Understanding What Happened To HP

Understanding What Happened To HP

The full scale of what HP's layoffs will do to the local economy are just becoming apparent to outsiders. Reading the comments on the Idaho Statesman website really shows how few people really understand the causes.

1. It is not because Carly Fiorina screwed up our printer designs! Look, I dislike Empress Carly as much as anyone, but Carly wasn't designing our printers.

2. It is not because of offshoring of jobs to take advantage of dollar a day labor. Yes, HP tried to move jobs to India and China--but the reasons are not what you think. Some of the offshoring was because some countries required local content in our printers. Brazil, for example, wanted to create a local electronics industry--and so HP ended up with a development group there.

Some of the offshoring was because there were localization requirements, usually around language, sometimes around features.

But much of the offshoring to India was started because, hard as it may be to believe, in the late 1990s, HP, like many other large U.S. companies, couldn't find Americans willing to come to work for them. One of my bosses told me that she was doing college recruiting trips for HP in 1999, and these college kids would ask what kind of car HP was offering. She was confused. It turned out that some companies were leasing cars as incentives to get new college grads to come to work! Offshoring jobs to India made a lot of sense when you couldn't hire college grads--there weren't enough of them to go around.

I was never impressed with the value of offshoring. Sure, labor costs in India were about 1/4 of what they were in Boise--but we were flying engineers and highly specialized equipment both directions, at enormous cost. In addition, while many of the engineers in India were completely competent, I did start to notice the last couple of years a decline in both English competence, and engineering competence--sometimes quite shockingly so. Some projects that had been sent to India--came back, because they weren't being done well.

Why? One of my friends who has spent a bit of time in India tells me that there are a lot of what call themselves colleges there that are really just trade schools, teaching a very narrow set of skills to satisfy particular markets, such as writing software for VxWorks. The demand for "software engineers" was being filled with people that weren't really up to the standards of the first wave of offshore Indian software engineers.

3. A big part of HP's problem was that laser printers became commodity items a lot quicker than many people expected. Once consumers are buying a product strictly on price--completely unconcerned with reputation or features--then HP was engaged in a race to the bottom--one that for structural reasons that I will not discuss, HP was not suited to winning.

4. There is one problem driving not just HP, but a lot of other U.S. companies to constantly slashing workers. In 1993, Democrats in Congress showed how much they hated "rich people" by passing a law that prohibited corporations from deducting as business expenses any annual salary exceeding one million dollars--and the salaries of the next four highest paid officers. So large corporations started to compensate officers with stock options instead. This created a strong incentive for officers of the corporation to keep the stock price rising for the next few quarters--even if it destroyed the long-term viability of the company. Note that this didn't actually prevent corporations from compensating their officers quite generously. (And in truth, Democrats weren't really trying to prevent that--they were just pretending to be on the side of the little guys, while continuing to cozy up to corporate fat cats.) It just created perverse incentives for how to run a large corporation.

A company that is developing complex products will need several years from the start of the process to the point where the product starts to bring in revenue. Think of this as a tunnel: you put money in one end of the tunnel in 2004; it turns into a return on investment in 2008. The products that you start developing in 2005, won't give a return until 2009. Ditto for 2006 to 2010, 2007 to 2011, and 2008 to 2012. If your focus, because of your stock options, is driving up the stock price over the next several quarters, the temptation to go for short-term improvements is very, very strong.

Cutting spending this year may impair profitability in 2012--or maybe it won't. It's hard to tell. But you can almost guarantee that cutting spending on long-term projects this year will drive up the stock price for the next quarter or two. This is why layoffs often lead to higher stock prices. Corporate officers whose primary income is derived from stock options have a strong incentive to cut costs right now. I don't think that stock options are necessarily a bad thing. But it does encourage a short-term view of how to run a company.