When eager engineers at Hewlett-Packard Co. (HPQ) took it upon themselves to create the company's first computer in the mid-1960s, normally fearless HP co-founder David Packard grudgingly gave his O.K. to bring it to market -- but only if they agreed not to call it a computer. Such was Packard's fear of raising the hackles of almighty IBM (IBM), the giant that dominated the industry from the dawn of the Electronics Age.
Now, tech is about to get a new biggest behemoth. It's HP. The Palo Alto, Calif., PC and printer giant had higher sales than IBM last quarter, and analysts project it will finish 2006 with greater annual sales than Big Blue for the first time ever: $91 billion for HP vs. $90.5 billion for IBM. The reason HP pulled ahead is simple: IBM last year sold off its $11 billion PC business to Lenovo Group Ltd. (LNVGY). But, because the companies have chosen fundamentally different paths, with HP aggressively going after consumers while IBM focuses on corporations, HP is expected to grow faster than IBM in coming years. Since both use blue in their logos, you might say there's a new Big Blue in the house.
Bragging rights aside, HP's leap to the lead signals a fundamental shift in the computer industry -- and a conundrum for tech companies. The industry got its start selling to corporations, and this year that market is expected to top $1 trillion in sales of hardware, software, and services. Consumer sales came later and still represent only 10% of the overall market. But now technology is becoming ubiquitous, and sales of everything from home computers to cell phones are growing much faster than the mature corporate business. Unit sales of Web-enabled cell phones, for instance, are expected to grow by 15.4% this year, while sales of Unix servers for corporations will shrink 1%, says researcher Gartner Inc.
All sorts of tech companies are plunging into consumer markets or expanding their footprints there. Cisco Systems (CSCO) now sells home networking gear, and Dell (DELL) is selling TVs. Here's where the conundrum comes in. For the most successful companies, corporate sales deliver rich profits, with operating margins on the order of 30% for software. Consumer tech? Margins can be razor thin, or nonexistent. Analysts figure that the makers of game consoles lose money on every box they sell for the first two years after launch. The challenge is to figure out how to jump on the fast-moving consumer bandwagon but still achieve fat profits. "These companies have stockholders who are used to certain returns. They'd better learn how to make it profitable," says analyst Bob Djurdjevic of tech industry consultancy Annex Research.
At least for the moment, HP seems to have figured it out. Because of its 41% market share in printers, HP also rules the market for replacement ink cartridges and other supplies. Those command 50%-plus margins, and the printer group kicked in more than half of HP's $1.7 billion operating profits last quarter. The key in consumer tech is to dominate a market, achieve economies of scale, and create a platform to sell premium-price products -- as HP has with printers and Apple Computer Inc. (AAPL) has with iPod and iTunes.
IBM plays things differently. "We're an enterprise IT company," says Bill Zeitler, general manager of IBM's computer and chip division. "It's an advantage vis-à-vis any company that is less focused." The challenge for IBM is to convince investors that it can grow its mammoth services business enough to expand at a healthy rate. While HP's stock price has risen 9% since Jan. 1, Big Blue's has dropped 2%.
Both HP and IBM have morphed repeatedly during their storied histories. IBM started off selling time clocks in 1914, and HP began in 1939 by building audio oscillators. Both have had their ups and downs but persevere because they have a knack for getting out of stagnating businesses and finding the next big thing. Size may not guarantee the market power it once did. But it does imply a certain staying power.
By Peter Burrows and Steve Hamm