NelsonHall recently attended an HP analyst summit in Boston, where our interest was focused on developments at HP Enterprise Services (HP ES). HP ES has room to breathe again, but the next few years will be at least as tough as the last two have been.

Financial progress to date against turnaround program

In its FY 2013 (ended October 31, 2013), the ‘Fix and Rebuild’ year of its turnaround program, HP ES’ financial performance was better than it had initially guided, with:

• Revenues of $23.5bn, down 8.2% (better than the guided decline of 10%-11%), down 7% in CC. The extent of contract runoffs was not as great as expected, due to delays in some of the ramp downs. This impact continues in FY 2014
• An EBIT margin of 2.9%, at the high end of previous guidance of 0%-3%.

HP ES accounted for 20.4% of total group revenue, but just 6.3% of divisional EBIT (the Enterprise Group and Printing divisions generate most earnings for HP, accounting between them for >75% of total divisional earnings). Clearly, improving operating margin is the main priority for HP ES over the next few years: the eventual target margin range is 7% to 9%. Guidance for FY 2014 is margin improvement to 3.5% to 4.5%, an uptick of 60 to 160 bps.

FY 2014 was initially intended to be a “recovery and expansion” year for HP ES. But, with some contract run offs taking longer than anticipated, top-line growth is not now expected until FY 2015. Current guidance for FY 2014 is a revenue decline of 4% to 6%.

What is HP ES doing to achieve future profitable growth?

As part of its ambition to increase its relevance to clients’ business agendas by positioning as being able to offer services across the “advise, transform, manage” spectrum, HP ES is introducing major changes in go-to-market and in value proposition that reflect an attempt to shift from a mind-set  that was product-centric to one that is services-led.

Key components of the current strategy include:

• Positioning its offerings against “business outcomes”
• Recruitment of client principals
• Revitalizing the sales engine. There is a slight increased focus on hunting this year, beyond account mining (in a recent earnings call, Nefkens referred to the proportion of the sales force deployed on new business lifting from just 4% in FY 2013 to 29% in FY 2014)
• Recruitment of client principals with industry domain experience
• Partnering for advisory capabilities
• Setting up a global practices organization, with an increased focus on industry offerings
• Targeted investment to expand capabilities in high-growth areas of the portfolio
• And, of course, reducing cost of service in some areas of the portfolio.

Let’s look briefly at each of these (apart from the last, where the levers being applied are obvious) …

Firstly, HP ES is working on aligning its various offerings against the following five “business outcomes”:

• Customer experience
• Citizen engagement
• Employee empowerment
• IT-enabled transformation
• Acquisitions, divestitures.

We think of these as five broad themes, rather than “business outcomes” (also, surprisingly, that there is the odd omission - which HP ES would no doubt lump into “IT-enabled transformation”). Nevertheless, this marks an attempt by HP ES to affect a huge shift in approach, from highlighting HP’s technology capabilities to focusing on clients’ business aspirations.

The big change in HP ES' "Advise, Transform, Manage” positioning is its ambition to act as a “trusted partner” who can act as an advisor to clients. In support of this, HP ES has been recruiting a significant number of client principals with specific industry or domain expertise to boost its ability to present some clients with an advisory front-end.

But the fact remains that HP ES does not really have any significant consulting capability; it has also been exploring partnerships. We wrote last year that any such partnerships would be with management consultancies such as PWC, Deloitte, McKinsey, and even Accenture. It appears there has been some progress with one of these recently, with HP ES taking care that in any agreement it should not end up in the low-margin role of IT infrastructure services partner. This is a necessary, though a risky, path that HP ES is treading. Necessity is the mother of invention,  as is the case with the CSC/HCL partnership.

The new global practices organization, a major organizational change, is comprised of seven practices:

• Industry outcomes: a key focus in the short term is developing industry use cases
• Mobility and workplace
• Analytics and data management
• Applications
• Business Process Services (BPO)
• Security services
• Workload and Cloud.

These do not appear to be P&Ls. The practices are “interconnected”: offerings in some are delivered through others (e.g. mobile app development appears in Mobility & Workplace but services are delivered in Applications). Again, in the high-level marketing, there is  an attempt to articulate business value (rather than, say, IT transformation) in each, a big shift from "cloud" being omnipresent in the marketing.

HP ES referred to making investments in relevant attractive sub-segments: the reality, however, is that the level of investment will be very small for an organization of its size (it still has to complete its restructuring plan, implementing major (10k) headcount reductions in EMEA, replicating what has been done in North America. The practice that probably has the highest priority for investment is security services: expect to see HP ES build out its analytics capabilities, set up a few more regional SOCs, and maybe gain advisory capabilities.

In the mid-to long-term, we would expect to see HP ES expand its industry IP.  For an organization of its size, HP ES has proprietary industry in just three verticals, all of which come from legacy EDS (e.g., the HP “Travel & Transportation Solution” can be traced back to the EDS acquisition of IT assets from Sabre Holdings for $660m back in 2001  (Saber also outsourced its IT to EDS in a  10-year, $2.2bn deal).

In conclusion

HP ES has made substantive progress in the last two years in, inter alia:

• Reducing the number of number of incidents and of “red accounts” (the few that remain are IT IM deals)
• Taking out cost: Whitman has indicated that, after the EMEA restructuring, there should be no more exceptional charges associated with restructuring
• Bringing in new leadership talent across the organization
• Retaining some very large renewals (e.g. Navy, some Medicaid deals).

It has also benefited from some much needed investments in areas such as salesforce.com and a resource management system.

The desired shift to more business-oriented offerings will not be easy for HP ES, nor will building the capabilities to position at the advisory end of the services spectrum. Hiring client principals, developing a repository of industry use-cases, positioning the offerings portfolio against business themes - these are all in their early stages, and the lack of industry IP, domain knowledge and advisory capabilities will continue to be a major challenge in some sectors. There is also a lot to do to revitalize the sales engine to be more proactive and also bring the full HP ES portfolio to clients.

HP ES is a huge ship to turn around (especially when the waters are not calm). Progress to date against the turnaround program is on plan, and there is now more meat on the bone around how it intends to pursue its “advise/ transform/manage” aspirations. Decisions on investments over the next two years (probably not this year) will make it more clear whether the aspiration will in reality mark a sea-change for HP ES.

NelsonHall will be publishing an updated Key Vendor Assessment on HP ES next week.