The incredible shrinking company

By Felix Salmon
August 22, 2013

Christopher Mims has a good piece on Meg Whitman’s Hewlett-Packard today, pointing out that the company’s success (at least as measured by its stock price) over the past year or so is in large part due to her cost-cutting abilities.

Mims doesn’t mention that this strategy is hardly new for HP: it was executed with just as much success under Mark Hurd. The really big errors at HP have taken place at the board level, both in terms of hiring and firing CEOs and in terms of approving ridiculous over-ambitious acquisitions. When it puts its mind to it, HP turns out to be pretty good at shrinking. It’s growth which turns out to be where the pitfalls lie.

Which is why I’d take issue with Mims here:

A more efficient, better-managed HP doesn’t mean much in the long run if the company cannot move beyond the stagnating businesses that make half of its current revenue—PCs and printers…

Without any innovative consumer products to speak of, HP is essentially at the mercy of big businesses’ appetite for technology. And they seem to be wanting less and less of whatever HP is selling…

While she’s managing HP’s consolidation and retreat admirably, is she the CEO who can get the company to once again break the mold? Given her background as head of eBay, a company that changed little under her decade-long rule, we have to be dubious.

I can understand where Mims is coming from. HP is a technology company, and under the unspoken rules of the US stock market, all public companies, and especially all technology companies, should constantly be growing as fast as possible. It’s the inexorable mathematics of discounting: if a company can deliver consistent growth which is faster than the prevailing discount rate used to calculate net present value, then its stock price should, by rights, be infinite. Consequently, given that infinite upside, it’s worth risking quite a lot to achieve growth.

But the facts are pretty plain: (a) HP is very good at producing excellent products in the shrinking markets which make up most of its business right now; (b) HP has in recent years shown no particular ability to produce excellent products in other markets; (c) Meg Whitman is not by nature a visionary innovator. Given those facts, it makes perfect sense for HP to run its existing businesses as efficiently and as profitably as it can, and to extract as much value out of them as possible, in the knowledge that all companies are mortal. In fact, it makes more sense to do that than it does to follow the Tim Armstrong playbook, where AOL’s CEO decided to take his enviable dial-up revenue stream and invest it in doomed content plays like Patch.

John Kay had an excellent column on this subject yesterday, under the headline “sometimes the best that a company can hope for is death”. He finds the genesis for the Mims view in the work of marketing guru Theodore Levitt, who said 50 years ago that companies can and should reinvent themselves in imaginative ways. Levitt was wrong, says Kay: what really matters is not imaginative executives, but rather competitive advantage. HP has a competitive advantage making PCs and printers and servers; that doesn’t mean that it can readily apply that competitive advantage elsewhere.

Kay’s example of JC Penney is a good one. Bill Ackman looked at Penney and saw it as a company in the “retail” bucket, just as Mims looks at HP and sees a company in the “technology” bucket. Ackman then looked for the biggest retail success story he could find — Apple — and tried to inject Apple-style success into JC Penney by hiring Apple’s Ron Johnson as Penney’s CEO. That didn’t work:

The outlets of both JC Penney and Apple are shops but the age group and disposable incomes of their customers – and their reasons for visiting the stores – were entirely different: JC Penney and Apple were not really in the same business.

Penney was not going to succeed by looking at successes elsewhere in the retail space and trying to copy them with little regard for its own existing strengths. And similarly, if HP decides to “break the mold” again, the inevitable consequence will be yet further billions in avoidable write-downs. Once upon a time, HP had a legendary R&D operation — but that operation fell victim to Hurd’s cost-cutting, and in any case no R&D shop can maintain excellence forever. The HP board knows that, which is why they were open to ambitious acquisitions; they simply failed to notice that the acquisitions in question were fundamentally really bad deals.

In general, the stock market’s bias towards growth makes it very difficult for a public-company CEO to execute a strategy of shrinking profitably. Maybe at some point, as a result, Whitman will decide to take HP private, or will accept a takeover offer from a private-equity shop. But for the time being, an ambitious growth strategy is the last thing that HP needs.

It’s not easy to excel in a shrinking business: as Kay says, it goes against human nature to accept that there might be a natural life cycle for a company. But if you work with the cycle, rather than against it, it’s still possible to get extremely impressive results. Just look, for example, at Lehman Brothers International Europe — the bankrupt entity which has been spending the past five years quietly trying to repay its creditors as much money as it can. The latest news? Those creditors are going to be repaid 100 cents on the dollar — including statutory interest at 8%. As a result, some Lehman claims are trading at as much as 120 cents on the dollar.

The best thing for Whitman to do, then, is to accept that HP’s core business is in decline, but to still execute that core business as efficiently as possible. That takes a very different style of management than Silicon Valley is used to, but it can be done. And it’s much more likely to work than some Hail Mary acquisition attempt.

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