So, HP, ready for the PC price wars, crumbling margins?

Hewlett-Packard's move to keep its PC unit makes sense for now, but low margins, hard-drive shortages, and tablet cannibalization are just around the corner.

HP Compaq 8200 Elite
The HP Compaq 8200 Elite all-in-one PC. Hewlett-Packard says it's going all in on PCs. Hewlett-Packard

Hewlett-Packard CEO Meg Whitman crunched the numbers and determined that the company had to keep its PC division. The big question now is how far HP will go on pricing to defend its PC market share.

The reasons for keeping the PC unit were fairly clear cut (story, statement, Techmeme).

  • Without the PC division, HP would have incurred $1 billion in higher supply chain costs.
  • A spin-off would have cost $1.5 billion in separation and startup costs. For HP, $1.5 billion shouldn’t be a lot of money, but the company paid $10 billion in cash for Autonomy. It needs to build up its cash hoard again.
  • The lack of PCs would have hurt HP’s server, networking and storage business as well as the printer unit.
  • It’s unlikely that HP had any realistic buyers and credit was tight for private equity to step in.
  • There’s also a branding problem in a spin-off. "PSG benefits from HP's global scale and innovation," said Whitman. "It would be very challenging for a new PC company to build such a strong brand."

In many respects, HP’s decision revolved around the fact it couldn’t afford to spin off the PC unit. The company wasn’t ready. When IBM sold its PC unit, the company had other divisions doing well and the computer business was hived off. HP’s PC business is too integrated to extract easily.

Analysts Friday morning were supportive of HP’s move—actually they’ll take any sign of stability they can. Deutsche Bank analyst Chris Whitmore summed up the consensus view.

While not a surprise, HP made the right decision (in a timely manner) and correctly assessed a PC spin would be value destructive in terms of scale/procurement, global reach and pricing flexibility (bundling etc). This is the first step in the right direction but many uncertainties remain.

Indeed, HP has to integrate Autonomy, cook up a tablet strategy beyond me-too Windows 8 devices, sell WebOS and fix its services unit. However, a lot of uncertainty still remains for the PC unit. Just because HP said it is keeping its personal systems group doesn’t mean that it’s all clear sailing from here. Whitman on Thursday’s conference call already hinted that there was turbulence ahead.

Whitman acknowledged that the PC business is a low margin venture. But HP will be efficient on supply chain and ride the consumerization wave to appeal to both the consumer and CEO. Lenovo has the same plan. Actually so does Dell.

Add it up and Whitman is going to see PC margin pressure sooner than later. Toss in hard drive shortages from the floods in Thailand and HP’s PC unit’s financial profile isn’t going to look so hot over the next two quarters.

Here are the issues HP’s PC unit will face:

A price war to maintain market share. Whitmore noted:

While HP has stepped back from the ledge, it is unclear how much damage has already been done to HP's reputation, brand and business relationships. At a minimum, customer trust and confidence has been damaged and will take time to repair. We believe Lenovo and Dell are benefiting from customer/partner defections and related dislocation caused by the review of PSG. We believe HP's PC margins are under severe pressure as it fights to maintain share (pricing / bundling).

Barclays analyst Ben Reitzes also expects low margins to arrive quickly.

Unlike IBM, we think HP is not ready; its services and software strategies are still immature and not ready to shoulder the burden of driving the sales process at the company. Over the next year, however, we believe that HP may need to be more price-aggressive than it has been to make sure it doesn't lose share and rebuild trust with resellers, especially in Asia.

A dreadful fiscal fourth quarter Nov. 21 for PCs and probably all of HP. Analysts expect Whitman to cut HP’s outlook dramatically. First, she can easily blame Leo Apotheker and give herself wiggle room to top estimates in future quarters. In addition, the PC uncertainty also probably hit the server, networking and storage business. Whitman has to cut the outlook so she has the room to execute a PC price war.

There is no tablet strategy. Whitman noted that HP will get back into the tablet business most likely with Microsoft’s Windows 8. Executives chafed when analysts said that tablet plan is too late. It’s unclear what HP will do to differentiate a TouchPad 2.0. Whitmore added:

We expect HP to compete in the tablet space with Win 8 devices. This strategy is neither unique nor differentiated and is late (iOS and Android ecosystems / competitors have a multi-year lead). We believe HP's Win 8 devices will have difficulty competing on both a cost and user experience standpoint.

While HP is figuring out its tablet plan, the popular devices will continue to eat away at consumer PC sales. Half of HP’s PC business is consumer.

And finally there are hard drive shortages on deck. As reported before, the PC supply chain is reeling because of floods in Thailand. HP will take a big hit. Hard drive prices will go up, but HP won’t have room to pass on the increases to customers since it has to maintain market share. Whitman knows the PC business is low margin. She’s going to find out in a hurry how low margin PCs can go.

This story originally appeared at ZDNet's Between the Lines with the headline "HP keeps its PC business: Price war, crumbling profit margins next."

 

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