Analysis: VoodooPC - Why so little could mean so much for HP

Posted by Wolfgang Gruener

 

Chicago (IL) - HP's recent purchase of boutique PC builder VoodooPC has taken many by surprise. HP's PC division and Voodoo couldn't be more different and couldn't be less complementary. TG Daily talked to Voodoo's founders, HP and other custom PC builders to find out more - and found that HP has bought itself a Formula 1 team, that could lead the way to an immense payoff.

There are very few news in the IT industry that are truly surprising. Most of them are explainable in one way or the other almost immediately with some knowledge of respective market segments and the help of hints in press releases. That, however, was not the case with last week's announcement of HP's acquisition of VoodooPC. It wasn't just surprising, it was shocking: What in the world does HP want with VoodooPC?

On the surface, the acquisition makes absolutely no sense. On the one side, there's HP, the world's second largest PC builder with shipments of 8.3 million PCs and a global market share of 15.9%, according to market research firm IDC. HP's PC revenues were about $6.9 billion in the second quarter of this year; profits came in at $275 million. HP PCs face cutthroat competition, especially with Dell, in virtually all mainstream consumer and business PC segments as well as workstation markets. HP's PC are as generic as PCs can be and are about as exciting as mom's minivan.

VoodooPC, on the other side, competes in the very small segment of custom PCs that cater to users who only care for the best and have the necessary income to pay for that. While HP does not offer PCs above $2600 (including a 19" monitor), you can spend twice that for just a (46") monitor over at Voodoo, and - if you want - up to $17,000 for a custom-built and custom painted machine that will compete in the champion's league of benchmarks. Josh Smith, chief executive officer of VoodooPC competitor Biohazard Computer Systems, described this market with an example from the automotive market: "You always could wonder why someone needs a $9000 system. But then, who really needs a Ferrari? No one. Who wants a Ferrari? Everyone."

As VoodooPC is a privately held company, it is unclear how many PCs the company actually sells, but if production volumes are a measure of exclusivity, VoodooPCs may be even more exclusive than Ferraris: It is believed that VoodooPC is one of the smaller custom PC builders in the market with less than 100 PCs shipped every month and revenues less than $1 million per month. It's an easily approachable family business with a highly loyal customer base that is now being integrated into a not so personal, giant PC builder.

So in essence, what could minivan builder HP gain from exotic sports car manufacturer Voodoo - and vice versa? Was it a desperate move for HP to match Dellienware? And if so, can HP sell a gaming PC and can VoodooPC catch up with Alienware? Can HP increase PC margins with Voodoo and will it dilute the Voodoo brand? Or, does Voodoo's future look like a Compaq PC with a fancy Voodoo logo?

These were our first questions - and surprisingly, we quickly learned that we thought into the wrong direction. HP has a different, quite innovative strategy for Voodoo in mind.

Why HP/VoodooPC can't be a Dell/Alienware

It's the most obvious conclusion that one could make without digging deeper into the acquisition details: HP's move is nothing more than a strategy to become a part of the PC gaming industry and the firm's hope to catch up with Dell, which swallowed Alienware in March of this year. And while there are similarities mentioned in the merger announcements - for example, both companies say that they intend to operate their custom PC builders as separate business units - the deals differ in key areas which imply that HP will be going a very different route than Dell.

Other than HP, Dell has been trying to establish its own gaming PC brand with the "XPS" series for some years. The series currently ranges from multimedia PCs with prices starting at about $1000 to the high-end XPS 700 that can cost more than $8000, when equipped with a 30" display. There are even notebooks and designer PCs for which Dell charges more than $7000. But price isn't everything in the gaming and enthusiast segment and Dell apparently felt compelled to add Alienware as a potential upgrade brand to its portfolio. In HP's case, Voodoo will represent the only and entire PC product line, at least for now.

Before its acquisition by Dell, Alienware already was somewhat the Dell of custom PC builders - with substantial production volumes and a R&D budget most boutique companies could not match. From this perspective, if HP really wanted to copy Dell/Alienware, the smallish Voodoo would have been a bad choice and the company should have looked at a manufacturer with similar volumes, perhaps Velocity Micro.

Also the simple addition of an exclusive PC manufacturer to a mainstream lineup isn't that simple and hides several challenges, including differences in corporate culture, customer expectations, product development and marketing. While it isn't completely clear what purpose Alienware will have for Dell in the long run, it appears at this time that it may mean to Dell what Lamborghini means to Audi or what Jaguar means to Ford - an established brand that can transition experienced users from the mainstream to the high-end in exchange for the willingness to pay extra for an additional sense of luxury.

During a conversation last July, Dell chairman Michael Dell mentioned that the Dell and Alienware brands own a combined share 60% of the high-end gaming and enthusiast computer market in the US - which leads us to believe that Dell will pursue a strategy of driving that overall market with XPS and Alienware almost next to each other, or at least with the possibility of some overlap, as two separate brands. However, just like Ford has experienced, adding a flagship brand not always pays off, and even Dell may have to adjust Alienware's strategy, as revenues aren't that significant yet: During the announcement of Q2 2006 earnings, chief executive officer Kevin Rollins told analysts that the revenues generated by Alienware were "negligible." And the future will tell, if Alienware's existing customers will stay or move to other boutique players, if Alienware has to create a new customer base and if Dell will have to use some incentives for XPS owners to trade-up.

In essence, Alienware has revenue responsibility. Voodoo certainly has that as well, but it appears to be more a side effect of its main purpose - to accelerate the adoption of new, high-end technologies in the commercial market that will trickle down into the mainstream over time.

Hewlett-Packard positions Voodoo as the PC division's Formula 1 team

A first indication about the thoughts behind the merger agreement can be found in the blog of VoodooPC co-founder Rahul Sood. He spends a great deal on explaining that it was a very rational idea to "plug into" a company that would allow VoodooPC to grow on the very high-end of PCs. But its may not be too obvious how a mainstream company such as HP can help VoodooPC on the high end.

In a conversation with HP and VoodooPC representatives, HP's chief technology officer of the personal systems group and future general manager of HP's gaming business unit Phil McKinney explained that HP isn't so new to PC gaming. "HP is already in the gaming space. We are the number one workstation provider in the developer space and we are the number one infrastructure provider in online gaming," said McKinney.

Of course, HP never really had a presence in the client area, if we leave a very limited edition higher-end system that HP offered under the Compaq brand back in 2004 out of consideration. But interestingly, the company claims to sit a huge pile of somewhat secret technologies and innovation, which it can't bring to the market with its current lineup of generic PCs. To take advantage of this innovation, the firm needed access to a brand and customers who are willing to pay for the privilege to get their hands on new tech first.

To connect with enthusiasts and create an opportunity to bring true "content enjoyment" systems, to the market, HP realized that it "needed a different DNA" than what it has available today. "We needed someone who could take that innovation, get it into the value chain and had customers who appreciate and understand that technology. And that was Voodoo," McKinney said.

Interestingly, Voodoo is not expected to change its face and become a mass-market player. HP's idea is to use Voodoo more like a Formula 1 team: Traditionally, such teams are maintained by large automobile makers such as Toyota or Mercedes-Benz not only for prestige or the fun of racing but to develop new technologies that will make it into their mainstream products over time as well as to leverage racing success for some advertising value.

A very similar approach could emerge from the HP-VoodooPC alignment. "If you look at the high-end extreme gaming space," McKinney said, "the technology what you see today will find its way into the mainstream a couple of years from now." He pointed to HP Labs' $3.5 billion R&D budget and 750 scientists and said that the company was looking for a solution "to accelerate the way to bring those extreme technologies to the market."

Looking to the Formula 1, which brought us technologies such as shifter paddles on the steering wheel, VoodooPC could become a vehicle that introduces new and proprietary technologies developed by HP in the hope that some of those new features will trickle down into the mainstream over time. Considering the fact that many of those technologies are and will be patented by HP, it isn't hard to imagine that even one successful innovation could pay for Voodoo's purchase multiple times without the need to sell large quantities of enthusiast systems.

It is also interesting that it was not HP that approached VoodooPC, but rather the other way around. Ravi Sood, co-founder of VoodooPC explained that the company was looking for a way to grow without the need to drop its prices and move more into the mainstream. "For the last one and a half years we have been thinking about how to innovate beyond our current means," he said. "You can imagine all the gamers at Voodoo who think bigger and beyond of what we currently can do. We needed access to serious innovation, serious engineers and serious scientists without having to compromise our quality and brand. We found that the only way we could do that is to plug into an R&D center like HP Labs. These guys are sitting on a ton of technology gamers have to get their hands on."

Brother Rahul expands on these thoughts in his blog: "HP is hungry for new innovations, and if you can imagine what plugging our corporate DNA into their labs would do - well, you get the picture. We are now in the position to create absolutely fantastic products in all categories. Voodoo and HP are complimentary opposites. This deadly combination of Voodoo's gaming/luxury PC expertise and our brand DNA and influence, with HP's innovations, scale, and leverage is going to lead to some of the most compelling machines money can buy."

HP as well as the VoodooPC founders expect that there will be no change how VoodooPCs will be developed, created and sold - the computers will be kept out of retail and sold exclusively through Voodoo's website. However, Ravi Sood mentioned that the company plans to expand into other markets such as "Germany and other parts of Europe."

Playing with customer perceptions: How will enthusiasts react to the acquisition?

HP's and Voodoo's idea about establishing an innovative way to develop new PC technologies - and to "redefine the PC, as Ravi Sood put it - may be very convincing on paper, but the strategy is not without risk. The unknown variable is the user, who needs to be convinced to shell about more than $10,000 for a computer and perhaps even more with some unique HP touches, as Ravi Sood believes.

The argument to pay for a VoodooPC that is attached to the HP-brand, even just in the background, could become quite a challenge. Biohazard's Josh Smith mentioned that especially in the enthusiast computer space, "you have to be careful not to destroy the foundation you are standing on."

That foundation, which was described by McKinney as "DNA", could not be more different than what HP represents and time will tell, if such DNA can be simply acquired and successfully integrated into a larger organization.

The center of this challenge and the key to HP's success will be the customer. However, a customer who pays more $10,000 for a high-end system is very different from a mainstream customer. According to Smith, people who buy enthusiast systems are highly loyal, typically "support the underdog," are interested in the very best and value integrity. Through the acquisition, the perception of VoodooPC could be changing, as enthusiasts scrutinize the source they are buying from and VoodooPC could be seen as a part of common corporate America. For example, Smith believes that "any bad customer experience, which everyone had, will now be magnified and more intense for VoodooPC."

The close connection of the VoodooPC founders to their customers have saved them from the accusations of a sellout so far, at least according to the posts on Rahul Sood's blog, but there is a very real chance that HP's mainstream status could be diluting the VoodooPC brand, even if VoodooPC does not lower its prices. Conceivably, the perception of the company could transition from a boutique to a high-end builder, which will not be able to charge the premiums Voodoo demands today.

Of course, HP and VoodooPC see this differently and, perhaps aware of this situation, have taken steps to do everything possible to avoid a scenario in which Voodoo could become a mainstream product. Asked about Voodoo's status inside HP and Voodoo's ability to continue high-end PCs with the components necessary for such machines, Ravi Sood said that "[HP respects] our brand and customer experience and you will not see a VoodooPC in a retail store." He continued: "The brand will maintain the upper, upper, elite status, maybe it will become even more elite."

McKinney added that HP "did not acquire Voodoo for the revenue." He said that HP will not "merge and mess up both brands. Voodoo is a premium brand and will drive innovation from our HP Labs." To emphasize the separation, he said that Voodoo is highly respected within HP and receive unique ability to make decisions on what to build into a performance machine.

The impact on other performance PC builders

Of course, decisions made by Voodoo and HP will begin to have substantial impact on other players in the market. Randy Copeland, founder of Velocity Micro, a manufacturer that pumps out "thousands of systems every month," conceded that he tried to "make some sense out of the Voodoo announcement" when he first heard about. He told TG Daily that while Voodoo is now changing from a company that, due to its size, had no impact on Velocity Micro in the past to an organization that either could "go away as a competitor" or have a negative impact on him, if "HP can pull it off."

"OEM's always wanted to go into the gaming space, so this is nothing new," he said. However, he mentioned that just in case HP will be able to integrate Voodoo successfully, he "will not be sitting still." "We are doing very well right now and have a significant R&D budget to innovate," he said.

In fact, Velocity Micro may be in some sort of a safety zone, as it is perceived as one of the larger performance players and recently announced to move into retail by selling notebooks through Best Buy. If Voodoo will be aiming for the very high-end, the implications for companies such as Biohazard may be more serious. "It's like you are having Wal-Mart moving in at the end of the street," Smith said.

And as long as enthusiast users will perceive Voodoo as part of that Wal-Mart, there may be little change in the industry. Even in the crowded automotive space, there's enough room for those Paganis, Spykers and Koenigseggs to survive with highly-exclusive, low-volume models that try to appeal to buyers who want to be different. But if VoodooPC can become a boutique builder with a Wal-Mart-sized backing then users may not only be looking into a future of some interesting PC and HP into times of growing PC revenues, but small boutique builders may also have to rethink how to compete against an emerging Goliath.