Rebuilding, The HP WayRebuilding, The HP Way

In a powder-blue, pin-striped pantsuit, Carly Fiorina doesn't look like a CEO who's feeling the strain of a good thing gone bad. Cool and confident are more like it. In a conference room on Hewlett-Packard's campus near the paneled offices that once served HP co-founders William Hewlett and David Packard, Fiorina reiterates the strategy she's been working on since coming to HP two years ago: To sell the services, software, systems, and devices needed to provision IT as a "service" via 24-by-7 technology infrastructures.

In concept, it sounds like a daring way to re-invent the computer company that was founded in 1939 in a Palo Alto, Calif., garage, but which grew so big and diverse that it lost its edge. Fiorina, who's also HP's chairwoman, told a group of analysts two months ago that a lack of focus created fragmentation and complexity at the company. "And that meant that we were sometimes too timid, too confused, too slow," she said.

In practice, the turnaround job--reorganizing and consolidating dozens of business units, rallying 93,000 employees around a new mission, and communicating a new strategy to business customers--hasn't been easy. "I don't know what their strategy is," admits James Hatch, CIO and VP with Pactiv Corp., a packaging-materials company in Lake Forest, Ill. Earlier this year, Pactiv standardized on HP servers, but Hatch says HP's grand plan had little to do with his decision. Rather, Pactiv needed to simplify its IT architecture and already has in-house expertise in HP systems. Of HP, he says: "They're hard to do business with. It's hard to know who the thought leaders are, how to establish a truly in-depth partnership."

The suddenness of the economic downturn has only complicated the reinvention of HP. "None of this is easy," Fiorina says.

That's an understatement. In the first six months of this year, HP issued repeated warnings that it would fall short of sales expectations--chipping away at Fiorina's credibility in the process. Fiorina defends HP's financial-forecasting record, arguing that HP saw trouble coming before most technology companies. The company paid the price on the stock market for admitting it. "I didn't like calling it earlier than most people," she says. "You get the crap kicked out of you."

There have been two rounds of layoffs: 1,700 marketing positions in January and 3,000 management positions in April. Earlier this month, HP asked employees to take pay cuts or use accumulated vacation days as a cost-saving measure. The near-term outlook isn't any better. The company is forecasting that revenue will be flat or will decline in its third fiscal quarter, which ends July 31, and its stock is trading near its 52-week low. It's little wonder that Fiorina herself is in the hot seat.

So why does she remain upbeat? Largely overlooked in all the bad news, she says, are some significant advances. Though HP's sales are declining during the IT spending slump, it's gaining market share in some parts of the ink-jet printer, computer server, storage, and services markets. In the first three months of this year, the company acquired XML middleware specialist Bluestone Software, joined with other vendors in creating an open-source development lab, and extended a partnership with Qwest Communications Inc. that strengthens its position in the hosting market. "The economy has clouded a lot of people's perceptions of what's really going on here," Fiorina says.

HP's services organization has been a bright spot and will be critical to realizing Fiorina's broader vision for the company. She elevated the group--which has more than 20,000 professionals--to business-unit status in March and named 19-year HP veteran Ann Livermore as its president. Within the unit, consulting revenue shot up 33% in HP's second fiscal quarter ended April 30, compared with the same period a year ago, while revenue from outsourcing jumped 23%. Overall, HP's services business, which includes financing, grew 9% in the quarter, helping to mitigate declines in other areas of the company. Companywide, second-quarter sales declined 4% to $11.6 billion, and operating income plunged 64% to $324 million.

Last year, a bold attempt to significantly expand HP's services organization unraveled when a deal to acquire PricewaterhouseCoopers fell through. Now, HP is taking smaller steps. Last week, it revealed plans to acquire Comdisco Inc.'s disaster-recovery business for $610 million, a move that would give HP immediate capabilities in consulting and support for that niche.

HP's increasing strength in services, Fiorina says, stems from the company's reputation for strong systems support. Volt Information Sciences Inc. in New York became a believer when it called on HP last month to repair a critical Fibre Channel card that had failed in an N-class server. HP responded within two hours, less than half the time specified in the services contract. Volt bought three HP Unix servers two years ago and has deployed HP PCs on 700 desktops since then. Daniel Hallihan, corporate VP of accounting operations at Volt, sees Fiorina's hand at work. "Initially they told us, 'Here's the boxes you want,' but HP is moving to become a seller with significant levels of service and support," he says.

HP isn't the first computer hardware company to stake future growth on IT services; IBM has already mastered this formula, and earlier this month Compaq revealed plans to pursue a similar tack (see "Compaq's Challenge,"). But neither fact deters Fiorina, who, if she's the target of some harsh opinions, can also dish them out. IBM, she says, "basically asks customers to outsource the status quo." And "all Compaq has done is follow our strategy by nine months, to the letter."

Another critical step has been HP's ability to reconnect with its top corporate accounts. When Fiorina joined HP in 1999, sales to the company's top 100 accounts had actually been declining. But by assigning relationship managers to those accounts and better coordinating sales teams, it's managed to turn that around. Last year, HP realized 30% growth in its top corporate accounts, Fiorina says. And in the first quarter of fiscal 2001, which was disappointing in many other respects, sales to those accounts were up more than 20%.

To stay on that track, HP will have to demonstrate bottom-line results to senior technology managers. What, for example, can HP do to help CIOs looking for ways to cut costs? Or harder still: How can HP help companies apply technology to their competitive advantage while at the same time help them cope with tighter IT budgets?

Those aren't rhetorical questions. They're posed by Jerry Miller, CIO and senior VP of Sears, Roebuck and Co., and presented to Fiorina by information. Her answers: Cut costs by consolidating servers and storage, and gain advantage by transforming supply-chain and other business processes and using IT to do it. "There are a lot of business processes sitting in retail that need to be transformed," she says. "That's why I say there's a big difference between outsourcing the status quo and coming in and saying, 'Let's transform the business process and the technology platform that goes along with it.'"

What Fiorina and other HP executives have in mind is getting the company's services, software, and hardware offerings working together to form the foundation for what they call "always-on Internet infrastructures." Using them, business IT departments can deliver IT as a service to the business units they support, and service providers can do the same for businesses that want to outsource management of their IT. "It's about building a computing capability that, instead of being a collection of fairly static boxes networked together in a pretty inefficient way, is a network environment that's flexible, that can be dynamically reallocated based upon real-time requirements," Fiorina says. Another way to think of it: delivering IT as a utility, like water or electricity.

The hardest part about overhauling HP to deliver the IT utility concept is making the many different parts--software, enterprise hardware, and services--fit into a coherent whole. Fiorina and her team of executives are trying to do that by combining and focusing product offerings in some cases and eliminating them in others. In the first quarter, HP unveiled two broad software suites, under the Netaction and OpenView brand names, that pull together products that had been marketed separately. It has also sold off or killed a half-dozen software products that didn't fit its plan. Three examples: Smart Contact, a telemarketing application developed by HP Labs, was sold to Cisco Systems. Upgrades to OpenMail, an E-mail client with little market share, have been discontinued. And Verifone, an online payment company, is being sold to the buyout firm Gores Technology Group.

What's left is a sizable software unit that concentrates on middleware and network and systems management. In fact, without disclosing actual sales, Bill Russell, VP of software solutions at HP, says the company's software business generates enough licensing revenue that it would rank in the world's 10 largest software companies if it were an independent entity. "You don't think of HP as a software company," Russell acknowledges. "We're looking to change that." In the second quarter, HP's software business grew 15%, compared with a year earlier, driven largely by a 28% increase in sales of OpenView.

But HP faces some well-established competitors. BEA Systems, IBM, iPlanet E-Commerce Solutions, and Oracle already have a grip on the Web application server market, while BMC Software, Computer Associates, IBM's Tivoli subsidiary, and Micromuse go head-to-head with OpenView in systems and network management. So what makes HP's software strategy special? "We'll have product capabilities others don't have," Russell says. "If you probe behind the covers, they're not all the same."

The acquisition of Bluestone's Java-and XML-based application servers and tools and experienced software engineers certainly helped. Other key products include Opencall, a platform for developing and deploying wireless voice services; E-speak, which handles the registration of Web services; and Internet Usage Manager, an Internet metering tool.

Charles Phillips, a software industry analyst with Morgan Stanley Dean Witter, says there's nothing unique about HP's effort to position itself as an enterprise software company. "Every hardware company fashions themselves as a software player," he says. Even so, Phillips says, HP's products in this area are "stronger than people think."

For all its technical skill, however, HP has never really had the marketing sizzle needed for the software business. Russell has been a good troubleshooter who's cleaned house and brought in new capabilities, Gartner analyst Paul McGuckin says, but HP still acts like a hardware supplier first and a software provider second. Sun Microsystems' CEO Scott McNealy "tells a story, the marketing people create a few buzzwords, and businesspeople are seduced by the image and vision of Java," McGuckin says. "HP is the polar opposite. They have excellent technology, with difficulty explaining it in ways that are compelling to customers."

HP was one of the first technology companies to discuss the concept of Web services, but it's done little to capitalize on the idea. In contrast, Microsoft has successfully focused industry attention on its own Web-services initiative, Microsoft.Net. Fiorina and her team may be working hard to create a unified HP product-service offering, but some customers are getting impatient. "I know it's a lot to bring hardware in line with services and security, but I'd like HP to deliver the E-business Web services second generation that was promised more than a year ago," says Lisa Harris, senior VP and CIO at $3.15 billion Staff Leasing Inc., a human-resources outsourcer in Bradenton, Fla.

HP has a more-established reputation in the enterprise system hardware market. Overall revenue for the company's computing systems business declined 7% in the second quarter, compared with a year earlier, but there was this highlight: Sales of high-end Unix systems actually grew 3%. Last fall, HP began shipping its new Superdome server, which scales to 64 CPUs, and the company says orders are strong. Without a credible high-end server, HP would have a hard time convincing customers to consolidate operations on large servers as part of its utility concept.

Duane Zitzner, president of HP's computing-systems division, says HP's server effort is focused on reliability and scalability, and for that, HP generally gets good marks from its customers. Charlie Bell, VP of IT infrastructure with Amazon.com Inc., says HP systems stayed up 100% of the time through the E-retailer's holiday shopping crunch late last year. "That's when people like me are usually getting paged and losing sleep," Bell says. Adds Staff Leasing's Harris: "I was a Sun fanatic two years ago, but now I think HP has high availability, reliability, and scalability over Sun and IBM."

Zitzner calls those the "abilities," but success with these factors will hardly make HP stand out in the server market. IT managers have come to expect that computer vendors will make steady improvements on such measurements. So what's the differentiator? Fiorina points to HP's development work with Intel on the 64-bit Itanium chip launched last month. "We understand how to tune that chip better than anybody else," she says. But Compaq and Intel's joint announcement just a few weeks ago, promising to work together to put Intel chips in all Compaq high-end servers, showed that HP's advantage may be short-lived--if one exists at all.

Too often, HP still isn't even in the high-end game. Kim Ross, CIO of demographic and market-research company Nielsen Media Research in Dunedin, Fla., has relied on Sun as the core of the company's 180-server system, and his desire to consider competitors' products should be an opportunity for HP. "I've never taken a first step with HP," he says. "HP never got that high up on the screen."

One way HP expects to get noticed is new pricing options for hardware, including the pay-as-you-go utility model that other hardware companies are beginning to offer (see story, p. 20). HP says it's ready to help businesses put the IT-as-utility model to work. It recently began offering an IT leasing option called Power Plant, through which IT departments can lease rather than buy computer systems and pay only for what's needed. In January, the company unveiled

e-Utilica, a turnkey data center that can be used by service providers to offer pay-per-use storage and computing services. The company is also using its own IT department as a model of how its grand strategy could work. HP merged its central IT department and its outsourcing unit to form HP Operations, which manages HP's own IT needs and serves outside customers.

HP is a behind-the-scenes player in an application-hosting service that TRW Systems provides to the U.S. Army. TRW Systems in Reston, Va., is the $4.5 billion systems-integration business unit for automotive parts and aerospace manufacturer TRW Corp. In the next one to two years, TRW Systems and HP will install thin clients with wireless capabilities on Army trucks and maintain servers in safe data centers that can be located anywhere in the world. Tim Daley, director of ASP services for TRW Systems, says his group will survive while other application service providers struggle and fail because he bears no capital costs. "HP owns it, manages it, and replaces it," Daley says. "All I have is an operating expense, as if it was electricity."

The pay-as-you-go model will require patience on the part of HP, Daley predicts, because profit requires high volume--and the market's not delivering that yet. The good news for HP is that Daley sees HP's vision as a differentiator from IBM and Sun. "HP has embraced this, and the competitors haven't," he says.

HP faces some pretty obvious roadblocks to success: a soft economy, tighter IT budgets, across-the-board competition, and an unforgiving market for technology stocks. But there's also a bigger, nagging question about HP's ambitious strategy: Is it taking on too much? HP generated $49.9 billion in revenue last year, but 40% of that--and more than half of its profit--came from its printer-and-ink business. It's an important cash cow, but one that's arguably tangential to HP's strategic goal of being the always-on infrastructure expert. Remove ink and printers from the equation, and HP is a $30 billion business competing in three major IT categories--services, software, and computer hardware--against a Who's Who of the IT industry: Compaq, Dell Computer, IBM, Microsoft, and Sun.

Despite growing pressure from impatient analysts and investors, Fiorina shows no sign of wavering. "We will not sacrifice our strategy for a few cents in a current quarter," she said at the analysts' meeting in May.

Last month, on the 25th anniversary of her own graduation from Stanford University, the self-described "Type A" personality recounted her rise to the top of corporate management in a commencement speech to Stanford's graduating class of 2001: "I knew that with this job would come a fair bit of scrutiny and criticism. I left fear behind."

That's a good thing. With the end of the third quarter a week away, things could get tougher for HP--and its fearless leader.