Lew Platt's Fix It Plan For Hewlett Packard

As margins shrink and growth slows, the CEO struggles to rev up HP's innovation engine

For years, CEO Lewis E. Platt has used his annual management-review meeting to warn Hewlett-Packard Co.'s executives not to get sloppy. After all, the company was growing at more than 20% a year, making it the fastest-growing $30 billion company in the U.S. It would be easy for giddy executives to become less watchful. Sure enough, by last January's meeting, the company had missed Wall Street's expectations for five straight quarters. So to kick off the weekend meeting at a Monterey (Calif.) hotel, Platt tried a different tactic. The normally amiable CEO blasted his top 200-plus managers for shoddy execution, lax cost controls, and overreliance on slow-growth markets.

Then, a steely Platt told them to write down "two things you'll do differently on Monday morning." Since all the managers had laptops, Platt got their plans immediately. And he didn't like what he saw. Disappointed, he laid into them the next day. "You guys just don't get it, do you?" Platt scolded. "I expect more coherent plans from you moving forward," recalls an attendee.

FALLING SHORT. Now, Platt is facing similar expectations from investors. Since mid-1996, after years of blowing away the most bullish estimates, HP's sales have settled below the 20% growth clip analysts had come to expect. For the 1997 fiscal year, the company recorded a 12% revenue growth rate, down from 22% the year before. Worse, earnings have zigzagged wildly as the company has struggled with factors ranging from the Asian flu to erratic execution to falling prices for personal computers and printers.

The latest example: Although sales growth is back up--rising 16%, to $12 billion--HP shocked analysts with an 18% jump in operating expenses and a 12% dip in earnings in the quarter that ended on Apr. 30. That sent the stock spiraling downward 26%, where it is stuck at around 60. Concedes Platt: "The competition has closed the gap. Our execution just isn't what it used to be."

Wait a nanosecond. Not HP. This is the company that has been synonymous with progressive, top-notch management. HP is not only the inventor but also a top practitioner of many of the business philosophies and tactics that have led to Silicon Valley's global dominance of high tech--pushing the envelope by giving employees the freedom to innovate and take risks.

But in the past year, the Palo Alto (Calif.) giant has suffered a rash of embarrassing gaffes. In the summer of 1997, HP ran short on supplies of its flagship LaserJet printer for several months. Then it suffered two painful delays in the delivery of high-end computer servers. While HP prospered for decades on cushy 50%-plus gross profit margins, it now gets more than 60% of its revenue from lower-margin commodity products such as PCs and printers. That has dragged corporate gross margins down from 47.2% in 1990 to 34% in 1997--but operating costs have risen the past two quarters. "The conventional wisdom, that HP is a superbly managed company, is taking a bit of a body blow," says analyst Daniel R. Kunstler of J.P. Morgan Securities.

To be sure, HP remains a powerhouse by almost any measure. Despite falling short of Wall Street's expectations, the most recent quarterly sales growth topped the rate for IBM, Sun Microsystems, and Compaq Computer. As for earnings, which totaled $685 million in the quarter, HP has an insurance policy that rivals envy: a $4 billion annual annuity in lucrative paper, ink, and toner-cartridge sales from its printer business, where it enjoys 50%-plus U.S. market share. And HP remains a top player in most of its markets, including PCs, where it has vaulted from the 27th place in 1992 to No.4 today.

Still, the company hasn't come up with any blockbuster innovations of late, long an HP hallmark. The company has done some pioneering work in such areas as digital photography and printing off the Internet, but it has failed to transform these efforts into vibrant businesses. Instead, current and former executives say that HP has become so focused on protecting its existing businesses that it has taken its eye off the critical job of creating tomorrow's new markets.

"MAINTENANCE MODE." Without breakthrough products--which typically command premium prices because competition is limited--the company is forced to compete largely on price. "I look at HP as being in maintenance mode," says former No.2 Richard E. Belluzzo, who left in January to run Silicon Graphics Corp. "HP has got tremendous potential, people, technology, and a great brand, but there's something missing [that would] move the company to the next level."

Indeed, Belluzzo had been pressing hard for drastic change during his final months at HP. Former and current managers say this put him at loggerheads with Platt, who wanted to move more slowly. Belluzzo, for example, pushed to slash pricey overseas sales offices and divert investment from slower growth, old-line HP businesses to invest in high-growth areas such as PCs, say current and former executives. Platt complained to board members late last fall that Belluzzo's superaggressive efforts had become overly disruptive, they say. Platt won't discuss Belluzzo. "I'm not going down that rathole. It has nothing to do with the issues we face as a company."

Today, Platt is clearly focused on HP's future with a two-part fix-it plan firmly in motion. First, he needs to get HP's house in order by cutting costs and sharpening execution. Longer term, though, the 57-year-old CEO wants to ensure growth by extending current businesses and creating brand new ones. To do this, he is building on the belief of founders Bill Hewlett and David Packard that smart people will do great things if given the independence and authority to make their own decisions--fast. So Platt is easing back on corporate control of HP's business units. He is giving managers more freedom to define their own goals and policies.

COSTLY DISCOUNTS. But with freedom comes accountability. Through new pay policies, Platt hopes to tie each manager's salary to the performance of his or her unit. Platt was a guinea pig for this last year, when the board linked some 40% of his compensation to HP's performance. Now, Platt has asked the board to do the same for HP's top 40 executives.

The company's PC chief, Duane E. Zitzner, already is adopting the same philosophy. Starting this quarter, Zitzner will award stock options to his managers based on revenue growth, as well as shareholder value. That way, employees won't be tempted to offer unreasonable price breaks to make quota--a mistake that cost HP dearly last quarter, when it offered discounts of up to 50% to keep business from rivals such as Compaq. "We chased deals we shouldn't have chased," says Zitzner. "You get so into the battle that you can lose perspective."

Platt also is hacking away at the company's spiraling costs. He put out a call for a 5% cut in operating expenses--a pledge he made at a May analysts' meeting where he proclaimed: "I'm mad as hell, and I'm not going to take it anymore." Now, the newly empowered division heads are responding quickly. The personal-computer division, which shocked people by losing an estimated $50 million on a 70% increase in unit sales, is out banging on suppliers for price breaks. "We saw much more of a tough-guy attitude from HP within a week of the earnings announcement," says a top U.S. supplier of HP's PC unit. "They were saying: `It's a new era, and you better cut our prices or we'll go somewhere else."'

And then there's R&D, where the company spent $3 billion last year. In the past, each HP unit kicked in a portion of sales to fund the company's vaunted HP Labs. That's fine for high-margin businesses that need top-notch technology, but it's a financial ball and chain for the PC business, which must compete with the likes of Dell Computer. The new lab tab? HP businesses now pay the labs 8% of their R&D budget, a figure tailored to the development needs of each division. "This is an example of Lew letting us run our own businesses," says Webb McKinney, who heads the consumer PC unit.

In the long run, though, Platt's No.1 worry is growth. In late 1997, Chief Financial Officer Robert P. Wayman did a study of companies generating $40 billion-plus in annual sales and found that they grow, on average, less than a piddling 5%--not nearly enough to support HP's shrinking margins. That lit a fire under Platt, who is now trying to spark new innovation.

SKEPTICISM. One method: He has created a special unit to incubate promising new technology ideas. The first project is a whizzy new computer-display technology that Platt says could generate "billions" in sales. Unit chiefs must also show where they're spending their money. The goal: a higher mix of investment in new or fast-growing markets. "It's not enough anymore to just make your numbers," says Richard H. Lampman, who runs HP's efforts in computer research and development. "You have to show you're contributing to the future."

Will Platt's plan work? Some people are skeptical. His recent changes, they say, may not be enough to help HP address its biggest long-term challenge: developing new markets. After all, PCs and laser printers are a fixture in Corporate America, and penetration of home PCs is approaching 45%. Critics say that to meet its goal of continued 15%-plus growth, HP needs to plow fresh ground. Says former HP PC chief Robert Frankenberg, who now runs Encanto Networks Inc., a maker of networking gear: "HP needs to be less protective of its current kingdoms and go attack some undefended hills."

More than ever, that approach depends on Platt. After three months, the 32-year HP veteran decided in early May not to replace Belluzzo, who ran the printer and PC businesses that account for 83% of total revenue. Now, rather than just focusing on corporatewide functions, Platt is overseeing the major businesses himself. He heads an executive committee, which includes the chiefs of HP's six key business units. "We all love Rick [Belluzzo], but each of our businesses is big enough to deserve a closer relationship with Lew," says Antonio M. Perez, who runs the $8 billion ink-jet printer business.

HP must do more. Under his six-year CEO tenure, HP has had plenty of good ideas, but little to show for them. Consider networked printers. Few analysts argue with HP's claim that networked printers will one day replace pricey copiers. The theory: Why should companies incur the high cost of copying and distributing documents that may not even be read when they could be stored on high-speed printers and printed out as needed? Boeing Co., for example, is moving to store its huge service manuals online so that technicians can print just the parts they need. Yet HP has made little headway pushing its "distribute-and-print" vision, say analysts.

Meanwhile, HP still hasn't made much of a dent on the Internet, a mark of shame for Silicon Valley's granddaddy. Having purchased VeriFone Inc., the leading manufacturer of credit-card readers and authorization software, HP hopes to become a top electronic-commerce player by outfitting PCs with VeriFone's credit-card readers. This would allow cybershoppers a secure way to buy products or download E-cash from home. So far, there's a small pilot program with Citicorp in Manhattan, but little other progress.

There's also been little movement in Internet imaging. Analysts drool over the potential sales of printers, inks, and computers if HP could accelerate development of technologies to let consumers and corporations print documents such as coupons, articles, and annual reports right off the Web. Many technical hurdles exist, but "as the overwhelming market leader, you look to HP to solve them," says Deutsche Bank Securities analyst Michael K. Kwatinetz.

The big digital photography initiation is off to a slow start, too. While HP's $400 PhotoSmart printer was the first machine capable of matching a snapshot in image quality, HP has failed to follow up with an all-out marketing blitz that could persuade consumers to give up their trusty old cameras. The result: HP has sold fewer than 25,000 PhotoSmart units since it hit the shelves a year ago, says analyst Marco Boer with market researcher IT Strategies. Later this year, however, the company is expected to roll out new products that let shutterbugs wirelessly zap their digital shots from HP cameras to special HP printers--a departure from most other schemes, which require a PC to do this.

Platt says give it time. He insists that HP launched its digital photography business knowing camera makers had yet to come up with digital gear offering the required image quality at a price most consumers could afford. "We could be accused of developing some of these markets too early," he says.

Besides, argues Platt, HP is turning up the innovation engine now. CFO Wayman says that with overall sales exceeding internal projections by 5% to 7% in recent years, unit chiefs were simply too busy keeping up with demand to focus on new opportunities. "When you're running as fast as we've been, you tend to pay less attention to cultivating seeds," he says.

That's about to change. In March, Platt O.K.'d a plan to hatch a series of internal "software startups" to attack promising cyberniches. Rather than get lost in HP's sprawling software organization, these units are set off on their own. Staffers are measured and compensated for attaining the same milestones that venture capitalists demand of typical startups, such as delivering code on time or attaining a key customer. On June 29, HP unveiled the first of these: HP OpenPix ImageIgniter, which makes software to let cybershoppers easily view and manipulate high-resolution images. Says Platt: "If we see good ideas, we'll fund them."

SPOTTY RECORD. Now, Platt must prove he will move to turn these nascent efforts into big businesses capable of sustaining HP's growth goals. There are plenty of skeptics. "Under Lew's leadership, there's been an aversion to risk," says a former HP executive. "I can't point to one big new business that has been created since he's been in place." Argues Platt: "For those who say we're not attacking new kingdoms, look at PCs."

There are signs that HP may not have the stomach for the new fast-growth, low-margin businesses that dominate high-tech these days. Since its latest quarterly disappointment, the company has backed away from a 1997 pledge to become the PC market share leader by 2001. "We're not going to chase market share at all costs," says PC chief Zitzner.

Instead, some board members are quietly wondering if PC sales are worth fighting for at all, admits Wayman. "This certainly raises questions about how good [the PC] business is," he says. Platt disagrees. The scrappy PC market is just the training ground HP needs to prove that big companies run as fast as little ones. "We envision a model where most of the computer business looks like the PC business," Platt says. "You can't duck that. It's the future." Platt has to move boldly to make that future as bright as HP's past.

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