HP and Palm: The Explosion that Will Rock the Computer Industry

With the Palm acquisition, HP is clearly taking a path that is away from Microsoft but not toward Google. While this is part of a general trend, started by Apple and Microsoft, to vertically integrate their businesses in a seeming return to the world before the PC, it also reflects on the relative size and power of HP and Microsoft. In effect, HP is simply too large to be subordinated to Microsoft and Microsoft has been too large to be subordinated by HP since the early 90s. Let’s talk about these changes and then I’ll do a follow-up on who the beneficiaries of this are, short and long term. The impact of HP's move goes well beyond Palm and into the very fabric of the existing computer market and who leads it.

Computer Market

When compared to other manufacturing markets like white goods (refrigerators, etc.), automotive, and consumer electronics, the computer market is not only relatively young, it is also still extremely specialized. In most of those markets, the companies with the power are the ones that build the devices that are sold. Market pressures and the need for multiple bidders keep suppliers from flipping this in their favor, as has happened with Intel and Microsoft.

In virtually all other markets, the company building the product decides what will go in that product, specifies the parts, sends them out to bid, and brings the completed offering to market. They increasingly may have the product manufactured by a contract manufacturer and they may buy volume parts off the shelf, but the products are designed to their specification.

In the computer market, both Intel and Microsoft build to their own specification. They may seek feedback from the hardware OEMs, but it is clear that the final decision is theirs and they work to ensure that what they provide is consistent across all vendors. The result, along with control, shifted profits to them as the hardware OEMs increasingly had trouble differentiating from each other.

Apple Spoils the Game

Apple (as an aside, if you haven’t seen the John Stewart rant on Apple, it is worth the time to watch it) effectively saw this as a serious problem and didn’t license Microsoft’s OS, even though economies of scale (the fact that Intel and AMD could provide a given level of performance relatively cheaply due to high volumes) did eventually shift it to Intel. However, even with Intel, Apple is unique and has avoided much of Intel’s co-marketing program and has largely trivialized the parts, choosing to deploy new technologies later and effectively shift some of the profits back to itself. The result is that over the last 10 years, Apple has increased its profitability significantly and is now the envy of the computer market. Apple is the most successful, the least loyal to either Intel or Microsoft, and the most profitable, something that isn’t lost on the others. But few can afford the switching cost of abandoning the Windows model.

AMD’s Success, Google’s Failure

Both AMD, against Intel, and Google (Android), against Microsoft were seen by the OEMs as a way to shift the power and margins back to a model that better favors them and gives them more control. You’ll see a significant shift to AMD in the second half of the year by a number of OEMs because AMD has been able to close significantly the price performance gap, at least on the desktop, due to its focus on graphics. You won’t just see this on consumer products but on business lines as well.

This doesn’t reflect on any weakness in Intel’s line but predominantly on the overall need to shift balance back to the OEMs. However, Google’s efforts against Microsoft appear to be failing. First it started demonstrating similar behaviors to Microsoft in that it surprised the vendors with the Chrome OS, catching them napping, and then started dictating tightly what hardware would be connected to some platforms. It may be designing its own chip. Then it showcased that it couldn’t protect the related IP, when Apple sued HTC, in Android identifying a significant hidden cost.

The Apple litigation against HTC, followed by the licensing of Microsoft’s technology to HTC, identifies a hidden cost for using Android, which wasn’t part of the initial analysis. This cost is likely between $40 and $80 per handset but, depending on the outcome of the Apple litigation, could actually turn out to exceed this range. This suddenly made the Android platform less of a solution and potentially an even bigger problem than the alternatives.

HP Buys Palm

As the largest computer hardware vendor in the market, HP has the strength to force the market back into a model that is more profitable for HP and away from Intel and Microsoft. It has always been one of the most aggressive on AMD but has had significant problems finding a way around Microsoft. It had intended to move heavily to Android across a number of products but, as noted above, that route turned out to be simply switching one bad problem for one equally bad but more expensive. Instead, it bought Palm, which gives it access to an OS in line with Android, more mature than Chrome OS and Windows Phone 7, and one that it can control.

While initially this may seem like just a smartphone play, it intends to take the platform to tablets (something Microsoft refused to allow it to do with Windows Phone 7, and Google might have forced it off of when the ChromeOS arrived) and on to other things. Eventual targets would be client devices connected to its thin client and blade PC solutions but, eventually, the variety of products could potentially exceed its Windows PC lines -- though this could take as much as a decade.

Wrapping Up

Often, companies and people mirror each other as relationships mature. In the beginning, Microsoft and Intel were subordinated to the companies building the hardware products. Then these firms allowed themselves, by nature of focused prices wars and general segment success, to flip places and be subordinated. I’ve seen relationships where one person is dominant and that dominance flips for a variety of reasons, but I've seldom seen a relationship survive when the situation changes and the submissive party tries to seize control again. That’s what is happening between HP and Microsoft. It will have significant implications for both companies.

But just like in a human relationship, there is no real blame to be assigned to either firm. Dynamics change, forcing relationships to change, and generally these relationships don’t survive intact. Right now, HP is a big indicator that the market is changing to a more traditional model, but only to those that weren’t watching Apple closely as the effective canary in this coal mine. We saw this coming some time ago. We’ll look at impact next, but I doubt any of us yet realize what a big change will result from this move. HP has started a fire, and like any fire, the outcome of this one is far from certain. What is certain is that the existing computer power structure is crumbling and change is in the wind.