HP services — where profit prospects are better
Long-term profit prospects are better for HP services than for its personal device businesses — PCs, workstations, tablets, as well as smartphones, a segment which HP recently announced it will eventually re-enter.
As Domicity showed in the previous post, thanks to the EDS acquisition, annual revenue of the HP services sector has grown to nearly match HP’s PC-dominated Personal Systems Group. However, the services business has been much more profitable than the PC business. Cumulative operating income from services will total almost $20-billion for the period FY2009 through 2012, compared to about $8-billion for the PC-dominated Personal Systems unit.
As we discuss below, not all is well with the services business. But the problems should be fairly short-term, beginning to turn around in mid FY2013. By contrast, growth and profitability problems in the device business appear more structural and intractable.
Domicity’s HP in Cloud Computing report provides a detailed analysis of the industry giant’s business and strategies as it moves into the cloud. Click here for further information.
The profit problems in HP’s PC/tablet business emanate from a value chain that is largely out of the company’s direct control. Microsoft and others handle the software; Intel and others provide components and subsystems; ODMs and contract manufacturers do the production and much of the design; logistics companies fulfill orders; resellers carry out much of the sales and support activity.
Outsourcing and offshoring of the value chain constrains HP’s potential for innovation compared to device competitors such as Apple and Samsung. HP can plunge with both feet into the Windows 8 opportunity, but most of the profits will still flow to Microsoft and other partners.
HP could potentially drive more profit into its PC business model by shipping a cloud offering with each of the millions of access devices it sells. However, it may be too late to compete with consumer and SMB cloud services from the likes of Box, Google, Apple, Microsoft, Salesforce.com, Samsung and Dropbox.
Premium pricing for transformative product technology may be the best way for HP to generate better device profits. Potentially transformative blue sky technologies include: Aurasma augmented reality, which HP acquired with its Autonomy acquisition; HP Labs’ memristor non-volatile semiconductor memory; and flexible ultra-thin plastic displays.
However, commercializing these technologies to generate profitable differentiation will be challenging.
Problems and solutions in the HP services sector
The HP services sector also has problems, but they appear much more solvable, with the solutions leading to a path toward growth and operating margins near or above the HP average.
The HP services business is really two different sectors — Technology Services and Enterprise Services.
Technology Services carries out product integration and support activities. The core of Technology Services was contributed through HP’s 2002 acquisition of Compaq. Formerly part of Enterprise Services, Technology Services has been attached to the Enterprise Group that sells HP’s servers, storage, networking, and systems management software.
Technology Services is currently generating revenue at an annual rate a little below $11-billion. Revenue growth has been flat the past several years, but this unit could begin growing again now that it is integrated with the product business. Technology Services is highly profitable, delivering an operating margin of 28% in the first three quarters of FY2012. This is nearly three times management’s current operating margin goal of 10% for the entire company.
Enterprise Services delivers consulting, applications, and outsourcing services to large enterprises. The core of Enterprise Services was picked up with the 2008 acquisition of EDS.
The Enterprise Services business is under heavy pressure at the moment due to internal management issues and because several large accounts are reducing their business with HP. Enterprise Services revenue (not including Technology Services) totaled $24.9-billion in FY2010, HP’s most recent peak year. This will decline to some $22-billion in FY2013. Operating margins will decline to 3% from the 10% that was posted in FY2010. They are expected to increase back to about 9%, close to the HP corporate-wide target, once new leadership at Enterprise Services brings in a range of planned reforms.
HP ascribes roughly half of Enterprise Services’ revenue decline to the loss of business due to several “runaway” services accounts. The rest primarily relates to poor management, in particular decisions that removed most profit and loss responsibility from account managers. HP has put in new leadership at Enterprise Services that is remedying the accountability problem, rationalizing staffing and bricks and mortar, as well as bringing in advanced labor management systems. All of these measures are expected to get revenue and profit growing again.
In making the case for why HP services is a significantly more valuable business over the long-term than the company’s business in PCs and other client devices, it is worth pointing out that Technology Services generates an operating margin more than four times that of the PC/tablet business. The operating margin of Enterprise Services has fallen below that of the PC business, but management expects it will get back to nearly twice the PC rate in fairly short order.
Furthermore the cloud offers HP services several more reliable paths to profitable growth than exist with the PC/tablet business, including:
- Building cloud hosting data centers for enterprises, telcos and other service providers — Here, HP is already a leading contender and is developing technology to deliver more data center throughput per dollar and per watt of energy than the competition. Additionally, HP is a leader in the open source OpenStack movement and if OpenStack maintains momentum it will boost both HP’s private and hosted cloud businesses.
- Providing cloud hosting services from HP data centers — HP is building out global capacity to host the needs of a full range of customers, from outsourcing the IT shops of large enterprises in a managed/trusted cloud format, to providing Amazon-style public cloud services for application developers and a range of cloud-based businesses.
- Developing cloud-hosted businesses through HP business units — HP’s own cloud-based businesses hold the potential to boost company profits. These include: SaaS versions of HP’s IT management software; cloud-hosted data storage and analytics using the Autonomy and Vertica acquisitions; cloud-based print-on-demand products; vertical clouds for industries where the company has developed or acquired specialized intellectual property; cloud hosted enterprise software from SAP, Microsoft and other HP partners.
HP has the broad customer base and the technological capability to develop innovative cloud-based services offerings. The challenge is to grow these businesses faster than its legacy services deteriorate.
Here is some good news for HP. The market appears to be moving in its direction, away from labor-intensive “your mess for less” outsourced applications and infrastructure services, and towards HP’s strength in data center-based services.
The past is often prologue. HP services has outperformed its PC business in recent years. Domicity expects it to be a more valuable business in the future.
Posted by Marc Brien, VP Research, DOMICITY LTD.
Domicity publishes reports analyzing the strategies and operations of global cloud computing leaders. Find out about Domicity’s latest report. In addition to published reports, Domicity consults on the strategies & operations of I.T. companies and market trends, and advises government on economic development and investment attraction.