Merging Movements of the Hewlett Packard and Compaq Computers - Essay Example

A Paper in Managerial Economics THE HEWLETT PACKARD – COMPAQ MERGER Introduction The IT industry is an oligopoly that includes erstwhile leader IBM, and Dell Computer, the merged and Compaq and Hewlett Packard, and Gateway 2000, recently merged into Taiwan-based Acer. Competition is intense and profit margins are slim. There is a strong drive towards technological innovations and quality improvements. Most notable in recent years has been the success of Dell in taking over the leadership of the industry by virtue of its high quality, innovative marketing techniques, and cost efficiencies in terms of production, logistics, and distribution in serving its customers. Other companies, particularly Compaq and Gateway 2000 have tried to emulate its direct sales method but have not managed quite well to make a dent on Dell’s competitive advantage. Before its merger with HP, Compaq had acquired Digital Equipment Co. for $9.6 billion. Its merger with HP was calculated to produce cost economies by eliminating inefficiencies and reaping important economies of scale by combining operations of the companies involved, particularly where they are complementary. Under oligopoly, collusion whether explicit or implicit, is prohibited by law. Healthy competition among the players redounds to the advantage of buyers and consumers as they reap the benefits of both quality and low prices. Any attempt by one player to reduce the price below prevailing price of a certain product category, assuming the absence of quality differences or product differentiation, would cause the others to match the decrease, thereby benefiting consumers but to the disadvantage of the sellers, Raising the price would also mean that the initiating player would lose sales because the other players would not follow suit and would receive purchase orders from customers who change their preference in favor the companies maintaining the prevailing price. With more companies merging and the government approving such merger plans despite possible anti-trust implications, there would be higher barriers to new entrants. The Planned Merger. Pre-merger Hewlett-Packard Company was a leading global provider of computing and imaging solutions and services with total revenue of $45.2 billion in its 2001 fiscal year. In September 2001, Hewlett Packard and Compaq concluded a horizontal merger agreement which would create a global technology leader, providing a complete set of IT products and services for both businesses and consumers, worth $87 billion in revenues. It was intended to compete with and perhaps edge out competitors Dell and IBM. The new HP (with a new NYSE stock symbol HPQ) would become the foremost global player in servers, imaging and printing, and would belong to the top 3 in IT services, storage and management software. In addition, the combination would intensify the company’s commitment, for which Compaq was distinctively well known, to open, market-unifying systems and architecture and aggressive direct and channel distribution models. With operations in 160 countries, the new company was to realize cost synergies of $2.0 billion in fiscal year 2003, rising to $2.5 billion by mid 2004. The merged company was focused not only to tide over its current cost efficiency problems but also to ultimately gain dominance in the industry. Opposition to the merger: “It was the dumbest deal of the decade,” according to Michael Dell of Dell Computer Co. Also, Walter Hewlett, son of one of the company’s founders, aggressively campaigned via a proxy fight to prevent the merger from being consummated. He called merger proposal a “$25 billion mistake that would ruin both companies and provide rivals Dell and IBM footholds for burned customers” of both companies (HP declares victory in Compaq merger 2002). From the economic point of view, one of the main objections was that the parties to the merger had overlapping units and lacked complementation in their operations: One-third of HP’s revenue came from the PC, notebooks and servers, while half of Compaq’s revenue were derived from the same product lines; and furthermore, the Unix servers of both were also similar. Secondly, there was an issue of how to integrate their PC divisions inasmuch as HP outsourced all of its manufacturing work while Compaq had been trying to move into build-to-order manufacturing for several years. A survey of employees’ attitudes towards the prospective combination disclosed the prevalence of low morale with opposition having a 2:1 preponderance over those in favor, as the merger was going to result in the elimination of thousands of jobs at the two companies; however, chairman Carly Fiorina refuted the claim by saying that HP’s own survey showed the contrary. She justified the cutting of about 15,000 jobs within the next several months by saying that it was for the purpose of “returning important businesses to profitability.” Drawing from past experience and observation, some on the opposite fence of the debate said that the nature of the PC industry was such that the mergers and acquisitions were fraught with difficulty and rarely worked, that it was hard to find a successful outcome of one PC company buying another, the benefit accruing only in terms of acquiring the customer base. Proponents of the Merger Those who favored the merger, headed by chairman Fiorina herself, said that recession and bitter competition from main rivals Dell and IBM left the two competitors HP and Compaq no choice but to consolidate to cut costs and streamline product categories, adding that the merger would result in a cost synergy of $2.5 billion a year. (Hewlett Packard and Compaq Agree to Merge, 2001). It was, she said, an effective way to deal with the cost pressure caused by Dell Computer. Inasmuch as the NT server business was doing poorly, the merger should address the problem of loss of revenues and momentum in generating sales and profits. “We can create substantial shareowner value through significant cost structure improvements and access to new growth opportunities. At a particularly challenging time for the IT industry, this combination vaults us into a leadership role with customers and partners -- together we will shape the industry for years,” Fiorina asserted. Both HP and Compaq had cooperated in the past and understood each other’s operations and capabilities. During the period of declining hardware sales both companies had cooperated in projects such as the joint efforts for e-commerce procurement. In January of that year, a Bear Stearns analyst had recommended that HP should buy Compaq and suggested that Gateway 2000 should sell out to a Japanese company or to Dell, and that IBM should sell its business for more services business. A merger with Compaq was supposed to result in the maximization of long-term value by exploring the HP’s assets rather than that HP spin off its profitable printer business as an alternative to a merger. Industry Analyst’s Verdict Later, a respected merger-analysis firm, Institutional Shareholder Services (ISS) of Rockville, Md, which plays a key role in many shareholder disputes by analyzing the issues and recommending how shareholders should vote, rejected the arguments of dissident HP board member Walter Hewlett, who had waged an intense campaign against the merger. Shareholders of both companies were to vote on the merger in two weeks. The ISS statement, according to Boston.com, says: "While Mr. Hewlett makes a credible case that the risks associated with the transaction are real and material, we believe that managements upside scenario is achievable.” (Merging Compaq with HP endorsed 2002) Merger Scenario During the proxy fight, the pros won by a light margin over the cons. Perhaps as indicator of the somewhat skeptical attitude of the market towards the merger the price of Hp dropped from $20 to $18.80, compared to $23.25 when the merger plan was announced. On the other hand, Compaq shares went up 78 cents at $11.14, compared to $12.35 at the merger plan announcement (Hewlett Packard Agree to Merge... n.d.). The effect of the merger was that Compaq share holders would receive .6325 shares of the new company for each share of Compaq. HP shareholders would own 64 per cent of the firm and Compaq 36 per cent. Company headquarters would remain at Palo Alto, California, but significant presence in Houston, headquarters of Compaq, would be maintained (Hewlett Packard and Compaq Agree to Merge, 2001). Results Year Later. Hewlett-Packard Chairman and CEO Carly Fiorina, who headed Hewlett-Packard Co. since 1999 and oversaw the largest merger in the U.S. technology sector, left the company in 2005 due to HPs poor performance after receiving a severance package of $14 million. She was immediately replaced by Mark Hurd. The results years later proved that the logic driving the merger was sound after all, and mainly because its new chairman and CEO Mark Hurd made it work. According to a Stanford GSB article, he set out to educating managers and employees on how to realize the projected cost and operational efficiencies and translate them into higher margins for each business unit. Because he exploited the possibilities of the merger, he was able to achieve a higher growth rate for the company (Compaq and HP: Ultimately, the Urge to Merge Was Right, 2007). Fiorina had built the groundwork for the goal setting and operational planning leading towards the strategic integration planning. However, during the implementation of the operational plans, she got too immersed in the complexity of the operational plan and the link towards the long-term direction was lost. There was a weak feedback loop between the operational integration phases and the long-term strategic goals of the merged company, preventing the management from testing the new strategy with key customers and responding with more flexibility to the longer-term shifts in the direction of the market. The team that formulated the plans during the pre-approval phases had been disbanded during the implementation phase and were not in a position to make its contributions to the plan execution. According to the Stanford GSB report (2007), Hurd did a better job of reading the strategic direction of the market and make adjustments considering its mission as a technology company. HP recorded $91.7 billion in revenues in 2006 compared to $91.4 billion for IBM. In 2007 that revenue was s$104 billion, making HP the first IT company in history to exceed the $100 billion mark (HP 2007 Annual Report). Conclusion It is too early to say that Hewlett Packard will be able to maintain its prime position in the PC industry on the basis of its 2007 results. A number of variables play a role, including the leadership, a culture of creativity and technological innovation, and harmonious relationship among member of the management team and workers coming from both companies. The industry is characterized by high cost and low profit margins. It is also an oligopoly where there is mutual interdependence in decision making. A move in terms of pricing can immediately trigger a response. The kinked demand curve gives one a good analysis of how the other players will respond to any price move (Baumol and Blinder, 1997; Truett and Truett, 2004). Innovations can be imitated with ease. A lot of proactive and flexible operational and strategic approaches will be required of the company if it has to maintain its lead. On the other hand, Dell and IBM are not sleeping and would no doubt launch their own aggressive campaigns to regain dominance in the industry. REFERENCES Baumol, W. J. & Blinder, A. S. (1997). Microeconomics: Principles and policy (7th ed.), Orlando, FL: The Dryden Press. Hill, C. W. L. (2001). Global Business Today (2nd ed.). New York: Irwin/McGraw Hill Hitt, M.A., Ireland, R.D., & Hoskisson, R.E. (1999). Strategic Management: Concepts, Competition and Globalization, (3rd ed.) Cincinnati, OH: South Western Publishing Co. HP 2007 Annual Report. Retrieved from http://media.corporate-ir.net/media_files/irol/71/71087/AR2007/index.html Truett, L.J. & Truett, D. B. (2004). Managerial economics: Analysis, problems, cases (8th ed.). Hoboken, NJ: John Wiley & Sons. HP declares victory in Compaq merger (2002, March 19). Retrieved June 24, 2008, from http://news.cnet.com/2100-1001-863432.html Fiorina: HP Expects $3 Billion in Savings (2002, December 3). Retrieved June 24, 2008 http://www.pcmag.com/article2/0,2817,745899,00.asp Merging Compaq with HP endorsed (2002, March 6). Retrieved June 23, 2008, from http://www.boston.com/dailyglobe/2002/03/06/business/pf/merging_compaq_with_hp.html Hewlett Packard and Compaq Agree to Merge (2001, September 3). Retrieved June 23, 2008, from http://www.hp.com/hpinfo/newsroom/press/2001/010904a.html Compaq and HP: Ultimately, the Urge to Merge Was Right (2007, June). Stanford Graduate School. of Business. Retrieved from http://www.gsb.stanford.edu/news/research/urgetomerge.html Read More