Applying ‘HP Invent’ to Its PC Business

In the garage of his Cupertino, Calif., home, Tom Anderson controls a tidy miniature world where all the trains run on time.

Anderson’s meticulously crafted O-scale model train layout offers a soothing complement to his frenetic day job as the Hewlett-Packard Co. executive charged with selling desktop computers against market leader Dell Inc. -- a task akin to racing a barreling locomotive.

“You’re flying at 600 miles an hour 200 feet above the ground,” said Anderson, a red-haired Illinois native whose affable demeanor belies his drive to put No. 2 HP back on top in personal computers. “Things can come up and bite you.”

That’s just what Dell has done over the last decade. It chewed away at the $190-billion global PC market until it clinched its position as the industry leader, finishing 2004 with a 17.9% global share compared with HP’s 15.8%. And smaller players such as Gateway Inc. and Apple Computer Inc. are nibbling at HP.

The beating HP has taken in PCs was one of the reasons behind Chief Executive Carly Fiorina’s ouster last week. Board members and investors are looking closely at how HP can recoup some of the ground it has lost to Dell, especially in consumer PCs sold to home users.

“It’s not an impossible situation,” said Chuck Jones, a hardware analyst with Stein Roe Investment Counsel in San Francisco, “but it’s a difficult situation from the combination that more people are gravitating toward laptops, and the low margins.”

Margins in the PC industry are as thin as a silicon wafer. Dell, which boasts the highest margins in the industry, earns an average 5% to 6% on consumer PCs and around 10% on PCs for the corporate market. HP, which does not separately report consumer and corporate results, ekes out only about a 1% margin.

Anderson, 58, obsesses daily over how to reverse all that and switch HP to another track. Some analysts and company insiders have called on Palo Alto-based HP to spin off its profitable printer business. Fiorina fought to keep the company together, and the board last week said it had no plans to change course.

Anderson agrees with that decision, but appreciates more than most the difficulty in convincing buyers that PCs are anything but commodities.

His latest strategy: Pitch HP PCs as the center of a digital home. So-called Media Center PCs record and store television broadcasts. Entertainment PCs, or EPCs, are designed for the living room and look like traditional stereo components. EPCs also store TV shows and can zap digital photos, music and video or TV around the house.

Taking a design page from Apple, HP’s Media Center PCs stand out as stylish and space-age, with black panels, brushed aluminum accents and buttons with blue lights. Its Entertainment PCs are black and sleek. Those special PCs are catching on, but still represent just a tiny fraction of HP’s overall product line -- which ranges from bargain-basement machines for less than $400 to $3,000 devices packed with features.

More important than any single product, analysts say, is that HP must apply its marketing slogan -- “HP Invent” -- to its manufacturing and distribution methods, which are inherently more costly and cumbersome than Dell’s.

“The business can be a very profitable one if it’s managed right,” Needham & Co. analyst Charles Wolf said.

Added Stein Roe’s Jones: “HP’s got a tough row to hoe.”

Tim Bajarin of Creative Strategies, a technology research and consulting firm, said the entertainment-based PC approach might work if HP backed it with a range of other products catering to Hollywood -- what he called “the entire digital ecosystem.” In addition to PCs in the home, that ecosystem includes all the technology and services needed to make, deliver and use digital entertainment.

This approach pushes HP into competition with some redoubtable consumer-electronics brands, such as Sony Corp. and Samsung Electronics Co., Bajarin said.

“That’s why there’s this conventional wisdom that says you might be better off by being really great at one thing,” he said. But the end-to-end approach may be right for HP, Bajarin said, adding, “they’re about the only one who has the ability to do it.”

As it is, HP is losing market share across the board, mostly to Round Rock, Texas-based Dell. In addition, after Gateway and EMachines Inc. merged last year, the combined company rolled out deal after deal to sell PCs through retail partners such as Best Buy Co. and Office Depot Inc. -- prime selling grounds for HP. And even Apple, with only 2% of the U.S. PC market, generated considerable buzz and hefty sales of its iPod digital music players, which in turn helped boost sales of its desktop machines.

When Fiorina ran Hewlett-Packard, she liked to say size didn’t matter, telling financial analysts in November that “our strategy in the PC business is not to go for bragging rights for No. 1 in revenue or sales but to have steady competitive growth and profitability.”

Anderson has his own take on his job.

“I’m obsessed with beating Dell,” he said. “I hate it if Dell beats us, and I love it when we beat Dell.”

Dell is a relatively new target for Anderson, who began at HP 35 years ago. In those days, the enemy was Compaq Computer Corp.

“I wanted to make sure that every day I did something that was going to hurt Compaq,” Anderson recalled recently at HP’s consumer PC facility, also in Cupertino, which sits next to some buildings once occupied by Compaq. “And if I didn’t, when I got in my car, I’d drive by their parking lot and throw a brick at one of their cars.”

Just a joke, Anderson was quick to say, but “I hated those guys. I personified those guys as my enemy.”

Then, in 2002, Anderson’s enemies joined his corporate family with HP’s $19-billion acquisition of Compaq. That deal pushed HP’s market share slightly above Dell’s. The two jockeyed for a few quarters, but Dell ultimately pulled ahead, where it has remained for the last two years.

Anderson says that keeps him up at night. By day, he scoots from meeting to meeting -- with retailers, component manufacturers, cable operators and entertainment companies that might one day use HP machines to display their content.

His focus is how to squeeze more bells and whistles into low-end computers. To that end, he contemplates what costs he can remove from PCs, how he can get cheaper parts and what hardware features he can eliminate.

“I don’t like the fact that as we go up the line we get really highly differentiated, and we can add all this value,” he says. “I’d like to be able to do it up and down, and that’s what we don’t know how to do. I want that kind of edge in the lowest price point.”

Dell excels at that, giving buyers of even its cheapest PCs choices over how to configure them. But if Anderson and HP want to catch up, “they have to focus more on matching the Dell distribution model” of shipping computers directly to consumers, said Needham’s Wolf.

Through its so-called direct model, Dell sells directly to consumers and businesses over the Internet and telephone. Eliminating overhead costs for middlemen, store space and inventory, Dell competes on price and customer service, and can make money on razor-thin margins.

HP spends billions on research and development including eye-catching design, and has to share profits with retail chains that stock its products.

To that end, HP is trying to increase its direct sales, with volume rising 25% in 2004. But HP’s direct telephone shopping service lacks sophistication in dealing with customers compared with Dell or even Gateway. For instance, when Gateway salespeople answer the phone, they immediately ask for a caller’s name and telephone number for follow up sales calls.

In two separate calls to HP’s toll-free shopping number, operators politely answered questions about products, but never asked for the caller’s contact information.

“That’s the wrong way to do it,” Anderson acknowledged. “We need to be aggressive in that business, but what we don’t [want to] do is dramatically undercut our retailers’ price.”

And that tension undermines HP’s efforts, said Rod Bare, a computer analyst with investment research firm Morningstar in Chicago.

“Their distribution channel is more expensive than Dell’s, but they have to compete with Dell on price,” Bare said. “Dell is able to react quickly and get configurations that customers want. It’s really able to meet the customer’s needs better than the next guy, who’s left with selling less.”

HP’s Personal Systems Group, which sells PCs, was long a money loser, barely breaking even in 2003. In its fiscal 2004 year, which ended Oct. 31, the unit earned an operating profit of $210 million on revenue of $24.6 billion, or an operating margin of 0.85%. The company doesn’t disclose net earnings for its separate divisions.

By contrast, HP’s Imaging & Printing Group had an operating profit of $3.8 billion on virtually the same sales, $24.2 billion, for an operating margin of 15.7%. Dell, which started selling printers this year, recorded an operating margin of 8.6% over the first three quarters of 2004.

Anderson said consumer desktop PCs turned a net profit in 1998 -- he won’t say how much -- after three years of losses, and he has a dollar bill mounted on a plaque in his office to remind him of it. Since then the business has had its ups and downs, but consumer desktops have been profitable for the last five quarters, he said.

But with the guts of most PCs virtually indistinguishable from each other, the question for HP is whether people are willing to pay a premium for sleek packaging from HP the way they do for Apple products.

“The long-term thing is moving your PC more to the entertainment side of the equation, whether it be in your den or the role it can play in the rest of your house,” said Anderson’s boss, John Romano, senior vice president of HP’s Global Consumer PC Business Unit. “That’s going to be a 10-year trend.”

And it’s the engine Anderson and HP are betting will pull the company to fatter margins and better days. They just hope the train hasn’t already left the station.

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Times staff writer Jon Healey contributed to this report.