Hewlett-Packard and the Failure of Imagination

One week ago, the tech market went haywire -- and shook Apple (NAS: AAPL) to its core.

No, I'm not talking about Steve Jobs's surprise resignation. Although that was certainly big news, it didn't do much to change the company, or hurt the stock price. I'm talking about the midnight fire sale that Hewlett-Packard (NYS: HPQ) held to liquidate its "TouchPad" tablet inventory two Saturdays back.

In response, buyers formed actual lines at Best Buy (NYS: BBY) and Walmart (NYS: WMT) storefronts, while simultaneously mobbing the companies' websites in hopes of scoring a tablet. In the space of about 24 hours of frenzied buying, HP sold out essentially its entire inventory of TouchPads -- reportedly moving 350,000 units last Saturday alone.

But wasn't iPad kicking every other tablet maker's battery compartments up and down Silicon Valley? Didn't it basically leave Research In Motion (NAS: RIMM) for dead, drive Dell (NAS: DELL) from the field of battle, sue Samsung into submission, and drive HP itself right out of the computer biz?

Well, yes. By all rights, Apple should stand astride the tablet world like a colossus, pounding its chest and bellowing its victory. Instead, it's looking a bit dazed, at least for the moment.

So how did HP turn the tables on Apple and post one glorious day of eye-popping sales numbers? Simple. It dropped its asking price for the TouchPad to $99.

If you can't beat 'em, blitz 'em
CNET took the weekend to ponder the implications of HP's accidental success story. Rather than spend "hundreds of millions" of dollars on a marketing blitz to advertise a new product, why didn't HP just come out and massively undercut the iPad on price? Why not use dollars that would otherwise have been spent on Madison Avenue product pushers to instead create a feeding frenzy of shoppers looking to score a good tablet at a great price?

As one tech analyst put it, when HP's initial inability to make a dent in Apple's market share represented not "a product failure," but "a pricing failure."

The blitz that could have been
Now, the objections to this approach are obvious. It's hard to compete with Apple on price because Apple's bought up the component supplies; it's got great scale of production; it's vertically integrated -- and so on and so on. All these factors make it more expensive for competitors to build a rival product. Estimates suggest that the parts that go into a TouchPad alone cost $300 or more, and that's not counting the cost of building factories to assemble the things, plus the energy cost of assembly, paying workers, warranty costs ... Add in these expenses, and HP probably has to charge $500 or more for a tablet if it wants to earn any profit at all.

But that's just the point: HP doesn't have to make a profit on the hardware. In fact, that's almost antithetical to HP's business model.

Razor and blade, printer and ink
Historically, HP's bread and butter business was not PCs, but printers. With a near-40% market share , it still rules the printer business precisely because it prices its models not to earn a profit on the hardware, but rather to lock consumers into buying its proprietary ink cartridges at steep profit margins.

Rival printer makers like Canon (NYS: CCJ) and Lexmark have struggled to displace HP from its market-leading position, because HP is content to eke out a small profit or even take a loss up front, secure in the knowledge that it will earn back its losses in high-priced ink farther down the road. HP could have done the same thing with tablets. It could have charged an attractive up-front price for TouchPad (maybe not $99, necessarily), and then charged more for TouchPad apps than similar iPad apps cost.

Foolish takeaway
When you get right down to it, I think CNET has a point. TouchPad failed not by having a bad product, but by bringing it to market with bad pricing. More importantly, though, it represents a failure of imagination. HP had everything necessary in its corporate toolchest to make a go of the tablet business, the same way it recaptured the lead in PCs from Dell all those years ago. The company simply had to follow the gameplan it laid down for its printer business decades ago.

Instead, HP fumbled the ball. But that doesn't mean that no one out will learn from HP's mistake, or take a lesson from the weekend sales frenzy sparked by the appearance of an attractively priced tablet. Tomorrow, I'll take a look at one company that could do just that.

Make sure you don't miss tomorrow's installment! Add Hewlett-Packard to your Watchlist now.

At the time this article was published The Motley Fool owns shares of Wal-Mart Stores, Best Buy, Apple, and Research In Motion. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, Dell, Apple, and Best Buy, and  creating a bull call spread position in Apple and a diagonal call position in Wal-Mart Stores.Fool contributor Rich Smith does not own shares of any company named above. Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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