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Hewlett-Packard Company (HPQ)Stock (Computer Software Industry, Computer Hardware Manufacturing Industry, Consumer Products Industry)
 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. 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 May 2008. In addition, HP has continued to leverage its core print and imaging business, which generated 27.2% of sales and accounted for 41% of the total operating margin, by offering highly specialized printers to commercial customers with its Indigo offerings. As the largest diversified technology firm, HP faced threats from many fronts. On a macro level, the company depends heavily on enterprise-level capital spending, which highly sensitive to changes in the economy (technology is often one of the first items cut during economic declines). Also, the PC industry is becoming commoditized, threatening to squeeze HP's already thin margins in that sector, which drives one-third of all revenues; at 3.9%, PC sales have the lowest margin of any of their businesses. Even their highly profitable print and imaging business is being challenged by large office supply retailers and upstart ink supply stores, which refill HP's used cartridges. This trend has huge potential impact to HP's bottom line because the company makes almost all of its profits from the sales of ink, and it has been estimated that they may even sell printer hardware at a slight loss.
[edit] 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:
[edit] Operational EfficiencyHP 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[1]). 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. [edit] Trends and Forces[edit] 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 27% of total revenue and accounted for 41% of the total operating margin. In 2007, about 58% of revenue within the group came from the sale of printing supplies, mostly printing ink. Sales of commercial hardware have increased in recent years and in 2007 accounted for 27% of Imaging and Printing revenue. 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. [edit] Personal Computers HP became the leading provider of personal computers in 2006 after surpassing previous market leader, Dell. As of late 2007, HP has about a 20% market share for PC's over Dell's 15% market share. HP's personal computers include a variety of desktops, notebooks, and workstations. Desktops and notebooks make up the majority of PC sales, together accounting for almost 95% of revenue from PC sales in 2006. Overall PC sales increased 24.7% between 2006 and 2007. This large increase is primarily from a 19.3% increase in notebook sales. Notebook sales have seen considerable momentum as consumers and businesses require mobility in their technology, as such in 2007 sales of notebook computers increased nearly 20% and sales of desktop computers increased only 4% from 2006. The highest growth rates in the PC business are in Asia and other emerging markets, driving worries that the industry will become further commoditized. In the worldwide market, demand for laptops are growing over 20%, much faster than the demand for desktops at under 2%; laptops also tend to have higher margins than desktops. In fourth quarter 2007, China's PC sales grew 100% year over year (y/y). This portion of HP's business has very thin operating margins (3.9%) and a relatively high share of desktops (over half). In an attempt to increase the small margins earned on PC sales, in mid-2008 HP announced the launch of a multitude of new products designed to be highly differentiable- a departure from former HP computers which had been standardized and barely distinguishable from competitors' products. These launches included 17 new notebooks, many of which have "Touchsmart" technology allowing the screen to be used as a touch screen. The notebooks with this technology are priced commensurately with premium and highly identifiable laptops offered by other computer producers such as Apple (AAPL).[2] [edit] Windows VistaIn early 2007 Microsoft released its new Windows operating system, Vista. As many consumers and businesses decide to take advantage of Vista's new features and update their operating systems, some will decide to purchase new computers and other IT products as well. [edit] Expansion of Software and ServicesAn 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 and Software segments accounted for 18% of total revenue in 2007 and had segment operating margins of 11% and 14.9% respectively. To grow their offerings in this area, HP acquired Mercury Interactive Corporation, a leader in information technology services and software for approximately $4.5 billion in the second half of fiscal 2006. Incrementally 2007 revenue for its Software segment grew 79% as direct result of the acquisition. Through the Mercury acquisition, HP hopes to become the dominant player in the IT services and software market, where it will be competing directly with general IT companies such as IBM and IT consulting and services firms like Accenture. HP has acquired and combined so many different pieces of software, it’s not surprising that family may lack a coherence (think HP, Digital, Compaq, Tandem). Between 30% and 50% of all existing HP software revenue has been acquired in the last 3 to 5 years. One of the latest, Mercury Interactive, was itself already the product of a few acquisitions. At over $100B in annual revenues, the $2.3B of software reported by HP is unlikely to get much attention from top management. As it stands the HP software product family is loosely concentrated around IT lifecycle management [ITLM] with products like OpenView and the Mercury offerings at the core. Reading through the report makes the HP Software Group is a substantial mishmash that lacks even the semblance of a strategy from other hardware manufacturers like IBM and EMC. [edit] Growth in EnterpriseHP'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,[3] 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."[4] 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.[5] [edit] 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.
 Hewlett-Packard Company2004 Data 2005 Data 2006 Data 2007 Data 2008 Data Most Recent Data Available [edit] Hardware: PCs and ServersIn 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. [edit] IT ServicesIBM 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.
[edit] Printing and ImagingWhile 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.
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. [edit] References
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