Problem
Client: You must have heard the recent breaking news that HP has overtaken Dell as the largest seller of PCs. However, today, HP stock went down, where as Dell stock went up. HP is worried, and has been worried for the past few years. Their board ousted Carly Fiorina last year and hired a new CEO. Now, the chairman of the board herself was ousted amidst spying scandals. The new CEO wants to improve the bottom line and have hired your firm to strategize how to out-compete Dell. Dell seems to be winning marketing battles not only on PCs and storage business, but is also aggressively nibbling away at HP’s market share in its very profitable printers business. Here are the income statements for the last three years for both HP and Dell, and all data is in thousands:
What would you advise HP’s corporate management to do?
Solution
(Note: The client's / interviewer's words are in italics, and the consulant's words are in bold.)Consultant: From the data presented, it seems like Dell’s gross margins are lower compared to HP’s. Dell’s latest gross margins are 9.95 / 55.908 = 18%, where as HP’s margins are 20.472/86.696 = 23.6%. Yet, Dell had more than $3.5 billion net profits out of $56 billion revenue, where as HP could muster only $2.4 billion out of a significantly higher revenue of $87 billion! In other words, Dell’s profit margins are 3.572/ 55.908 = 6.4%, where as HP’s net profit margins are only 2.398/86.696= 2.8%. It is not even half of Dell’s 6.4%.
Client:Yes, that is why HP
has hired your firm, so that you can give sound advise on how it can improve
its profit margins. Can you tell me how you should begin? Do you want to
calculate any other margins, like the operating margins, perhaps?
Consultant: Yes, I was going to
say that HP is spending significantly more in both R&D and SG&A (sales,
general, and administrative). HP spent almost $4 billion in R&D, where as
Dell spent less than half a billion. Compared to Dell’s $5 billion in sales and
administrative expenses, HP spent $11 billion. For starters, let’s calculate
the operating margins. Dell’s operating margins are 4.347/55.908 = 7.7%, where
as HP’s operating margins are 3.689/86.696 = 4.2 %. So, HP’s operating expenses
are dragging the margins down. HP’s operating margins are 4.2/7.7= 55% of
Dell’s. In other words, Dell is operationally far superior, and no wonder, its
stock keeps going up, while HP’s went down today.
So, what would be your
advice to the HP corporate management? Cut costs?
Definitely. PCs are increasingly commoditized, and from HP’s gross margins which are higher to Dell’s, it is clear that they probably enjoy a good bargaining power with the contract manufacturers who make these PCs for Dell, HP, Acer, IBM, etc. in Taiwan and China. However, when it comes to operating margins, Dell is eating all the cake. They are not spending anything on R&D, and way less on sales. Probably Dell’s DellDirect Internet sales channel helps them a lot to keep sales costs down. HP should definitely explore that model, and divert part of its R&D expenses to investigate that. What are the major components of HP’s R&D initiatives. What are its major distribution channels? Do we have any information on that?
Sure, HP considers its R&D to be a core competency. After all, it is still considered to be the mother of all Silicon Valley computer companies: it consumed Tandem Computers from Cupertino a few years ago, and then acquired Compaq, primarily to out compete Dell. A significant portion of its R&D goes into creating innovative printers, and more than 20% of HP’s businss still comes from its printing business line. Cutting R&D will jeopardize future growth of its printing business, among others. R&D is HP’s competitive advantage. HP’s annual statement states that its competitive advantages include our broad portfolio, our innovation and research and development capabilities, and the availability of our products directly from HP or through our HP channel partners.So, they will probably not like the idea of cutting R&D expenses.
OK, we can come back to R&D later, if time permits. Once you add the R&D of $3.4 billion to the COGS (cost of goods sold) of $66 billion, the re-defined gross margins for HP become (20.472 - 3.49)/86.696 = 19.5%, which are still higher than Dell’s gross margin of 18%. So, it is clear that higher SG&A expenses are the reason HP’s operating margins are lower than Dell’s. Unless they cut costs in SG&A, Dell will continue to be operationally more efficient. So, can we discuss in more detail HP’s sales operations, to start with? What are its existing distribution channels and who are its channel partners? Does it have a direct sales force which can be pruned?
Yes, there might be room
to prune the direct sales force. Direct sales is one of the channels. Indirect sales
channels are strategic, and provide HP a competitive advantage, as I already
mentioned. So, going into the details at this stage will not make sense, since
HP enjoys significant bargaining power with these channel partners. What other
ideas do you have in reducing SG&A?
What are the other causes why SG&A is so high? Is it the payroll of HP’s consulting services arm? Do you have any details you can share with me on HP’s services business?
Yes, the principal areas in which HP Services (HPS) competes are technology services, consulting and integration and managed services. The technology services and consulting and integration markets have been under significant pressure as customers scrutinize their IT spending. However, this trend has benefited the managed services business as customers attempt to reduce their IT costs and focus their resources on their core businesses. In this segment, the key competitors include IBM Global Services and the services businesses of other technology products organizations, as well as Electronic Data Systems Corporation, Accenture and other systems integration firms. Many of these competitors are able to offer a wide range of services through a global network of service providers, and some of these competitors enjoy significant brand recognition. HPS teams with many services companies to extend its reach and augment its capabilities. HPS’ competitive advantages include its global delivery organization, its deep technical expertise, its diagnostic and IT management tools, and the flexibility and choice it offers its customers.
You mentioned IBM Global Services and Accenture. You also mentioned HP’s global delivery organization. I am aware that both IBM Global Services and Accenture continue to hire systems professionals in India while cutting payroll in US, to take advantage of the labor arbitrage. How aggressive is HP in its recruiting efforts in India?
They have a delivery organization to cater to Indian clients. Are you suggesting that HPS should study the IBM Global Services model more closely, and recruit in India for delivery of systems in US, like IBM and Accenture do?
Definitely. That will bring HPS’ costs down, because a software engineer here costs five times as much as it costs in India. Further, HP Labs could also move some of its research operations overseas, like Microsoft is doing in China and Russia.
OK, what else would you suggest to bring down SG&A?
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