HP and EDS: The Product Case

This entry is the first in our series of four entries on the HP/ED deal.

The Setting

Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion on revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.

A company undertakes an acquisition to achieve one or more of three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.

The Product Case

Combining these two companies is an important, but not the final, step toward answering the product needs of HP in the marketplace. The combination of the two product lines is positive since the two current lines are complementary. EDS covers more of the services business than does HP. EDS offers many services, including running mainframe systems, help desks and managing billing and payroll systems. The HP services business is more attuned to supporting its hardware product sales. It is best known for managing infrastructure, such as server systems.

The bad news is that both HP and EDS are losing market share in the computer services industry. The industry is growing at 8-10% a year. Both HP and EDS have slower growth rates. Both companies suffer from some kind of performance problem, i.e., the Functionality, Reliability or Convenience of the product purchase. (See the Perspective “How Customers Buy” in the Tools/Perspectives section of StrategyStreet.com.) The combined company will have to overcome these market weaknesses to become a star performer.

IBM, the market leader, offers Functionality that the combined company does not offer today. IBM offers a broader array of business consulting skills than either HP or EDS possess. IBM uses these superior consulting skills to create capabilities that are unique in the marketplace. And because these skills are unique, they command a price premium. This price premium explains at least part of the differences in the operating profits of IBM compared to its peers in services.

This combination certainly increases the product portfolio of both companies. In order to round out that portfolio, another acquisition involving a company or companies that have broader business consulting skills is necessary and likely.

In our next blog entry on this merger, we will talk about the combined company’s prospects for customer acquisition.