HP Services: the evolution continues

Kate Hanaghan, Analyst

We recently met with senior management at HP Services during an analyst conference held in the US. HP's TSG (Technology Solutions Group - which comprises Enterprise Servers and Storage, HP Services and HP Software) team gave an update on HP's IT services strategy. Services accounted for 17.8% of HP's total $87 billion revenues in FY2005. So whatever HP does to develop its services strategy, it can't ignore what this means for the other $71.5 billion that is derived from everything from PDAs to high-end servers.

The services portfolio spans support services (a very large portion), managed services (outsourcing), consulting and integration and, more recently, managed print services. Since Q1 2004, services revenues (excluding managed print) have grown from $3.2 billion to $3.8 billion. However, throughout 2005 growth slowed so that by Q1 2006 revenues declined by 2% during the quarter (although they grew by 3% in constant-currency terms). Meanwhile, divisional operating margin (a variant of EBITA) - via a few ups and downs - currently sits at 7.8%, which is below the 8.3% of two years ago.

Drilling down a little further, Technology Services (the support organisation accounting for 62% of revenues in FY 2005) saw its growth in dollar terms fall steadily in 2005, from 14% in Q1 to just 4% in Q4. Similarly, Managed Services (the outsourcing business, with 20% of worldwide sales) saw growth fall from 44% in Q1 to 9.0% in Q4 and Consulting & Integration (18% of sales) saw growth halve from 20% in Q1 to 11% in Q4. Slow growth continued into Q1 2006, with dollar-rate shrinkage in all sectors, equating to mid-single-digit growth in constant-currency terms.

So the challenges are obvious. Areas for focus in the rest of FY 2006 include making further improvements to the global service delivery engine, signing the right deals on the right terms and increasing the attach rate of services to product sales.

The mid-term opportunity

Let's remind ourselves that 62% of what HP does in services comes from maintenance. And, as we've seen, HP seems to have hit a wall here, with growth now in low- or mid-single digits. The company is therefore focusing on the other parts of its services business - namely Managed Services and Consulting & Integration - to drive growth. Managed print services is the latest addition to the services stable, and another area of focus.

Back at the conference, the collection of executives was mostly on message with the Adaptive Enterprise 'mantra' - HP's marketing around the alignment of business and IT. Within this, infrastructure outsourcing is positioned as the 'transformation engine'. We think that, in the mid-term, HP has the opportunity to become a greater force in infrastructure outsourcing if it is able, for example, to fine-tune its global delivery service.

Around its managed services pitch, HP speaks of its ability to innovate. It's far from alone in pushing the innovation angle to customers - indeed, we're hearing plenty of noise from HP's peers around this right now. We'd make two points here. Firstly, suppliers should note that exciting innovation is not always the top priority for customers; a solid and steady outsourcing arrangement may be their prime objective. Secondly, while we see evidence that HP and others are working in an innovative way with their largest customers, we are not convinced the innovation message is necessarily applicable to customers across the board - i.e. those below the top tier. Beware of hopping onto 'bandwagons' is our advice! Nevertheless, a closer connection between HP Services and the company's labs could generate real value for customers and HP alike.

While innovation was a notable theme at the analyst conference, for customers, HP Services is much more likely to be viewed as a solid provider of reliable, low-risk infrastructure-oriented services than a bleeding-edge innovator - much of this ground being occupied by more business process-oriented service providers. And that isn't a bad thing. However, there is a sense among customers that HP could approach them with a little more confidence. HP knows that it needs to increase the number of business - as opposed to technology - conversations it has with customers. Many customers want to see that their provider understands their business environment, but HP needs to make sure its pace matches that of the customer. In its enthusiasm to prove it can innovate and create 'transformational' solutions, HP must not lose sight of the fact that for many customers it is still 'just' a (good) provider of infrastructure and 'plain old maintenance', as one customer put it.

A strategy in evolution

HP's services strategy continues to evolve. HP's Consulting and Integration business, in particular, is currently receiving a lot of management attention and investment, while the Managed Services business will be expected to broaden its portfolio (e.g. more application management) while also tightening its commercial approach. The question, of course, is where this will take it. Our Navigator model positions HP as a 'market shaker' in infrastructure outsourcing, as opposed to a 'market maker' capable of determining the direction of the market. By this we mean that HP isn't a driving force of the outsourcing 'elite', but rather a potentially disruptive player. Two or three years down the line, we expect to see HP punching above its weight in infrastructure-led outsourcing, with IT services that play to its strengths in infrastructure areas such as ITIL, SOA and utility computing. If HP Services can carve out a strong differentiation, it should be able to get those growth figures back to market-stealing rates. As ever, the numbers will speak for themselves, and we'll be reporting on HP's progress during Q2 later this month.

Kate Hanaghan is a member of Ovum's IT Services advisory team. Her expertise is focused on companies providing support services to the UK market. HP, IBM and Computacenter are among the companies she tracks.