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WIKI ANALYSIS
Hewlett-Packard (NYSE: HPQ) is a diversified technology company that has reached several key milestones in recent years. Even in the poor economic conditions of 2008, the company had a net revenue growth of 13% from $104.2 billion in FY07 to $118.3 billion in FY08.[1]
The drivers of HP's recent success have been two-pronged. The company has undergone significant cost cutting measures since 2005, and operating margins increased from 4.0% then to 8.4% in 2007. However these have decreased slightly (by 0.3 %) from FY07 to FY08.[2] At the same time, the company has focused on driving growth in key areas such as software and services. Software and services are generally much higher margin than hardware. IBM, which generates most revenues from services, realizes operating profits nearly twice as high as either HP or Dell. This transition continued with HP's acquisition of business network producer Electronic Data Systems (EDS) in August 2008. This acquisition helped improve the weighted-average net revenue growth of HP Services division from 1.1% in FY07 to 5.6% in FY08.[1]
In 2009 Quarter 3, Hewlett-Packard suffered declining profits and reported a $1.64 billion profit on $27.5 billion in sales.[3]
Business Overview
HP is the global leader in Personal Systems and Imaging and Printing. The company HP provides a wide range of products and services to its customers and is divided into six business segments:
- Personal Systems: Hewlett-Packard is the world's largest manufacturer of personal computers, and its Personal Systems Group (PSG) is responsible for the development and sale of HP's commercial and consumer PCs, workstations, handheld devices, digital entertainment systems, and other related services and accessories.
- Imaging and Printing: Hewlett-Packard is the leading provider of imaging and printing systems in the world. HP's Imaging and Printing Group (IPG) provides consumer and commercial printer hardware, printing supplies, printing media and accessories, and scanning devices.
- Enterprise Storage and Servers: HP is one of the leading providers of servers in the world, offering a wide range of servers and storage products and solutions for small businesses and larger corporations. The Enterprise Storage and Severs (ESS) segment offers industry standard servers, business critical systems, and storage products and services. The recent acquisition of EDS will make HP the second largest producer (after IBM) of data systems and data processing for businesses and large enterprises.
- HP Services: This segment offers a large variety of information technology services, including technology services, consulting and integration services, and managed services. Technology services range from individual product support to business technology solution services for global corporations. Consulting and Integration covers the design and execution of technology solutions for customers. Managed services include outsourcing, managed web services and other services. HP Services works with HP's IPG and ESS segments in order to provide customers with full, end-to-end business solutions.
- Software: HP's Software segment provides management software solutions that assist large companies in managing their operations and information technology infrastructure through HP's OpenView software brand. HP Software's other major offering is the OpenCall brand which offers a platform for utilizing voice and data services for network providers. HP recently acquired the Mercury Interactive Corporation, an IT management software and services company, in order to further expand the offerings of HP's Software segment.
- HP Financial Services: Hewlett-Packard offers financing, leasing, and other financial management services for its larger enterprise customers, small businesses, and educational and governmental customers in order to allow its customers to purchase complete end-to-end information technology solutions.
| Segment (2008) | Revenue (mm) | Operating Income (mm) | Operating Margin | Percent of Total Revenue | Revenue Growth from 2007 to 2008 |
|---|---|---|---|---|---|
| Personal Systems[4] | $42,295 | $2,375 | 5.6% | 36% | 16.2% |
| Imaging and Printing[5] | $29,385 | $4,590 | 15.6% | 25% | 3.2% |
| Enterprise Storage and Servers[6] | $19,400 | $2,577 | 13.3% | 16% | 4.1% |
| HP Services[7] | $22,397 | $2,491 | 11.1% | 19% | 35% |
| Software[8] | $3,029 | $461 | 15.2% | 2.5% | 20% |
| HP Financial Services[9] | $2,698 | $192 | 7,1% | 2% | 15.5% |
Note: Total segment operating income is greater than total company operating income because there are expenses included in calculating total operating income that are not included in total segment operating income, because they are associated with the whole company rather than individual business segments.
Operational Efficiency
HP has been cutting its operating costs since 2005, when operating expenses accounted for approximately 96% of total revenue. The bulk of these measures fell under the goal of streamlining the company's structure and included removing several layers of management, phasing global operations into all of HP's business segments, and outsourcing more production to subcontractors(by mid-2008, more than half of HP's PCs are built entirely by subcontractors[10]). These measures considerably improved HP's profitability as its operating margin rose from 4.0% in 2005 to 8.4% in 2007 and to nearly 10% for the first half of 2008. HP plans on continuing to look for areas where operating efficiency and profitability can be improved, such as the development and installation of its own new IT databases or the improvement of their supply chain.
Trends and Forces
Imaging and Printing
Hewlett-Packard's most profitable venture is their Imaging and Printing Group, which the company operates like a razor-and-razor-blade business model. It has been estimated that HP sells consumer printers at a loss, commercial printers at a small profit and its replacement ink cartridges at with a margin over 50%. As a whole, the Imaging and Printing accounted for 25% of total revenue for FY08, with supplies being the only sector in this group that grew between FY07 and FY08 in net revenue.[5]
The business model for this group makes the revenue stream volatile. The lowering margins in the commercial and customer hardware market have affected the total revenues generated by this group. Though positive, the total growth in revenue was only 3.6% for the whole group between 2007-08 (while it was 6.3% between FY07 and FY06).[5] HP is taking steps to increase its Imaging and Printing services in order to maximize the customer base it serves. For large scale commercial businesses, HP introduced a its high-end digital printer offering (called Indigo) and acquired Scitex Vision, a specialty company ultra-wide digital printing. HP's strength is printing and imaging is threatened by increased competition from laser printers and inkjets.
Personal Computers
HP became the leading provider of personal computers in 2006 after surpassing previous market leader, Dell. HP's personal computers include a variety of desktops, notebooks, and workstations. Together they made up the largest revenue for HP in FY08.
The global downturn has affected the growth rates in revenues for both the notebook and desktop PC markets. A 18.9% decrease in revenues at 30th April 2008 ($8.1B) when compared to 30th April 2009 ($10.1B).[12] In spite of these current losses, HP's outlooks looks positive as analysts predict the market to increase in 2010 as the global economy improves.[13]
Expansion of Software and Services
An integral part of a company's infrastructure is the software and services that helps manage the company and the servers it runs on. HP's Services segments accounted for 19% of total revenue in 2008, while HP Software was responsible for 2.5% of the total revenue and each had segment profit margins of 11.1% and 15.2% respectively.[7][8] To grow their offerings in this area, HP acquired EDS in August of 2008. This acquisition had a direct impact on the revenue generation for this group.
However the global recession has taken its toll on this group as well with 15.3% loss in revenue for FY09Q1 when compared in FY08's 1st quarter results.[14]
Growth in Enterprise
HP's Enterprise Servers and Storage division is the main segment through which Hewlett-Packard offers information technology infrastructure products and management to businesses. The ESS group accounted for 18% of total revenue in 2007 with a segment operating margin of 10.5%. In order to increase their leading market share in the server industry, HP has been changing their product mix within the ESS group to adjust to the industry trends.
One of the company's key leverage points is its existing relationships with enterprise customers for its printer and PC businesses. With a broadening portfolio of hardware and even services, HP can move to provide full technology offerings to its customers. On the down side, enterprise-level capital spending is highly sensitive to changes in the economy and technology is often one of the first items cut during economic declines. The US financial services sector is expected to decrease orders due to the credit crunch. At the same time, HP reported that it was largely unaffected by this in Q4 2007 because of their relatively small exposure to the financial services sector.
In May 2008, HPQ completed plans to acquire Electronic Data Systems (EDS) for $13.9 billion,[15] a 32.5% premium over EDS's share price before this potential deal was announced. This would make HPQ the number two producer of large-scale corporate data systems, allowing it to compete with number one, International Business Machines (IBM), more effectively. Additionally, HPQ and EDS have different product lines and customer bases which would allow many "cross-selling opportunities."[16] Despite this potential size advantage, there are several possible problems with this acquisition. First, HPQ paid a considerable premium for EDS, which suffered a 62% decline in profits for Q1 2008, and has had very limited profit growth over the past 5 years. Second, the market for large corporate data systems is highly competitive, resulting in low profit margins. Finally, EDS has 140,000 employees, the vast majority of which are expensive US workers, leading to high labor costs, which is a serious handicap in this cutthroat market segment where more and more work is being transferred to lower cost programmers in places such as India. The two companies will be totally integrated over a three year period, with management expecting to cut $1.8 billion a year in costs through the merger.[17]
Competition
Although HP's main competitors are Dell and IBM, each of these companies has a different focus area. Dell makes most of its money on PC and server hardware, while IBM has shifted towards a IT services provider. HP provides both of those offerings but maintains a large cash cow business with its printers, which generate half of all operating profits.
| Company (2007) | Total Revenue ($M) | Gross Profit ($M) | Gross Profit Rate (%) | Net Income ($M) | Operating Margin (%) | Revenue Growth from 2007 (%) |
|---|---|---|---|---|---|---|
| IBM | 103,630[18] | 45,661[1] | 44.1[1] | 12,334[1] | 11.9[1] | 4.9[1] |
| Hewlett-Packard | 118,364[1] | 28,443[1] | 24.0[1][19] | 8,329[1] | 8.8[1][20] | 13.5[1][21] |
| Dell | 61,101[22] | 10,975[22] | 17.9%[22][19] | 2,478[22] | 5.2[22][20] | (0.5)[22][21] |
Hardware: PCs and Servers
In terms of revenue, HP is the largest producer of personal computers with Dell coming in at a close second. However the PC market is fragmented with the top ten companies accounting for only approximately 57% of global desktop sales. The notebook market is more concentrated with the top ten companies controlling over 80% of the market. In the server market--which is generally higher margin that PCs--HP is a close second to IBM, with Dell ranking third.
IT Services
IBM is a far more profitable company than either HP or Dell, with an operating margin of 13.6% in 2007 compared to Dell and HP's operating margins of 5.6% and 8.3% respectively. This can largely be attributed to IBM's 40+% gross profit rate from its high-margin services business, which generates over 50% of its overall revenue. As a more profitable enterprise, IBM has the opportunity to reinvest in its business and take back the leading spot in the IT industry which it just lost to HP in 2006, based on overall enterprise revenues.
Printing and Imaging
While HP's two largest competitors are IBM and Dell, neither of these two companies produce printing and imaging hardware. This is one of the largest differences between HP and its competitors because such large portions of revenue (27%) and operating margin (over 40%) come from HP's Imaging and Printing segment.
The printer market can be divided into two product categories--inkjet printers and laser printers--where HP's major competitors include Lexmark, Canon, Epson, Xerox and Samsung. HP is the market leader for both types of printers. In inkjet printers, HP held approximately 45% of the market as of the third quarter of 2006 with Canon trailing in second at 18% and then Epson and Lexmark tied for third with about 16% of the market each. For laser printers, HP held approximately 40% of the market as of the third quarter of 2006, with nearest competitors Samsung and Canon, holding 10% and 9% of the market, respectively. HP has been the leader in the printer market for years and has increased its market share consistently since the end of 2005.
A majority of revenue and nearly all profits in the Printing and Imaging segment come from the sale of ink cartridges, which extend the revenue streams from a printer hardware customer by 3 to 4 years. As such, one of the biggest threats to their cash cow business is the emergence of cartridge remanufacturers or refillers, especially for the inkjet market (laser cartridges are much more complicated). Various companies are getting into this game and cutting into HP's cartridge sales.
- Office supply retailers such as Staples and Office Depot have started to sell their own private-label ink cartridges, which are old HP cartridges filled with their own toners and inks
- Standalone supply stores such as Cartridge World and Internet vendors are growing very fast. These companies also refill old cartridges with less expensive inks
While HP has responded to this competitive threat by defending patents on its cartridges and creating their own programs to collect empty cartridges, continued growth from this sector will put pressure on both sales and margins of this business.
References
- ↑ 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 1.09 1.10 1.11 1.12 HPQ 2008 10-K pg. 49
- ↑ HPQ 2008 10-K pg. 51
- ↑ Cliff Edwards (August 18, 2009). Poor HP Earnings Dim Hopes for Tech. BusinessWeek.
- ↑ HPQ 2008 10k pg. 60
- ↑ 5.0 5.1 5.2 5.3 HPQ 2008 10k pg. 61
- ↑ HPQ 2008 10k pg. 56
- ↑ 7.0 7.1 HPQ 2008 10k pg. 57
- ↑ 8.0 8.1 HPQ 2008 10k pg. 59
- ↑ HPQ 2008 10k pg. 62
- ↑ WSJ: Dell Plans to Sell Factories in Effort to Cut Costs
- ↑ 11.0 11.1 HPQ 2008 10-K pg. 158
- ↑ HPQ 2009 10-Q1 pg. 71
- ↑ PC Shipments Showing Signs of Recovery, Gartner Says. PC World (2009-06-25). Retrieved on 06-28-2009.
- ↑ HPQ 2009 10-Q1 pg. 72
- ↑ Reuters: HP Closes $13.9 billion purchase of EDS
- ↑ http://feeds.reuters.com/~r/reuters/topNews/~3/289535782/idUSN1230539620080513
- ↑ marketwatch: H-P to cut nearly 25,000 jobs, citing EDS integration
- ↑ IBM 2008 10-K pg. 19
- ↑ 19.0 19.1 [Gross Profit Rate = (Revenue-COGS)/Revenue]
- ↑ 20.0 20.1 [Operating Margin=Operating Earnings/Total Revenue]
- ↑ 21.0 21.1 [Calculated using 2007 and 2008 numbers]
- ↑ 22.0 22.1 22.2 22.3 22.4 22.5 DELL 2008 10-K pg. 20
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