The Merging of Two Tech Giants - Managerial Economics

Introduction

A week before 9/11, 2001, Hewlett-Packard and Compaq Computers announced a definitive merger agreement to create an $87 billion global technology leader. Tenaciously campaigning for the integration from the start was current CEO Carly Fiorina, poised to take the reigns as chairman and chief of the new HP. Industry analysts claimed it just didn't make economic sense, predicting Dell Computers would soon dominate the market as HP and Compaq wasted time untangling their selves. And pundits' assumptions were correct--albeit only for the first few years under Fiorina's control. Today, the combined company is stronger than ever, with revenues more than doubling premerger year-end figures. This paper is designed to describe the merger between Hewlett-Packard and Compaq Computers in relation to the nature of industry and the structure-conduct-performance paradigm of managerial economics.

A Tale of Two Companies

Out of a tiny garage in Palo Alto, California, Stanford University graduates Bill Hewlett and Dave Packard founded Hewlett-Packard Inc. after launching their first product, an audio oscillator, in 1939. Taking a quantum leap forward 60 years to 1999, Carleton (Carly) S. Fiorina is named President and CEO of HP, inheriting a lucrative company with $42 billion in revenue and 84,400 employees. At the commencing of the 21st century, HP has grown to become the world's largest technology company, with a comprehensive portfolio that spans printing, personal computing, software, and IT infrastructure. On January 12, 2001, co-founder Bill Hewlett dies. Later that year, the merger between HP and Compaq begins (HP Timeline).

Since its inception in 1982, Compaq Computer Corporation--established by Jim Harris, Bill Murto, and Rod Canion, all senior managers at Texas Instruments--has proven consistent with its corporate mantra of "compatibility and quality." Prized for its excellent craftsmanship, durability, and ease of use, Compaq produced some of the first IBM PC compatible computers, and its products quickly became mainstays in the PC world, despite relatively late entry into the market. The firm progressed to become the third largest computer company, behind IBM and HP, with revenue of $42 billion in fiscal year 2001. Compaq remained independent until its merger with Hewlett-Packard in 2002 (Compaq History).

Integration

The two primary reasons firms engage in horizontal integration are (1) to enjoy the cost savings of economies of scale or scope, and (2) to enhance their market power. However, many senior executives fear mergers and acquisitions despite the combined company's reaped benefits because their positions are at stake (Baye). Carly Fiorina and Compaq CEO Michael Capellas, on the other hand, were on board from day one. Capellas felt there was too much capacity in the computer industry and that it made sense to consolidate during an economic downturn. Fiorina was ecstatic at the proposal to integrate, seeing the merger as an opportunity to create a highly competitive, well-positioned technology giant (Harvard Business).

Acknowledging the many obstacles ahead, the executives assembled an integration team comprised of both HP and Compaq employees immediately after the merger was announced. With office quarters dubbed the "clean room", the team dedicated itself to developing a master plan to be implemented upon the merger's close. It started with just a small group of employees, but evolved to nearly 2,500 because the scope of decisions involved in melding the two companies was immense (Harvard Business). However, the integration team had to be careful not to violate any antitrust laws as the merger was still pending approval from the FTC and DOJ.

Opposition

When the agreement of merger was announced to the public, HP faced criticism both internal and external to the firm. Outwardly, analysts said it was near suicide, as mergers within the tech industry had proven difficult historically, not to mention the less than perfect track records of prior HP and Compaq acquisitions (Harvard Business). Observer Todd Kort, principal analyst for Gartner Research, was quoted in Time magazine saying, "This is not a case of 1 + 1 = 2. It's more like 1 + 1 = 1.5." IDC analyst Roger Kay stated, "Dell must be totally gleeful, because these guys are going to spend all their time untangling themselves." Further, Michael Dell, CEO of Dell Computers, boldly called it "the dumbest deal of the decade." (Huffington Post). These pundits were essentially questioning the logic of HP--a global market leader in the high-margin printer business--in acquiring a PC manufacturer like Compaq at a time when computers were fast emerging as low-margin commodity products (ICMR).

Despite being the biggest deal in the history of the computer industry, HP and Compaq stock took a beating amidst cynicism of the soon-to-be merged entity; share prices declined by 21.5% and 15.7%, respectively. And together, the pair lost $13 billion in market capitalization in just a couple of days (ICMR). Hence, the HP-Compaq integration was proving to be an uphill battle.

Inwardly, the merger met even greater adversaries. Leading the crusade was Walter Hewlett, son of HP's co-founder, Bill Hewlett. He not only sat on the board of directors, but also controlled a sizeable portion of HP stock, therefore giving him considerable clout in the decision to merge. Along with other Hewlett and Packard family members and large shareholders, a war was waged to thwart the acquisition of Compaq (Huffington Post). Even with their best efforts of deterrence, Walter Hewlett and fellow antagonists were nonetheless outvoted. In one of the narrowest margins ever, the companies would officially be consolidated into the new HP.

The path was not fully cleared, however, as the Federal Trade Commission and Department of Justice had the authority to challenge the merger depending on their assessment of market shares, concentration levels, and competitive outlook. Under the Horizontal Merger Guidelines, these agencies view industries with Herfindahl-Hirschman indexes (HHIs) in excess of 1,800 to be highly concentrated (i.e. few competitors), and may attempt to block horizontal integration if it will increase the index by more than 100 points (Baye).

Obtained from the U.S. Census Bureau, our text provides concentration ratios and HHIs for select manufacturing industries. Electronic computers--a category in which HP and Compaq would fall--has an HHI of 2662 and a C₄ of 81 percent. The C₄ represents