Things are likely to get worse before they get better for HP, write Scott Morrison and Richard Waters

A year after it shocked the technology world with a plan to buy rival Compaq Computer, Hewlett-Packard is finding out just how hard the going can be.

An eight-month battle to win shareholder support and a four-month struggle to merge their complex global organisations have been followed by what could be the most gruelling part of all: another leg of the severe technology industry downturn.

HP - which employs 2,100 in Leixlip and Dublin - acknowledged last week at the enlarged company's inaugural quarterly earnings report that the prolonged slump in information technology spending had made its post-merger challenges all the more daunting.

In an interview, Mr Jeff Clarke, the executive vice-president in charge of the integration, said the latest pressures in the industry had already forced the company to intensify its plans to cut costs.

The difficult climate has raised questions among observers as to whether post-merger revenue targets can be met in coming quarters, though Ms Carly Fiorina, HP's chief executive, refused last week to back down from her targets.

She has at least been able to project a sense that the complex job of merging the two companies is on track.

Based on the initial integration targets for the merger, "things have come together", says Mr Mark Wolfenberger, technology strategist at Credit Suisse First Boston.

But combining the two company's products and services in a way that lifts the new company's revenues, rather than merely losing customers to rivals, will be a harder case to make. "From a synergy point of view, it is yet to be proven," says Mr Wolfenberger.

If anything, the early evidence shows just how hard it will be for HP to meet its ambitious target of losing no more than 5 per cent of revenues as a direct result of the merger.

To cling to sales in the corporate computing world in particular, HP has had to offer customers bigger discounts than it had hoped - partly a result of the severe pricing pressure that has hit all makers of enterprise computing products.

HP has handed big discounts to customers who have switched from its Alpha servers - a line of products it is to discontinue - to its SuperDome machines.

It also absorbed additional costs to coax customers to Compaq's popular industry-standard ProLiant servers.

These incentives generated about $100 million (€100.67 million) in unforeseen charges in the latest quarter, said Mr Clarke.

"We knew that the transition would take time \ what we are finding is that in a weak environment customers are looking to incentives in order to transition, and we are able to provide those," he adds. "The transition has been as we planned - the pricing \ has been greater than we expected."

In the personal computer market, meanwhile, there are indications that the company is struggling to halt the slide in combined market share of the former HP and Compaq brands, while it also faces a difficult job in attempting to maintain the presence of both brands in stores.

The PC unit reported a $198 million operating loss in the last quarter as revenues fell 19 per cent. Dell Computer, its key rival, has continued to gain market share.

Some analysts claim that Dell could by next year regain the market leadership in PC sales, which it lost to the enlarged HP.

Four months into the merger, HP has yet to explain how it plans to differentiate the rival HP and Compaq brands, though some analysts suggest it may have to drop one of the labels, a route also pushed by some retailers.

It is already looking to increase the proportion of PCs sold direct to narrow the cost advantage enjoyed by Dell.

However, while the enterprise computing and PC divisions have continued to suffer, HP's services and imaging and printing units have so far provided a strong antidote to the company's recent weaknesses.

The services business recorded a $275 million operating profit in the quarter while imaging and printing delivered a 137 per cent rise in earnings to $813 million as revenues climbed 10 per cent to $4.7 billion.

And Ms Fiorina has at least been able to meet her promise to slash costs in the early days of the merger, laying to rest some of the concerns that the complex merger would lead to organisational paralysis.

Also, HP has set about speeding efforts to adapt to the worsening business climate. "We have accelerated the pace of many of our decisions," says Mr Clarke.

The sense of urgency is strongest within HP's enterprise unit, which is responsible for server and storage equipment.

The business reported an operating loss of $422 million in the latest quarter as sales fell 22 per cent year on year.

HP cited sluggish global IT spending and aggressive discounting by rivals but the business also suffered from a higher-than-expected decline in sales of the Alpha servers.

The considerable headway made in cost-cutting has come in spite of some difficult logistical challenges.

Labour laws, systems requirements and tax issues have prevented the company from moving as quickly as it would like to integrate the two groups in many countries outside the US, executives admit.

In some regions, where it has not legally been able to complete the merger of national units yet, HP is still obliged to keep its Compaq operations separate for the time being.

While hurdles such as these were by no means unexpected and are not representative of the entire integration process, they illustrate the type of complex problems HP must slowly work through to complete the monumental task of integrating the two former rivals.

They also highlight the difficulty of presenting a unified face to the world - an important consideration as HP tries to win over its big customers to its new strategy. While sales teams for HP's largest accounts were set up when the merger closed, Mr Clarke acknowledges that there are instances in which HP and Compaq sales teams remain, technically, in head-to-head competition with one another.

Slashing expenses has at least been the most visible post-merger success to date. HP says it is on track to deliver annualised savings of $500 million by the end of its fiscal year in October, rising to $2.5 billion in 2003 and a further $3 billion the following year.

The company had already cut 6,500 jobs by last week as part of its plan to trim 10,000 employees by the end of October. And there is no reason to doubt HP will have cut at least 15,000 jobs, about 10 per cent of the combined workforce, by next year.

However, cost cutting has an inevitable impact on company morale and further job cuts could make things worse. Mr Clarke says management expected "morale problems" and is attempting to mitigate the effects of the lay-offs by moving as clearly and quickly as possible.

With signs that conditions in the battered tech industry are likely to get worse before they start to improve, this is an issue HP executives are likely to be dealing with for a long time.