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October 24, 2001

Service, Please

Will the new HP sell enterprise software and services better than before?

by Justin Kestelyn

If nothing else, the impending merger of Hewlett-Packard and Compaq Computer Corp. proves once again that fear and greed are the two great driving forces behind many business decisions. In this particular case, fear is the dominant force in the equation.

On September 4, the companies announced a $25 billion deal in which the companies will unite to create a $87 billion behemoth that will rival the size of IBM. We've seen nothing like it since Compaq's acquisition of Digital Equipment Corp., which interestingly was motivated by some of the same factors.

The secret has been out for some time now that HP CEO Carly Fiorina - who was brought over from Lucent a couple of years ago for her acumen in deal-making - covets more services revenue to offset HP's bleeding revenue from IT equipment purchases. Last year, the company was rumored to be on the verge of pouncing on PricewaterhouseCoopers, but negotiations stalled.

Since then, the company has been brutalized even further by the collapse of IT budgets worldwide, and services revenue remains at 15 percent, compared to IBM's gold-standard 40 percent. (As an aside, a recent report from Merrill Lynch suggests that although 2002 IT budgets will modestly exceed those of 2001, many CIOs will be handcuffed from actually spending those funds in their entirety. According to Merrill Lynch, that's a rarity.)

Compaq is in a similar situation, having eagerly raced Dell Computer Corp. "to the bottom" of the PC market and now learning to live there. (Michael Dell successfully followed Ronald Reagan's Cold War strategy, only in reverse: Instead of spending his rival into oblivion, he has forced it to cut costs to a residue. For the first time, Dell is now the #1 PC manufacturer.) At the same time, CEO Michael Capellas has been struggling to establish a Compaq presence in the data center - the long-standing goal that in part drove the 1998 Digital acquisition (the deal occurred before his watch). Indeed, in a June memo distributed to employees, Capellas described a new strategy that elevates the importance of Compaq's services business and even predicted the acquisition of a U.S. services company "with core strengths in our targeted vertical markets."

STEAM AHEAD

Compaq's inability to execute on both these fronts was surely a motivating factor to make the deal. In another Sept. 4 letter to employees, this time related to the HP announcement, Capellas described the new company's mission as becoming "the industry's leading IT solutions provider." According to Capellas, the Compaq-fortified HP will "define the technologies and solutions that transform the business and personal experiences of our customers - from fault-tolerant servers at the high end, to powerful Unix servers in the data center, to industry-standard servers delivering content and Web services at the edge of the network." He also cites HP's number-two market position in Unix servers as well as HP OpenView's integration, network management, and interoperability capabilities as significant points of synergy with Compaq's product lines.

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For its part, HP will increase its services group headcount to 65,000, but many in the group are involved in routine repair and maintenance work, not the high-gain consulting engagements that are IBM Global Services' bread and butter.

If the merger completes successfully, it will be interesting to observe the fate of some specific initiatives and software products among the two companies, including Compaq's Zero Latency Enterprise solution and HP's E-Speak Web services framework and Bluestone application server. Neither company was particularly adept at marketing and selling software on its own, so whether the new company can successfully ramp up complex application implementations involving such elements remains to be seen. All we know for sure at the moment is that this new combination clearly is motivated by each companies' weaknesses, not strengths.