Hewlett-Packard Deal Highlights Life in the Economy

What's this? A big M&A deal? Maybe the economy isn't so moribund after all.

Hewlett-Packard's plan to buy Electronic Data Systems for about $14 billion is a sensible strategic alignment. HP is mostly an equipment company, with a huge but low-margin personal computer division and a storied business in printers, paper, and ink. EDS is a big information-technology firm that runs back-end computing systems for dozens of big corporations—but has failed to offshore its own operations or cut costs as aggressively as competitors.

Bringing the two together gives HP a foothold in an important growth sector and creates a company big enough to compete around the world with IBM and other tech goliaths.

The deal also reinforces where the action is in today's economy. IBM—which invented the PC—sold its own computer division to Lenovo in 2005, solidifying a decadelong move out of commodities that can be made cheaply in China or other low-cost countries. Instead, IBM has doubled down on high-end IT and consulting services that are far more profitable. HP isn't going as far as selling its PC unit, but CEO Mark Hurd is clearly steering HP in the same direction as IBM.

Unlike mainline manufacturing and other 20th-century industries that are in decline, IT is a bright spot in the U.S. economy—as long as you include lots of overseas offshoots. The IT services industry is growing about 8 percent per year, according to the Wall Street Journal. IBM, Accenture, Oracle, and other American firms are getting a lot of that business—but shipping much of the work overseas to India and other low-cost countries. Well-run Indian companies like Tata, Infosys, and Wipro are going after much of the same business—while expanding their footprint in the United States, to help manage all the American accounts coming their way.

HP and EDS could complement each other well. EDS has multimillion-dollar contracts with dozens of firms in the defense, automotive, and manufacturing industries. Taking over that business might give HP an inside track for selling its computer equipment. Still, the EDS purchase has a lot of risks. For the deal to work, HP will have to:

Merge two cultures that make a Microsoft-Yahoo merger seem like instant harmony. "EDS is a very militaristic culture, very authoritative," says Prof. Eric Johnson of Dartmouth's Tuck School of Business. "It's very unlike HP, with its open doors, where anybody can send an E-mail to the CEO."

Streamline EDS. The Texas-based firm founded by Ross Perot has struggled with profitability, partly because it has maintained a strong employment base in the United States while competitors have been quickly tapping cheaper overseas labor markets. Hurd has earned plaudits for cutting costs at HP; now he'll have to do it at the EDS division, where resistance might be stiffer. "HP may have to go through the usual bloodbath making all those transitions," Johnson says.

Manage sprawl. The two companies say the EDS division will remain in Texas, which will complicate Hurd's management challenge. It took a good five years for HP to fully digest Compaq, which it bought for $25 billion in 2002; that was an enormously contentious deal that still gets mixed reviews. No doubt Hurd knows he needs to deliver more conclusive results with EDS—and faster.