Manufacturing PCs is not a high-margin business. There's a lot of competition, and outside of specialty segments like gaming PCs, there's not much differentiation. A mainstream laptop from HP (HPQ 0.65%) is going to be very similar to a mainstream laptop from Dell or Lenovo.
The pandemic flipped the PC industry on its head. Insatiable demand, driven by working and learning from home coupled with supply chain constraints and shortages, created a bonanza for HP and other PC manufacturers. Not only did sales soar, but so did profits. At its quarterly peak, the adjusted operating margin in HP's personal-systems segment topped 8%.
That's not normal, and it was never going to last. Historically, HP managed operating margins closer to 4% in the PC business. Margins could be a bit higher during periods of strong demand, but a doubling of margins was a pandemic anomaly.
Key Data Points
Back to normal
With global PC shipments crashing nearly 20% in the calendar third quarter, it should be no surprise that HP's PC business is not doing nearly as well as it has done over the past couple of years. Personal-systems revenue slumped 13% year over year for HP in the fiscal third quarter, and adjusted operating margin fell back to a more typical 4.5%.
Total units dropped 21%, right in line with the market. It wasn't just consumer PC sales that were weak. While consumer PC revenue plunged 25%, commercial PC revenue was also down 6%.
Decent demand for commercial PCs has sustained HP up until now. In the second quarter, even as consumer PC demand slumped, HP managed to grow commercial PC revenue by 7%. It now seems that businesses are starting to pull back as economic uncertainty ramps up.
The personal-systems segment does include peripherals and accessories, like the company's latest 4K streaming webcam. These types of products are likely more profitable than notebooks and desktops, but they only represent about 7% of the segment's total revenue. That's probably not big enough to really move the needle.
HP has a plan
The PC market is likely going to be weak for a while. HP is predicting that overall PC unit shipments will drop by 10% in fiscal 2023, compared to 2022. The company expects soft demand and high channel-inventory levels to put pressure on pricing through the first half of next year and potentially into the second half.
There's not much HP can do about demand, so the company is looking to aggressively tackle costs. HP unveiled a substantial cost-cutting plan, along with its third-quarter results. The goal is to shave off at least $1.4 billion of annualized costs by the end of fiscal 2025, with at least 40% of that total achieved by the end of fiscal 2023.
Layoffs will be part of the equation. HP plans to reduce headcount by between 4,000 and 6,000 over the next few years, which is somewhere around 10% of its 51,000 employees as of the end of fiscal 2021. On top of layoffs, HP will narrow its focus to its strongest businesses and achieve cost savings through automation and other digital initiatives. HP expects to take around $1 billion in charges related to these initiatives.
Restructuring all the time
This kind of plan is exactly what Wall Street wanted to hear, but it's also not the first time HP has done this sort of thing. The company's "Fiscal 2020 Plan" approved toward the end of 2019 involved a headcount reduction of 7,000 to 9,000 employees. HP got lucky, with the best demand environment it's seen in a long time in 2020 and 2021.
Even if HP can actually achieve these cost cuts, many of which are tied to vague things like "digitization of end-to-end processes" and "build connected experiences through digital platforms," the economics of the PC business aren't going to change. And some of the items, like portfolio optimization, have the potential to reduce revenue.
No matter what HP says about cost-cutting, the era of profits well above historical levels in the PC segment is probably over.
