Hewlett-Packard (HP) has high hopes for its software business. For a company used to operating in markets – in particular, personal computers and printers – where margins are typically razor-thin, the software market looks extremely attractive, promising margins as high as 80%.

But if software margins look seductive, HP’s results, to date, have disappointed. Despite showing healthy revenue growth, the software business has not reported an operating profit for eight consecutive financial quarters.

“There is a lot of upfront cost associated with software development. But that is the advantage of being a large company – HP can afford the investment and patience that it takes,” says Todd DeLaughter, worldwide vice president and general manager of the management software organisation at HP. Profitability in the software business is now expected at the end of 2005, he says. Once profitable, the software business will drive “huge margins” for HP, says DeLaughter.

In its efforts to reach profitability, HP’s $922 million software business has suffered some well publicised hiccups. First, there was the 2001 acquisition of application server specialist BlueStone for $470 million; the product was abandoned after little more than a year.

Then there was the October 2004 scrapping of its Utility Data Center (UDC) offering, which bundled the company’s hardware with virtualisation, provisioning and other systems management software to provide different applications with the computing resources they required at any point in time.

But HP’s Nora Denzel, general manager of the Adaptive Enterprise unit, has taken these reverses in her stride. At the company’s November 2004 Software Universe event in Madrid, Denzel was talking up the software unit’s recent revenue growth, its successful integration of key acquisitions and the key role software will play in HP’s multi-million dollar ‘Adaptive Enterprise’ initiative.

This focuses on synchronising business and IT process in order to “capitalise on change” – and relies on software to reallocate IT resources according to business process needs. The software that will underpin the Adaptive Enterprise project is HP’s venerable OpenView systems and network management tools.

But Denzel is playing for high stakes. The company has poured millions into software research and development and into a number of acquisitions. In January 2004, HP bought two companies that offered automated systems management functions: Novadigm, a specialist in automated server configuration management, and Consera, which sold tools for data centre planning and modelling.

With the first fruits of the Adaptive Enterprise project emerging, HP Software is now under intense scrutiny from both customers and investors. In Madrid, for example, the company announced the launch of OpenView Automation Manager – in effect, a more modular replacement for UDC – which dynamically allocates pooled IT resources as business needs change. The product also works with server and storage virtualisation, and uses business models to understand how the business depends on IT resources, monitoring performance and adjusting resources as needed.

Even with those pieces in place, HP’s software strategy looks limited when compared to that of IBM, its main rival. IBM’s approach is arguably more holistic, embracing not only network and systems management (with the Tivoli suite) but also middleware, databases and enterprise content management applications.

There is a simple – if expensive – solution, says Corey Ferengul, an analyst with IT market research company, Meta Group. “I believe that HP needs to acquire BEA Systems,” he says. Without application server technology, there is a hole at the heart of HP’s Adaptive Enterprise strategy, he adds.

But the scars from the botched BlueStone acquisition are still fresh – as is the recognition of the huge challenge ahead. “We’ve been in [the application server] market and we got out of that market,” says DeLaughter. “Adaptive Enterprise gives us what we need to engage customers in a business-level discussion, and that’s where we’re focusing right now.”