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Back in 2007, the owner of a North Carolina company that resells Hewlett-Packard (HPQ) printer supplies says her firm's phones were ringing non-stop. Customers were irate about defective HP ink cartridges purchased from her firm. Several big corporate customers told her they spent days cleaning up leaky ink. The buyer for one local municipality was so furious about damage to the city's printers that he canceled his contract.
She began to worry: Perhaps the $40,000 in ink cartridges her company had purchased at a 10% discount from an Internet supplier were fakes. When she called HP, the company advised her to check security seals on the boxes containing the ink. They were identical to other packaging in her warehouse. Then one of HP's ink detectives knocked on her door. Part of a little-known group that roves the globe to track down counterfeits, the man confirmed her fears. "We were duped," says the woman, who asked not to be identified for fear of losing other customers. "We found out the hard way that counterfeiters are putting more into making the boxes than they are into the actual product."
Combating counterfeit ink has become a major priority for HP CEO Mark V. Hurd. Analysts estimate the Palo Alto (Calif.)-based company's imaging and printing group lost more than $1 billion in revenue to illegal counterfeits last year. And the company is concerned that shoddy products will do even more damage to its reputation. "Counterfeit cartridges hurt HP's business," says Hurd. "More importantly, they hurt our customers, who are not getting what they think they are paying for."
The revenue drain comes as HP's printing business, once so lucrative it delivered nearly 60% of the company's operating profit, has fallen on hard times. Sales have tumbled 21% this year, to $11.9 billion, while profits have slumped. At the same time, HP is struggling with the recession in its other businesses, and its stock is off 5% this year.
HP isn't alone in losing out to counterfeit ink. The entire industry missed out on an estimated $3 billion in sales last year to counterfeits, according to market researcher IDC. Counterfeit ink has become a growth business in part because of printer makers' business model. HP and other manufacturers sell printers on the cheap and make virtually all their profits on ink and other supplies. But many customers wince at the cost of replacement ink, which can sell for the equivalent of $8,000 a gallon. Some consciously take their chances on lower-cost counterfeits, since quality can be decent. Others buy counterfeit ink without knowing it.
The Internet has made it easier for people around the world to buy and sell illicit products of all types. The International Chamber of Commerce estimates counterfeiting cost businesses about $600 billion in 2007, or roughly 6% of global trade. Some 10% of tech products sold globally are counterfeit, according to a study by KPMG and the tech trade group Alliance for Gray Market and Counterfeit Abatement. "Counterfeiting is one of the most significant threats to the free market," wrote KPMG partner Richard Girgenti in the study.
For years, HP could afford to ignore the problem. The worldwide ink market grew from $11 billion a decade ago to about $45 billion last year. And the profit margins on replacement ink ran as high as 60%. Counterfeits were an annoying problem, but HP spent more energy trying to thwart companies that made legal, low-cost alternative inks that were compatible with its printers. Counterfeit ink was so low a priority that earlier in the decade HP dropped out of the Imaging Supplies Coalition, the industry trade group that publicizes the issue and counts Canon (CAJ), Xerox (XRX), and Toshiba (TOSBF) as members.
Times have changed, however, and HP rejoined the group in March. As financial firms go bust and thousands of workers lose their jobs, people are printing fewer pages—and using less ink. IDC predicts the number of printed pages will decline for the first time this year, to 1.47 trillion pages, from 1.5 trillion in 2008. At the same time, counterfeiting has grown to the point that one in 20 ink cartridges sitting on store shelves globally is suspected of being fake. Now HP, Samsung, and others are hiring teams of private investigators and setting up forensic labs around the world to analyze suspect ink and packaging. They take their findings to law enforcement to help nab big distributors of counterfeit ink supplies. "Stemming the flow of counterfeits has become an absolute priority," says IDC analyst Jake Wang.
In the North Carolina case, HP's Anti-Counterfeiting Force swung into action. Peter Hunt, the group's Singapore-based director, dispatched one of his 12 investigators to examine pallets of ink in the reseller's warehouse. Then they worked with North Carolina authorities to set up a sting operation. Within weeks, a local man was charged with selling counterfeit HP, Samsung, and Canon toner and ink cartridges via his Web site. Some $60,000 in fake goods was seized. HP traced the origin of the ink to China, where it believes 80% of counterfeit ink originates. "The marching orders from the highest levels are this: Protect our brand and the enormous amount of R&D that has gone into creating our products," Hunt says.
HP scored its biggest antipiracy success in May 2007 in Foshan City, China. After tracking illicit supplies for more than six months, the company worked with Chinese police to raid 14 warehouses, seizing $88 million in equipment, supplies, and packaging materials from a variety of manufacturers. Two men were convicted this year and sent to jail.
Ink counterfeiters have developed techniques to throw off investigators. One approach: They sell supplies only slightly below the usual cost, unlike knockoffs of, say, Rolex watches. The North Carolina reseller says that's why she wasn't concerned. "Who would think they'd be selling ink for a 500% markup?" she asks.
Edwards is a correspondent in BusinessWeek's Silicon Valley bureau.