Mark Hurd’s Real Legacy at Hewlett-Packard: Reverticalization

The somewhat lurid circumstances surrounding Mark Hurd’s resignation Friday as chief executive of Palo Alto, CA-based Hewlett-Packard have left plenty of room for gossip. Hurd stepped aside after a board investigation into a sexual harassment claim by a former marketing contractor; the board cleared Hurd of the harassment allegation, but found that he’d fudged expense reports to hide payments to the woman, who, it emerged over the weekend, is a former actress named Jodie Fisher.

For HP insiders, the episode must feel like a painful echo of previous executive departures, notably that of former board chair Patricia Dunn, who stepped down after a corporate espionage episode came to light in 2006. Now employees and shareholders must wait while interim CEO Cathie Lesjak, formerly the company’s chief financial officer, works to contain the damage and find a replacement.

But more significant than the scandal and the gossip, in the long run, will be the market’s assessment of Hurd’s record as a promoter of growth, innovation, and strategic change within HP. And the biggest lesson here—one that Hurd’s successor would be wise to learn—may be that vertical integration pays. The company’s biggest successes in recent years have come from taking manufacturing, software, and services—components of the computer industry that have been largely scattered since the 1980s—and tying them back together.

Certainly, Hurd leaves HP in a much sounder financial state than when the former NCR executive was chosen in early 2005 to rebuild the company after years of disappointing performance under former CEO Carly Fiorina. Net revenue grew from $86 billion in 2005 to $115 billion in 2009, increasing through the recession and helping the company to surpass even longtime rival IBM to become the world’s second-largest information technology company by revenue (trailing only Korea’s Samsung). While HP’s stock dipped nearly 10 percent on Friday following the announcement of Hurd’s departure, that same stock had more than doubled on Hurd’s watch, from a low of around $20 per share in April 2005 to the $43-$53 range this year.

In the market for consumer PCs, long the foundation of HP’s business, the company bounded forward under Hurd’s leadership, regaining the No. 1 spot in global market share from Dell in 2006. It’s held on to that ranking ever since, despite a major dip in PC purchasing in 2008-2009. In 2009 the company also became the leading supplier of PCs to the U.S. enterprise market, and it’s consistently in close competition with IBM to supply the most enterprise servers.

Between 2004 and 2009, HP spent $17 billion on research and development and $20 billion on acquisitions, capping off a buying spree with the purchase of infotech giants Electronic Data Systems (EDS), 3Com, and Palm. “The corporation is exceptionally well positioned strategically,” Hurd said in a statement announcing his resignation. “HP has an extremely talented executive team supported by a dedicated and customer focused work force. I expect that the company will continue to be successful in the future.”

To the extent that Hurd’s prediction comes true, some observers believe, it may be thanks to his own aggressive effort to extend HP’s product lines, making the company into a one-stop shop in many of the markets where it plays.

In the realm of corporate data centers, for example, the acquisition of Opsware in 2007 and of 3Com this year brought the company networking software and switches to layer atop its server and storage technology. In corporate computer services, the acquisition of EDS in 2008 brought HP an enterprise IT outsourcing division to help big companies run the same hardware and software that it was selling to them. And while competitors like IBM have exited the PC market, HP has doubled down: since its controversial $25 billion acquisition of Compaq in 2002, now seen as Fiorina’s most important legacy, the company has invested tens of billions more either building its own factories to make PC components or forming long-term partnerships with suppliers.

David Tennenhouse, a former Intel research director who’s now a partner at San Mateo, CA-based New Venture Partners, calls this strategy “reverticalization”—in essence, a return to the vertical integration that characterized the computer industry until the 1980s. Before that time, the dominant hardware makers (think IBM, Burroughs, Unisys, NCR, Control Data, Honeywell, DEC, Prime, Wang, Data General, and HP) also sold the proprietary systems software, applications, and services needed to make their machines useful. But then came the rise of giants like Intel and Microsoft, who supplied basic platforms like CPUs and operating systems and supported a broad, horizontal system of specialization in areas like storage, peripherals, networking, and of course, software.

“There is a tendency to assume that horizontalization is the way the world should be, but it’s probably just one swing of the pendulum,” says Tennenhouse. “I think HP has done a masterful job of staying ahead of the swing, and realizing that the swing worked for HP and so jumping on it and swinging harder.”

In the PC business, the printer business, and the enterprise computing business, HP’s vertical integration “doesn’t go all the way down to the silicon, which is still horizontal, but they have really reverticalized everything going up,” says Tennenhouse. In fact, HP’s successes cutting costs through consolidation and then gaining market share may have galvanized other infotech powerhouses to follow suit. “I’m not sure what Oracle’s thinking was around the Sun acquisition, but a certain amount of it must have been just looking at what those other guys are doing,” says Tennenhouse. “I wouldn’t give Mark Hurd credit for driving the whole landscape, but you can certainly say that a lot has changed on his watch, and he was a leading player in it.”

Parts of HP’s reverticalization effort are half-formed and incomplete, of course. HP hasn’t made its own semiconductors since spinning off Agilent in 1999, though it has a close partnership with AMD, and there’s even been speculation that the perpetual second-place chipmaker might be one of HP’s next big takeover targets. (Apple and IBM are also mentioned as potential acquirers.)

And it’s not clear what role Hurd envisioned for Palm inside HP, although the obvious speculation is that HP hopes to emulate Apple’s success pursuing a vertical model in the smartphone and tablet market. (Palm was probably more valuable for WebOS, its smartphone operating system, than for its actual devices, which aren’t best-sellers.)

But in smartphones and tablets, HP will have to compete not just with Apple itself, but with an expressly horizontal model in the Google-led Android initiative, which is gaining steam quickly. So the pendulum keeps swinging—but for now, the departing CEO seems to have HP riding it in the right direction.

Wade Roush is the producer and host of the podcast Soonish and a contributing editor at Xconomy. Follow @soonishpodcast

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