Compaq's ace in the hole?

It was a familiar enough story. But investors desperate to grasp at anything remotely resembling good news these days focused on the one undeniable bright spot in an otherwise drab report: Revenues from Compaq's services division had climbed 7 percent from a year earlier, and now account for 23 percent of the company's total business.

All this is part of a longer-term transformation; moving the Houston-based computer maker far beyond its box-making origins, Capellas ultimately wants services to exceed 30 percent of Compaq's revenue. That tall order falls to Peter Blackmore, a British import in charge of a division numbering some 38,000 people as executive vice president of sales and services.

Blackmore, who is a highly regarded executive and considered future CEO material--either at Compaq or somewhere else--will earn his keep if he meets those expectations: Compaq still plays a distant second fiddle to IBM, which has emerged as the undisputed heavyweight in the services business. What's more, the company's absorption of the old services division incorporated during its huge 1998 acquisition of Digital Equipment has not gone smoothly.

CNET's News.com spoke with Blackmore following the release of the company's latest earnings report to get an update on how he intends to boost Compaq's services business, even in the teeth of an industrywide slowdown.

Q: Peter, your boss didn't have much good news to report in the second quarter--with the exception of Global Services. What's particularly different about that business in the current environment when nearly everything else seems to be in a rut? Why are services going in the opposite direction?
A: There are a few factors. Customers are still spending money, but they're very much looking for efficiency improvements or ways to drive key revenue-generating apps. Also, there's a need to use their resources effectively; more and more people are treating hardware as a utility or want to outsource it as they're looking at ways of better managing their infrastructure. Underneath what's a tough market environment, we're seeing a fundamental shift in how the IT market is positioned with customers.

Box makers have found 2001 to be a challenge because of this brutal falloff in demand. Is there any reason to believe that demand for services will not also be impacted? The logic being that if fewer computers get sold to business, there's no reason to contract third-party support?
No. Even in a tough economy, things that save money make sense to all. Services are not immune to the economy, but it does better than the hardware business.

Global Services now accounts for 23 percent of the company's revenue. Mike Capellas says he wants it over 30 percent. Are you close to the day when services becomes the single largest component of sales at Compaq?
Well, as we build up to a situation where the mix is one-third access, one-third enterprise, one-third services, you get there; it will obviously take a bit of time to get there, but not that long a time. That's a good business model for us. Now whether services gets larger--in some countries, it already is. In Japan, we got 34 percent of our Japanese revenue from services. It's 30 percent in the United Kingdom, the same in Switzerland. From a shareholder perspective, the gross profit out of Compaq Japan is 4 or 5 points higher.

That would be a change for a company which began way back when as a clone maker.
That was some time ago, but change is good.

Once you reach that point, it's a totally different Compaq. At that stage, does it make sense to continue as a box maker--especially since there's little or no money in that segment while it's Fat City in the services world?
There are clearly low margins on PCs, primarily in the consumer world. In the commercial world, it's not bad. In access devices, the margins are significantly higher than on PCs. What you're seeing is everybody focusing on what I see as a transition between PC-centric access to much richer access with all these wireless devices...The reality is that much technology is built on industry-standard building blocks. And customers are very savvy and they recognize that the real differentiator is the value-add of solution services.

Have you arranged your division differently from a year ago?
It's not massively different from last year, but we re-skilled a lot of people. We both downsized and recruited. A year ago, we would have said we weren't as effective in consulting and integration outsourcing as we might have been. But in May of last year, we integrated services into our worldwide sales group and that gave us a lot of leverage in accounts because, historically, they were going in independently. This made sense to customers because they had just one face going in.

One of the big reasons for spending several billion dollars to buy Digital in 1998 was its services business. With the benefit of hindsight, what should Compaq have done differently to make that integration work better?
Well, I think the strategic logic was 100 percent correct. It wasn't just services; we were repositioning Compaq as a strong enterprise player. What you had was the complexity of a large integration, and the speed around that, the clarity of aligning organizations. With 20-20 hindsight, we could have done better. There clearly was a period when we weren't executing fast enough. It comes down to execution; strategy is great but you have to execute. Since that time, we have moved forward.

Compaq earlier this year had a tentative deal to buy Proxicom, an Internet services company. But the deal collapsed when a higher bid came along. Are you still looking to buy services firms?
If the fit is right and the price is right, the answer is "of course."

Something along the lines of a blockbuster or another smaller-sized pick-up?
We are targeted very much on small to medium-sized ones, so the fit is easily done. The logic being that it doesn't take a massive amount of energy and you can bring it in effectively.

When they're out in the field, what's the pitch that your people make to customers who are about to choose between you, HP and IBM?
This is the value of having well-defined practices. Then you can train your people to represent Compaq as very strong in various verticals; you target your skills and represent yourself accordingly. We also represent our global capabilities. There are not many companies that can cover 200 countries.

Is IBM the tougher nut to crack?
They're a good competitor, clearly. But customers normally want two strategic partners. There's plenty of business for us.

On average, what kind of margins are you seeing in the services business?
We made 14 percent before tax. IBM's results were the same.

Knowing the way things go in the computer industry, is it inevitable that services will eventually suffer the same kind of margin erosion that have hit PCs, workstations and servers over the years?
With hardware, it's hard to differentiate; you could argue that you buy a PC from X or a PC from Y. It's very different in the services business because your product is your people. Typically, there's a people shortage even though we're going through an economic downturn. Therefore, you can't commoditize a scarcity or commoditze a people skill. The customer will say, "Gosh, that's what I want. Somebody who's proven."

Peter, as it turns out you're considered to be one of the up-and-comers at Compaq. Would you eventually like to be considered for a CEO position somewhere in the industry?
If that happens, fine. If not, fine. It's much more important that the people who work with you enjoy working with you and respect you.