26-HP/EDS Combination: The Conclusion

Two strong industry leaders, both highly successful in other markets, decide to combine their subsidiaries in one market in order to gain market share and improve economies of scale. This made some good sense a few years ago. It didn’t turn out quite the way they hoped, though. We cover the story and four separate blogs, numbers 23 – 26.

Posted 6/4/08

This entry is the last in our series of four entries on the HP/ED deal.

The Setting

Hewlett Packard has proposed a take-over of EDS, in order to improve its services, revenues and profits. EDS is #2 to IBM in the computer services industry. Hewlett Packard is #5. The combined company, at $38 billion in revenues, would have only a 5% share of the market. IBM has $54 billion in services revenues and 7% market share. The reaction in the stock market has been mixed. Hewlett Packard stockholders don’t like it. Its share price fell. The EDS shareholders like it a lot better, as their shares increased in value.

A company undertakes an acquisition to achieve one or more of these three objectives: first, acquire a product that it does not have; second, acquire customers that it otherwise could not service; and third, establish a new lower unit cost through the combination of the two companies. We will look at each of these, in turn, in the current HP and EDS deal and then summarize our conclusions in the last entry.

Our Conclusion

As we explained in the previous three blog entries, the combination is likely to succeed in all three of the major objectives of an acquisition. It improves the product offering. It opens up the combined company to new customers. And it is virtually certain to reduce the unit costs the company incurs. A successful acquisition almost always requires success in two of the three objectives in order to make economic sense. This combination meets all three objectives.

This combination is essential to shift market share.

There is a hidden force behind the business logic for the merger between HP and EDS in the computer services industry. The hidden force is the dominance of “failure” in normal market share movement.

Failure moves more market share than does success in most mature markets (see “Failure Shifts More Share Than Success” in StrategyStreet.com/Tools/Perspectives). In most fast-growing markets, there are many opportunities to “win” market share. You “win” market share by offering customers something that other competitors cannot, or will not, offer them. But as markets become more mature and growth slows, “winning” market share becomes much more difficult. The reason? Competitors copy the most obvious innovations. These obvious innovations tend to be product Functions or unique Pricing schemes.

Once an industry reaches a slower growth level of maturity, “failure” tends to drive far more market share than does success. By “failure”, we mean that an incumbent supplier does not meet the customers’ expectations. These customer expectations are the result of the customer’s beliefs about the product offerings of other competitors. The “failing” incumbent cannot offer the Functions, Reliability, Convenience or Price that the customer expects and “fails” the customer. This “failure” causes the customer to open his relationship to other suppliers.

Once a market becomes “failure” driven, it takes many years to move significant market share from one competitor to another. Then, acquisitions become important to growth and profitability. Of course, these acquisitions have value only to the extent that the acquiring company is able to retain the purchased customers (see “Acquiring Share, Not Sand” in StrategyStreet.com/Tools/Perspectives).

Despite the fact that the #2 and #5 competitors in the marketplace are combining to compete more effectively with the #1 competitor, you should expect little or no price pressure to emerge in the market as a result. This market is highly fragmented with the top competitors holding only 20% of it. That leaves another 80% of the market served by smaller firms. The larger, more sophisticated competitors should grow at the expense of smaller companies, a typical evolution in fragmented markets. Furthermore, the growth in the marketplace, at 8-10% per annum, means that the infrastructure of the industry has to double every eight to ten years. This takes capital and profits and, therefore, reasonable prices.

This combination is a very good bet for success. Not a sure bet, but certainly a good one. However, it is unlikely to be successful very quickly. IBM stumbled for several years as it created a strong services business. IBM bought a consulting firm to help it improve its service offerings. The integration of its acquired consulting firm proved difficult and costly. IBM got over that hurdle and now has a profitable and fast-growing business. I expect that this HP/EDS combination will become far more profitable and fast growing than either current company, even if there are some bumps in the road.

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Update 2022:

An objective analysis of the combination of HP and EDS would have to conclude that it succeeded, though not in a spectacular way. The combination of HP and EDS produced little results in the form of unique products. It did broaden the product line and allow HP to remain one of the industry leaders.  It helped in the acquisition of permanent customers as the combined company moved from fifth to close to second in industry market share. The combination did reduce the costs of the combined company by increasing the company’s economies of scale.

Born out of HP’s split, HPE focuses on enterprise products and services. Hewlett Packard Enterprise (HPE) was created in 2015 when HP split its operation into two. On one side is HP Inc, the printer and PC arm of the company, while HPE deals with enterprise products and services

As of early 2022, DXC Technology, which contains much of the old EDS, had sales of $4 billion, down 11.6% from the previous quarter. The company was operating at a net loss. At the same time, IBM reported quarterly sales of $16.7 billion, an increase of 6.5%. IBM was profitable.

In 2016, IBM held 7% of the IT services business, excluding consulting and business process outsourcing.  Accenture was second with 4% with HPE a close third at 4%.   In this fragmented market, the top ten competitors held only 30% of the market.

This acquisition improved the productivity of the combined companies cost structure. HERE is how some winning companies achieve productivity in their cost structure

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Update 10/26

Blog 23 tells how three cloud leaders, AWS from Amazon, Azure from Microsoft and Google cloud, replaced IBM, HP and EDS as the Standard Leaders. Together they hold 63% of the cloud infrastructure market, which grew about 37% over the trailing 12 months to roughly $500 billion. That 63% is not a share of all computer services, a market of about $1.5 trillion that grew 3.8% in 2025.

The leaders’ global data centers create wide moats, as long as their uptime meets customer expectations. Customers found pay-per-use pricing attractive because it allowed them to experiment without a long-term commitment. These innovations also have produced superb economies of scale for the leaders.

The leaders of the cloud business seem to have reached a high level of penetration of the Very Large and Large customers. These customers view their computer services providers as strategic partners. These partnerships focus on broader business goals rather than straightforward costs. Once a supplier establishes such a customer relationship that relationship becomes extremely difficult to flip to another supplier. Even so, share is moving among the leaders: from the second quarter of 2024 to 2026 AWS share fell from 32% to 28%, Microsoft from 23% to 20% and Google rose from 12% to 15%. Our best guess is that new Function benefits, AI computing above all, are causing the shift. In search of continued growth, the leaders are now adapting their products to serve the Medium and Small customers.

Profits are attractive today: AWS earned an operating margin of about 39% and Google Cloud about 36% in the second quarter of 2026. Whether they are sustainable depends on whether the data-center build-out, roughly $190 billion to $220 billion planned for 2026 at each of Amazon, Alphabet and Microsoft, earns its return.

This is no longer the same industry where IBM and HP were leaders. All of their positive changes were overwhelmed by a new Next Leader concept of the business in cloud. No one competes the same way they did before. The HP/EDS combination met the three objectives the Blog set for an acquisition, and then the market changed under it. HP wrote off about $8 billion of the $13.9 billion price in 2012 and merged the business into DXC in 2017.

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Quick Hits

Six patterns from the StrategyStreet system this story confirms.

1. A share shift away from you calls for a prompt response. You have a choice of matching or exceeding the superior performance of the companies gaining share or of entering a market they are creating that is absorbing your share. Waiting is not a good option because you are already late.
2. Product Parochialism cost the leaders their market. IBM, HP and EDS defended their own hardware, software and outsourcing contracts while AWS, Azure and Google, Next Leader Transformers, rebuilt computer services around more of the customer’s needs. IBM’s SoftLayer purchase in 2013 and HP’s public cloud, closed in 2016, came too late and stayed tied to their own products.
3. A deal that meets its objectives can still fail to pay when the market evolves. The original Blog judged HP/EDS a good bet because it met all three objectives. But, by 2012 HP had written off about $8 billion of the $13.9 billion price, a failed acquisition. And in 2017 the business went into DXC, whose revenue has fallen every year since FY2018.
4. Adding a complementary product line does not fix a Performance (FRC) problem if the combined company’s Performance lags. HP and EDS fit together in 2008, yet both were losing share in an industry growing 8% to 10%. The deal left the combined company at 5% share against IBM’s 7%.
5. Share moves fastest where demand grows, and new Function benefits drive it. Cloud infrastructure grew about 37% over the trailing 12 months to the second quarter of 2026. In the two years to then AWS share fell from 32% to 28%, Microsoft from 23% to 20% and Google rose from 12% to 15%, and our best guess is that AI computing is the new Function behind the shift.
6. Pay-per-use pricing turned a Price benefit into a Convenience benefit. Customers found it attractive because they could experiment without a long-term commitment.

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