December 4, 2002 4:32 PM PST

HP: The feast is in the trimmings

SAN FRANCISCO--When Hewlett-Packard talks about its progress since its acquisition of Compaq Computer seven months ago, the discussion inevitably turns to how the company is trimming its costs.

So far, HP has measured the success of its merger in large part by its headway in cutting costs. The company's initial goal was to trim $2.5 billion in costs by 2004. Then, in June, HP said it could reach that amount by fiscal 2003 and cut $3 billion in cost savings by 2004. On Wednesday, HP said it plans to trim all $3 billion in costs by the end of the current fiscal year.

The question now is how long HP will be able to benefit from lower costs--or put another way, when will the company need to start growing sales to meet its earnings targets?

The computer giant can probably look forward to at least one more year of earnings growth on the back of a slimmer payroll. HP has forecasted just 2 percent to 4 percent revenue growth for the current year, and some analysts say the company could meet its earnings targets even if it shows no growth in revenue.

HP CEO Carly Fiorina offered a similar assessment to analysts Wednesday, saying that the company can meet its earnings targets despite an economic environment that "continues to be difficult to predict."

"Fundamentally we are in control of our own destiny," Fiorina told financial analysts at the conclusion of a two-day meeting here for Wall Street analysts and investors.

That may be true for the current fiscal year, which runs through Oct. 31. But analysts say that in the following year HP will have to prove that it can grow sales and not just slash budgets.

"Going into 2004, if they can't grow revenue, they won't meet consensus" earnings projections, said one Wall Street analyst who asked not to be identified.

For its part, HP doesn't see its cost savings ending after 2003. However, it does plan to stop categorizing future cuts as merger-related. "In the supply chain, we believe there is more than $1 billion (in cost cuts) we can do post-merger," Jeff Clarke, former chief financial officer of Compaq, said in an interview with CNET News.com. Clarke is taking over supply chain duties from Mike Winkler, another former Compaq executive.

So where are all these cuts coming from?

A fair chunk of the savings is clearly coming from slashing HP's work force. From the time the merger was announced on Labor Day 2001, HP has said there would be job cuts. That number has risen from 15,000 to 16,800 and now stands at 17,900.

But HP is also cutting costs in other areas, everything from the disk drives in its PCs to the pens and pencils used by employees. Roughly $1.1 billion of the cost savings HP expects to achieve this year come from improvements in its supply chain.

Some of HP's biggest savings have come from lowering the cost of the components that go inside its products. HP got suppliers to lower their costs in two stages. The first step, which took place just after the merger closed, was making sure that HP was getting the lowest price that either premerger HP and premerger Compaq was getting.

We've only just begun
But HP warned suppliers that this was only the first step and pledged that it would be back for more savings, something Clarke said has now taken place. In some cases, Clarke said, suppliers came to HP on their own, seeking to offer even lower costs in exchange for a greater share of the business.

In all, HP says it has saved $459 million in direct procurement costs, which is the amount the company pays for items that go into HP products.

But not all of the cost savings have come from narrowing the supplier base, Clarke said. In some cases, HP actually opened up its design, seeking to have more suppliers for particular components, ensuring continued price competition over time.

HP is also turning increasingly to electronic auctions, forcing suppliers to bid in real-time for its business. HP is currently purchasing around $1 billion in orders a year through auctions, Winkler said in an interview, an amount that will grow "substantially" over time.

"We've saved, on average, 15 percent on everything we've bought" through auctions, Winkler said.

Although HP has been very public about the amount of savings it is getting, the company has said less about the specifics of where it is saving the most. In some cases, such as components, it clearly doesn't want to tip its hand to competitors. But in other areas, it is the suppliers that HP is trying to protect.

Often, HP's suppliers are some of its biggest customers. In markets such as telecommunications, for example, HP splits its business across many companies because all of the major players are HP customers and buy far more HP gear than what the company purchases from them, Clarke said.

Beyond just extracting concessions from existing suppliers, HP is also redesigning its products to incorporate cheaper components. Such moves have added another $230 million in annual savings. The redesign effort is not limited to just HP gear. HP has been able to shave $4 off the cost of making its PCs by changing the packaging that the machines ship in.

"That's $80 million to $100 million just out of redesigning our boxes," Winkler said at the meeting.

While such moves have earned praise from analysts, skepticism remains about how HP stacks up against Dell Computer and others. Fiorina says that HP's money-losing PC business will be profitable by next quarter and promises that she won't use the company's profitable printing business to underwrite red ink from PCs.

"We will not subsidize (our) businesses," Fiorina said. "Each of our businesses has to be profitable and cost competitive."

 

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