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10 Trends in Troubled Times

11 Jun, 2009 By: Charles LeCompte imageSource

10 Trends in Troubled Times

All industries are currently feeling the effects of the recession, and the digital imaging industry is no exception. However, in the case of digital imaging, the recession is only one factor among many in an industry that is being transformed by structural changes. The
recession has certainly cut into the industry’s profitability, but that effect will be temporary. Other trends are permanently changing the way the industry does business. These changes are driven by the same vital force that drives change in all industries—free market

If we take a quick snapshot of the industry as it currently stands, what stands out most is its profitability. Digital imaging is one of the most profitable businesses on earth, primarily because of its infamous razor-and-blades business model, in which companies offer
discounted hardware, often sold at or below cost, in order to capture the life-cycle stream of supplies sales. Of course, the supplies are sold at far above cost, taking advantage of the fact that customers usually have few alternatives for buying printer/copier cartridges
and must purchase them from the OEM.

Just how profitable is the imaging industry? The financial results of publicly held imaging companies show that their operating margins are generally at least 10 percent, and occasionally above 20 percent. This puts average imaging companies in the same league as leading
firms in other industries, such as General Electric, Intel, Nokia, and Toyota. Consumables are now the cornerstone of every imaging company’s business model. For example, they generate about two-thirds of imaging revenue for HP, Lexmark, Océ, and Xerox, according to published
figures, and the same is true for most other imaging companies, although most do not break down their hardware/supplies revenue.

Three Competitive Battlefields

Nonetheless, profitability spawns competition, and that certainly is true in the imaging industry. Over time, three competitive battlefields have emerged: aftermarket (printer cartridge) competition, hardware price competition, and, most recently, cost-per-page
competition, all of which are intertwined in a complex dynamic.

Because supplies are such a profitable item for printer manufacturers, sometimes offering profit margins as high as 80 percent, entrepreneurs have viewed this business as an ideal opportunity to undercut manufacturer prices while still earning a healthy profit. As a
result, either remanufactured or newly manufactured aftermarket alternatives are available for all but the most obscure cartridges. These third-party cartridges usually are sold for 20 to 30 percent less than a brand-name cartridge from the manufacturer. Over time, the
non-OEM aftermarket share of the overall supplies business has grown to about 30 percent, as aftermarket companies have successfully captured a market segment of thrifty, brand-insensitive customers.

Of course, printer manufacturers have not sat idly by as 30 percent of their profitable supplies market disappeared. Instead, they have developed an arsenal of weapons to thwart aftermarket competitors, including technology (complex hard-to-copy cartridges, inks, toners,
and encryption chips), legal actions (usually patent infringement suits but occasionally trademark suits), economic strategies (increasing the number of new cartridges they launch and shortening cartridge life cycles because these factors make it less profitable for an
aftermarket vendor to copy a cartridge), marketing tactics (commissioning studies that question the quality and reliability of aftermarket cartridges), and agreements with channels (paying retailers not to carry aftermarket cartridges).

The second competitive battlefield in the imaging industry is the hardware price competition between printer manufacturers. Competition based on hardware price is nothing new, but the nature of the battle changed with the introduction of the razor-and-blades business
model. Vendors soon realized that they could sell hardware at or below cost, sometimes far below cost, and still make a profit over the machine’s life cycle as a result of high-margin consumables sales. But in recent years, the industry has learned that there is a limit to
this strategy. In some market segments, particularly in the entry level, the model falls apart because customers do not print enough and therefore do not buy enough cartridges, or because customers buy only aftermarket cartridges, leaving the manufacturer in a situation in
which it has given away the printer but hasn’t sold enough cartridges to cover the loss. As a result, several vendors, notably Epson and Lexmark, have entirely withdrawn from these entry-level ink jet market segments.

Competing on Cost per Page

One of the premises of the razor-and-blades business model is that customers will buy the cheapest hardware they can find without realizing that, in the end, the savings they realize on a cheap printer are more than outweighed by subsequent purchases of costly cartridges.
However, as customers have learned more about printers, many have become frustrated with the high cost of cartridges. This has created a third competitive battlefield for manufacturers: cost-per-page competition, in which companies try to win customers by offering printers
that use low-cost, high-capacity cartridges to deliver the lowest cost per page. For most companies, the very concept is distasteful, because it threatens the razor-and-blades business model that has made the industry so profitable. But in some market segments and some
geographies, that model simply no longer works.

In the United States and Europe, Eastman Kodak has taken a cost-per-page approach with a new line of ink jet printers that it launched in 2007. The devices use low-cost, high-capacity cartridges that truly offer a lower cost per page than that of competing products. As a
late entrant into a very competitive market, Kodak needed something that would set it apart from its rivals, and cost per page seemed to be the perfect opportunity. Initially, Kodak hoped to sell its printers at a higher price than competitive models, but it quickly learned
that strategy wouldn’t work. The company introduced a new line of lower-priced models that enabled it to compete without charging more for its cartridges. So far, sales are lagging behind the firm’s goals.

It is in developing countries, particularly China, where cost-per-page competition is the most evolved. This is not surprising. Chinese customers are famously thrifty and have proven to be quicker than consumers in wealthier countries in apprehending the implications of
the razor-and-blades model and its high-cost print cartridges. Epson was the pioneer of the cost-per-page strategy in China, launching its first ME series of ink jet printers there in 2004. The firm had little choice. Aftermarket competition had stolen more than half of
Epson’s cartridge market, making it impossible for the firm to make money using the razor-and-blades business model. By utilizing low-cost print cartridges, the Epson ME machines delivered a far lower cost per page compared to competitive products, though the company sold the
devices for a considerably higher price. The new strategy worked. Epson has now introduced three generations of ME printers in China, each with more functionality than the last.

The surest sign of Epson’s success is that HP has now followed suit in China with its own series of InkAdvantage, or “Huisheng” (“money-saving”) ink jet printers which are sold at a higher price but use cost-effective cartridges to produce very low cost per page. To Lyra’s
knowledge, this is the first time that two companies have battled head-to-head using cost per page as their primary weapon. Unlike Epson, which so far offers the ME products only in China, HP has now introduced InkAdvantage printers in other countries, including India,
Indonesia, and Vietnam, and it appears that the products will be sold in virtually all emerging markets throughout the world.

Impact of the Recession

Not surprisingly, the global economic recession is having a huge impact on the imaging industry. The financial results of publicly traded imaging companies show that revenue in the final quarter of 2008 decreased 16 percent compared to the same quarter a year ago, while
operating profit fell 36 percent.

Companies report that customers at all levels—consumers, businesses (small and large), and commercial customers—are delaying purchases, either to save money or because they are having trouble financing the purchases. Meanwhile, weak demand is forcing vendors to cut prices,
which further hurts revenue and profit. Many vendors also report that customers are printing less. Other factors that have affected many companies’ financial results are adverse exchange-rate shifts, losses on investments & problems collecting receivables.

The industry’s response has been predictable—layoffs, pay cuts and pay freezes, cuts in shareholder dividends, a halt to stock repurchase programs, and an intensified focus on improving efficiency through outsourcing, inventory reduction, and the sale of non-core assets.
Also, many companies have raised the price of their supplies, sometimes two or even three times in just the past six months.

The black cloud of the recession has had a silver lining for some sectors of the imaging business. Aftermarket consumables vendors report that sales have strengthened as customers have sought to save money. In addition, many companies report that their managed print
service programs, which usually can immediately save customers 20 or 30 percent on their printing costs, are booming.

The big question for the imaging industry is whether the recession-driven decline in print usage will be temporary, or if it will evolve into a permanent change in customer habits. Of course, the industry is already nervous about falling usage, as a myriad of electronic
alternatives to paper proliferate. It would not be the least surprising if the recession accelerates trends away from paper that are already underway. However, it will be a year or more before it is possible to determine if this in fact is happening. Until then, all the
industry can do is cross its fingers.

Lyra Research: The Digital Imaging Authority

Lyra Research collaborates with imaging industry decision makers worldwide, enabling clients to strengthen their market position & achieve profitable growth. Lyra’s expert analysts and editors help clients devise & implement creative solutions to business challenges,
arming them with competitive intelligence, strategic & tactical advice, news & analysis, and market forecasts. Lyra’s research and consulting services, award-winning  journals and events have set a standard for analysis of imaging hardware, consumables, and digital
photography markets.

Charles LeCompte is President of Lyra Research. To learn more on how Lyra can become your strategic business partner visit www.lyra.com or directly contact Tom Sandock at 617-454-2621 or
for further information.

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