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Posted by Marc Brien, VP Research, Domicity Ltd.
(For an expanded analysis, download Domicity’s free 21-page e.Paper. Login or email is not required. This post is based on research for an upcoming Domicity CORProfile competitive analysis study of a global cloud leader. To receive advance notice, please click here.)
If the personal scandal that ultimately felled Mark Hurd had not become public, it is likely that Hewlett-Packard’s former CEO would still have been shown the door, sooner rather than later.
Why? Hurd’s approach was unsustainable. He was boosting earnings by under-investing in core areas — eating the seed corn. R&D, workforce pay and benefits and sales and customer support were squeezed intolerably.
The 30-year proportional analysis of HP’s income statement shown below illustrates how HP’s cost structure has become undernourished since the company’s heyday in the 1980s and 1990s.
At 23.8%, HP’s average gross margin in FY2010 (ended Oct. 31, 2010) had dropped to less than half of FY1980’s 52.4%.
Spending on R&D and SG&A are equally revealing. According to Chuck House’s first-rate book The HP Phenomenon, founders Bill Hewlett and Dave Packard targeted spending 10% of revenue on R&D. By FY2010, R&D spending had dropped to just over 2%. SG&A expense had been trimmed to a very low 10%.
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To compete more intelligently with high value-added/high investment rivals such as IBM, Oracle, EMC, NetApp and Microsoft, HP needs to fatten key parts of its value chain.
Hurd’s replacement Léo Apotheker has been busy reengineering the business model since he became CEO on November 1, 2010, searching to put HP’s EPS and share price back on an upward trajectory.
For the first four months, Apotheker looked at all the bits and pieces he inherited and devised a strategy that put all the company’s businesses within a cloud computing context.
HP’s server-side businesses — servers, storage, networking, software and professional services — would all be optimized to deliver private and public cloud infrastructure. Its venerable printer business was to be the off-ramp.
Enabled with the webOS software HP picked up through its 2010 acquisition of Palm, PCs, smartphones and tablets were to be the on-ramp to the cloud.
Just three months later, after the on-ramp collapsed due to lack of interest in webOS devices, Apotheker is moving to exit the market for PCs and other client devices. Now, the company is focusing on the rest of the plan, particularly its enterprise services and enterprise products businesses.
Increasing R&D and SG&A (selling, general and administrative) expense as a percent of revenue is inherent to the reengineering. Apotheker’s challenge is to find ways to boost gross margin (gross profit as a percentage of revenue) to finance these increases.
If HP fails to boost gross margins, its EPS will suffer and the company’s beleaguered share price will take a further hit. Looking to place blame, Wall Street could be quick to hammer HP for dumping Mark Hurd over a mere peccadillo with a contractor.
The server-side businesses, where HP will now concentrate most of its resources, are much higher margin than the PC business it is abandoning. Building up these businesses to become more competitive, particularly with IBM, explains why Apotheker’s acquisition program has already allocated more than $10-billion to the purchase of Vertica and Autonomy .
Domicity’s free downloadable e.Paper tackles these issues in greater detail.
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