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HP revels in Fiorina's vision, Hurd's discipline

Company investors and employees have two leaders to thank for HP's resurgence this year, as the Compaq bet finally starts to pay off.

Big profits can do wonders for an executive's reputation.

Last year, after Hewlett-Packard CEO Carly Fiorina was unceremoniously dumped by the company's board of directors, many analysts and employees considered the move a statement about HP's controversial acquisition of Compaq in 2002. At the time, HP was still struggling to integrate its vast array of businesses, and several organizational upheavals had failed to pay off the way that Fiorina had envisioned. Wall Street was even calling for a breakup of the company as the only way to salvage the situation.

"It's important to remember how resurgent IBM was and how gangbusters Dell was going."
--Jonathan Eunice, Illuminata analyst

But HP's board held fast to the line that it was confident in the strategy that Fiorina had chosen with Compaq. The decision to remove Fiorina was prompted by the poor execution of that strategy, not the notion that adding Compaq's hefty PC and server market share to HP's high-end servers and printers could make the company a global hardware powerhouse, board members said in several statements.

More than a year later, after the aggressive cost-cutting tactics of new CEO Mark Hurd, HP is a Wall Street darling once again, without exiting any businesses or dramatically changing its strategy. HP's remaining employees and shareholders have reason to cheer, but Silicon Valley has to ask itself a painful question: Even if she wasn't the best person for the job, was Fiorina right?

The stated goals of HP's Compaq acquisition were to attain 8 percent to 10 percent operating margins, hold industry-leading market share in several categories, and achieve the cost savings that come along with size and scale that neither company could hope to achieve separately. So far in 2006, HP has come pretty close to those goals.

Last quarter, one of its most successful since the merger, HP's operating margin was 6.9 percent. The company is a market leader in printers and low-end servers, but trails Dell in PCs and IBM in services. And with $4.5 billion in net profits through the first nine months of its fiscal year, HP is on track to record more profit in 2006 than it did in the last two years combined.

An HP representative declined to commment for this article.

So what accounts for HP's current success? Clearly, Hurd's decision to lay off 15,000 employees has cut costs. HP's revenue grew only 5 percent in its fiscal third quarter compared to last year, but its profit jumped from only $100 million in last year's third-quarter to $1.4 billion this year.

Without Compaq's PCs and low-end servers, some analysts say it's hard to imagine where HP would be today. The company's printer division remains the engine for most of its profits, accounting for $884 million of the company's $1.4 billion in profits during the most recent quarter. However, high-end server growth has stalled as customers switch to cheaper, low-end servers based on Intel and Advanced Micro Devices's x86 chips. That trend has been going on for a long time, with even longtime, high-end server maker Sun taking the plunge into the low-cost server market.

HP also has more negotiating heft than it did before the merger. Back in 2001, HP and the former Compaq were at the mercy of their major suppliers, Microsoft and Intel, said Jonathan Eunice, an analyst with Illuminata. Microsoft and Intel knew they could play the two companies off of one another when it came to introducing new technology or hammering out contracts, he said.

The combined organization now has the size to negotiate agreements with alternative suppliers, like Advanced Micro Devices, without seriously affecting HP's relationships with its primary suppliers, Eunice said. It was hard to get to that point, but "sometimes you need to do ugly things," he said. "They're using their economic power to good effect."

One of the most cited objections to the acquisition was that HP would be subject to the "squeeze," unable to compete with IBM's breadth at the high end and Dell's nimble cost structure at the low end. "It's important to remember how resurgent IBM was and how gangbusters Dell was going," Eunice said.

IBM remains a formidable competitor, for the most lucrative corporate accounts with a software and services portfolio that overshadows everyone in technology, and a comfortable position on the high-end servers market with its Power-based systems. After slashing HP's headcount in the middle of 2005, Hurd has turned his attention to this market, adding companies like Peregrine Systems and Mercury Interactive to its software division.

In the PC and server market, HP has had more success. Its decision to bet heavily on AMD's Opteron chip in 2004 has allowed it to maintain its leading market share position and differentiate itself from Dell, which only this year caved into the pressure to use AMD's chips. HP's low-end server revenue grew 6 percent during the quarter, while Dell's only increased 1 percent.

"She started having to do layoffs, and the amount of money that each business unit manager could control was so centralized, no one felt they had knobs or dials or any axes of control."
--Illuminata analyst Jonathan Eunice

The company's PC division became consistently profitable in 2004, and a shift in PC buying patterns to retail outlets has allowed HP to enjoy greater success in recent quarters. It still trails Dell in PC market share, but Dell has been forced to cut profit expectations in part because it has captured too much market share at the unprofitable low end of the market, company executives have said.

Suddenly, Wall Street likes the stock again. HP's stock has outperformed the Dow Jones index, the Nasdaq, the S&P 500 and the stocks of its three major competitors (Dell, IBM, and Sun) in the years since the merger. Even though Compaq's businesses are helping HP to compete, the rise in the stock has dovetailed with the arrival of Hurd.

There's finally a sense within HP, according to analysts and employees, that the postmerger chaos has settled, in part because Hurd has clarified roles and given managers more autonomy over their business. After Hurd arrived, he discovered that "we had a front-end sales group that shared decisions with the product generation organizations. In a few cases, there were nine layers of management between the CEO and a customer. And some business divisions had less than 30 percent of their budgets directly under their control because of the way costs were allocated," he noted in his letter to shareholders accompanying HP's 2005 annual report.

"[Fiorina] sought to be the center of HP, to centralize decision making. But she started having to do layoffs, and the amount of money that each business unit manager could control was so centralized, no one felt they had knobs or dials or any axes of control," Eunice said.

New executives have brought fresh blood into HP's ranks, and new board members have done the same thing for the executive committee. The company appears to be more unified than it was under Fiorina, when former Compaq and HP staffers were still finding their way in the newly melded organization.

Fiorina was an easy target for many frustrated HP employees, partners and customers, said Roger Kay, an analyst with Endpoint Technologies Associates. Her flashy style and marketing jargon turned off many of the old guard "HP way" engineers, who were more accustomed to low-key executives.

"Her ability to execute was limited, but she had good ideas and good visions," Kay said. Had Fiorina been willing to accept a strong operationally inclined second-in-command--perhaps someone like Hurd--the company might not have floundered the way it did in 2003 and 2004, with multiple reorganizations and earnings misses.

However, thanks in no small part to Hurd, it appears that Fiorina's controversial merger plan is slowly getting its due.

"People vilified her for the purchase of Compaq, but it's turned out to be a good thing. She liquefied the company and got it out of its stodginess, and Mark was able to form that liquid," Kay said.