HP Following IBM Lead, Readies for Death of Hardware, Software

(MoneyWatch)  You've undoubtedly heard that HP's earnings were up, year-over-year, and that revenue was down. But the real story for the company continues to be how it is shifting from being a product- to a service-oriented organization, following the path that IBM successfully charted. R&D spending as a percentage of revenue continues to trend downward and the service business the only part showing growth. So you have to wonder whether the transformation is relative, with product sales having taken a hit because of the economy, or if HP's product business basically hit a ceiling and that service is the only hope for the future.

It's been some time now that we've been following HP's numbers, specifically regarding a transformation from an engineering-driving product company to a more service-oriented one. The numbers for the fourth quarter and FY 2009, released late yesterday, continue piling up the evidence that instead of setting up an engineering lab in a garage, maybe Bill Hewlett and Dave Packard might have opened a consulting desk.

If we continue the look at R&D spending, absolute dollars went up a bit between Q3 and Q4, as you can see in the following chart.

However, the trend is still clearly down, and year-over-year, absolute dollar spending is still down 16.4 percent. Think about that -- it's a huge drop, particularly when HP still uses the "HP Invent" imagery on its web site when announcing the quarter and year end results.

And look at the trend of R&D as a percentage of revenue:

It continues a significant trend of dropping. In one sense, the only reason that absolute R&D spending went up quarter to quarter is that revenue did as well. Now look at another view of the business, as in year-over-year revenue by division:

The services division is a little deceptive because the EDS acquisition closed in August 2008. But even looking at Q4 on a year-over-year basis, services went from $8.28 billion in 2008 to $8.93 billion in 2009, a 7.9 percent increase, but all product lines were down. Given that we're comparing this last quarter with what was hitting the depth of the business panic coming out of the financial crisis, that should be disconcerting to management.

And it likely is. The new trends in virtualization and cloud-based computing over the long run are only going to reduce the amount of hardware and software that companies buy due to the atomization of computing. Clearly I'm not saying that hardware and software as categories are going to die in absolute terms. But they will as relative drivers of the high speed growth to which tech companies are addicted.

That revenue expansion will have to come from someplace else. I think what we're seeing now is part of a longer term trend -- maybe currently visible only due to the financial meltdown, but something that will grow until its presence is unavoidable. IBM figured this out years ago. HP is doing what it must. The real question becomes what are the rest of the enterprise product companies going to do?

Images courtesy Hewlett-Packard.