One of our local newspapers is running a series on the problems of public transportation in the San Francisco Bay Area. The problem seems to be that ridership is well off of plan. The economy, and its attendant reduction in jobs and squeeze on commuter pocketbooks, has reduced demand.
Virtually all of the authorities in charge of the various modes of public transportation have found the same magic elixir for this sickness. They plan to reduce services and raise prices at the same time. Let’s see now. We find that demand is off and our answer is to reduce what people can get for their money (offer less) and to charge them more to get that “less.” How is this likely to work? This will work only if the authorities can raise the prices enough to offset the likely accelerated loss in commuter revenues that the Price increase and Performance decrease is likely to bring.
Let’s use a few simple concepts to express better what is taking place. Any business offers a Value to its customers. The Value is a combination of the Performance the business offers the customer plus the Price the business charges. The Performance includes Benefits such as Features, Reliability and Convenience of purchase. The company must beat its competition in offering this Value in order to grow market share. Right now customers are telling public transportation authorities that the current level of service for the price charged is not high enough to keep all of them using public transportation.
The business supports its Performance with its Cost Structure. The company’s Cost Structure must allow the business to make a margin on the sale of the product to the customer. Here again, the business must have a Cost Structure at least as productive as that of its competition or its margins will be lower than those of the competition. Most of these public transportation authorities are losing money. They may not be less productive than direct competitors because there are so few of those kinds of competitors. However, they are less competitive than the consumer’s alternative, perhaps even the consumer’s own automobile.
A business in a loss position has negative margins. Costs are greater than revenues. The business has two levers to pull in order to get out of this situation, other than stringent cost reduction on the current Cost Structure. First, it may raise Prices and hope that the additional revenues on the customers who stay will be greater than the revenues lost by customers who leave due to the higher price. Second, it may reduce the Performance it offers the customer as well as the costs that support that Performance. As costs come down, margins may increase, as long as customers do not defect. In extreme situations, a business may raise Prices and reduce Performance at the same time.
How extreme is this radical approach of raising Prices and reducing Performance at the same time (gutting the former Value proposition)? Over the years we have evaluated thousands of Price increases. We have found that companies are able to raise Price and reduce Performance at the same time in about 3% of the cases where Prices rise in an industry. When you see this kind of an action, you can usually assume that the industry has very strong pricing power. (See the Perspective, “Who Has Pricing Power?” on StrategyStreet.com.) For example, HP and Lexmark International launched lower capacity ink cartridges with smaller price tags to try and counter the growth of off-brand printer ink sellers. These cartridges had starting prices below $15 a cartridge but their cost per ounce of ink was higher than the predecessor products. In another case, the cable T.V. industry for years prospered by raising prices well in excess of inflation at the same time as forcing consumers to buy packages of channels, including many channels the customers did not want or ever use.
Occasionally, you also see the phenomenon of a raised Price and decreased Performance in an act of desperation to save the business. (See the Symptom & Implication, “New competition is entering a settled market” on StrategyStreet.com.) The airline industry has begun charging for previously free services, such as checking bags and serving onboard meals at the same time that its prices have gradually risen. The legacy airlines may have no choice. The difference, in this case, is that the airline industry is operating at higher levels of utilization and actually has a bit of pricing power today. Newspaper publishers have raised prices and reduced coverage in their print products to stay alive. The outlook for public transportation, and some other industries in desperate need, such as newspapers, is grim.
Showing posts with label HP. Show all posts
Showing posts with label HP. Show all posts
Tuesday, February 2, 2010
Monday, June 2, 2008
HP and EDS: The Cost Case
This entry is the third in our series of four entries on the HP/EDS 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 these 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 Cost Case
The cost outlook for this acquisition is surely positive. The cost reduction opportunities are plentiful.
EDS was slow to shift some of its infrastructure to lower cost countries, such as India, so it starts out with high operating costs. EDS has operating margins of 6%, which are half those of IBM, and lower than those of HP in the services business. The combination of the two companies will have enough overhead overlap to allow significant cost savings.
HP, as the acquirer, is better positioned to reduce costs. HP’s CEO has proven himself to be an effective cost manager. The HP management group has been fire-tried in the hardware business. The hardware business is much tougher than the services business because it is closer to a commodity with standard features. Cost is always an important element of the hardware business. The combined company is virtually certain to see significant reductions in unit costs.
In our fourth and last entry, we will summarize our conclusions on this combination.
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 these 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 Cost Case
The cost outlook for this acquisition is surely positive. The cost reduction opportunities are plentiful.
EDS was slow to shift some of its infrastructure to lower cost countries, such as India, so it starts out with high operating costs. EDS has operating margins of 6%, which are half those of IBM, and lower than those of HP in the services business. The combination of the two companies will have enough overhead overlap to allow significant cost savings.
HP, as the acquirer, is better positioned to reduce costs. HP’s CEO has proven himself to be an effective cost manager. The HP management group has been fire-tried in the hardware business. The hardware business is much tougher than the services business because it is closer to a commodity with standard features. Cost is always an important element of the hardware business. The combined company is virtually certain to see significant reductions in unit costs.
In our fourth and last entry, we will summarize our conclusions on this combination.
Thursday, May 29, 2008
HP and EDS: The Customer Case
This entry is the second in our series of four entries on the HP/EDS 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 these 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 Customer Case
It is likely that this combination will improve the customer base for the combined company. Since the products are complementary, it is likely that the buyers of those products are complementary as well. Both current companies would thus have access to new sets of customers.
In addition, the combined company will appeal to more customers than either of the former companies in their stand-alone state because the combination is able to offer a broader product line to those sets of customers who need those broader services. The new company comes closer to a one-stop shop.
You might ask yourself whether the stronger company could not win customers away from the weaker company, rather than having one buy the other. That is unlikely. Even at the relatively high annual growth rates in the market of 8-10%, it is becoming increasingly difficult for companies to gain a great deal of market share by taking customers away from competition. A good acquisition, on the other hand, does shift customers. (See the Perspective, “Acqusitions: The Buy or Win Decision” in StrategyStreet.com/Tools/Perspectives.)
In our next blog entry on this merger, we will talk about the cost driver behind this combination.
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 these 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 Customer Case
It is likely that this combination will improve the customer base for the combined company. Since the products are complementary, it is likely that the buyers of those products are complementary as well. Both current companies would thus have access to new sets of customers.
In addition, the combined company will appeal to more customers than either of the former companies in their stand-alone state because the combination is able to offer a broader product line to those sets of customers who need those broader services. The new company comes closer to a one-stop shop.
You might ask yourself whether the stronger company could not win customers away from the weaker company, rather than having one buy the other. That is unlikely. Even at the relatively high annual growth rates in the market of 8-10%, it is becoming increasingly difficult for companies to gain a great deal of market share by taking customers away from competition. A good acquisition, on the other hand, does shift customers. (See the Perspective, “Acqusitions: The Buy or Win Decision” in StrategyStreet.com/Tools/Perspectives.)
In our next blog entry on this merger, we will talk about the cost driver behind this combination.
Tuesday, May 27, 2008
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.
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.
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