 processor-based systems let users run multiple operating systems within a single chip using a technique called partitioning. At present, HP's Itanium servers support partitioning only above the chip level, making them less flexible and cost efficient. HP plans to add subchip partitioning in the summer, but IBM has a big head start.

HP's storage products have been "losing ground to the competition in terms of features and functions," says Gartner analyst Carl Claunch. Interim CEO Wayman acknowledged as much by saying that the company's storage product road map has "fallen behind."

Part of the problem could be that Fiorina reduced spending on research and development at the post-merger HP. In the year before the merger, Compaq and HP spent a combined $4.06 billion on R&D. Last year, the merged operation spent $3.5 billion. By contrast, IBM increased R&D spending nearly 12% in 2004 to $5.7 billion.

And while HP ranks fourth in IT services, about 60% of its services-related revenue is low-margin support and maintenance work, says Moors & Cabot analyst Cindy Shaw. HP should move more aggressively into the market for high-end IT services and consulting, Shaw says.

Still, many observers believe that HP doesn't need a whole new game plan, just more-effective management. "It's got the right mix of businesses and strategies. The problem is not consistently delivering on its potential. They need an entirely different type of person to lead going forward, someone who can successfully juggle 200 balls at the same time," Gartner's Claunch says.

In the meantime, some of HP's enterprise customers see little reason to shop for other vendors. "I think HP has such a great recipe now that I don't see why they'd want to make major changes," says Gene Golden, VP of IT for TicketsNow.com. The company uses a variety of HP equipment, including rack-mounted server and blade-server platforms, desktop and laptop computers, and PDAs. Fiorina's departure "is so high up and far removed that I don't see it as having any impact on me at all," Golden says. "I can't imagine that anyone new they brought in would make changes that would change my opinion."

"I would say the types of changes I anticipate should have no impact for us," agrees Total System Services' Kelly. "I think we'll be dealing with the same people." Recently, HP provided the company with three weeks of free lab time in HP's Houston office to test applications on hundreds of different servers. "That kind of thing just cemented our relationship," Kelly says. If HP is to remain a stalwart in the IT market, its next CEO will need to find more customers like Kelly while fixing the company.

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