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HP/COMPAQ: Can the HP way become the Compaq way?

Experts say the writing was on the wall, but a gasp of surprise could still be heard industrywide Tuesday after officials for both Hewlett-Packard (HP) and Compaq announced they would pursue a merger.

The plan calls for HP to acquire Compaq in an all-stock purchase valued at $US25 billion, according to officials for both companies. The target competition is enterprise IT service leader IBM, the worldwide leader in IT service revenue according to International Data Corp. (IDC).

In the last few years, HP and Compaq each have been companies in the midst of internal transformations. Both have been in near lock-step on decisions concerning the importance of promoting IT services over standalone products, as well as the decision by each manufacturer to abandon high-end PA-RISC computing platforms to develop along Intel's Itanium processor family.

Those similarities aside, industry experts see a long, tough road ahead for HP and Compaq as they move toward becoming one.

"We think the operation will be successful as long as the patient doesn't die on the operating table. There is a lot of risk associated in making this move, mostly around execution, integration, and services," said John Gantz, senior IDC analyst.

Like many industry experts, Gantz points to overlapping service and product offerings from HP and Compaq as a potential nemesis to a smooth consolidation of the two company's resources.

"You can go down the list, product line by product line, and find synergies and cost savings, but the issue will be how they can pull the whole thing together into an integrated whole that ends up being competitive with IBM," Gantz said.

Todd Kort, a principal analyst at Gartner Group, agrees that identical product catalogs from HP and Compaq make a merger difficult to understand. Because of this, Kort believes that although a merger between HP and Compaq is likely to be approved by regulating bodies, the two companies may very well find reason to throw in the towel before a merger is complete.

"I'm pretty negative about this," said Kort. "I think there is so much overlap that I find it hard to understand how [a merger] makes sense. And just like the PricewaterhouseCoopers [acquisition attempt by HP] that eventually fell apart, there are so many questions about [the HP and Compaq] deal that I think [HP and Compaq executives] might revisit the issue and say this really doesn't buy anything against IBM or Dell."

Opposing corporate cultures will add an additional degree of difficulty as HP and Compaq proceed towards a merger.

"It took IBM six or seven years to pull its act together, and now HP and Compaq have a similar chore ahead of them. You have two distinct companies with two distinct cultures at work. Last I looked the way Compaq assimilated DEC, it didn't work out so great for along long time," said Dana Gardner, senior analyst at Aberdeen Group.

"HP outsources almost 100 per cent of its manufacturing and Compaq does almost 100 per cent of its own manufacturing. If HP pulls out all of its business partnerships and tries to bring it to Compaq, it will destroy a lot of hard-won business relationships," Gardner said.

Workforce reductions as well as the fact that HP and Compaq are former foes also complicates the cultural issues separating the two companies, said Ashok Kumar, an industry analyst at US Bancorp Piper Jaffray.

"There are many potential pitfalls in executing this strategy. To realise the projected $2.5 billion in cost savings will require a large number of layoffs, including in the server area," said Kumar. "HP has already endured multiple rounds of layoffs under CEO Carly Fiorina, and many have not been handled well, resulting in poor morale. Compaq employees have been trained to view HP in a hostile fashion; soothing these feelings will not be simple. A major challenge will be retaining key personnel through the massive restructuring that the merger will require."

"This seems a marriage of desperation and contraction rather than one of mutual benefit and growth," said Aberdeen's Gardner. "They both will have to do away with a bunch of resources and layoffs. It is not the kind of merger that makes you conjure up the whole being greater than the sum of the parts."

"Both of them are still major league IT companies, but each worried that they might be demoted into the minors," said Rick Partridge, a senior research analyst at D.H. Brown. "They were worried that of the economy gets too bad, they may find themselves with a diminished market share."

As HP and Compaq begin to sort out their separate sales channel issues, deciding who gets what where accounts begin to overlap, direct PC sellers Dell and Gateway could stand to gain.

"Right now Dell has to be watering at the mouth," said Kort. "And I think that if I'm Gateway I'm happy about the deal as well. Compaq and HP are big in the consumer market. If they don't have to compete hard against one another, then they give Gateway more breathing room. If Gateway holds on for another year, that might be about the time this merger takes place, and that could be a win for Gateway."

"Dell will be invited to bid on any enterprise deal," said Kort, "simply because they force others to lower their prices."

Then there is the issue surrounding printers. Compaq re-sells printers from HP competitor Lexmark. With printer powerhouse HP calling the shots on what brand of printer gets bundled with a PC, Compaq will have to usher out Lexmark.

"In terms of the printer business, this is a good move for HP in the consumer space. They get more desktops out there that they can sell printers to," Gantz said.

Experts agree time is of the essence in finalizing any merger between HP and Compaq.

"It is likely the thing could lead to delayed decisions on some very important issues. They might lose some speed in decision-making during this integration period which is always bad, something your toughest competitors could easily exploit," Gantz said.

Partridge agrees. "Any delay will take the wind out of their sails. If they can capture that excitement, outstanding. But if they have to take nine months off while they battle over details, well, IBM isn't going to stand still. Competitors will try to strengthen their positions. The challenge is to keep the appropriate momentum."