Saving a 'Fundamentally Flawed' Business

John Chambers believes Hewlett-Packard Co. (NYSE: HPQ) is on the ropes and is unlikely to recover strongly enough to regain its old glory. The CEO and chairman of Cisco Systems Inc. (Nasdaq: CSCO) believes Meg Whitman, his counterpart at HP, may not succeed in turning around the company. He may be right; at best, Whitman will succeed in whittling down HP's cost structure enough to improve its margins, but she will also eventually preside over a much smaller giant.

Chambers advanced two reasons for his conclusion. First, "there's not been a company ever turned around by the fifth CEO on the job," he told Reuters in an interview, referring to the succession of senior executives who have been appointed to lead HP over the course of the last seven years. I checked, and HP has indeed had five CEOs in substantive or acting capacities since Carleton Fiorina left in 2005.

Chambers's second reason for his pessimism about HP's future resonated with me. The Cisco boss said rivals, including his company, which competes against HP in the networking equipment market, are hacking away at HP's market share while the Palo Alto, Calif.-based company is busy with cost-cutting and reorganization actions. He said Whitman has a "tough hand to play, but... I like competing against that hand, and we are going to try and accelerate that while they are struggling."

HP's "weak hand" isn't merely due to the revolving CEO door the company has had in the last decade. Like many other tech enterprises across the global economy, HP is a flawed company whose competitiveness has been compromised due to its failure to recognize and respond to shifts in its markets. The company, says short seller and hedge fund manager Jim Chanos, "missed the fundamental shift from personal computers" to tablets and phones, according to an article in the Insider Monkey. Turning HP around won't be achieved by simply cutting costs, he says.

I agree. But now that we understand a "fundamentally flawed" company cannot recover simply by shaving costs, what are the options open to the management of such an enterprise? This is an important question for the high-tech industry especially because of the seismic changes taking place in many segments of the market. The tech sector is awash in cash and on the surface seems to be thriving -- but that perception is deceptive. Below the surface, many technology companies are struggling to maintain market share, improve margins, and in some cases even justify their presence in certain sectors.

In the last decade alone, many chip suppliers, distributors, OEMs, and contract manufacturers have disappeared, gobbled up by rivals for a fraction of their valuation at the beginning of the century. The turmoil continues today; companies like Research in Motion, Flextronics, Nokia, HP, and Dell are thrashing about in a never-ending search for market validation and growth. All have evaluated, or are in the process of evaluating, their presence in markets that propelled them to the top of their sectors but which have since gone soft.

Even Intel Corp. (Nasdaq: INTC), the perennial market leader in the semiconductor industry, is searching for its soul. It has spent billions on acquisitions it hoped would help transform its operations and reduce its dependence on the PC microprocessor business. It has faced stiff headwind, although unlike others caught in the same position, Intel has pressed ahead with both acquisitions and increased investments in R&D as well as next-generation manufacturing technology in the conviction these moves will help it beat the odds.

Others that were not as blessed with huge cash resources haven't been as fortunate. Advanced Micro Devices Inc. (AMD) (NYSE: AMD), for example, finally threw in the towel and sold its semiconductor manufacturing division after decades of toe-to-toe slugfests with Intel. Its sales and capitalization reflect the disappointing performance. AMD's annual sales are forecast to sink to $5.8 billion this year, down from $6.6 billion in 2011, while its market value of $2.4 billion makes one wonder why it ever was seen as a serious rival to Intel (market cap $113.3 billion).

What many of these companies share is failure to anticipate change or spearhead innovation in their markets. This is the definition of a "fundamentally flawed" company. Turning companies so seriously flawed around will be extremely difficult, and businesses that can be safely placed in this category will not even survive, no matter how savagely executives cut costs.