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Slugfest In The Service Biz


Legal Affairs

SLUGFEST IN THE SERVICE BIZ

Gene Dillon, a supervisor of print services at Sprint Corp.'s Westwood (Kan.) headquarters, had long complained to Xerox Corp. that its maintenance on five Xerox laser printers at Sprint's headquarters was too slow--and getting slower. Last year, he finally did something about it, contracting with Copier Services Unlimited, an independent service organization (ISO) that promised more attentiveness for less money. When Xerox learned that a competitor for this sliver of its service business had surfaced, the company dispatched a senior customer service official to Westwood to plead its case. But, says Dillon, "it was too little, too late."

That the opportunity to service five printers would cause Xerox to fly an executive to Kansas instead of relying on local personnel to handle the flap isn't as surprising as it sounds. Xerox currently counts on its service division to pull in $6 billion, or 45% of the company's $13.4 billion in gross revenues, says B. Alex Henderson, an analyst at Prudential Securities Inc. And Xerox isn't alone. Experts estimate that many manufacturers rely on service-related businesses, also called aftermarkets, for up to 50% of their gross revenues--particularly in those industries where competition among hardware sellers is especially grueling. In high-tech industries alone, service revenues are expected to reach $160 billion by 1995.

"Manufacturers use service as a way of making profit," says Donald F. Blumberg, a Fort Washington (Pa.) consultant specializing in service industries. "It's like the razor business. You almost want to give the razor away, because the money is really in the razor blades."

Now, these so-called service annuities are under attack. In perhaps as many as 60 lawsuits, manufacturers of everything from copiers to computers to medical equipment to air conditioners are being dragged into court by ISOs who contend that the manufacturers have gone too far to protect their lucrative turf. Dozens of companies, including Eastman Kodak, Wang Laboratories, Honeywell, and Data General, are being accused of deliberately keeping competitors out of their service markets by following restrictive policies, such as refusing to sell them parts or supplies--conduct that could violate antitrust laws (table, page 109). "Third-party maintenance organizations are really muscling their way into a lot of markets to which they were once denied," says Rodger D. Young, a lawyer in Southfield, Mich., who represents many independent service organizations.

ISOs started to make headway after winning an important ruling in a 1992 Supreme Court decision. The case, brought by 18 service suppliers, accused Kodak of illegally tying the sale of its products to its service. Although the court didn't rule on whether Kodak's specific practices were unlawful, its decision paved the way for a barrage of suits claiming antitrust violations in cases where manufacturers limit competition in aftermarkets.

PACKAGE DEAL. At issue is a common business strategy employed by many companies that invest in developing and creating products: When customers buy equipment, they are strongly encouraged to buy a comprehensive service package. The power of a brand name, access to customers, and strict parts policies have for the most part allowed manufacturers to dominate their maintenance markets. "Manufacturers feel hassled," says Daniel M. Wall, who is representing Kodak in three antitrust cases. "This is ordinary competitive behavior that is subjecting them to expensive, time-consuming litigation." Kodak denies any wrongdoing, as do the other companies named in these suits.

But advocates for the ISOs say there's nothing ordinary about excluding competitors from markets. Richard L. Watkins, CEO of Copier Service, Xerox' rival, says that new parts are obtainable through a limited number of suppliers, many of whom are foreign, or through Xerox. But Xerox may charge ISOs a steep premium--when it deigns to sell to them at all. For example, a photoreceptor belt, purchased from a third-party vendor, costs Watkins $325; he says Xerox would charge him more than $900. "The ISOs just want a level playing field," says Ronald Katz, an attorney who has filed antitrust suits on behalf of ISOs.

Whether such behavior is illegal or merely shrewd business is debatable. But in court, the ISOs have made progress. In December, without admitting guilt, Xerox announced it would issue $225 million in certificates to its customers and ISOs to settle a class action. The certificates will be good only for buying Xerox products. The company also agreed to sell parts directly to competitors. A federal judge in Texas is expected to finalize the deal on Mar. 11.

Xerox says the settlement was purely a business decision that will compel the company to be even more aggressive in seeking to hold onto service accounts, such as the one it lost at Sprint. "What we've found, frankly, was that we weren't prepared at the point of sale to really ensure that our people knew how to market and to sell the value that Xerox has vs. the competitor," says Xerox' David T. Erwin, vice-president for strategy and integration. "But we feel the annuity stream is vital to us, and we will be highly competitive in securing that business." Erwin adds that he is confident Xerox will be able to keep competitors from taking a big bite out of its service income.

HANDSHAKES. Other companies, such as Allen-Bradley Co., have also settled cases challenging parts policies--though the terms of most of the settlements are kept secret. The shifting legal landscape and the promise of more open markets has led to a fourfold increase in the number of ISOs over the past five years, from 300 to 1,200. The bulk are mom-and-pop shops capable of challenging manufacturers on a local level rather than on a national scale. What's more, manufacturers, noting the opportunities in servicing other companies' products, have gotten into the act. Three years ago, almost no manufacturers offered such services. Today, 750 companies have started multibrand service outfits, including IBM, Digital Equipment, and Unisys, says consultant Blumberg.

Growth in the service marketplace indicates that many manufacturers are resigned to greater competition for maintenance contracts--and that has resulted in friendlier relations. For the first time, representatives from IBM, Hewlett-Packard, and DEC are scheduled to fly to Freeport, Bahamas, to participate in the annual meeting of Independent Service Network International, the largest ISO trade group. The topic for the event, set to begin Feb. 27, will be Margins & Markets: Seizing Opportunities Today for 21st Century Growth.

Yet while some companies are joining the pack, others are more focused on winning the antitrust cases. Kodak, Honeywell, and Northern Telecom, for instance, show no sign of giving in to plaintiffs' demands. And their lawyers insist the motivation isn't just profits. "What's at stake for manufacturers is their ability to control quality of product and distribution systems," says James C. Burling, a defense lawyer for Northern Telecom Inc., which is accused of locking out ISOs from servicing its telephone-switching equipment.

Putting up a fight has led to some savvy counterattacks. Several manufacturers have sued ISOs for copyright or patent infringement--in effect charging service competitors with using the manufacturers' proprietary parts or diagnostic software without first gaining permission or securing licenses. Thus far, judges have been sympathetic to these claims. "You can't say you've suffered an antitrust injury if it's an injury to a business that was founded on copyright infringement," says Uall. Last year, Grumman Systems Support Corp. was ordered to pay Data General $52.3 million for making and using copies of Data General's software to maintain its computers. The case is on appeal.

No doubt these nasty legal skirmishes will continue to multiply. But in a market that has grown exponentially in the past few years--and will continue to expand--there should be plenty of business to go around.

TAKING ON THE GIANTS

XEROX Accused of anticompetitive practices to dominate the copier-service market. A proposed $225 million class-action settlement, which requires Xerox to sell its parts to competitors, goes before a federal judge for approval on Mar. 11.

EASTMAN KODAK Suits in Texas and California allege that Kodak illegally refuses to sell parts and supplies for its photocopiers to independent service organizations. The first trial is scheduled for January, 1995.

HONEYWELL Accused of illegally linking the maintenance of its

industrial-control products to the purchase of equipment. A trial is set for this summer in Detroit.

NORTHERN TELECOM Plaintiffs allege that Northern Telecom refuses to sell software for its PBX switches

to anyone who uses a third-party maintenance organization. A trial is expected later this year.

DATA: BUSINESS WEEKLinda Himelstein in New York


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