Upstarts Spread in the Ink Wars


Printer makers have long known that ink is as good as gold. Just ask the folks at market leader Hewlett-Packard (HPQ). Analysts say ink and toner supplies made up more than 80% of fiscal 2004 profit for the computer giant, although they brought in less than a quarter of the company's $80 billion in sales.

But, now, a new breed of fast-growing upstarts is out to crash the profit party. Across America, retail stores where consumers and small-business owners can go to have empty printer and toner cartridges refilled -- typically at half the cost of the original -- are cropping up alongside Starbucks (SBUX) and Subway restaurants.

The largest of these chains, Emeryville (Calif.)-based Cartridge World, opened its 1,000th store on Oct. 26. The privately held business plans to increase the number of U.S. outlets, now at 275, to more than 3,000 in the next decade. And Rapid Refill Ink International, based in Springfield, Ore., says the number of its U.S. storefronts will surge from 40 to 1,000 by 2009. "This industry reminds me of the wild dot-com days," says Dave Shaw, Rapid Refill's vice-president of franchise development and a veteran of the Internet boom.

QUICK AND EASY. Though many dot-coms had no compelling reason for being, these franchisers are filling what could be considered a legitimate need. Burt Yarkin, chief executive of Cartridge World North America, likes to point out that the ink inside a new cartridge from HP, Lexmark (LXK), or Canon (CAJ) costs roughly $60 an ounce -- more than an ounce of Chanel No. 5 perfume ($44.11) or Dom Perignon champagne ($4.53). "People know they're getting ripped off," says Yarkin.

Indeed, an HP 45 inkjet cartridge sold through HP's Web site will set you back $30, while the Cartridge World in Conroe, Tex., will refill an empty one for just $16.50. "Our service has been unbelievably well-received," says store owner Jim Spillman, a former Electronic Data Systems (EDS) executive. "Everyone likes to save money."

Until recently, however, few consumers realized it was possible to refill empty cartridges. Those in the know had to deal with messy do-it-yourself refill kits, order iffy-quality ink from online outfits, or buy house brands at mega-stores such as Staples (SPLS) and Office Depot (ODP).

With the new retail chains, shoppers can get their cartridges refilled in just a few minutes. Rapid Refill even sets up drop boxes at coffee shops, dry cleaners, and other easy-access locales. Most of the stores serve local companies as well. Many have their own vans that pick up empties and return them refilled at no extra charge.

TRICKY BALANCING ACT.So how does this seemingly too-good-to-be-true setup work? As long as HP and its peers maintain sky-high margins, there's plenty of room for undercutting, typically by 40% to 50%. Unlike the printing giants, which spend lavishly on research and development to invent electronics-packed printheads and printers to work with their cartridges, these chains' costs are much more pedestrian. They buy inks made by third-party suppliers, often for less than $1 per cartridge. After paying rent, salaries for a few staffers, and some low-tech equipment, they can easily clear a 20% net income, company reps say.

"The road for us is wide open," says Yarkin. "We're giving consumers and businesses a choice." And, for now, it's all legal -- so long as refillers make it clear the product is not new and ensure that inks purchased from third parties don't infringe on existing patents.

This results in a tricky balancing act for the likes of HP, Lexmark, and Canon. If they cut prices, they sacrifice margin. Yet if they make a big show of trying to shut down this fast-growing industry -- say, by creating technologies that make it difficult or impossible for refillers to reuse cartridges -- they risk raising the ire of consumer advocates and regulators, not to mention drawing attention to a low-cost alternative to their products.

NOT TOO CONCERNED. Hewlett-Packard has waged legal battles to keep refillers honest, though. On Oct. 20, HP announced it had settled a suit with Rhinotek Computer Products, which agreed to change its packaging to highlight that its cartridges are secondhand and that it doesn't use certified HP inks. That same day, HP sent a letter threatening litigation against Cartridge World, alleging that some of its inks infringed on patented HP ink formulations.

"It doesn't concern us," says Cartridge World's Yarkin, who says that's the first such legal challenge his company has faced. "HP was concerned about a couple of inks out of 150. We don't manufacture the inks, but if there are any issues, we have ways to resolve them." Cartridge World can either demand that the supplier change its ink formulation or simply use a different ink.

That would suit HP fine, says HP printer-supplies chief Pradeep Jotwani. "We support fair and free competition. All I want is to make sure there's a level playing field."

PINCHED PROFITS.Analysts at Lyra Research figure that refillers already have grabbed roughly 10% of the U.S. market. Together with knockoff brands, this so-called aftermarket represents around 20% of the $25 billion ink and toner-supplies business. That may sting, but not enough to compel the big dogs to lower prices -- and thereby take a bite out of their soaring margins, say analysts.

Nor have the upstarts made enough of a dent to force HP and its peers to start offering their own refilling services, a practice that would hurt sales of new cartridges. "While we're a pain to them financially, it doesn't make sense for them to respond at this point," says Rapid Refill's Shaw.

But printer makers can't completely ignore the threat. When Lexmark announced disappointing financial results on Oct. 26, CEO Paul Curlander didn't rule out that aftermarket refilling chains may have been part of the problem. Earlier in the month, Lexmark warned investors that profit would miss the company's earlier forecast, sending shares into a tailspin (see BW Online, 10/05/05, "Lexmark: Printing Skimpier Profits").

"BASICALLY STABLE" SHARE. HP executives claim they're not overly concerned with the new competition. Despite most refillers' offer of a 100% guarantee on their products, HP is confident that most consumers are willing to pay higher prices to get the real thing. "Some people will try" these stores, says HP printer chief Vyomesh Joshi, "but how many will keep using them?"

While the quality of refilled cartridges has undoubtedly improved in recent years, some independent analysts say a tangible difference still exists. "I use aftermarket ink all the time," says Lyra Research analyst Jim Forrest. "But when I print a photo of my grandson, I'll use the genuine ink. HP guarantees it for 100 years on their paper, and the quality is a bit better. You can see it."

Indeed, HP's Jotwani notes that a healthy aftermarket has been around for 20 years but HP's market share has remained "basically stable." That's because HP continually comes up with better printers, most of which have their own ink or toner cartridges, he says. So aftermarket rivals are forever racing to keep up with the latest innovations. "This business is driven by technology," says Jotwani, adding that HP's printer-supplies unit has 4,000 patents and 2,000 R&D engineers. "This is serious stuff."

LOOKING TO EXPAND.Although experts may be able to spot slightly off-color hues, many consumers are more focused on their wallets, says Cartridge World's Yarkin. The company, which got its start in 1997 in Australia, now has franchises in 30 countries and generated roughly $300 million in sales last year.

Since entering the U.S. market in mid-2003, it has been signing up a new franchisee almost every day. After two weeks of training at a mock store at its headquarters, franchisees are supplied with the necessary equipment and marketing collateral, along with an initial stock of the 150 or so inks required to fill almost any brand-name cartridge. When inventory runs low, it is quickly refilled from a 20,000-square-foot warehouse in Berkeley, Calif., that contains roughly $1 million worth of ink at any given time.

The process has been successful enough to attract a wide range of franchisees, who typically start earning a profit on an upfront investment of around $100,000 within around nine months. Terry Shea, a former executive vice-president of operations for an Atlanta-based textiles company, signed on after reading about Cartridge World during one of his many trips from his hometown in Chicago. After opening up a store in Oak Park, Ill., he logged sales of $36,000 in his ninth month. With those hefty per-store operating margins, that translates to $80,000 in annual income -- even after paying the 8% franchising fee. Shea is about to open a second store and is looking for a site for a third.

ENVIRONMENTAL PUSH. Still, refiller upstarts face roadblocks. One is obtaining enough empty cartridges to pre-fill, so customers can simply trade in their empties, rather than wait the 10 minutes or so to get their own back. This has led franchisees to get creative -- often helping schools, churches, and other civic groups organize fundraisers by collecting empties. Erv Zintner, a former finance executive with National Car Rental who owns a store in Maple Grove, Minn., says he has contributed $20,000 to such groups so far.

Refillers often appeal to environmental concerns as well. While HP urges its customers to send back empty cartridges for safe disposal, the company crushes them and then reuses the plastic and metal bits. Refillers, on the other hand, argue that they're reducing the load on the world's landfills by reusing the cartridges. "The really environmentally friendly thing to do is to reuse the product," says Yarkin. (He says the average inkjet cartridge can be reused as many as seven times, while a toner cartridge can be "remanufactured" indefinitely.)

Even if the HPs of the world can't slow down this latest franchising craze, there's always the chance that it could overheat on its own. In a number of famous instances -- think Boston Chicken -- hot new franchising operations expanded so much that stores ate into each other's markets, hurting everyone's profits.

But, for now, that seems a remote possibility. "Being a financial guy, I'm always worried about the exit strategy," says Zintner, who is 58. His current plan: Start some more stores before he retires and develop a management team to run it, including his son-in-law. "I've been very pleased so far. I'm very confident."

READER COMMENTS


Best LBO Ever
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus