Lenovo (NASDAQOTH: LNVGY) group has seen astounding growth number in its PC business. It has passed Dell to become the number two PC company by volume last year, only behind Hewlett-Packard . Lenovo vaulted itself into this position by swallowing up competing PC makers, the largest of which was International Business Machines's ThinkPad division in 2005. Now, Lenovo seems to be looking up the food chain from consumers to enterprises by searching the market for a server manufacturer.
Lenovo’s game plan
Lonovo seems to want to copy and paste its dominance in the PC market into the more lucrative server market. Rumors have been swirling around that Lenovo is in talks with IBM to purchase its low end server business. It does seem to fit the long term plans for both IBM and Lenovo to sell off the division, but what will it mean for the competitive landscape? IBM is focusing on services and software that have higher margins and can help it on its path to earn $20 per share by 2015. Lenovo, on the other hand, is looking to establish a presence and name brand further up the value chain.
If IBM sells this service to Lenovo, we will probably see the same type of aggressive marketing by Lenovo as we have seen in the PC sector. Leonvo appears not to be in the business of margins at this time; at 2% operating margin, it's a razor thin business. It looks like Lenovo wants to shake out its weaker competitors, much like what Wal-Mart is accused of whenever it enters a small town. If Dell and HP can’t compete on prices for the long-term in these markets, Lenovo will continue to gain market share. As it becomes the dominant player, it can then start to raise prices and worry about profitability.
Dell has been in talks to go private for most of this year. The PC and low-end corporate server maker has operating margins at 5.3% and pays out 11% of its earnings to support a 2.4% dividend. Dell has been slow to move into the corporate services and software market, and is hoping that going private will allow it to restructure faster.
Hewlett-Packard has normalized operating margins of 5.7%, if we back out the major write-downs associated with botched acquisitions this past year. The current number one PC maker has been trying to move out of the commoditized PC business and into services and software (sounds familiar) to improve its margins, and move away from an industry with shrinking sales.
Both HP and Dell have to answer to investors and were not able to compete with China’s Lenovo on price in the PC market. When it comes to their bread and butter corporate clients, Lenovo will be just as ruthless on pricing. We can see in the chart above that both HP and Dell are losing their advantages to companies that compete on price, like Lenovo and Asus.
What to do?
Dell and HP are competing head-to-head with competitors that have better fixed-cost structures. Lenovo is based in China, where salaries are among the lowest in the world. Revenue is soaring at Lenovo as the company increases its market share by purchasing smaller competitors and using their scale to further reduce the fixed cost per unit.
HP and Dell need to either differentiate their products or increase the efficiency of their supply chain. Both companies are losing shipment volume and they need to act before those divisions are completely out-competed by their Asian counterparts. Whether HP and Dell are the purchasers or purchasees, we will be seeing a lot more consolidation in the PC market as time goes on.
Foolish bottom line
HP and Dell investors are pushing them in the direction of IBM, which currently has operating margins of 21%, four times those of HP and Dell. IBM continues to shift toward a more profitable mix of revenue. The business segments that are currently floundering at IBM are the major revenue drivers of both HP and Dell. If HP and Dell keep focusing on corporate customers, they will be going toe-to-toe with large competitors like IBM and Oracle. The corporate technology space will be an uphill battle against long-term servicing contracts and years of expertise. The options HP and Dell face do not look promising, and will need to be executed nearly perfectly if these two tech titans don’t want to become the next Kodak.
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