H-P Cedes PC Market Share To Dell
By Pui-Wing Tam
Of THE WALL STREET JOURNAL
SOMETIMES BEING No. 1 isn't worth the effort. Hewlett-Packard Co. seems to have learned that lesson -- and investors could benefit.
The technology giant's personal-computer business has long faced the difficult choice between focusing on grabbing market share or on improving profitability. For much of the past two years, H-P has chosen the first approach, aggressively battling rival Dell Inc. to claim bragging rights as the top PC seller.
But in an important change, H-P is now backing off from seeking market share at all costs, or going all-out to unseat Dell from the top slot.
Normally, market-share retreats aren't anything to write home about. Yet this one has some investors applauding. Becoming less aggressive on PC market share "is a positive thing for H-P," says Sunil Reddy, portfolio manager of Fifth Third Technology Fund. Hugh Mullin, a fund manager at Putnam Investment Management, says H-P is doing "the right thing for shareholders."
The reason for the applause: The Palo Alto, Calif., company is now making clear that profits are its top priority. "We won't sacrifice profitability for market share," Carly Fiorina, H-P's chief executive, said at a meeting with analysts late last year. Her comments are echoed by Vyomesh "VJ" Joshi, who heads the company's highly profitable printer unit and who last week also was put in charge of the PC business. "The focus is first going to be on the bottom line," he says.
The dogfight in PCs has relentlessly driven down hardware prices and profit margins, pushing some companies out of the market altogether. H-P, however, has recently bucked the trend, maintaining an average selling price for its computers of around $1,200 for the past two quarters, according to research firm Gartner Inc. H-P says its PCs' average selling price has stayed constant for the past year.
By contrast, H-P lowered prices throughout 2003 and part of 2004 to match or undercut Dell. The strategy yielded some bragging rights for H-P -- it beat Dell as the top seller of PCs for two quarters out of the past nine -- but it also resulted in dismal profits. Indeed, since mid-2002, the operating profit of H-P's PC business hadn't until recently exceeded 1% of sales.
Now that H-P is putting less weight on being the world's top seller of PCs, its profit margins are inching up. In its most-recent fiscal quarter, which ended Oct. 31, H-P's operating profit margin for PCs rose slightly to 1.2%. That helped -- albeit modestly -- to offset declining margins in other areas of H-P's business, notably in its enterprise-computing unit, fund managers say.
"Focusing on profitability leads to slower growth, but it also leads to more consistent results and performance," said Marty Shagrin, an analyst at Victory Capital Management, which owned more than four million H-P shares at the end of September, according to Securities and Exchange Commission filings. "What's the point of being in a business if you can't make any money?" asks Mr. Shagrin, who doesn't rate the stock.
Improved PC profits aren't yet showing up in H-P's stock. In 2004, H-P shares declined around 9% even as the tech-heavy Nasdaq Composite Index finished the year higher. After hitting a 12-month low in August when H-P reported disappointing financial results, the company's stock has risen modestly. On Friday, ahead of yesterday's holiday for Martin Luther King Jr. Day, the stock rose 12 cents to $20.07 in 4 p.m. New York Stock Exchange composite trading, giving the company a market value of slightly more than $60 billion.
But investors say the picture is bound to change if H-P can improve PC profitability in a sustained manner over the next few quarters. Mr. Shagrin, for one, contends that the stock is so cheap -- trading at just 11 times projected earnings in the next 12 months -- that any improved profits will likely be rewarded. Dell, in contrast, is trading at 25 times earnings in the next 12 months, with a market capitalization in excess of $100 billion.
Going after both market share and profits is next to impossible with the constant downward pressure on PC prices. Only those players with the leanest business structures -- particularly Dell, which stresses direct sales on the Web and over the phone -- have been prospering lately. H-P, which sells through retailers and other middlemen in addition to direct channels, has a built-in cost disadvantage.
H-P executives began emphasizing PC profits late last year, marking a change from the message that began when the company bought Compaq Computer Corp. three years ago, sharply expanding its PC business. While Ms. Fiorina said at the time that all of H-P's businesses would have to be profitable, she also drew attention to the battle with Dell. H-P was in a "two-horse race," Ms. Fiorina frequently said. Bob Wayman, the company's chief financial officer, told Wall Street analysts the company was content to sell PCs "at a very modest profit for now."
That changed after H-P missed Wall Street earnings estimates in August, says Deborah Nelson, vice president of marketing in H-P's personal-computing unit. Ms. Nelson notes that H-P is now a "solid No. 2" in PCs and "feels very comfortable with that market position."
In a sense, H-P has been forced to accept that role. Since early 2004, Dell has topped H-P's PC market share by several percentage points. As of the third quarter of 2004, for example, H-P's world-wide PC market share was 15.6%, compared with Dell's 17.8%, according to research firm IDC. When PC market shares for 2004's fourth quarter are released by Gartner and IDC this week, Dell is expected to maintain its No. 1 position, analysts say.
H-P's Ms. Nelson says the results in the past few quarters reflect the fact that customers perceive Dell's PCs to be less expensive, and because H-P had holes in its corporate PC lineup. H-P is now remedying those weaknesses by educating consumers on how competitive H-P's PC pricing is. H-P also plans to introduce new notebook computers for corporations over the next few weeks that will complete its lineup, she says.
Focusing on profitability has its risks, of course. H-P could lose so much PC sales volume that it might not make enough revenue to cover the fixed costs of its business.
Jason Maxwell, an analyst at Trust Company of the West, notes that several technology companies have tried to strike the right balance between PC profitability and market share, and failed. International Business Machines Corp., for one, struggled for years to reach that equilibrium in its PC business, Mr. Maxwell said. In the end, though, IBM gave up the fight. Late last year, it agreed to sell off its PC business to Chinese computer company Lenovo Group Ltd. According to SEC filings, Mr. Maxwell's firm owned 3.9 million H-P shares at the end of September.
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