G W o Analysis & Commentary

CELEBRITY CEOFiorina keynotes atechnologyconference in 2004

28 I BusinessWeek I February 21

ALSO IN THIS SECTION:The inside story ofCarly's ouster

Dealmakers lookcloser, spend less

Search: The keywordsfor ad buyers—pay up

Ford's caution may killany turnaround

I

Despite the board's insistencethat it will stay the Carly course,a breakup may be the only way toturn the company around.BY BEN ELGIN

arleton S. Fiorina's last stand at, Hewlett-Packard Co. took place,

aptly enough, at an airport hotel.For six years the jet-setting CEO

' ^ had flown the globe, smiling andperfectly coiffed even as shestepped off of red-eye flights. Jet

lag never slowed down her delivery or muddledher message, which described the sprawling HPas nothing less than the beating heart of the techindustry. Yet on a damp Sunday evening in

Chicago, as much of the nation focused on theSuper Bowl, the 50-year-old Fiorina was em-broiled in urgent talks with her board at a con-ference room at the O'Hare Hyatt, says an HP in-sider. The next day, Feb. 7, she was fired.

Thus ends the stormy reign of the highest-rank-ing woman in Corporate America and one of theboldest gamblers in the tech world. Fiorina pulledout all the stops as she hitched her soaring ambi-tion to Silicon Valley's most venerable icon.

Not content to battle just one tech giant or two.

Analysis & Commentar

WhatHappensToffieOne-StojShor *Carly LeftBehind?Fiorina positioned HP asperhaps the widest-rangingtech company in the world,with offerings from digitalcameras to supercomputers.If her successor opts to narrowthe focus, these divisions arecandidates for spin-offs.

she took on a whole stable of them, fromIBM and Dell to Sony and EMC. In theend, she failed. Outside of its stellar print-ing business, the $80 bülion HP sheleaves behind is struggling in everythingfrom PCs to software. The proud Fiorinadeparts as a humbled ex-CEO, but not apoor one: The board softened the blowwith a $21 million severance package.

The board, which named Chief Finan-cial Officer Robert P. Wayman, a 36-yearveteran, as interim CEO, is now searchingfor an exec ready and able to rescue HP.The crucial question for the next leader:Should HP remain intact? For months anumber of Wall Street analysts havepushed for a breakup, arguing that HP'spieces, from the dynamic printer divisionto the lagging computer businesses,would be worth far more apart.

Fiorina fiercely resisted the calls, andthe board supported her. But followingthe Feb. 9 announcement of her depar-ture, investors bid up HP stock by 7%, to$21.53, in part because of the possibilityof a change in course. "We believe thelong-term probability of a breakup ofthecompany is rising despite indicationsfrom the board that no such move is cur-rently planned," wrote analyst Steven

Milunovich of Merrill Lynch & Co. in a re-port that day.

The forces for a breakup may grow bythe time Fiorina's successor takes over.The logic is straightforward: HP may sim-ply be trying to do too much. The giantlacks both the resources and manage-ment skills to compete with the best ofthebest in nearly every industry in tech. Andinvestors aren't likely to wait patiently fora gradual turnaround.

SHOCK, THEN A PARTYTHE SIMPLEST CHOICE would be to spinoff the corporate computing businesses,which are struggling gainst Dell and IBM,and force them to make the tough choicesnecessary to survive as independent enti-ties. Then a trimmed-dovra HP could plowahead as the world's leading printing andimaging company. No doubt analysts in-side the company and out wiU be slicingHP into countless permutations over thecoming months and feeding them intotheir computer models. "You want to or-ganize your business around your cus-tomers, or at least around your markets,"says Ted Schadler, a vice-president at For-rester Research Inc. "To do that, you wantto split up your business."

At HP, where Fiorina was a deeply di-visive figure, news of her departurebrought starkly different responses. Asthe board stated its determination to stickVidth Fiorina's broad-based strategy,some employees felt sorrow at her depar-ture. For others, "it was a shock, then itwas a party," says one. Then an e-mail be-gan making the rounds: "Dingdong, thewitch is dead."

Now HP's board is on the hunt for a re-placement. They're looking for a CEOwho can rescue HP, much the way LouisV. Gerstner Jr. hfred a troubled IBM fromthe sick bay when he arrived in 1993. Aleading candidate, say insiders, is MCIInc. CEO Michael A. Capellas, who soldCompaq Computer Corp. to Fiorina in ahotly contested $19 billion merger threeyears ago and briefly served as her No. 2.

Other possibilities include IBM'sglobal-services chief, John Joyce, and Ed-ward J. Zander, the former president ofSun Microsystems Inc. who is now CEOof cell-phone giant Motorola Inc. Buteven the most talented exec will face anuphill battle trying to keep Fiorina's HP,with its sprawling array of products indozens of different markets, in onepiece. "It's a Herculean task," says Jay R.

30 I BusinessWeek I February 21, 2005

PRINTERSThe star of the company, printers accountfor 76% of the HP's operating profits andnearly all of the company's $64 billion stockmarket valuation. Some analysts have beenpushing for a spin-off, insisting its value isburied under HP's other tepid businesses.Another scenario? The next CEO sticks withprinters-and sells the computer divisions.

¿PROSPECTS Great at least for a couple of;ars. But Dell is crashing into printers

jronfi below, threatening HP's margins. AndfP will have to pour billions into R&D to

in front of the pack.

IE $60 billion to $65 billion

CORPORATE COMPUTINGHP leads in storage and runs a strong secondin servers. But profits and margins lag. Itscorporate hardware businesses notchedabysmal 1.1% operating margins in 2004.Services would likely be faring better if HPhad bought PricewaterhouseCoopers threeyears ago. But HP balked at the price of thedeal, allowing IBM to make the acquisition.

PROSPECTS HP will continue to be squeezedbetween Dell on the low end and IBM for thebig corporate installations. HP desperatelyneeds to bulk up its software business, apotentially profitable market.

VALUE $18 billion to $22 billion

PCSCombining HP with Compaq created agiant-but not a profitable one. Dell isclobbering HP in PCs, with its lead stretchingto 18.3% of the global market. Thatcompares to a 15.7% stake for HP It's ^margins hit a meager 0.9% in 2004, far " Jbelow what the company projected when itmerged with Compaq.

PROSPECTS Poor, as long as Dell is in themarket and customers are focused ontraditional computing. But with its blend ofconsumer electronics and imaging, HP iswell positioned for the digital home market^

VALUE $1 billion to $3 billion

Galbraith, a management consultantand author of Building OrganizationsAround the Global Customer.

One question is whether the board'sstated commitment to Fiorina's plan wiUhamper the headhunting effort. The high-powered execs being considered may beloath to take on what has proven to besuch a difficult task, particidarly if theycan't set their own strategy. "If some exec-utives get the sense that their hands aregoing to be somewhat tied in making sig-nificant changes, that will limit the pool ofeligible candidates," saysanalyst Tony Ursillo ofLoomis Sayles.

While a miracle turn-around can never beruled out, the more like-ly scenario is an eventu-al breakup of HP. Thatwould spell the end of anera. Ever since its found-ing in a Palo Alto garage66 years ago, HP hasrepresented the triumphof a special brand of en-trepreneurialism thatcame to represent Sili-con Valley. At its heart

ifs an engineering-driven culture thatvalues teamwork and rewards ideas andinventions, not pedigrees.

In truth, Fiorina was battling HP's sto-ried culture from the day she arrived. Adynamic sales exec from Lucent Technolo-gies, she was the first outsider to head thecompany. And she didn't hesitate to takeout her hacksaw. Immediately, she beganto reel in HP's 80-plus autonomous busi-ness units into a more centralized, four-di-vision giant. She eventually laid off tens ofthousands of workers.

Battling decades-oldinertia, Fiorina beganto centrally managetasks such as brandingand advertising. Evenher critics say thatthese steps were need-ed, and that she foughtsome important battlesto streainline HP's or-ganization. "Carly rec-ognized the need to

DECEMBER 2004The drumbeat fromWall Street wasgetting louder

start leveraging the common strengths ofthe company," says Bojana Fazarinc,HP's former director of marketing servic-es and branding, who is now an inde-pendent consultant.

She was decisive, no doubt about that,and a gifted communicator. But even ear-ly in her reign at HP, she began to demon-strate the weaknesses that would lead toher fall. First, she fired or scared away ex-ecs in droves, including such prominentfigures as Antonio Perez, now president ofEastman Kodak, and Mary McDowell,now a senior executive at Nokia. She alsoresisted changing course—a dangeroustrait in an industry in which the most suc-cessñil leaders have been those whodon't fall in love with their strategies.

Throughout her tenure, say insiders,she continued to blame HP's woes on thecompan/s culture—not on severe man-agement shortcomings, including herown. "She didn't develop enough effec-tive lieutenants," says Stephen P. Mader,vice-chairman of Christian & Timbers,±e headhunting firm that recruited Fior-ina into HP. "Twice she passed up...op-portunities to have a chief operating of-ficer. Looks like it bit her."

The Compaq merger was the defining

February 21, 2005 I BusinessWeek I 31

N6WS Analysis & Commentar

Who'siviextOn theHotSeat?HP is looking for atop-notchoperationsexecutive tosucceed Fiorinaas CEO. Here aresome of the likelycandidates:

MICHAEL CAPELUSMCI's CEO ran Compaqfor three years beforeits merger with HP.Capellas, 50, knows HPwell and excels atbuilding morale andimproving execution-just what's needed. He'stied up with the MCIturnaround attempt.Butif it's acquired, he'llbe available.

VYOMESH"VJ"JOSHIThe 50-year-oldexecutive vice-president of HP's hugeirriaging and printingdivision just had PCsadded to his list ofresponsibilities. He hasto be considered thetop inside candidatebecause imaging andprinting supplies three-quarters of HP's profits.

EDWARD ZANDERHe has been CEO ofMotorola for only 13months, but already hehas inipressed analystswith his strategy andresults. Would theformer SunMicrosystems COOleave Moto so soon?Maybe. The 58 year-oldkept his home irCalifornia.

moment in Fiorina's reign. By buyingCompaq, she created a giant withtremendous scale and all of the clout andeconomies that come with it. But she didnot fundamentally change HP's abuity tofend off Dell in the low end of computingor match IBM's sophistication in the en-terprise. So HP has come up short againstboth of them. Equally important, the bat-tle over the merger divided the once-col-legial company into angry, partisan fac-tions. Insiders say the contentiousness ofthe dispute was a key part of why Fiorinabecame so wedded to her plan for HP.

But Fiorina's soaring vision ran into awall of opposition. Director and scionWalter Hewlett rose up against it, andhuge swaths of employees and share-holders joined the cause. They feared thatthe deal would dilute HP's lucrativeprinting and imaging business and an in-flux of hard-charging Compaq execswould turn HP's hallowed culture upsidedovsm. The dispute spiraled into a bitterproxy battle and wound upin the courts. Hewlett waspushed off the board of thecompany his father founded.

While if s convenient forHP's leaders to blame poorexecution for their prob-lems, what aus the companyruns much deeper than re-placing a few top execu-tives. In enterprise comput-ing, HP has failed toimprove its lot. While it is

The boardsoftened theblow with a$21 milliongoodbyepackage

stul narrowly the market share lead instorage and in key server markets, in-cluding Unix and PC servers, if s losingground to EMC Corp. in storage and DellInc. and IBM in servers. In some cases, itstechnology just hasn't kept up. In others,it has made bad bets.

IN DELL'S SHADOWTHE BIGGEST OF those was forming apartnership with Intel Corp. to co-devel-op the Itanium processor as the brainsfor high-end servers. After half a decadeof trying, Itanium has gained littleground. Meanwhile, HP stopped devel-oping its ovrai high-end processor, calledPA-RISC. Now if s stuck slugging it outfor share in the market for commodityservers that run on Microsoft's Win-dows—where Dell excels.

HP struggles just as much in softwareand services. Its tiny software unit lost$125 million last year on just $922 mil-lion in sales. If s highly unusual not to

make money in enterprisesoftware. In services it has asizable but slow-growingmaintenance and repairbusiness, yet it hassqueezed profits in an at-tempt to gain market sharein managed services such asrunning corporations' IToperations. Acting CEOWayman said during thecompany's press conferenceon Feb. 9 that while the

JOHN JOYCEFormerly IBM's CFO, the I51-year-old now runsthe company's $46billion global servicesunit. He has a strongoperationsbackground-ascontroller for IBM'sglobal operations andas head of its internalreengineering project inthe mid-1990s. J f l

unifs revenues have been grovidngstrongly, the company has to focus moreon profits now.

Even HP's gilded $24 bilhon printingbusiness, viewed by many as the compa-ny's savior, faces a rising number of chal-lenges. Since Dell jumped into the marketin early 2003, it has quickly picked upmarket share in inkjet models, the lowend of the business. During the first threequarters of 2004, Dell accounted for 13%of inkjet sales in the U.S., according toIDC. While still a fraction of HP's marketshare, it presents a troubling trend. Agrovrtng base of Dell printers means itcould eat into HP's lucrative business ofselling ink refills to existing customers."Dell is on the radar. If s a big long-termissue for Hewlett-Packard," says KenSmith, a portfolio manager at institution-al investor Münder Capital.

HP is betting that it can stay ahead onprinters by pouring resources into itslabs—and innovating constantly. In timethe company expects state-of-the-artprinting technology to spread into newdomains, with printers even being har-nessed to spray out billions of precision-engineered semiconductors. Though HPspends more that $1 billion on printerR&D, analysts question whether it cankeep its edge. "The have the ability to car-ry it off, but not indefinitely," says JoeD'Elia of researcher iSuppli Corp.

The management ouster at HP givesthe company a chance to rebuild trustwith investors. During Fiorina's 21 quar-

32 I BusinessWeek I February 21, 2005

News Analysis & Commentarters atop HP, the company missed profitexpectations eight times. Sure, thaf s bet-ter than the 21 quarters before Fiorina ar-rived. But it's also more than double thecombined misses of IBM and Dell overthe same period. "Investor credibility is ahuge issue with HP" says analyst LauraConigliaro of Goldman Sachs & Co. In-deed, in 2004, HP's stock plunged 8%,underperforming virtually every one of itscompetitors.

The good news for HP? Even if theboard clings to Fiorina's vision, the nextCEO is sure to have a bold mandate forchange within the divisions. That's sore-ly needed. Take the PC business. Before

the merger, Compaq was making signif-icant strides following Dell's efficientmodel of direct sales to customers. Yetwhen the companies merged, this initia-tive never won broad support. Why? HPcouldn't aggressively push PCs and by-pass retailers, when it needed their helpto sell printers. The result: HP has stuckto the old industry model as it battles su-per-efficient Dell. HP's market share iseroding in PCs, and the division strug-gles to eke out a profit.

If the new CEO hangs on to the $24.6billion PC business, the boss is likely tomove quickly toward the Dell model-even at the risk of angering retailers.

Should the direct-sales model sputter,the choices grow starker. IBM finally re-solved the same issue in December, sell-ing its PC division to China's Lenovo for$1.25 billion.

More bold moves are needed in HP's en-terprise business. While the company ac-quired more than a half-dozen small soft-ware companies in the past 18 months, ithas balked at a bigger acquisidon. Insiderssay that some board members were upsetthat Fiorina didn't more aggressively pur-sue Veritas Software Corp., a profitablemaker of storage software that was ac-quired by Symantec Corp. in December.The bottom line is that HP lost money in

The Inside StoryOf Carly's Ouster

By the end of 2004, the pressurein Hewlett-Packard Co.'s corneroffice was almost unbearable.With Chief Executive Carleton S.Fiorina's efforts to fix the $80

billion computing colossus stalled andtensions building with the board, one of hightech's most powerful executives beganmulling an exit plan, BusinessWeekhaslearned.

Around the holidays, Fiorina heldseparate meetings with at least four high-profile chief executives to glean advice onmaking a "graceful exit" from HP, accordingto industry sources. These industryluminaries, approached by Fiorina atyearend business conferences, includedCisco Chief Executive John I Chambersand Intel President Paul S. Otellini. Duringthe conversations, Fiorina told the CEOs shewas feeling some pressure from HP's boardand inquired about face-saving ways toleave the company should she decide it wasin the best interest of shareholders,according to the sources. Fiorina,Chambers, and Otellini didn't returnrequests for comment.

It was a decision she didn't get a chanceto make. On the evening of Sunday, Feb. 6,HP's board hunkered down with Fiorina in anemergency meeting held at Chicago'sO'Hare Hyatt Hotel, As a light rain drizzledoutside, the directors stewed over their starCEO's failure to execute her ambitious planfor the company In addition, directors wereconcerned about the "board's inability to

work constructively with [Fiorina],"according to an HP insider The next day,they asked Fiorina to step down. And onWednesday, Feb. 9, at 5 a.m. Pacific time, HP

Days of

Days ofPainIn five and a halfturbulent years,Fiorina took a SiliconValley legend on awild and high-profileride as she made hername as the most-powerful womanexecutive in America

10

stunned the world, announcing Fiorina'sdismissal, ending her 5'/: year stint atop oneof the legends of Silicon Valley.

Despite the surprise announcement, theboard's concerns about its chief had beenmounting for nearly a year. Sure, she haddazzled directors and many investors withher passionate work in pushing through thecontroversial merger with CompaqComputer Corp. in 2002. And theimmediate integration of the two companiesbested expectations, silencing even herfiercest critics. But by late 2003, investors

JUNE '99

JÜLY17,1999 Carly Fiorinatakes over as CEO of Hewlett-Packard, the first outsider torun the Silicon Valley icon.

SEPT.3,2001 Fiorina andCompaq CEO Mike Capellasannounce a controversialmerger, spawning bitteropposition from boardmember Walter Hewlett.

MAY3,2002 After a narrowproxy victory, HP's mergerwith Compaq closes.

MARCH, 2003 Dell entersthe printer market,threatening HP's cash cow

DECEMBER, 2003 Dell pullahead of HP in overall PCshipments during 2003.

34 I BusinessWeek I February 21, 2005

software last year, despite itbeing one of the most prof- Mlitable markets for most cor- ( _ ] E 0 WÍ11porate computing rivals."The software business isway behind what you'd ex-pect from a company thissize," says Goldman'sConigliaro.

As HP embarks on a difS-cult transition, execs will beworking hard to put forth animage of calm and stabuity.The company's business depends on it In-deed, competitors from IBM to DeU to SunwiU be highlighting HP's management tur-

as they compete oncorporate-computing

deals. Even with longtime^^ veterans, fi-om Waymanto printers chief VyomeshJ°^^'' sucking around, thispromises to be a diflBculttask."Ifsomebodyhasapenpoised over a purchase or-^^^' ^^ doesn't want there tobe a moment of hesitation,"says Andy Buder, a vice-president at researcher Gart-

ner. "The company will go to great pains toshow the world that nothing is changingright away."

While execs press forward with grit-ted teeth, the drama at HP seems tocome full circle. Six years ago, it was atanother airport hotel in Chicago that di-rectors hired Fiorina. But things aren'tgoing back to where they started. Not achance. She may be gone, but HP nowcarries the indelible stamp of CarlyFiorina. •

-With Steve Hamm and Spencer Antein New York and Robert D. Hof Cliff Ed-wards, and Peter Burrows in San Mateo

BusinessWeek online For more on HP andCarly Fiorina's ouster, please visit us online atwww. busi nessweek.com

began shifting their focus from the Compaqdeal to HP's ebbing position against keycompetitors IBM and Dell. They bored in onthe ragged financial performance that led tothe swooning stock price. "[Fiorina's] goodwith marketing; she's a good speaker for thecompany," says a former HP executive. "Butthis is a company that doesn't need astatesman. It needs a hands-on operationsperson."

The tide really began turning againstFiorina following HP's massive profitshortfall in the third quarter of last year. That

marked HP's second miss in five quartersand further damaged the company'scredibility on Wall Street-a major issue,since HP's stock has long traded atmultiples well below those of itscompetitors. Although Fiorina fired threetop sales executives for the miss, the board'sdoubts about its CEO grew. At the sametime, the board's proddings of Fiorina tobolster HP's operations talent went largelyunheeded.

As HP struggled to nail down itsoperations, some directors were chagrined

I I I—r-'02

'AUG. 12,2004 HP badlyÎ misses third-quarter

expectations, raisingquestions about Fiorina's

• ability to execute

^MBER, 2004 Fiorinaseeks advice from several

•CEOs on how to make a"graceful exit" from HP.

'03

JAN. 12-15,2005 HP Sboard holds an offsitemeeting in San Francisco.Increasingly frustrated, thedirectors move to shiftoperating responsibilitiesfrom Fiorina to keylieutenants. They also bringformer director Tom Perkinsback to the board.

'04 FEB. 9,'05

FEB. 7,2005 At a meeting ina Chicago area hotel, HP'sboard asks Fiorina to stepdown. She agrees.

FEB. 9,2005 At 5 a.m. localtime, interim CEO BobWayman sends an e-mail toemployees informing themof the management change.

that Fiorina didn't move more quickly tostrengthen HP's position against Dell andIBM. For instance, although HP hasgradually built up its direct-sales efforts tobetter compete with ultra-efficient Dell,some directors felt the company wasn'tmoving fast enough, according to the HPinsider.

In addition, HP balked at a majoracquisition to bolster its money-losingsoftware business. In 2004, HP hadconsidered acquiring Veritas Software butdidn't move quickly enough, according tocurrent and former HP execs. In December,Symantec gobbled up the profitablesoftware company-leaving some HPdirectors unhappy. "Things needed to makeus more competitive in certain segmentsweren't being done," says the insider.

By November of 2004, HP's directorsbegan holding periodic conference calls-without Fiorina-to discuss their CEO'sperformance. And by the time of the board'sJanuary meeting in San Francisco, it enlistedthree directors to meet with Fiorina todiscuss its concerns with her performance.The trio produced a document indicatingtheir concerns represented the consensus ofthe entire board.

The ensuing board meeting, which wassupposed to be an annual strategy review,became focused on the performance ofFiorina and HP. And during the meeting,directors pushed forward a plan to distributesome of Fiorina's operating responsibilitiesto her key lieutenants. Sources familiar withthe reorganization plans say they are onhold because of the management shake-up.

It was a heavy blow to Fiorina's credibilityas the company's leader. Just weeks later,she was out. It had become increasinglyclear that HP's need for a nuts-and-boltsoperations whiz far outweighed the benefitsof a high-profile CEO.

-By Ben Elgin in San Mateo, Calit.

February 21, 2005 I BusinessWeek I 35

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