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45-770 Corporate Strategy

The Rise and Fall of Hewlett Packards Server Business

John Chiang (yutangc@tepper.cmu.edu)
Khanh Ngo (kngo@tepper.cmu.edu)
Raghavendra Venkata Prasad Palipi Kandubai (raghavev@tepper.cmu.edu)
Shoya "Shaw" Ojik (sojika@tepper.cmu.edu)

The nuances of Hewlett Packards server business encompasses a barrage of qualitative
conditions; with regards to a fast cycle, Hewlett Packard competed in an oligopolistic market where
significant technical competencies, extensive sales and marketing channels and server software
solutions served as barriers to entry. Garnering market share and substantial return on equity,
Hewlett Packard prospered as its technical strengths and expanded horizontally as an enterprise
solutions provider with computers, printers and software in its product portfolio. Hewlett Packard
prospered as corporations were willing to buy servers from only select vendors who could provide
a reliable server; after-all server downtime constitutes loss revenue for many web based
firms. Importantly, this factor alone however does not make Hewlett Packard an enthralling
business case study. With the advent of cloud based computing, where server demand is offloaded
to an array of servers hosted in the cloud, and with more corporations building their own servers,
Hewlett Packard can no longer claim a sustained market leadership in the server business and no
longer can claim disproportionate return on equity. Ultimately, Hewlett Packard must determine a
recourse to stem the decline in the server business and return one of their most profitable segments
back to growth.

A Brief History of the Server

A server is a computerized process that responds to requests across a computer network to
provide a network service. Depending on the function of the server some of the typical computing
servers are database server, file server, mail server, print server, web server, gaming server and
application server. The very first servers arrived on the technology landscape in the 1960s. They
were mainframe computers set up as time-sharing systems, allowing multiple tele-printer terminals
to share the use of one mainframe computer processor. This was common in business applications
and in science and engineering. IBM produced approximately 70% of all computers in 1964. In
1964 IBM introduced the 360 series mainframe computer, and soon it became the biggest player
in the server market. During the 1960s, the computer industry was characterized as 'IBM and the
seven dwarfs' because none of its competitors' revenue was even one-tenth of IBM's and soon they
all left the market scene. In 1970 IBM released the System/370 which continued to bring in the
cash flows. In the year 1981 IBM hosted a LISTSERV (a server that holds the mailing lists for
groups of users) on an IBM Virtual Machine Mainframe over the BITNET. The next significant
step in the server space was taken in the year 1991 when the World Wide Web was hosted on a
NeXTCube hardware. It was the first instance of a web server. In 1994 Compaq introduced the
first rack-mountable server, the ProLiant Series. In 2001, RLX Technologies, which consisted of
mostly former Compaq Computer Corp employees, shipped the first modern blade server. RLX
was acquired by Hewlett Packard in 2005. The server industry was dominated by IBM to the extent,
in 2000, IBMs servers revenue was 81% larger than the 2nd largest player Hewlett Packard.


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The IBM Model

In the 1950s and 1960s the big electronics firms tried to dominate the emerging computer
market by utilizing their core competency of electronics manufacturing and by using economies of
scale and scope. But these corporations with the most extensive knowledge of the technology
required to build computers failed against firms which had to build up these techniques from
scratch. By the early 1970s, most of these firms had abandoned commercial computer
manufacturing. Several reasons were identified for the failure of these giant electronics firms
they couldnt recognize that the industry was fast cycle, they frequently invested one cycle behind
in obsolete technology, they had large a portfolio of products and they divided very less funds to
their computer divisions, they lacked market awareness, they lacked the scale in sales and they
lacked the required expertise and experience in the marketing channels to sell to the vast consumer
market. To make the situation worse the barriers to entry kept increasing as technologies advanced
and the computer market expanded requiring a spiral of heavy investments.
IBM succeed where the other big electronics firms failed as it had market knowledge - with
its products already in the first and second generation phases when the electronic firms made their
foray into the computer systems market. IBM had market knowledge that consumers were going
away from the second generation punched card systems to integrated circuit based computers. But
what they lacked in electronics and computing skills they made up by acquisitions of smaller
computer operations. Thus, IBM negated the barriers to entry erected by the big electronics firms
but the electronic firms with no sales and marketing skills couldnt compete through the retail
market with IBM.
Michael Porter suggested that scale economies in production, research, marketing and
service (as discovered to their chagrin by Xerox and GE) are the key barriers to entry in the
mainframe computer industry (which was the early server industry). IBM served as the template
which allowed Hewlett Packard to copy many of the companys barriers to entry. Hewlett Packard
has erected substantial barriers based on technological progressiveness in industries like calculators
and minicomputers, where other firms are following strategies based on experience and scale.

Entry of Hewlett Packard

Hewlett Packard entered the server market in 1973 through its Hewlett Packard 3000 series
minicomputers which allowed time sharing. It garnered a reputation for reliability and power and
took market share from IBMs mainframes. The key to the tremendous success of the Hewlett
Packard 3000 was the bundling of the Hewlett Packard-developed network database management
system IMAGE. By bundling IMAGE with the server, Hewlett Packard created an ecosystem of
applications and development utilities that could rely upon IMAGE as a data repository in any
Hewlett Packard 3000. Additional reasons for the success of the 3000 series were that they were
more reliable compared to the competition, and they sold in greater number than IBM computers
for their ability to recover from power failures. The issues that plagued Hewlett Packard 3000 were
the peripheral support delays and Hewlett Packards product strategy in terms of not supporting
peripherals for Hewlett Packard 3000 though supporting them for Hewlett Packard 9000
hardware. The Hewlett Packard 3000 has enjoyed one of the longest lifetimes for any business
computer system. It began shipping in the year 1973 and new models continued to ship till the year
2003. It is still used by many clients and Hewlett Packard continued to support the series through
2006 and there is an ecosystem of companies providing support to the clients who are still using
servers of that series. Hewlett Packard followed up their 3000 series with HP 9000 series in the
year 1984, HP Integrity servers since 2003, the Superdome servers since 2010.


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Sustaining Core Competency through M&A

A core competency is a specific factor that a business sees as central to the way the
company or its employees work. It fulfils three key criteria:
1. It is not easy for competitors to imitate.
2. It can be reused widely for many products and markets.
3. It must contribute to the end consumer's experienced benefits and the value of the product
or service to its customers.
A core competency can take various forms, including technical/subject matter know-how,
a reliable process and/or close relationships with customers and suppliers. It may also include
product development or culture, such as employee dedication, best Human Resource Management
(HRM), good market coverage, etc. Core competencies are particular strengths relative to other
organizations in the industry, which provide the fundamental basis for the provision of added
value. It includes communication, involvement and a deep commitment to working across
organizational boundaries.
Although Hewlett Packard had entered the server market with the Hewlett Packard 3000,
it had already been building core competencies; after all, the technical prowess to build and
maintain servers does not arise overnight. In the early years, Hewlett Packards core competency
was high-quality electronic test and measurement equipment. However, Hewlett Packard achieved
a new set of core competencies by utilizing M&A. HP bought Data Systems Inc in 1964 and with
it got the rights to a computer design called the DSI 1000. It formed a new computer division with
internal and DSI employees and in 1966, Hewlett Packard entered the computer market with
minicomputers. In 1968, Hewlett Packard began marketing the worlds first marketed, massproduced personal computer. The first mass produced computer helped Hewlett Packard develop
strengths in engineering, manufacturing, technological innovation, and management of
innovation. More importantly, by using its strength in the personal computer market, Hewlett
Packard could use its technical prowess to develop the Hewlett Packard 3000. The ability to
produce mass computers was directly translatable to building mass servers, as Hewlett Packard
leveraged its manufacturing strengths to another segment. The process of M&A building the core
competency of the company was followed again in the year 1989 when Apollo Computers was
acquired by HP. After the acquisition, HP integrated much of the Apollo technology into their
second generation servers and workstations, the HP 9000 series. The next major acquisition was of
Compaq in 2002 which gave HP access to low end server market through the ProLiant brand which
lead the x86 server market in revenues and units sold.
Additionally the tradition of engineering helps Hewlett Packard maintain a core
competency. Hewlett Packard has been able to recruit the most proficient engineers from the
Silicon Valley, and continue to grow the firms engineering prowess. Core competencies reflect
the collective learning of an organization and involve coordinating diverse production skills and
integrating multiple streams of technologies. Where other companies focus purely on
manufacturing, maintaining a strong base of engineers allows Hewlett Packard to leverage its
engineering strengths to other segments. Having a pool of engineers allows Hewlett Packard to not
only write software for its servers, but leverage its talent into server services. The ability to bundle
services along with its hardware is one of HPs competencies that continues to be unmatched.

Horizontal integration
Horizontal integration is the process of acquiring or merging with industry competitors to
achieve the competitive advantages that come with large scale and scope. Horizontal integration
allows companies to grow, and therefore to realize economies of scale. This is especially important

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in industries with high fixed costs. Another benefit of horizontal integration is the cost savings
due to reducing duplication between the two companies, for example, eliminating duplicate
headquarter offices. In addition, horizontal integration can allow the company to offer a wider
range of products that can be sold together for a single price, a strategy called product
bundling. Customers value the convenience of bundled products, leading to differentiation.
Horizontal integration facilitates another strategy, similar to bundling, called a total
solution. Hewlett Packards long-term strategy is focused on leveraging its portfolio of hardware,
software and services as they adapt to a changing/hybrid model of IT delivery and consumption
driven by the growing adoption of cloud computing and increased demand for integrated IT
solutions. This is an important strategy in the industry, where corporate customers prefer the ease
and coordination of purchasing all their hardware and service from a single source. To successfully
execute on this strategy, Hewlett Packard needs to continue to further evolve the focus of its
organization towards the delivery of integrated IT solutions for its customers and to invest and
expand into cloud computing, security, and information management and analytics.
The ESSN segment provides server, storage and networking products that fulfil a wide
range of customer needs and market requirements. Hewlett-Packards Converged Infrastructure
portfolio of servers, storage and networking combined with its Cloud Service Automation software
suite creates the Hewlett Packard Cloud System. This integrated solution enables enterprise and
service-provider clients to deliver infrastructure, platform and software-as-a-service in a private,
public or hybrid cloud environment. By providing a broad portfolio of server, storage and
networking solutions, ESSN aims to optimize the combined product solutions required by different
customers and provide solutions for a wide range of operating environments, spanning both the
enterprise and the SMB markets.

Mergers & Acquisitions

In 2003, Hewlett Packard merged with Compaq. The synergy benefit followed by Hewlett
Packard and Compaq is cost leadership. After merger the cost of material purchased has been
reduced by 3%- 4% of both the companies. Here Hewlett Packard focused upon cost reduction and
to capture more market share. The company was quite successful in doing so, as the gross profit
ratio has been decreased from 2001 (28.61%) to 2003 (25.51%), as the figures show 3.1% change
and the objective of cost reduction has been achieved. There was a huge opportunity in the market
and industry, which promoted stronger as well as a stable growth. The 2002 sales figures of Hewlett
Packard was $56,588 million which was increased by 29.11% and reached up to $73,061 million
in 2003 which once again got projection of 9.37% and reached the level of $79,905 million in 2004.
Here the objective of the company to grow has been achieved after doing merger.
Also, in 2008 Hewlett Packard bought out Electronic Data System. With this acquisition, Hewlett
Packard intended to provide an opportunity to increase the depth and breadth of its relationships
with its partners and enable more integrated solutions for clients.
In 2011, Hewlett Packard completed the $12bn (7.8bn) buyout of UK software firm
Autonomy. According to press releases, the acquisition positions Hewlett Packard as a leader in
the large and growing enterprise information management space. Autonomys software offerings
power more than 25,000 customer accounts worldwide and, as part of Hewlett Packard, will
provide high-value business solutions to help customers manage the explosion of unstructured and
structured information. Autonomy offers solutions that are complementary across Hewlett
Packards enterprise offerings and strengthens the companys data analytics, cloud, and industry
and workflow management capabilities.


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Throughout these M&As, Hewlett Packard mainly intended to accomplish geographical or

revenue diversification, economies of scale or scope, horizontal integration, increased revenue or
market share and cross-selling of complementary products.
On 20 November 2012, Hewlett Packard announced that it was taking a write off of $8.8
billion of the $11.1 billion that it paid to acquire Autonomy in October 2010. Hewlett Packards
key argument is that they overpaid for Autonomy because of accounting manipulation. Even if
Hewlett Packard is right, it is said that accounting manipulation only accounts for $2.45 billion of
the $8.8 billion write off. The write off raises issues about the acquisition in terms of corporate
strategy, leadership, corporate governance as well as the accuracy of Autonomys accounts. Also,
we learned that it is said that about 70% of M&A deals fail. The seven major reasons are lack of
knowledge, no common vision, bad surprises, under resourced merger teams, poor governance,
inadequate communication, and weak program management. This failure can be derived from a
combination of these seven major reasons.

Current Market Situation

In 2012 the worldwide server market decreased by 1.9% compared to 2011 to 51.3 billion
revenues. According to IDC, in Q2 2013, the worldwide server market decrease 6.2% year over
year, which is actually the sixth time in the previous seven quarters that the worldwide server
market has experienced a year over year revenue decline. In this section of the report, we will look
further into the life cycle change of server and competition arisen in the server market, which we
think contributes the decreasing worldwide server revenue in the past couple of quarters.
(1) Server life cycle changes with requirements for fewer but more powerful servers
Many analysts observed that server replacement cycles these days generally run toward
three years from previous six to seven years. According to Richard McCormack, senior vice
president of Fujitsu America's server and solutions, virtualization would be the primary force
accelerating the pace of server life cycle. With the requirement of fewer but more powerful
virtualized machines built in companies owned places to handle some critical and scale up tasks,
more and more companies are willing to use server vendors cloud service to deal with other
computing tasks and data storage, by which they may save operation and administration cost.
Besides virtualization, the need to meet demands imposed by new and more powerful
software, such as applications incorporating multimedia, analytics or other processors to do
memory-intensive operations, provides another strong motivation for upgrading servers more
rapidly. A seemingly endless array of new or upgraded regulatory mandates is another factor
behind faster server turnarounds.
Some companies who predicted such trend and acted accordingly have better performance
result. For example, IBMs revenue from System z can improve solidly in the Q1 2013 is partly
due to the continuation of a refresh cycle. But IBM still has been hurt by its server of Unix systems
that are stuck in a valley of a four to six year upgrade cycle. Hewlett Packard faced the same issue
as well.


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(2) Competition from Cloud

Virtualization not only shortened the life cycle of physical servers, it became a competition
force to rob traditional server vendors market share. Keeping the focus on consolidation,
virtualization, and migration initiatives aimed at increasing efficiency and lowering data centre
infrastructure costs, mainstream SMB and enterprise server customers around the world are turning
to operations like Amazon Web Services or Rackspace Hosting Inc instead of buying and
maintaining their own servers. The trend adds to a pressures for server makers.
To respond to the competition, Hewlett Packard also built its own cloud service by working
with VMwares Cloud Foundry and OpenStack, an open source platform founded by NASA and
Rackspace. Hewlett Packard is building a public cloud, but in using OpenStack, it also wants to
create a service that dovetails with private clouds set up behind the firewall. Though the reality is
that physical server market revenues are hurt by cloud service at the moment, some people still
believe in the long term the demand for physical server will bounce again when enterprise face
more powerful machines to support more complication application and services I do think the
cloud in the short term has a negative impact," says John Chamber, Cisco's chief executive. "But
in the long term the impact is positive." Moreover, many companies have reasons to keep running
their own servers, particularly firms in regulated industries such as financial services.
(3) Demand decrease
Besides challenging economic conditions are dampening demand for new servers that may
be used for new IT projects, some biggest internet companies also caused some negative impact to
server vendors. They are building their own data centre by working directly with ODM companies,
which means their demand from traditional server vendor decrease. Google was the first big
company to purchase directly from Taiwans ODM companies like Quanta, Inventec, and
Wistron. Facebook has followed and probably Amazon has.
These big internet companies that have massive, internally developed applications has
reasonable interest to do so. For example, by rolling its own data centre, Facebook eliminates some
gratuitous differentiation, hardware features that make servers unique but do not benefit
Facebook. For example, the extra instrumentation on the motherboard, not only does it cost money
to purchase it from a materials perspective, but it also causes complexity in operations. Facebook
says it gets 24 percent financial savings from having a lower-cost infrastructure, and it saves 38
percent in ongoing operational costs as a result of building its own stuff.
Actually not every company are suitable for such business model. There are some
reasons. First, Most enterprise need a lot of server vendor support when dealing with complicated
integrated applications. Secondly, they cant buy from these ODM companies, because big
software companies such as Microsoft or VMware often dont support their products on these
systems. Gartner lumps the ODM market into the 20 percent of the server market sold by other
vendors, rather than the market-leading vendors like Hewlett Packard, IBM or Dell.

Industry structural analysis and Share Loss

Server market is an oligopoly market. Few players run the market for a long period and
basically have some price control capability. General speaking, there are two main kinds of server,
"standard" or x86 servers and non-x86, while x86 servers accounts for 75% of the market. But
while technology advances, more and more new servers launched to the market to try to win more
market shares. ODM and OEM companies are no longer satisfied with being hidden behind but

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look for running their own brands or developing new business opportunities. At the same time,
cloud market developing is another strong threat. Traditional leading server brands face
increasingly intense competition. There is a trend that companies are increasingly considering x86
servers for mission critical and other traditional scale-up solutions and non-x86 servers for
innovative, cost effective, and integrated solutions for analytics, cloud, mobile , and social
platforms. So, how can these traditional server market leaders find their own new niche in the
market become extremely critical.
Hewlett Packard, IBM and Dell are the top 3 leading brand. The competition is intense,
especially among Hewlett Packard and IBM, which changes the first place position from quarter
to quarter in the past five years. Please see below diagram. IBM has obvious peak in Q4, while
Hewlett Packard has more stable revenue among the whole year.

Server Market Share

09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 13Q1 13Q4





While looking at Q2 2013, IBM becomes the market leader again. What worth mentioning
is Dell and Cisco were the two big winners in Q2, because they find isolated server market
opportunities. Dell has great sales performance on its density-optimized servers, which are
favoured by large service providers and Internet companies. Dell has 60.5% market share for this
density-optimized servers. Although Hewlett Packard also launched their Moonshot server for the
hyper scale market, it didnt bring Hewlett Packard as much advantages as expected. Ciscos
increase also relies on the booming market for hyper scale servers used in virtualization data centres.
Below we use SWOT analysis to summarize Hewlett Packards current position in the
server market.


1. Hewlett Packard is uniquely positioned to

deliver software solution to manage server
lifecycle, cost control and operation efficiency.

1. Struggle with its server game plan

recently and thus lose first mover advantage
in some server market, like densityoptimized servers.

2. Hewlett Packard has product diversity:

server, IT total solution, service, and software
solution which can offer customers flexibility
when facing fast changing technology.

2. Mainstream server weakness was driven

by execution challenges, competitive pricing
and a misaligned go-to-market model.

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3. Strong brand reputation and well-built

channel. All time winner for global server
shipment volume.


1. Asia/Pacific market, where has 10% revenue

growth rate in Q2 2013.
2. The cloud computing market is expected to
grow by an average of 22% each year from
2011 to 2020.

1. Dell is lower-cost competitor. Hewlett

Packard is losing share at a staggering rate,
and they are losing it to Dell.
2. Cloud service vendors like Amazon Web
Service, Rackspace, Microsoft etc.

3. The new requirements of server service for

small and middle sized businesses (SMBs).
As Hewlett Packard continues to struggle to define its server game plan in the below section,
we will focus on Hewlett Packards strategy to turn around the current situation.

Recourse Strategy
In order to stem the rapid convergence and delay economic time, Hewlett Packard must
realign their business segment to anticipate changing business demands from their web technical
customers. While Hewlett Packard could previously delay economic time by relying upon the
naivet of corporations whose core competencies exclude server maintenance and implementation,
Hewlett Packards current generation of customers have the technical prowess and core
competencies to circumvent OEM server manufacturers entirely. Companies like Google, Apple,
and Facebook do not demand the bundling of server software tools and extraneous server
components that allowed Hewlett Packard to command premium margins in the standard cycle;
effectively, they evade Hewlett Packards value chain and staircase strategy of tying customers
OEM hardware and enterprise services.

Children Eating
In order to negate the core competencies of web technical companies, Hewlett Packard
must employ two tactics. Hewlett Packard must become a children eater and trade margins for
market share. Rather than bundling extraneous software and extra components, Hewlett Packard
must cater to the technical prowess of its customers. By building bare bone servers that do not
carry a software mark-up or extraneous component mark-up, Hewlett Packard can use its previous
fast cycle strengths to pivot away from its current extreme fast cycle conditions. Given that the
primary customers of Hewlett Packard servers demand certainty and reliability, with web based
companies server downtime constitutes loss revenue, Hewlett Packards reliable brand reputation
should give barebones servers a premium.

The second tactic Hewlett Packard must employ similarly relates to realigning products
closer to technology companys needs. The majority of operating expenses for companies like

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Google or Apple lie in server electricity costs. In order to minimize operating expenses, these
companies have prudently shifted from power hungry Intel X86 chips, which frequently command
higher margins, to low power efficient non-proprietary ARM chips; the same chips that are often
found in cell phone, as they are touted for their minimal electrical imprint. However, there exists
a significant first mover advantage that Hewlett Packard must utilize. Since most server software
is written for the X86 architecture, server software for chips based on the low power ARM
architecture must be redeveloped. Since most of this software is open source and no company can
capitalize upon it, Hewlett Packard is misguidedly reticent to developing hardware and software
for ARM servers. Developing hardware and software decouples the staircase bundling that Hewlett
Packard has previously enjoyed, selling hardware and server services. However, Hewlett Packard
must align their portfolio in line with the needs of these technology companies and become children

Demand Creation
Competing server companies like Dell and Lenovo will readily release ARM based servers
if Hewlett Packard fails to develop their own. Hewlett Packard can differentiate itself from other
OEM manufactures because it can develop ARM based server hardware, ARM based server
software tools, and an integrated solution; Lenovo and Dell cannot since this strays from their core
competencies do not lie in software solutions. Although this strategy entails writing server
software for low margins implied with ARM processors, Hewlett Packard has the competency to
develop an integrated hardware and software solution for ARM based servers commanding a
market premium (Google and Apple do not want to recode all their software tools). Hewlett
Packard must employ this children eating strategy lest Dell and Lenovo capitalize first off the
ARM server business.

Brand Differentiation
Although Hewlett Packard must drastically adopt changes to react to changing consumer
demand from their technically competent customers, it must adopt a different strategy for
companies that still demand a bundled hardware and server solution. Hewlett Packard must
differentiate between its bare bone server offerings to technology based companies and fully
integrated server solutions. Companies like Goldman Sachs or McDonalds, have core
competencies that are not aligned towards server maintenance. Therefore, they must be convinced
that it is worthy to pay premiums for an integrated solution. Hewlett Packard must differentiate
these products by complementing their server hardware with solutions for their less technical
clients like, integrated 24/7 customer support and enterprise firewall solutions. Hewlett -Packard
can also continue to preserve their strong margins along this customer segment. Hewlett Packard
should continue with their staircase strategy of selling hardware, software, and maintenance
solutions to their less technical clients.



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