Clean Room. The term suggests sterility and isolation. Which is exactly how a select group of Hewlett-Packard Co. and Compaq Computer employees must have felt, when they were chosen to map out the merger of the two high-tech giants' supply chains.

HP's "clean room" wasn't a literal place, but it might just as well have been. Its virtual inhabitants were stripped of their day-to-day responsibilities. For all practical purposes, they were no longer members of either organization. The reason: they were privy to sensitive information about long-time rivals. And they began their task months before HP's acquisition of Compaq won regulatory approval.

In fact, at the time the team undertook the job of integration, there was no guarantee that the merger would go through. The brainchild of HP chairman and chief executive officer Carly Fiorina, the $19bn deal came under intense fire from influential critics, both inside and outside the two companies. Among Fiorina's most vocal foes were the children of HP founders William Hewlett and David Packard. The opposition argued that the combination was bad for shareholders, employees and customers. They predicted it would go the way of virtually every high-tech merger that preceded it, devolving into an endless series of turf battles, redundant products and bloated bureaucracies.

Left unanswered was what would happen to the integration team if the merger fell through. Even with non-disclosure agreements, there was speculation that members would either have to leave their respective companies or be reassigned to positions that weren't compromised by their newfound knowledge.

But they soldiered on, and the results appear to have vindicated their efforts. Just over a year after the merger took effect, the "new" HP boasts a supply-chain that industry analysts are describing as remarkably cohesive. And, barring the effects of a down economy, HP appears to have retained, if not strengthened, its position in nearly every sector in which it competes.

The integration team wasn't large at the outset. (Membership would grow to nearly 1,200 by the end.) According to Dick Conrad, head of HP's supply-chain operation, it was led by three senior executives from each of the two companies. They were joined by one or two individuals from each side representing specific business processes, including procurement, logistics and manufacturing. Their initial job, in Conrad's words, was to identify best practices that would lead to "maximum synergies and value capture."

Planners were instructed to adopt a three-fold focus. Among a total workforce of 150,000, they had to identify the entire customer sales force, including country managers, global account reps and retail managers. (In the process, they contacted more than 250 key customers.) They had to create a product "road map," to guide top executives in deciding which products to continue or eliminate after the merger. And they had to detail some 80 percent of the two companies' total procurement spend, specifying which one was getting the best deal from suppliers in every case.

HP's single biggest win during the transition was in the area of direct-materials spend, Conrad says. The combined company is the world's largest consumer of disk drives, power supplies, microprocessors and software-operating systems, among other things. For most of its suppliers, it is the first- or second- largest customer. That presented plenty of opportunity for cutting the cost of materials.

The savings came in several ways. One was simply to adopt the lower of two prices, when HP and Compaq had a supplier in common. Another was to cut the price further, based on the additional buying power of the combined customer. HP could negotiate even better price breaks by winnowing down the number of suppliers with whom it dealt.

There were big vendor cutbacks in the logistics arena. When HP and Compaq came together, they were doing business with some 250 local couriers, 49 third-party logistics providers, 11 U.S. less-than-truckload carriers, more than 10 truckload companies, 11 freight forwarders and 10 ocean carriers, says Robert Gifford, vice president of worldwide logistics. In addition, the company was moving product through 109 distribution centers. In many cases, he says, it slashed those numbers by half from the moment the merger kicked in.

At the same time, the logistics function was completely revamped. Previously, it had been organized by business unit, especially in the case of HP. Today it is managed on a regional basis, with logistics personnel supporting all business units in a given part of the world. Gifford calls the change "a positive influence," one that forced the company to view operations beyond the limited scope of individual product lines.

"We are not a global logistics environment," Gifford adds. "We are a regional logistics environment, tied together by a very small global team." The latter is necessary so that HP can reap the economic benefits of global contracts with logistics and systems suppliers.

Thousands of Systems
Conrad says systems integration was the toughest part of the job. HP and Compaq each had a huge number of software applications running their various businesses. Some estimates put the number at between 9,000 and 15,000. They ranged from homegrown legacy systems to comprehensive packages like enterprise resource planning and materials-requirement planning (MRP) software. Like any large global company, HP uncovered multiple systems from the same vendors, each one tweaked to meet the needs of a particular region or division, all of which presented planners with enormous integration challenges.

Of special note was the lack of an aggregated demand-planning process for all HP and Compaq products. In an effort that Conrad describes as "interesting," the company had to cobble together various systems for an overall view. At times, it even resorted to spreadsheets to push ahead with integration.

The human factor, of course, was the most painful. Originally, HP had estimated the need to cut its combined workforce by 15,000 positions following the merger. That number ended up approaching 18,000, partly in response to a worse-than- anticipated market slowdown. The company now has a worldwide staff of around 138,000.

The layoffs, says Conrad, were "difficult, thoughtful and controversial." But they were anything but arbitrary. If one company's business unit was dominant, the other's was generally eliminated. In a few cases, where flexibility was important, HP opted for a combination of staff.

"In the logistics environment, the company took a rational approach," says Gifford. "We focused on true redundancies. We didn't do anything detrimental to the organization."

Any merger of big, established companies is going to result in some degree of culture clash. And the coming together of Palo Alto, Calif.-based HP with Houston's Compaq was no exception. Old-line HP employees grumbled about the loss of the "HP Way," derived from the informal management style of Silicon Valley. But the integration team addressed that issue, too. And they labored to ensure that personnel changes and business-unit decisions were made with relative speed, so that employees weren't left fretting over their fates for months. Conrad describes an "adopt-and-go" strategy, intended to avoid the bureaucratic dithering that has plagued so many mega-mergers.

Supply-Chain Structure
HP now consists of four core business groups: Enterprise Systems, providing high-end IT infrastructure; Imaging and Printing, including HP's popular line of printers; HP Services, offering IT consulting; and Personal Systems, incorporating desktop and notebook PCs, workstations and handheld devices. (Centralized research for all four units is provided by a fifth entity, HP Labs.)

Those products flow through three marketing pipelines: corporate and governmental, consumer-direct, and replenishment of retailers and distributors. From a supply-chain perspective, all of this boils down to five distinct fulfillment models (or "highways," as Conrad calls them):

• Direct shipment of product from contract manufacturers and original design manufacturers to customers;

• High-volume shipments of equipment and accessories to retailers, involving relatively small levels of customization;

• Value-added product, configured to order by the customer through in-store kiosks or the internet;

• Large-scale, value-added systems such as mainframes and high-end servers, manufactured by HP for corporate customers and governmental agencies; and

• Services, including the shipment of spare parts within narrow delivery windows, and major IT installations.

Those "highways" are supported by a host of internal business processes, including ERP and other IT systems, which cut across the separate units, Conrad says.

Both Conrad and Gifford claim not to have encountered any serious glitches in the merger process, other than the usual headaches involved in integrating disparate systems, terminating product lines and reshuffling management flow charts. The biggest surprises were external, such as the terrorist attacks of Sept. 11, 2001, which happened one week after the merger was announced, and last summer's shutdown of West Coast ports due to a longshore labor dispute. Other wild cards included a big increase in ocean-carrier freight rates, fuel surcharges triggered by the soaring price of oil, and an economic downturn that has stretched beyond management's expectations.

Many U.S. shippers saw their goods held up for weeks as a result of the West Coast port closures. Those with Christmas merchandise destined for store shelves were especially vulnerable. But HP managed to avoid the worst effects of the shutdown, through a combination of good contingency planning and its substantial muscle as a major shipper.

With the HP and Compaq units combined, the company had additional clout to wield with ocean carriers, airlines, and freight forwarders, who were inundated with pleas for special treatment by hordes of shippers. "We're one of the few big boys on the block," says Gifford, calling his ability to get carriers' attention "one of the absolute pleasures I've had."

With the integration proceeding well ahead of schedule, HP has enjoyed the luxury of learning from its successes instead of its mistakes. The biggest lesson, says Conrad, "is not to under-manage this." He attributes the company's success to exhaustive planning and modeling, especially by the isolated members of the "clean room."

"Right out of the chute, we knew exactly where we were headed," Conrad says. "There was a very maniacal focus on capturing the value of the deal."

Gifford says the project's success proved that the merger was more than a marketing plan - that it produced value on the operational side as well. In fact, the company has already surpassed its initial targets. Fiorina had promised to take out $2.5bn in costs by 2004. She ended up producing $3.1bn in savings in the first nine months. While the majority came from layoffs, more than $1bn can be attributed to lower supply-chain costs, through savings on direct-materials procurement, logistics and factory rationalization. (Logistics alone is responsible for more than $100m in savings, according to Gifford.) A substantial amount also came from the elimination of redundant products, Conrad says.

Long-Term Impact
It's still too early to assess the new HP's ability to compete over the long term. The company faces some stiff challenges, both from the dormant economy and fierce competition by lower-cost suppliers.

"HP has done a terrific job of integrating Compaq," says J. Stuart Francis, managing director and head of global technology investment banking with Lehman Brothers. "But they're one or two quarters away from running through their cost savings, and having to be more efficient in their supply chain."

While HP remains dominant in printers, enterprise storage systems and both Windows and UNIX servers, it is neck and neck with Dell Computer as the leading provider of personal computers. Only about 500,000 out of the more than 34m units shipped worldwide separate the two companies, said Jim McDonnell, vice president of marketing for HP Personal Systems Group, in a recent statement. "The number-one market share position is a two-horse race between HP and Dell, and the see-saw battle will continue well into the future," he said.

Unfortunately for HP, Dell still has the more efficient supply chain. It pioneered the build-to-order model for personal computers, and others have scrambled to catch up. Dell's days of inventory stand at between three and four, versus more than 40 for HP. Its days of sales outstanding are hovering at around 26, compared with 65 for HP.

HP recently got another wake-up call when Dell announced it would begin packaging printers under its own brand name through a partnership with Lexmark. And the company still must cope with sluggish demand in the U.S. and world markets. Revenues for fiscal 2002, ending Oct. 31, were $56.6bn, up from $45.2bn the year before. But it posted a loss for 2002 of $903m, versus a prior-year profit of $408m, due to a combination of lower sales and merger costs.

Things are already looking up, although management remains cautious about declaring victory for the merger. For the first quarter of fiscal 2003, ending Jan. 31, HP reported revenues of $17.9bn, down from $18bn in the previous quarter. Yet net income was up substantially, to $721m from $390m.

A lot of work remains to be done, Gifford says. In April, he estimated that HP was 12 to 18 months away from formal completion of the merger. Transportation was about 50 percent complete, he said, although the company remained ahead of schedule on all fronts. In particular, it needs to wrap up integration of business processes and practices within its five separate supply chains, both internally and with partners.

Conrad is following a three-year road map that focuses on new systems in the areas of ERP, customer relationship management, and the still-emerging technology of radio-frequency identification. In the case of the last, he says, HP intends to take "the leadership position," providing real-time order tracking to the customer's door via electronic means. It will also pursue more sophisticated procurement practices, such as electronic auctions, over the internet.

Outsourcing will continue to play a major role in supporting HP's supply chain. The company has pared back the number of third-party logistics providers with whom it works, but still depends heavily on them for key functions such as transportation, warehousing and overall distribution. When he was with Compaq, Gifford helped to oversee an outsourcing program that contributed to a $2.5bn reduction in inventory, and a 35 percent improvement in order-cycle times. That philosophy, linked to a further push for cost savings, is likely to thrive at the new HP.

"We believe there are further costs savings and synergies as we continue to simplify," says Conrad. Adds Gifford: "It's a journey we're on. It's not finished in a single year."