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Weekly Column

Resetting the Shot Clock: Why Hewlett Packard Buying Compaq is a Very Bad Idea, But Will Happen Anyway

Status: [CLOSED]
By Robert X. Cringely
bob@cringely.com

The big news this week is, of course, the surprise purchase of Compaq Computer by Hewlett-Packard. The deal, with its nominal value of $25 billion, is being touted by management of both companies as the usual mix of synergies and cost savings that are used to justify nearly every big merger. In this case, sadly, the big bosses are wrong. This mess of a merger seems to be taking place primarily because neither party can think of anything better to do.

Both companies are enormous and hallowed. Hewlett-Packard might be called the original Silicon Valley company except it was founded in Palo Alto, California, long before any of the chip companies that gave the Valley its name. What HP did was establish a way of doing business that was unique for its time — a company that valued engineering, valued the individual, believed in low debt and cash management and in sharing the wealth with its workers. These values worked fabulously for more than 50 years, but recently HP had faltered, and was seeking a new path under CEO Carly Fiorina, the first outsider ever recruited as CEO.

Compaq invented the IBM PC clone and made its reputation from out-engineering and out-manufacturing IBM. Started by some guys originally from Texas Instruments, Compaq staked-out the high-end of the PC market and defended it mightily and with great success. By the mid-1990s, Compaq was building more PCs than IBM, more PCs than any other company, and the further growth path seemed to be to compete with Big Blue across the board. To do this, Compaq acquired Tandem Computer, maker of famously reliable mainframes, and then Digital Equipment Corporation (DEC), the original maker of minicomputers. But these acquisitions didn't go as well as expected and that, combined with a general slow-down in the PC market, has hurt Compaq stock in recent months. Like HP, Compaq's stock is far down from the highs of 12 to 18 months ago. Nor is Compaq any longer the largest maker of PCs. That honor is now Dell's.

Compaq believed too well those books about branding. They thought that having a good brand name would get people to pay more for what is essentially the same computer running the same software as almost any other PC maker. It doesn't work like that.

Dell and IBM are the boogie men in this saga. Both HP and Compaq dreamed of competing head-to-head with Big Blue across a broad product line, and both were losing on the low end to Dell. In many ways, this deal has more to do with IBM and Dell than it has to do with HP and Compaq.

So let's look at those vaunted synergies that are supposed to be driving this deal. The idea is that the product lines will meld beautifully, which they don't at all.

At the high end, we have Compaq's former Tandem mainframes and HP's model 9000 mainframes. In the mid-range, we have HP's servers, Compaq's servers, and Compaq's (formerly DEC's) VAX minicomputers. At the low end, we have Windows PCs and handhelds. The only architectural similarities among any of these machines is at the low end, where they also share the similarity of losing money on every machine sold. Now THERE's a synergy. Otherwise, this is not a consolidated product line. This is no opportunity to move customers up from a server to a VAX to an HP 9000. These products, unlike the prospect of moving a customer up from a Chrysler to a Mercedes Benz, are more like moving that customer from a Chrysler to a dirigible to a submarine. Each computer line has unique and very different hardware, software, applications, and support organizations. They have almost no customers in common. Hence, no synergy.

But hey, we've been here before. I remember talking to a Compaq vice president shortly after the company bought Tandem. Compaq had discovered that Tandem's 4,000 salespeople had sold 110 systems the year before. That was crazy! Compaq would apply its finely-tuned reseller system to the Tandem line, reduce head count and explode profits. Only it didn't happen that way. This is because it really does take 4,000 salespeople to sell 110 Tandem mainframes. The Tandem acquisition was never really a success for Compaq.

So Compaq acquired DEC, a company that was demoralized and decimated, having already sold off its best parts. What Compaq got was almost a business, just not enough of one to make a profit. DEC has simply been a drain on Compaq's resources, which explains why we haven't seen a truly new DEC product in years as Compaq milked the dwindling customer base.

Today, the part of Compaq that was Tandem pretty much sells replacement systems to existing Tandem customers. The part of Compaq that was DEC pretty much sells replacement systems to existing DEC customers. There is no real growth in either business. That will not change following this merger.

HP, in contrast, has some good RISC/UNIX products and the only growing mini-computer business. So how does buying Tandem and DEC help either of these businesses? It doesn't.

Where Compaq does have strength is in manufacturing. Compaq knows how to build computers as well and as efficiently as any company in the world. HP, on the other hand, uses contract manufacturers AND SO WILL THE MERGED COMPANY. Guess where the 15,000 employees will come from who are slated to lose their jobs in this merger? They'll come primarily from the very best part of Compaq. Again, no synergy.

DEC has a good RISC chip in the Alpha, but that's now going to Intel, right? HP has been banking its future on Merced, Intel's coming 64-bit processor. But anyone will be able to make Merced products. HP will have trouble differentiating themselves with this strategy.

Yeah, but what about the PC business? Post-merger HP will be the biggest PC company in the world! Yes, and they'll be losing money on every machine. HP and Compaq are the last hold-outs for selling PCs strictly through dealers. Nobody makes money anymore doing that. Becoming a larger PC company that loses money doesn't make things better.

After the merger HP will actually have larger sales than IBM, yet IBM's earnings will be 80 percent higher. This is because much of HP's sales will be at the money-losing low end and most of IBM's sales are at the high-margin end of large systems, consulting and services.

HP will also be a larger PC maker than Dell, but Dell will make money at it while HP won't.

Frankly, it would have made much more sense for HP to buy Dell or Gateway than Compaq. The real knock-out punch, though, would have been IBM and Dell or Sun and Dell. Such a combination could be forced if this HP/Compaq deal gets any market traction, but I doubt that will happen.

In announcing the merger, HP and Compaq predicted that the combined company's sales would actually decline. They predicted hard going with regulators and lots of adjustments ahead. All of which means they know this is a bad move but are going to do it anyway. They talked about synergies that don't exist, cost savings that aren't real and that they don't truly believe. So why are they doing this merger?

Compaq was at a desperate dead end, and Carly Fiorina of HP wants to keep her job. Buying Compaq effectively resets the shot clock, buying her another 18 to 24 months before the HP board gives her the boot. This whole $25 billion deal is about executive ego. No other explanation comes even close to making sense.

And the reaction inside Dell and Gateway, IBM and Sun is uniform. Champagne corks are popping all 'round. HP's top competitors all see this as a prime opportunity to gain market share. During the inevitable period of post-merger management confusion these companies will tear into HP like sharks around a foundering whale. And HP will do almost nothing to respond, it will be so busy just trying to consolidate the business.

Look for some interesting moves by competitors. Neither HP nor Compaq is strong in notebook computers, for example. If the market moves in that direction (and IBM and Dell could force that) then the new HP may be in for even more trouble.

Obviously, I think this merger is what my Mama calls a "bonehead move." But given the amount of ego involved and the greedily nodding heads of all the investment bankers, the deal will probably go through. So just to help keep the playing field even, here is my advice to HP on how to hang on to some PC market share in the short term.

Both HP and Compaq are sitting on excess inventory beyond anything we can imagine. If they have any collective brains at all, they should start clearing that inventory TODAY by selling at auction on eBay or FairMarket. Start every auction at one dollar with no reserve price. Research shows that auctions that start low and have no reserve prices actually result in higher final sale prices. By selling from one dollar with no reserve, they'll sell 100 percent of inventory, but not be able to predict profit margin. Given that the game is to save costs, HP should take this risk. Such a move would undermine sales of new PCs from Dell and IBM, give a needed boost to sales, and make HP look for a short time like it knows what it is doing.

The alternative is to dig big holes in Nevada and make the world's most expensive landfill.

Auctions are really effective, but they scare the finance people. So be sure to fire the finance guys first, especially if they signed-off on this stupid merger.

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