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How Hewlett-Packard Plans to Recover From the PC Decline

Hewlett-Packard (NYSE: HPQ  ) delivered amazing results this week, causing shares to go up more than 7% pre-market. Although revenue for the fourth quarter of 2013 was down 3% from a year ago, this is the smallest decline the company has posted in the past nine quarters, in percentage terms. Moreover, net income came in at $1.4 billion as a result of strong sales from the enterprise division, which is successfully offsetting falling PC sales.

Although the company is still in a difficult position due to fierce competition from laptop and tablet manufacturers such as Lenovo, Hewlett-Packard appears to be stabilizing its business faster than expected. According to CEO Meg Whitman, Hewlett-Packard is only two years into her five-year turnaround plan. A new Hewlett-Packard is in the making, less vulnerable to the shrinking PC industry, and with stronger exposure to the high-margin enterprise hardware and software businesses, where the company is working together with Microsoft (NASDAQ: MSFT  ) . But how exactly does Hewlett-Packard plan to develop competitive advantages and achieve differentiation in a fierce market, where PCs and tablets are frequently regarded as mere commodities?

Source: Quartz and FactSet.

Planning the recovery
First, to increase competitiveness, Hewlett-Packard decided to reduce costs by becoming a more compact organization. The company has axed more than 27,000 people from its workforce since May 2012 in an attempt to save $3 billion, which will be used for research and development.

To offset the negative effect of weak PC sales, the company is trying to build new cash cows. For example, last month, Whitman announced at a tech conference in Bangkok that Hewlett-Packard is working on a 3-D printer, which could be released by mid-2014. If Hewlett-Packard manages to develop a low-cost 3-D printer, it could capture significant market share of a disruptive industry that's growing 20% per year, and benefit from a major improvement in top-line performance.

Printers and personal computers are still an important source of revenue for Hewlett-Packard, accounting for more than 40% of the company's operating income, and half of its revenue. In this particular segment, the company faces intense competition from Lenovo, the world's largest PC manufacturer, which enjoys three main advantages against most competitors: an R&D base, a strong brand name, and a global distribution network.

To recapture PC market share from Lenovo, Hewlett-Packard needs to develop more innovative PCs. This is a long-term process that involves heavy R&D investments. In the short run, the company is recovering market share after improving its execution and focusing on emerging markets. For example, the company saw strong growth in India after winning big government orders for educational tablets.

Software is the future
Software is an essential part of Whitman's turnaround plans for Hewlett-Packard because it allows the company to cross-sell its hardware. Software and hardware are usually sold as "integrated enterprise solutions," accounting for 50% of the company's operating profits. The company currently owns a $4 billion software portfolio, which includes several management and business analytics applications.

The partnership with Microsoft could have a strong positive effect on this segment, as both companies can improve their product offerings and execution power by optimizing hardware and software synchronization, and sharing tech expertise. So far, this partnership has allowed both companies to obtain various projects, from implementing vast high-performance networks based on Hewlett-Packard switches, to building cloud environments for big organizations.

Final Foolish takeaway
Although Hewlett-Packard still remains in a difficult position, the company is clearly making progress in its turnaround process. The new Hewlett-Packard should be more software-focused, have a more compact organization, and invest more in R&D. Furthermore, the company's investments in disruptive technology, such as 3-D printers, shows management is committed to innovation, and that it is not afraid of getting out of its comfort zone.

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