News analysis: Price pressures, slowing PC sales, sour economy and inherent merger difficulties set to make deal a headache

Hewlett-Packard and Compaq are combining to form the second biggest PC company with a significant presence in nearly every country in the world.

But it's not like life is going to get much easier.

Relentless price pressures, slowing PC sales, a sour economy, and the difficulty of merging two overlapping corporate bureaucracies that have been trying to shed employees during the past few months are just some of the problems facing Carly Fiorina and Michael Capellas, the respective chief executives of HP and Compaq.

"There are so many overlapping units, and there is no complementary benefit," said Ashok Kumar, an analyst at US Bancorp. "The problem with HP is that they have a lot to deal with, and it is going to be really tough."

On paper, the merger creates a computing colossus. Combined, the two companies pulled in revenues of $87.4bn (about £61bn) during the past four quarters--a figure that is second only to IBM's.

The acquisition also will help the two companies shed costs to better compete with Dell Computer, which surpassed Compaq as the largest PC maker in the first quarter this year. Measured by PC sales, the conglomerate will be slightly smaller than Dell in terms of market share.

HP also will get its hands on a consulting and services group. Last year, HP tried to buy PricewaterhouseCoopers, but the deal did not materialise.

Problems lurk within both Compaq and HP. Both companies have been losing market share and have suffered with lower PC revenue in recent quarters. In the second quarter, Compaq's market share was 12.1 percent; HP's was 6.9 percent, according to IDC.

Making matters worse, PCs will be the largest source of revenue for the new company at a time when prices are plummeting and unit sales are declining. Combined, the two companies sold $29bn worth of PCs during the past four quarters--a sum that dwarfs revenue from any other division for the two companies combined.

Face of the industry changed If the merger is completed, the industry will be reduced to a "Big Three" among PC makers: Dell, IBM and HP. Many analysts have predicted that IBM would exit the business. Gateway recently has made substantial cutbacks.

HP's buyout of Compaq is expected to intensify the pressure on Gateway, which is attempting to revamp itself into a US-only PC company. Gateway last week announced it would slash its workforce by 25 percent, close a US manufacturing plant and several call centres and shutter its Asian operations.

The merger between HP and Compaq could prove prickly. With so much overlap, layoffs are inevitable. Analysts, competitors and investors will watch carefully to see if the resulting organisation behaves more like Compaq, which has been a fairly aggressive company driven by sales goals, or HP, which has been more consensus-driven.

Since its founding in 1982, Compaq has been one of the most important players in the PC market. It was the first company to develop a clone of the IBM PC. Compaq also led the industry in notebooks. In the 1980s, Compaq co-founders Jim Harris and Rod Canion, while working on plans for what would become the portable computer, sketched out their vision on an upturned placemat at the House of Pies in Houston.

Compaq has been focused on cutting costs and was one of the early proponents of using Asian contract manufacturers. It overtook IBM to become the largest PC company in the world in 1994, and three years later became the first major manufacturer to release a sub-$1,000 PC.

The company largely stumbled when it couldn't undercut Dell on its direct-to-customer sales model. For years, Compaq struggled to move to a direct sales model.

By contrast, HP pre-dates the PC revolution by about 50 years. The company was started in a garage and got its first contract by making equipment for Disney's Fantasia. Besides having a storied technical history, HP is also famous for "the HP way", a management philosophy that stresses cooperation and the rights of individual employees.

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