By T.C. Doyle & Sonia R. Lelii, VARBusiness
From the May 07, 2003 issue of VARBusiness

When Rich Tear, president and co-founder of CSCI, a privately held VAR based in San Diego, first heard that his then-top vendor partner had agreed to merge with Hewlett-Packard in what would later turn out to be the biggest merger in high-tech history, his first reaction was, “Oh Compaq, not this.”

After enduring the Houston company’s forays into direct sales, changes in management and shifts in partner policies, Tear thought he had seen it all with Compaq, whose servers, PCs and other products account for 40-plus percent of his company’s business. But a merger with HP? Just thinking about the upheaval and potential for confusion kept him up at night. Like many in the solution-provider community who were significantly impacted by the deal, however, Tear kept his thoughts private and wondered if fate would prevent Hewlett-Packard CEO Carly Fiorina from completing her quest to merge two of computing’s biggest giants. It nearly did, of course. But after Fiorina pulled off the deal, Tear decided to stay true to his supplier. Boy, is he glad he did. Now, as HP celebrates the milestone one-year anniversary of the completion of the $19 billion deal, Tear says of the merger that reshaped the industry and once threatened his livelihood: “In the end, it’s turned out better than I ever could have expected.” An ‘A’ For Effort
HP has indeed exceeded expectations against all odds, at least as far as bringing two computing giants together. Neither a prolonged economic downturn nor even a war in Iraq have derailed the company and its executives. Even though sales slipped due to a global economic slump, gross margins actually improved by a whole point. Significant executive departures, once feared, have largely been confined to Michael Capellas, the former Compaq CEO who decided running a financially,and some would say ethically,bankrupt MCI would be better than serving as HP’s second-in-command. Overall, Meta suggests Global 2000 companies regard HP as a short-list candidate for major IT infrastructures, noting its strength in services, servers and storage. That has appealed to Procter & Gamble, among others. It recently agreed in principle to a 10-year, $3 billion managed-services contract with HP. Despite its momentum, HP remains the market’s No. 2 company by several measures. Compare HP’s market cap of $48.4 billion to IBM’s $144.8 billion; rival Sun is worth $10.4 billion. Wall Street values IBM not just for its size, but for its profitability, too. For example, for the year ended Oct. 31, 2002, the combined HP racked up sales of $72.3 billion and lost $928 million. IBM, however, racked up $81.2 billion in FY 2002 ended Dec. 31, 2002 and earned $3.6 billion. From a stock perspective, HP has endured highs and lows in the preceding 52 weeks. Initially, shares enjoyed a honeymoon period shortly after the combined company debuted in May. Shares started their run then around $17 each. They climbed as high as $20 and change before taking a two-month plunge. Shares sunk to just $10.75 before soaring to a new high of $21.20 in January. Then, as the threat of war loomed, another fall. Shares bottomed at $15, near where they are now. Shares today trade for just a dollar or so below where they began their journey one year ago. “On coming together, you’d have to give the company an ‘A’ for its integration job,” says Arthur Rhein, president and CEO of Pioneer-Standard, one of HP’s largest distribution partners. Cisco CEO John Chambers, a veteran of more than 80 acquisitions, says HP “has done better than almost anybody anticipated.” “We were one of the strong supporters of Carly in this move,” he says. “During the issue, we were very up-front in terms of both organizations realizing that there is a fundamental change taking place in the market. And not doing anything would result in both of them not being very successful.” Experts in business mergers including book author and alliance consultant Larraine Segil, co-founder of The Lared Group of Los Angeles, also give HP high marks. “It could go [down] as the finest integration jobs in corporate history ever,” she says. Considering what has gone wrong with other deals, she could be right. For example, the mass partner alienation envisioned by some did not materialize in the HP-Compaq deal. Rather than lose significant numbers of partners, HP actually gained new friends. It has also strengthened ties with thousands of partners already on board. Some now see the company and its policies,the HP PartnerOne program, in particular,as prudent bets in uncertain times. Recently, for example, AdvizeX Technologies, a 20-year HP partner based in Concord, Ohio, decided against renewing a contract with Sun Microsystems so that it could concentrate on its HP alliance. After spending two years experimenting with Sun, which grew to 15 percent of sales at the $80 million company, AdvizeX’s president and CEO Fred Traversi simply decided to bet his company’s future on a tighter alliance with HP. One reason was because his HP margins had actually climbed 2 percent in the last year. Another was the company’s more comprehensive product road map. “For us, putting more energy behind our HP relationship simply makes better business sense,” Traversi says. That’s not to say, of course, that all has gone well in the 12 months since the new HP debuted last May 7. It hasn’t. In particular, a relatively small but influential number of partners have suffered as a result of the deal. That includes many former Compaq VARs who, once they entered the HP fold, lost an important distinction that helped set them apart in communities from coast to coast. The “gold”-level status they enjoyed as Compaq resellers was not attainable for most under the new HP plan. (For more information, see “HP Vs. Its Rivals,” below.) HP has considered their plight and created the PartnerOne SMB Network, a new program that will provide increased benefits to more than 1,000 former Compaq Gold and legacy HP partners.

Then there’s the question of direct sales, still a sore spot for many partners. Of the roughly $72 billion worth of business HP did last year, two-thirds came as a direct result of HP’s collaboration with the channel. In the critical SMB space, the percent was even higher. Growing direct business there, partners say, could be counterproductive. For example, if HP loses just 5 percent of its indirect business in the SMB space as a result of trying to increase direct sales there, the net impact to HP’s top line could be greater than what it gains in direct sales. Whether that happens remains to be seen. Kevin Gilroy, vice president and general manager of commercial channels for the Americas at HP, says HP is not trying to grow direct over indirect. Instead, “[HP] wants the growth of each part of our business to reach natural levels.” Fiorina, once thought by many partners to be too much of a fan of direct sales, seems to have updated her message about beating Dell at its own game. Now, anytime she publicly discusses her company’s direct strategy, she almost always showcases HP’s involvement with partners. But that doesn’t mean she expects HP’s relationship with third-party allies to remain stagnant. Quite the contrary. “Our channel partners will continue to be a vital part of our success as we go forward,” she says. But, due to the need to adapt to changing market conditions and buying habits, the company’s involvement with partners must change, she adds. “In some cases, we are doing things that our partners could do better for us, so we have to be willing to put that on the table and let it go. And in other cases, our partners are adding costs that really don’t add sufficient value, so they’ve got to be willing to let that go,” she says. “It isn’t rocket science, but it is a different kind of relationship, with a deeper kind of collaboration and trust, and a willingness to share real data.” In the pages that follow, VARBusiness takes a close look at the HP economy one year after the merger. We offer feedback from partners affected by the deal, plus a snapshot of the company’s finances. We also provide detailed analysis of what’s happened to HP’s product portfolio. To make it easy to chart the company’s progress, we’ve even crafted a report card that showcases the highs and the lows of the HP year that was. After reading this, let us know your thoughts and answer a question made famous by former President Ronald Reagan: Are you better off than you were? HP claims to be.

HP At One
Today, HP remains a world leader in a number of categories. Printers. Printer supplies. PCs. In 2002, it was No. 1 in those areas, although others are bearing down. In particular, Dell threatens HP’s lead in servers. In 2002, HP increased server shipments in the United States by 4.7 percent to 506,589,good enough for a 26 percent share of the market, according to Gartner. Dell, however, increased sales by a whopping 22.2 percent to 487,984. That gave it a 25 percent share of the market. The trend is particularly worrisome for HP, because it appears that Dell is doing in servers exactly what it did in PCs, namely wrestle from it the coveted top spot in the U.S. market. Dell also plans to enter the printer market, but dethroning HP there won’t be easy. In 2002, HP owned roughly 50 percent of the U.S. computing market, Gartner says. “Dell’s impending entry into the printer market will not have any short-to-medium-term effect on HP,” a Meta Group report states. Overall, Meta suggests Global 2000 companies regard HP as a short-list candidate for major IT infrastructures, noting its strength in services, servers and storage. That has appealed to Procter & Gamble, among others. It recently agreed in principle to a 10-year, $3 billion managed-services contract with HP. Despite its momentum, HP remains the market’s No. 2 company by several measures. Compare HP’s market cap of $48.4 billion to IBM’s $144.8 billion; rival Sun is worth $10.4 billion. Wall Street values IBM not just for its size, but for its profitability, too. For example, for the year ended Oct. 31, 2002, the combined HP racked up sales of $72.3 billion and lost $928 million. IBM, however, racked up $81.2 billion in FY 2002 ended Dec. 31, 2002 and earned $3.6 billion. From a stock perspective, HP has endured highs and lows in the preceding 52 weeks. Initially, shares enjoyed a honeymoon period shortly after the combined company debuted in May. Shares started their run then around $17 each. They climbed as high as $20 and change before taking a two-month plunge. Shares sunk to just $10.75 before soaring to a new high of $21.20 in January. Then, as the threat of war loomed, another fall. Shares bottomed at $15, near where they are now. Shares today trade for just a dollar or so below where they began their journey one year ago. Progress In Products
One area where HP has made legitimate progress is in products and technologies. The work of hundreds of managers before the merger did, indeed, produce a workable product blueprint. That’s especially true in storage and servers, where HP made tough choices. Storage, in particular, was a critical area, because the merger vaulted HP into a leadership position: In March, IDC reported that HP tied with EMC for the No. 1 spot in external RAID revenue for the fourth quarter of 2002. Since the merger, HP has made more than 100 announcements involving storage products. They include integrating Compaq’s provisioning module into HP OpenView. The new provisioning product is called OpenView Storage Provisioner, which was announced last November. Although its storage portfolio is vast, storage hardware seemed to be the least difficult to sort out. That’s because the companies’ offerings were largely complementary. HP already had a monolithic storage subsystem through its reseller pact with Hitachi Data Systems, selling the Lightning high-end series. But with Compaq, HP now also has the modular EVA5000, a midrange product with a list price of about $200,000. Last December, the EVA was upgraded to support the HP-UX operating system. And in April, at the Storage Networking World show in Phoenix, HP introduced the EVA 3000 with a starting price in the $50,000 range. “What we find is the market for online storage is basically split almost 50/50 between those that want modular arrays and those that want monolithic,” says Bob Schultz, vice president of marketing for HP storage. “So the combination with EVA, which is modular, and the XP, which is monolithic, really [gives] us a stronger portfolio with our customers.” The product road map hasn’t come without pain. At least two storage products, for example, will be phased out: Compaq EMA storage system, which will be taken over by the EVA, and HP’s Virtual Array, which will be supported through 2004. That will leave HP with three storage product lines: the entry-level MSA, the modular enterprise EVA and the monolithic XP.

Rationalizing HP’s storage software plans took some more doing. One key decision involved taking Compaq’s provisioning and virtualization software, which was still in development when the merger was announced. Later, HP announced OpenView Continuous Access Storage Appliance (CASA). Streamlining and merging the server products presented a unique challenge for the company. For example, HP found itself with several server families that included two RISC processor architectures (HP’s PA RISC and Compaq’s Alpha chips) as well as two Unix operating systems (Compaq’s Tru64 Unix that runs on Alpha and HP’s HP-UX). HP formed two, separate server divisions: the Business Critical Servers, which handles RISC-based processor platforms and Itanium-based platforms; and the ISS, which manages some 15 different families of servers with three different form factors, including blade servers. According to Mark Hudson, vice president of HP’s Business Critical Server Systems, HP intends to keep the same plan Compaq had for its Alpha product line: Phase it out. Compaq’s Tru64 Unix operating system will eventually go away as well. But sometime next year, two of Tru64’s capabilities will be extended into the HP-UX operating system. Those will include TruCluster and the advanced file system. HP’s ultimate goal is to have two processors serve as the underlying architectures for the company’s systems, the Intel IA-32 microprocessor and the Intel 64-bit Itanium microprocessor. The company plans to have two more generations of its PA RISC (PA 8800, 8900) before moving forward to the Itanium platform. Later this year, HP will come out with the PA RISC 8800 that will allow HP’s Superdome to become a 128-way system rather than just a 64-way. As far as OSs, the company will move forward with HP-UX, which owns about 25 percent of the Unix market, and ditch its Tru64 operating system. HP will also maintain OpenVMS, because of the large customer-installed base, and port it to run on Itanium-based systems. What remains to be seen is how strongly HP will embrace Linux. Although it supports the OS, HP is not seen as a leader in Linux computing the way IBM and Sun are. More than mere Linux software, HP has much work to do to remedy its software portfolio, which today comprises individual hits including OpenView, but lacks a comprehensive framework that IBM and Sun already have. The Channel Question
Just as the company’s product chiefs worked to rationalize their product portfolios, so, too, have HP’s channel chiefs. Although faulted for not having a comprehensive partner program ready on day one and for later dropping the popular Hard Deck name, HP rallied in November with the introduction of HP PartnerOne, a soup-to-nuts program for HP allies of all ilk. PartnerOne melds together some 40 different complex and overlapping programs. “PartnerOne is simpler and easier to manage for HP, and, theoretically, it should reduce costs and complexity for us as well,” says Brian Okun, director of product marketing at Chips Computer Consulting. Still, PartnerOne is far from perfect. In addition to the issue with former Compaq Gold VARs, the program has onerous requirements. Some partners grumble that in order to maintain consistency with HP’s storage certification and training requirements, they have to pull their engineers out of the field for upwards of 20 days a year for training,too much time away from billable projects, they say.

Another complaint concerns enforcement of HP rules, or the lack thereof. Partners say the market is flush with price-oriented resellers that destroy margins for service-minded solution providers. Although partners have been pushing HP to eliminate these companies from its channel ranks, many of these HP allies remain. That could change this June, if new rules governing certification and reselling go into effect. Many companies could lose the ability to source HP products at aggressive discounts, thereby removing one source of price erosion. Gripes aside, partners continue to step up. That includes Pioneer-Standard, which recently became an HP PartnerOne Platinum partner. The company’s Enterprise Sales Group unit alone has more than 100 salespeople and engineers dedicated to HP. Pat O’Connor, vice president of marketing there, says becoming a Platinum Partner took work, even for a company of his size. “We completed all the sales training and technical certifications,about 250 different courses and programs,before HP completed the merger and relaunched,” he says. With partners generally on board, HP still has some work to do selling customers on the value of its strategies. Although more than a billion people around the world use HP technology every day, the company isn’t regarded as strategic as its rivals are, including those with far smaller customer bases and product portfolios. Consider the following: In our recent Enterprise Spending issue (April 28), enterprise customers from more than 300 companies rated which vendors were most important to them. Just 10.2 percent of customers identified HP as their most important vendor partner. Not surprisingly, the world’s largest and arguably most powerful computer company, IBM, rated ahead of HP. But so did a PC company (Dell) that does virtually no software or chip development, and a software company (Microsoft) that makes no servers, networking gear or storage hardware. Yes, HP cracked the top five, a significant accomplishment. But, somehow, you’d think a company with a product portfolio that includes everything from $49 printers to multimillion-dollar commercial systems would enjoy more respect among top customers. Maybe next year, when HP is done with the terrible twos. Additional reporting by Rob Wright.