Why HP went for Compaq

Merely "a defensive strategy brought on by negative financial conditions"?

HP's $25bn takeover of Compaq has shocked and surprised an industry still wiping its blurry eyes after a summer rest. Like the AOL Time Warner merger - which focused minds still fuddled with millennium hangovers - the deal forces everyone working in technology to sit up and take notice. Where to start? The first thing about this mega-merger is the massive overlap in products. Both are leaders in the PC market. Both big players in the mid-range Intel-based server market. Both have handheld devices. Both also play in the storage arena. Take a brief glance at the new, bigger HP, and its capabilities don't look that different from the old one - it just looks fatter (or bloated, perhaps). An HP acquisition of PwC last year would have given the computing company new capabilities - specifically a services arm to rival the best of them. But it couldn't make it, and has therefore turned in another more familiar direction. But being bloated will lead to the quickest, most obvious changes. Most analysts believe the combined company will only stand a chance if it makes swingeing job cuts - on top of those already announced by both firms this year. Plants and facilities will close across the world and, given the amount of duplication, it will not be just the factory workers that will get the boot - management up to the most senior levels will feel the pain. Andy Hill, managing analyst at Datamonitor, put it succinctly: "The only way to make the deal work is if management is prepared to wield the axe really pretty savagely. There's a lot of overlap - there's going to be a massive cull." Today is not a good day to wake up a Compaq employee. The amount of job cuts which will inevitably be required indicates how this deal should be viewed: it's one of consolidation, not so much expansion. HP says it will offer the most complete set of IT products and services for businesses and consumers, but the deal does little to expand the reach of either player. Martin Hingley, VP at analyst house IDC, said: "What can you get from the combined company that you couldn't get from either firm beforehand? This is the product of a defensive strategy brought on by the negative financial conditions in the US." Datamonitor's Hill agreed. "This proves that PC manufacturing is just not a good business to be in anymore," he said. Both CEOs, HP's Carly Fiorina and Compaq's Michael Capellas, pledged to turn their companies into fully-fledged services organisations - but neither have quite succeeded. Clive Longbottom, strategy partner at Quocirca, doesn't mince his words: "If both Carly and Michael had done what they said they'd do when they took over then they both wouldn't be in the mess they're in." With the hardware market becoming ever more commoditised most pundits say IT services are where efforts should be concentrated - consultants usually mean juicy profit margins. Some commentators have already compared the new HP to IBM - whose success with its Global Services division is unparalleled. Yet this argument doesn't quite stand up. The new HP has only half the staff and half the revenues of IBM Global Services in its equivalent division and additionally work has not been as high value, rarely going beyond systems integration. Certainly the reaction of the services companies' seems to confirm that opinion. Services giant CSC has come out today to say it is glad HP has chosen to stick to its core competency as a product company, and give up on being a services player. HP and Compaq also have the problem of dealing with integrating the two firms, a process not due to complete until the end of 2002. It is tempting to envisage champagne corks popping at Dell, IBM and Sun offices today knowing one of their biggest competitors will have its eye off the ball for at least 12 months. There are other hurdles as well. The merger has yet to be ratified by shareholders and yet to be cleared by the regulators Consolidation between two leading players in a market is rare and inevitably brings with it competition concerns. This takeover will be no different. Of course it is too early to say how excited the relevant regulators will get about this, but if the EC's recent record is anything to go by, HP shouldn't bank on an easy ride. We will know more in a month when the EU will decide whether it wants to take its initial glance at the merger into a full investigation. Edward Hoare, competition law partner at law firm Hobson Audley, said: "If I was a betting man, I'd say this will go into the next phase of investigation - one thing you know is the EC will not bow to political pressure on this." Of course the merger is not all bad news and, if completed, will form a formidable competitor to anyone in the hardware market. The new HP may end up the unassailable leader of the PC, server, printer and handheld device markets, finally putting an end to Dell's top spot dreams. But it is hard not to notice the immediate decrease in customer choice the merger will bring, as well as the uncertainty of current HP and Compaq customers suddenly having their product roadmaps thrown out of the window. About 90 days ago Capellas said he had just 180 days to save his company. No one thought his answer would be to sell it. In the circumstances, it's not so surprising he took Carly's offer - more that HP made it in the first place. As both customers and employees of the two firms today reconsider their futures, one can't help but wonder if this move is just a frightened over-reaction to the current downturn. And one that will do little to benefit them, or the industry as a whole.