Thursday, 22 November 2012

HP Needs a New Way

I have a particular fondness for HP because I remember reading "The HP Way" when it first came out in 1995. The book is written by David Packard and tells the story of HP from the beginning. In the book Packard explains that he is not a big fan of the MBA degree but is more interested in the MBWA (Management By Walking Around). HP's success was built on excellent products, technological innovation, knowing the customers, and adapting to change.After reading the book, I though, "wow! what an amazing company". HP was admired by many people and many business cases were written about it. HP is after all, credited as the founder of Silicon Valley.
In the 2000s HP pursued an aggressive expansion strategy that involved buying big companies (the merger with Compaq in 2002, the acquisition of EDS in 2008, the acquisition of 3Com in 2009 and the buyout of Palm in 2010). With this many big deals in such a relatively short period of time, critics wondered where the synergies were coming from. Along the way, HP had a number of product issues and accounting issues.
Now the company is in a death spiral. The stock is now trading at a 10 year low after recently announcing a $8.8 billion write-down and poor quarterly results (see here). HP is reeling from its $11 billion purchase of Autonomy. This was a move designed to help HP move farther into software and services (something that IBM has successfully done).

Over the past 2 years HP is down almost 70%. DELL has also had a difficult past 2 years, while  MSFT is holding steady.

HP can be compared with its competitors to see how efficient it is. To calculate technical efficiency I use data envelope analysis (DEA).  DEA is a non-parametric approach to the estimation of production functions. I use three inputs (employees, total assets, total operating costs) and one output (total revenues). Data are averages over the years 2004 - 2011. For those interested in the technical details, I use the 2 stage input approach with variable returns to scale (VRS).

The DEA results are presented in the above table. Total technical efficiency (CRS_TE) can be broken down into pure technical efficiency (VRS_TE) and a scale effect. The total technical efficiency measures indicate that Apple, Google, Dell, Microsoft and Accenture are efficient since their CRS_TE measures are equal to one. Cisco and HP are inefficient. HP. for example, can reduce its inputs by 1% and still produce the same output. In the case of HP, the pure technical efficiency measure of 1 indicates that allocation of inputs to output is efficient and the inefficiencies are coming from the scale effect which measures the size of the company. HP exhibits decreasing returns to scale (RTS) which means that given its production possibility frontier it is producing too much output. Value creation under decreasing returns to scale is difficult because decreasing returns to scale means that HP needs to get smaller.

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