Beating Dell: Why HP Acquired Compaq

In 2001,Hewlett-Packard (now HP) shocked the business world when its former CEO, Carly Fiorina, announced that rival computer maker Compaq had agreed to be acquired by HP. The announcement came at the end of a year in which slumping demand and strong competition from Dell had buffeted both companies. The merged company would have annual revenues of about $87.4 billion, putting it in the same league as IBM, and would be able to provide customers with a full range of computer products and services. With the exception of printers, where HP is the market leader, there was significant product overlap between HP and Compaq. To justify the acquisition, Fiorina claimed that it would yield a number of benefits. First, there would be significant cost savings. Some $2.5 billion a year would be taken out of annual expenses by eliminating redundant administrative functions and cutting 15,000 employees. In addition, combining the PC businesses of HP and Compaq would enable HP to capture significant scale economies and compete more efficiently with Dell. The same would be true in the computer server and storage businesses, areas where Dell was gaining share. Critics, however, were quick to point out that Dell’s competitive advantage was based on its cost-leadership business model, which was based on the efficient management of its supply chain— an area where both HP and Compaq lagged behind Dell. Although achieving economies of scale is desirable, would the merger allow the new HP to reduce its cost structure, such as by increasing its supply-chain efficiency? If the new HP could not change its PC business model to match Dell’s low costs, then the merger would not provide any real benefit. In addition to the cost advantages of the merger, Fiorina argued that the acquisition would give HP a critical mass in the computer service and consultancy business, where it lagged behind leader IBM significantly. By being able to offer customers a total solution to their information technology needs, both hardware and services, Fiorina argued that HP could gain new market share among corporate customers, who would now buy its PCs as part of the total “computer package”; moreover, HP would be entering the higher-margin service business. Here, too, however, critics were quick to perceive flaws. They argued that HP would still be a minnow in the service and consultancy area, with under 3% of market share. In 2004, HP announced that it had achieved its cost savings target and that it was continuing to find ways to reduce the duplication of resources in the merged company. However, it also announced that Dell’s entry into the printer business had hurt its profit margins and that the profit margins on the sales of its PCs were still well below those obtained by Dell. HP’s stock price plunged, and its board of directors reacted by firing Fiorina and bringing in a new CEO, Mark Hurd, a person with proven skills in managing a company’s cost structure. Hurd initiated another round of cost reductions by pruning HP’s product line and work force. In the spring of 2006, the company astounded analysts when it announced much higher profit margins on its sales of PCs and higher profits across the company. Many of Fiorina’s strategies had begun to pay off. HP’s PCs were much more attractive to customers, and Dell’s foray into printers had not proved highly successful against market leader HP. Neither had Dell’s entry into other electronics industries, such as MP3 players, televisions, and so on. The result was that competitive advantage in the PC industry seemed to be moving away from Dell toward HP. As we discussed in the Running Case in the last chapter, in response, Dell has been forced to find ways to increase its level of differentiation to increase the attractiveness of its machines and so defend its position against HP and Apple. Dell engaged in horizontal differentiation when it bought the upscale PC maker Alien ware in one move to increase product differentiation: it also entered into physical retailing when it began to open Dell PC stores in major shopping malls in 2006, imitating Apple’s strategy. To find even more cost savings, Dell also began to use AMD’s cheaper chips and broke its long-term exclusive tie to Intel. Analysts worry that its move to increase product differentiation may hurt Dell’s cost leadership position; despite its attempt to lower costs, they worry Dell might become stuck in the middle. However, Dell is still a strong competitor, and only time will tell how the battle for market share in the PC industry will play out as Dell, HP, and Apple work to find new ways to lower costs and differentiate their products to grow their sales, profits, and ROIC.