What HP learned from Procter & Gamble

This common-sense idea would seem to apply both to hospitality and to high-tech. And it explains why Hewlett-Packard executives sound so sure they can successfully expand beyond their own modest services operation to run a sprawling outsourcing company. Investors will get their first peek at how well HP is doing on Monday after the markets close, when it issues the first earnings report that includes its purchase of IT services firm EDS. (HP last week preannounced fourth-quarter sales and profits that beat analysts’ estimates, but the results weren’t broken down by business units.)

Though there will be plenty of questions late Monday about the health of HP’s core PC and printer businesses, analysts are sure to devote special attention to the newly-merged services and outsourcing operation. It represents both opportunity and danger: If HP can quickly whip EDS into shape, it will add more than $22 billion in revenue to the balance sheet. If not, eager competitors will steal EDS customers, and bloated costs will sink HP’s profits.

So why do HP executives sound confident? Long before they bought EDS for $13.9 billion earlier this year, they learned the ropes of the outsourcing business from working with one customer in particular: consumer products giant Procter & Gamble . For five years, HP has acted as P&G’s outsourced IT department, running data centers, providing equipment and offering technology support for a $85 billion company whose product portfolio includes Duracell batteries, Cover Girl cosmetics and Pringles potato chips.

The best reference

Outsourcing services are a very different animal from the traditional technology business. For years, tech companies mainly focused on building new gizmos, selling them by the boatload, and offering warranties in case they broke. But as technology has become more ubiquitous, the model has shifted. Now that every serious business seems to have a Web site, corporate e-mail, and any number of internal software systems, 75% of the typical corporate IT budget goes toward keeping those old systems running instead of buying new gizmos.

In response, many traditional technology companies — led by IBM and others — have gotten into the business of running customers’ IT shops through outsourcing contracts. Ideally, it’s a great deal for both parties: The customer pays a flat fee over a multi-year contract, and gets to turn over their headaches to someone else. The tech company can make a healthy profit by cutting costs and making things work more efficiently.

Not that the services business is easy; HP has faced plenty of challenges with Procter & Gamble. There was the time HP had to scramble to adjust tech systems when P&G bought Gillette, and again when Hurricane Katrina took down a key distribution center. There was even an embarrassing setback recently, when the company took a $650 million chunk of business away from HP and gave it to BT Global Services.

But overall, both sides seem pleased with how things have gone. HP executive vice president Ann Livermore holds up P&G as her most frequent customer reference in a business that’s sold on reputation. And Jim Fortner, who oversees technology for P&G, says he thinks HP will continue to do good work, even though big mergers can be painfully distracting. “We do more business with HP now than we did five years ago,” Fortner told Fortune. “We’ll probably continue to grow that business.”

This is a time when HP truly needs this type of endorsement from a high-profile customer; not every tech purchaser is optimistic about the prospect of a combined HP/EDS. General Motors tech chief Ralph Szygenda said last month that he’s uncomfortable with so much of his budget for both hardware and services going to one company. (HP has promised to make sure GM gets a good deal no matter what.) Szygenda told Bloomberg he had no immediate plans to change suppliers, but “Every company knows, I love you for today, but tomorrow is an economic decision.”

Competitive pressure

Meanwhile, competitors sense HP’s vulnerability. India-based outsourcer Infosys added more than 7,000 employees in the most recent quarter, particularly in Mexico, China and Europe, and grew sales nearly 25% over last year. CEO Kris Gopalakrishnan said earlier this year that he plans to compete for more of the high-end deals that HP will also covet.

And, of course, there’s the big kahuna of the outsourcing world, IBM. A person connected with Big Blue’s services business claims IBM has peeled away a few accounts from EDS since the HP deal was announced, and that IBM salespeople are touting their reputation for stability to woo businesses concerned about whether HP can cut staff and digest an acquisition while still delivering good service.

It could be an effective tactic. IBM has deeper experience in services than HP does, and can hook clients into the world’s biggest network of data centers. It has also made a science of choosing the right experts to solve customer problems. IBM’s Professional Marketplace, for example, is like a social network of 68,000 IBM consultants — the company says the tool has helped it to match people with projects 20% faster.

Still, HP likes its odds. Talk to Livermore and she’s likely to point out how much HP has learned since she first began pursuing the Procter & Gamble deal more than five years ago. Back then many saw HP as a foundering company struggling to recover from its last big acquisition, Compaq. Livermore could see that she had to build a healthy outsourcing operation for HP to have credibility as a business technology company, but she didn’t have any marquee clients.

Support from the top

So she pursued the Procter & Gamble account as if she couldn’t afford to lose, meticulously studying the prospective client’s needs and making frequent trips to P&G headquarters in Cincinnati to sit down with the decision makers. “I believe you have to look across the table into the whites of the eyes of the firm you’re going to be working with, and believe that they’re always going to do what’s right,” she said. To emphasize how badly HP wanted to win, she made sure to bring along then-CEO Carly Fiorina.

It worked. “Frankly, the HP proposal was just better than the others,” P&G’s Fortner recalled. “They came in here with clear executive support.”

Current HP CEO Mark Hurd has not only put the old Compaq demons to rest and turned around HP, he also clearly embraces the importance of hands-on customer contact. Disney Studios technology chief Jeff Mirich, who buys hardware, software and services from HP, said earlier this year that he counts executive access among the reasons why he has been doing more business with the company.

T-Mobile chief information officer chief Rob Strickland recalls being selected to have breakfast with Hurd before a meeting of CIOs, and being impressed that Hurd not only offered him a ride to the event in HP’s car, but also used the time to pepper him with detailed questions about T-Mobile’s needs and how HP could improve. “He started to set the tone for people around him that it was okay to engage customers at this level of intimacy,” Strickland said.

New energy

The hands-on approach continues. Last month HP hosted Procter & Gamble representatives at EDS’ home base in Plano, Texas, for a presentation about how the combined company will function. Fortner came away a believer. “This, I think, has resurrected EDS,” he said. “One plus one is going to equal four. You can just feel the energy in this new business.”

HP will need all that energy — and then some — to make the EDS acquisition work. And it can’t forget that IBM is breathing down its neck. Just consider Procter & Gamble. Even though HP handles many of the company’s technology needs, it still turns to IBM for IT security, payroll and benefits administration. Said Fortner: “HP doesn’t win them all.”

Perhaps not, but it will have to try.INTC) (JAVA) (CSCO)