Mind Your Own Business, Boys

Carly Fiorina has long struck a tone of defiant self-assurance, and it's beginning to seem justified. The CEO of tech giant Hewlett-Packard proved adept at playing Wall Street hardball, leading her company's ferociously contested proxy battle to buy Compaq Computer for $19 billion. She promised big benefits from that acquisition and last week began to deliver them. HP's quarterly earnings report showed the company stemming losses in its most troubled divisions PCs and corporate computer systems and surpassing its cost-cutting goals. HP shares have surged 72% since early October, including 15% last week.

Fiorina has quieted some of those she calls her "cynics and doubters," who had whispered that a woman with a marketing background was not fit to run HP. But she still faces formidable challenges, starting with generating profits in PCs and corporate "enterprise systems" at her newly merged company, which posted $35 billion in revenues in its first six months. Can she go from being a Churchillian leader, adept at giving a "We will never surrender" speech, to being more of a Lou Gerstner, IBM's former CEO, who was able not only to slash costs and jettison unpromising lines of business but also to steer the company toward new prospects and profits?

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Since HP's president, Michael Capellas, a respected operations manager and Compaq's last CEO, quit to run WorldCom in mid-November, Fiorina must now take full responsibility for HP's bottom line at a time when she must parry new threats from IBM and Dell. Both have spent the past year bulking up major parts of their businesses, while HP has been on a low-cal diet, trying to restore its flabby enterprises to health. As analyst Bill Shope of J.P. Morgan Chase puts it, "IBM is trying to squeeze HP at the upper end of the market, while Dell is challenging it at the lower end. HP has carved a spot in the middle, but it's not clear if that's where it should be."

Fiorina's supporters think HP in the middle will be a hit show. The rationale for acquiring Compaq has not changed, they argue. By buying Compaq's vast product portfolio, R.-and-D. muscle, direct-sales channel and 34,000 tech-service pros, HP could thwart IBM and Dell. "Analysts are waiting for us to put points on the scoreboard," says Michael Winkler, Fiorina's executive vice president for operations. (Fiorina declined to be interviewed.)

In terms of cost cutting, those points are accumulating. HP has shuttered nine assembly plants, cut 12,500 jobs and "rationalized" its product offerings, reducing them to 65,000 from 85,000. Result: $650 million in savings since the merger, which helped HP offset losses in its divisions that make PCs and enterprise-computing gear. "I'm keeping my shares," says Ben Rosen, Compaq's former chairman and a large shareholder. "HP is going to get so lean that earnings surprises will be on the upside."

Yet cutting jobs is easy compared with boosting profits while a lean and hungry rival like Dell is gnawing at you. From 2001's third quarter to this year's, Dell gained market share in two of Compaq's core segments: PCs and large corporate computers known as servers. Moreover, Dell figures that it can leverage its low-cost, direct-sales model to profit from just about any tech product whose components have in effect become commodities. Dell is angling to sell everything from personal digital assistants to its own brand of printers and ink cartridges, as well as an increasing array of networking gear, storage devices and services. "Dell is targeting just about every profit pool HP has," says industry analyst Julie Giera of the Giga Information Group.

Printing is shaping up as a crucial war zone. HP's imaging and printing division is a diamond mine, yielding $3.2 billion in profits in its past fiscal year. Most of that money comes not from printers but from sales of ink and toner cartridges that owners of HP printers buy almost exclusively from HP. While the firm barely breaks even on inkjet-printer sales, HP makes profit margins of about 60% on those cartridges, according to Charles Wolf, an analyst at Needham & Co.

Dell wants a slice of those printing profits and at the same time wants to crimp HP's cash flow: the money HP makes from selling cartridges helps subsidize its profitless PC and enterprise-computing divisions, which, with Compaq, lost $1.7 billion in the two companies' past fiscal year. "Michael Dell will bomb the market," says Wolf. "He'll be happy to make an 18% margin, which HP can't afford."

Also in a bid to strike at HP, Dell is pumping up its slate of services. Backtracking on its self-help model, Dell recently extended an agreement with EDS to provide higher levels of support to PC users a way for Dell to potentially make more money from PC sales and take a larger slice of the services market. Taking care of high-powered servers could become more lucrative too. Dell figures that as machines running on Intel chips and Windows or Linux software continue to improve and drop in price, so too will prices to install and service them, falling to the kinds of commodity levels at which Dell might maintain an edge. Rivals fear that because Dell's overall business is thriving, the firm will be able to afford to take a lower margin on such services and drive down prices across the board.