This entry is the last 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 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.
Our Conclusion
As we explained in the previous three blog entries, the combination is likely to succeed in all three of the major objectives of an acquisition. It improves the product offering. It opens up the combined company to new customers. And it is virtually certain to reduce the unit costs the company incurs. A successful acquisition almost always requires success in two of the three objectives in order to make economic sense. This combination meets all three objectives.
This combination is essential to shift market share.
There is a hidden force behind the business logic for the merger between HP and EDS in the computer services industry. The hidden force is the dominance of “failure” in normal market share movement.
Failure moves more market share than does success in most mature markets (see the Perspective, “Failure Shifts More Share Than Success” in StrategyStreet.com/Tools/Perspectives). In most fast-growing markets, there are many opportunities to “win” market share. You “win” market share by offering customers something that other competitors can not, or will not, offer them. But as markets become more mature and growth slows, “winning” market share becomes much more difficult. The reason? Competitors copy the most obvious innovations. These obvious innovations tend to be product Functions or unique Pricing schemes.
Once an industry reaches a slower growth level of maturity, “failure” tends to drive far more market share than does success. By “failure”, we mean that an incumbent supplier does not meet the customers’ expectations. These customer expectations are the result of the customer’s beliefs about the product offerings of other competitors. The “failing” incumbent can not offer the Functions, Reliability, Convenience or Price that the customer expects and “fails” the customer. This “failure” causes the customer to open his relationship to other suppliers.
Once a market becomes “failure” driven, it takes many years to move significant market share from one competitor to another. Then, acquisitions become important to growth and profitability. Of course, these acquisitions have value only to the extent that the acquiring company is able to retain the purchased customers (see “Acquiring Share, Not Sand” in StrategyStreet.com/Tools/Perspectives).
Despite the fact that the #2 and #5 competitors in the marketplace are combining to compete more effectively with the #1 competitor, you should expect little or no price pressure to emerge in the market as a result. This market is highly fragmented with the top competitors holding only 20% of it. That leaves another 80% of the market served by smaller firms. The larger, more sophisticated competitors should grow at the expense of smaller companies, a typical evolution in fragmented markets. Furthermore, the growth in the marketplace, at 8-10% per annum, means that the infrastructure of the industry has to double every eight to ten years. This takes capital and profits and, therefore, reasonable prices.
This combination is a very good bet for success. Not a sure bet, but certainly a good one. However, it is unlikely to be successful very quickly. IBM stumbled for several years as it created a strong services business. IBM bought a consulting firm to help it improve its service offerings. The integration of its acquired consulting firm proved difficult and costly. IBM got over that hurdle and now has a profitable and fast-growing business. I expect that this HP/EDS combination will become far more profitable and fast growing than either current company, even if there are some bumps in the road.
Showing posts with label acquistions. Show all posts
Showing posts with label acquistions. Show all posts
Wednesday, June 4, 2008
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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