Commitment to PC Market Hurts HP’s Bottom Line
When Hewlett-Packard Co. bought Compaq Computer Corp. last year in a $19-billion blockbuster technology deal, the company expected to become the undisputed leader in the crucial market for personal computers.
Instead, HP is struggling to retain the top spot and is losing money to boot.
Last week, the Palo Alto computer giant reported dismal results for its fiscal third quarter, prompting investors to shave more than $7 billion off the company’s market value as its stock plunged more than 10% in one day.
The worst of the bad news: HP’s struggling PC unit had slipped back into the red after two quarters of meager profit. Chief Executive Carly Fiorina blamed the shortfall on increased price competition from HP’s nemesis, Dell Inc.
The disappointing performance has some analysts wondering whether HP, whose name is practically synonymous with computers, should get out of the low-margin consumer desktop business altogether.
“It would probably in the long run enhance profitability to get out of it,” said Joseph Beaulieu, a computer analyst with Morningstar Inc.
So far, Fiorina maintains she’s committed to selling PCs.
In announcing the quarterly results last Tuesday, Fiorina promised to turn a profit in PCs in the current quarter by raising prices.
The next day, Dell said it would cut prices on its desktop computers by up to 6%. Dell said the timing of its announcement was coincidental, but the move will make it more difficult for Fiorina to deliver on her promise.
“Dell is absolutely serious about this price war,” said Rob Enderle, a technology consultant in San Jose. “They want someone to go away.”
The precarious future of the consumer PC segment was a major issue during HP’s months-long effort to acquire Compaq, a deal that was nearly derailed by shareholders who feared Compaq’s commitment to PCs would drag down the combined company.
The most recent figures do little to allay those fears. HP’s share of the estimated $169-billion global PC market has slipped from 20% in 2000 to 16% last year, according to IDC Research. Dell took the lead in October of last year, a mere five months after HP closed its mammoth deal with Compaq.
In the U.S. market, which accounts for 35% of global sales, Dell has held the PC title since 1999, when it surpassed then-independent Compaq. In the last year, Dell’s share of the U.S. PC market has increased from 26% to 32% while HP’s has stalled around 19%, according to IDC.
HP’s consumer PC and printing operations are roughly the same size when it comes to sales -- about $5 billion each per quarter -- but the two units produce vastly different results.
After at least eight consecutive quarters of losses in its PC business, HP eked out an operating profit of $54 million in the first two quarters of its 2003 fiscal year. By comparison, the company’s printer division posted a $1.8-billion operating profit for the period.
HP’s PC operations were profitable in the first half of this fiscal year because the company streamlined the business after the Compaq acquisition, including reducing component and shipping costs. But the $54-million gain was wiped out by the unit’s $56-million operating loss in the third quarter.
The deficit is “troubling, in light of Dell’s solid operating results within the same competitive environment,” said Joel Wagonfeld, technology analyst with Banc of America Securities. That suggests “that HP still has a long way to go in narrowing the cost differential with Dell.”
So why bother?
Fiorina and other HP executives insist they must sell PCs to compete for lucrative corporate customers. PC sales to companies account for 60% of HP’s PC sales. The company doesn’t disclose profit margins for the two halves of its PC business, except to say that gross margins are in the “low double-digits” on the consumer side and are higher on the commercial side.
“We have servers with desktops attached as workstations, and that’s important for some customers,” said Duane Zitzner, executive vice president of HP’s PC group.
HP sold nearly 22 million PCs last year -- more than anyone else in the world -- though Dell was close behind with nearly 21 million, according to the Framingham, Mass.-based market research firm IDC. The lead in the worldwide PC market has changed hands between HP and Dell four times in the last five quarters.
But “HP is much more than PCs; Dell is not,” said Jeff Clarke, HP’s executive vice president for global operations. PCs accounted for about 25% of HP’s $72.3 billion in fiscal 2002 revenue; they contributed 80% of Dell’s $35.4 billion in revenue last year.
Many Wall Street analysts who follow HP believe PCs will need to be at least a moderate profit center if the company is going to achieve its overall goal of boosting its operating margins to 8% to 10%, up from 4.9% in the most recent quarter.
Dell’s margins, by comparison, are in the 8.5% range, thanks to factors such as its low overhead and a frugal budget for research and development.
If it eventually decides to exit the consumer PC business, HP won’t be the first tech giant driven from the category. IBM Corp. now focuses largely on corporate customers with its higher-margin ThinkCentre desktops and ThinkPad laptops. It sold around 4 million of them, or about 6% of the world market, in the first half of 2003. The company frequently sells PCs as part of contracts to manage computer networks and services.
“Corporate customers are not just looking for desktops and laptops, but what kind of middleware is needed -- mainframes in the head office, or servers around the country,” said Ray Gorman, a spokesman for IBM’s PC division.
A move away from the consumer desktop business isn’t likely in HP’s near future. Earlier this month, the company rolled out 158 new consumer products tied to PCs and printers.
“We are absolutely committed to the desktop market in both commercial and consumer sales,” HP’s Clarke said.
