HP vs. IBM: Competitors or Allies?

Tuesday Feb 24th 2009 by Rob Enderle

The two tech giants maintain a competitive stance toward one another, yet long term it appears an alliance makes more sense.

Changes in large companies happen very slowly and, as a result, we can still look at companies that have changed vastly and see them for the way they were, not the way they are. Both HP and IBM have gone through massive changes in the past decade, taking them in nearly opposite directions. And, while they still compete, they compete much more narrowly now; as a result, IBM is probably more of a competitor to Microsoft now than it is with HP.

IBM sacrificed revenue for margin, largely giving HP the lead in the former but taking a vastly more profitable position in exchange. In addition, one of the questions that was debated in Microsoft was whether they should have a stronger services unit; Steve Ballmer won that debate because of his senior executive position in the 90s. But IBM may be the standing example that perhaps it should have gone the other way. Let’s talk about that this week.

HP: The “H” in Hardware

HP is growing their services unit strongly with the acquisition of EDS, and it’s interesting to note that it is largely services in its latest financial results that carried their bottom line. Virtually every other major business line was off significantly. This isn’t because HP is badly run; on the contrary, they remain one of the best run hardware companies on the planet. It is because in this worldwide market downturn every business they had was hit, and even a hardware structure designed to weather storms suffered in the face of a perfect storm.

HP’s major divisions are PSG or Personal Systems Group, which does PCs; IPG or Imaging and Printing Group, which mostly does printers; and ESS or Enterprise Storage and Server, which does storage hardware and contains their server lines. Each group arguably leads its respective industry. In the case of IPG by a rather impressive, near-total dominance margin. These units, which are nearly totally hardware-based, constituted around 74% of their business in 2008 (note: all percentages are based on Income Contribution).

The other major businesses are services, which with the acquisition of EDS constitute 20%, software, which constitutes around 4%, and Financing, which constitutes 2%. By any measure they are a hardware company that has a strong services unit. As primary competitors they have Sun, which they have pounded into submission; Dell, which they took the PC lead from last year; and every printer company at any level on the planet, which they regularly scare the hell out of.

But not so much IBM anymore.

IBM: Microsoft with Services

IBM, which was clearly a hardware company prior to the 90s, had its hat handed to it in the 90s by Microsoft, and has been transformed in this decade.

IBM’s software unit represents a whopping 40% of their business and is one of the major areas of emphasis for the company (again, note: all percentages are based on Income Contribution). This unit regularly runs up against Microsoft and companies like Oracle and probably wants to partner with HP more than compete with it. Because of the way software is priced and sold it is largely, at least over the short term, financial storm proof. And you also saw Microsoft’s Server and Tools unit shrug off the current financial difficulties without much apparent effort as well, validating this.

IBM retains the largest single technology services unit in the world and this unit represents a whopping 42% of their business. As with HP, services have remained in very high demand during the downturn, and because IBM has a larger services unit they achieved a much higher benefit.

Let’s stop for a moment and compare: HP is two thirds hardware, IBM is four fifths software and services. Clearly, these are not similar companies.

The rest of IBM is mostly servers and mainframes, which account for 9% of their business; and financing, which also accounts for about 9%, largely to support the servers and mainframes and going back to the original IBM. In reality IBM is as much a bank as they are a hardware company and, given the current environment for banks, it’s a good thing they’re not much of a bank.

This isn’t intended to belittle IBM’s hardware efforts, only to show that as a corporate entity, hardware isn’t at the core of IBM anymore. What is particularly ironic to me was that in the early 90s I was one of the folks in IBM that led a team and tried to spin out Software because we believed that only by doing so would software be successful. Our effort was killed. However, in effect, IBM has been largely transformed into the software company we envisioned and it actually worked out rather well.

IBM’s customer satisfaction, loyalty, and trust scores exceed Microsoft’s significantly in enterprises, suggesting that this combination of services and software may have been the better mix at least for that market. It also suggests that Microsoft’s decision not to go into services may have been a bad one.

As a result of this decision, IBM software and services likely represents Microsoft’s greatest enterprise competitive threat today.

Should HP follow IBM?

HP was ahead of IBM in revenue in 2008, $118B to $104B, but the more significant number is gross margin, and here IBM led HP $46B to $28B.

More important, during the downturn as we have already seen, software and services is more resilient and this would suggest, if you only looked at the numbers, that IBM was on a path HP should follow.

This would be a mistaken conclusion. IBM entered the decade with a software company second only to Microsoft and has a heavy software focus in their DNA. HP lacks a strong software core and were they to try to emulate IBM it would both take too long and probably fail miserably, because they lack enough of the critical competence.

In addition, the opportunity cost with partners like Microsoft would probably easily overwhelm, at least for the short term, the economic benefits. You only have to look at Sun, which tried a similar path, to see that the result would probably be a vastly smaller and weaker HP.

HP, at its core, is a hardware company; IBM had dual competencies. That gives both companies a different set of viable choices for the future. Software just isn’t one of HP’s viable choices at the moment.

An HP-IBM Alliance?

The only real conclusion to draw from this is that IBM and HP are now largely different companies at or near dominance in their chosen industries. It is just interesting to note that, increasingly, those chosen industries are not the same ones and this anticipates a future time when the two firms may find that a partnership would be more lucrative for both than their current competitive stance.

It is interesting to note that their overlap has dropped to about 29% (20% HP services + 9% IBM hardware; I don’t think financing counts) and should it drop below 20%, a partnership could become a reality. Right now the HP IPG unit and IBM software unit could easily partner with the other company.

In the end we have to occasionally take a fresh look at companies, much like we should with people who also change, and challenge initial impressions. Both change and, in this case, IBM and HP have changed so much they really are vastly different from each other today.

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