Few industry observers would argue with HP executives' plan to move into younger, higher-margin businesses such as colour printers for corporate networks and digital imaging for consumers. But Hewlett believes HP has a better chance without Compaq. And many analysts point to HP's rivals as good examples of how printer companies can be successful without selling other enterprise products outside of printing and imaging. Lexmark in recent years gained share in midrange, networked printers after being spun off from IBM in 1991 and going public in 1995. And although HP is the single largest printer maker, other major printer vendors -- including Xerox and Ricoh in lasers, Epson, Lexmark and Brother in inkjets, and Canon in both -- have significant market shares despite being niche companies. But the future of the printing industry is changing, said Greg Wallace, director of marketing for HP's imaging and printing unit. "Five years ago, a static (printer) play worked," he said. "Today, it's running into turbulence." Companies can't count on printer profits forever, warns Andrade. "I don't think the printer is going to be such a great business down the road," he said. "It is following behind the PC trend," in which minimal differences between different companies' products led first to consumers focusing on price and then to aggressive price wars. He may have a point. Traditional PC-based desktop printing, which fuels much of HP's printer-related business, has been hurt in recent quarters by profit declines due to price wars, especially in low-end printers. Operating margins for HP's printing and imaging unit in the third quarter dropped to 8.7 percent, its lowest level dating back to at least February 1999 -- the earliest data available under HP's current business structure. The printing and imaging division's fourth-quarter profit margin was 10.5 percent, down from 12.6 percent in the same period a year earlier. Lexmark, one of HP's main rivals at the low end of the market, recently reported 2001 gross margin of 31.5 percent on an operational basis, down from 33 percent in 2000. Lexmark executives said they expect profit margins to improve this year. And HP this week said it will report better-than-expected first-quarter results and cited improved consumer demand for imaging and printing as a major factor in the improvement. NPD's data for the overall industry shows average prices for inkjet printers have fallen or stayed flat in 10 of the past 12 quarters, and have dropped 32 percent since the first quarter of 1999. Laser printers have become 27 percent cheaper. Inkjet cartridge prices rose 19 percent over the same period; but except for HP, the biggest makers of printers have seen lower prices for printer supplies in recent months. The largest vendors saw their inkjet cartridge sales rise 23 percent in December, much lower growth than the 44 percent seen in November, Salomon Smith Barney analyst Jonathan Rosenzweig said in a recent report. "The true trajectory apparently was more sluggish than anticipated, exacerbating the slowdown in production and hindering gross margins in the period," Rosenzweig wrote. Murky future?
Some observers have argued that the Internet eventually will reduce the need for printing, although that hasn't happened yet, said Ken Weilerstein, research director with Gartner Group. "Until we really have a paper-like display technology, I don't think there's going to be a huge impact" on supply sales, he said. But the long-term trends for much of the printer business aren't promising, said Marco Boer, consulting partner with IT Strategies. Demand is slowing for traditional inkjet printers and black-and-white laser printers, largely because printers can last 10 years or more. Although the printing industry has traditionally made its profits on cartridge, paper and toner sales, people are starting to print less, Boer believes. "It's going to be pretty hard to get that growth back unless they can really get that digital-photo market going," Boer said. "I think it will be tough. The usage of colour printing is not a natural for people who mostly print Word documents...Not all of us are graphic artists. How much colour toner are people really going to use?" Analysts generally give HP credit for pointing its printing and imaging unit in the right direction. The company is correct in looking at new, broader markets for growth, said Weilerstein, although he added that HP's technology for colour workgroup printers has fallen behind that of rivals. A strong brand has helped offset that technology lag, but HP can't afford to let it slide, and the danger is that the difficulties of absorbing Compaq will distract HP's executives and divert money needed in printer research and development, Weilerstein and others said. "There'll be an obvious temptation to invest profits from the printer business into other parts of HP rather than putting it back into the printer business," Weilerstein said. "To some extent, that's going on already, but a Compaq merger could accelerate that." HP disagrees. Compaq's merger won't be a distraction, Wallace said. If anything, adding Compaq would help, he said, because it would strengthen the rest of HP, thus easing the pressure on the imaging and printing business. William Hewlett and his allies, of course, say absorbing Compaq will hurt the other businesses rather than help them. Yet regardless of how Compaq will affect the profitability of HP as a whole, Wallace argues the Compaq merger will help strategically because it lets HP speed up adoption not only of digital images but also network printers in corporations. Approval of the HP-Compaq deal will largely rest on how people think it will affect HP's printing and imaging business -- the most profitable division in either company. A quick glance at HP's financials highlights the importance of imaging and printing. That segment earned almost $2bn in the fourth quarter, which was more than HP's operating profit as a whole. Even in a good quarter, such as the fourth quarter of 2000, printers in recent years have been responsible for almost two-thirds of the company's operating income. But there is a drag on the division, and Hewlett argues a merger with Compaq will increase it. Analysts expressed a similar fear: "I think he's absolutely right about that," Boer said. Some analysts in recent years have gone so far as to suggest that HP concentrate entirely on printing and imaging, but HP chief executive Carly Fiorina has repeatedly rebuffed the idea of shedding other businesses in favor of printing. Some critics say the reluctance comes from corporate ego -- Fiorina didn't join HP to become the chief executive of a printer company -- but she defends the vision of HP as a diverse company offering as much breadth as IBM. HP's other business will help the printing division in the long run, Fiorina has often said. "We looked at focusing solely on our imaging and printing franchise, as some have suggested, but the consequences were unacceptable," Fiorina told an audience Monday at a Goldman Sachs investment conference. "Digital publishing...requires more than a great print engine and toner and ink...Digital publishing is also about digital content creation, distribution and transformation; (it's) the metamorphosis of what's currently a physical process into a digital, networked process. Capturing this opportunity requires servers, storage and network-management software, and professional services." But Compaq in the past tried selling laser printers in conjunction with PCs, and it eventually gave up on the idea because sales of one had little to do with the other, said William Gott, president of printer market research firm VM Strategies and editor of an industry newsletter, Printer Market Monitor. Offering PCs and networking hardware doesn't have as much impact on printers as HP executives believe, Gott said. "Certainly it helps, but it's probably not a necessity," he said. HP doesn't need Compaq to drive growth in printers -- the merger would simply make things easier, Wallace said. "Could we do it without this merger? Yeah," Wallace said. "Could we do it faster and better with it? We believe so." News.com's Stephen Shankland contributed to this report.
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