The Ink Has Not Yet Dried in This Tale

By Terril Yue Jones

June 20, 2004 12 AM PT

Times Staff Writer

Could a machine that costs as little as $80 pose a serious threat to Silicon Valley stalwart Hewlett-Packard Co.?

Executives at computer powerhouse Dell Inc. certainly hope so. The company famous for selling low-cost, no-nonsense PCs has opened a new front in one of the high-tech industry’s fiercest rivalries with its entry into the printer business.

Dell and HP already battle quarter by quarter for the title of world’s top PC maker. The two have traded the No. 1 spot in each of the last three quarters, according to market research firm IDC. They also slug it out over server computers and storage systems for business, government and university clients.

Now Dell is attacking HP where it hurts the most: The printer business accounted for 74% of HP’s operating profit last year. That means HP can’t afford to give any ground there.

Dell’s gains in printers are modest but, for HP, ominous.

The company sold 2 million Dell-branded printers in the 10 months after their March 2003 introduction. That was twice as many as planners had originally forecast.

What’s more, sales of high-margin ink cartridges are 25% stronger than anticipated, and the printer and ink division is expected to take in $1 billion in revenue in just its second year of operation, to become Dell’s fastest product ramp-up ever. Dell President Kevin Rollins said last week that he intended to cut prices for printers and ink significantly as the business continued to grow.

Dell’s move into the $13-billion U.S. printer market was designed as a smart strategic decision leading to a steady profit stream, not as an assault on HP. But it’s hardly a surprise that it would evolve into one. The rivalry between the two companies is intense.

An internal HP website with competitive information for its sales force was dubbed by employees the “Beat Dell site.” Even HP Chief Executive Carly Fiorina does her part, needling Dell founder Michael Dell in public appearances. After Dell broke his ankle falling off a horse last fall, Fiorina capitalized on the injury during an industry conference by suggesting that his company would meet a similar fate if it tried to get into a complicated field known as grid computing.

Rollins, who will become Dell’s chief executive next month, likes to point out that HP “hasn’t made money in the PC space for a long time.” In an interview with The Times last year, he took direct aim at the company’s high-profile struggle to boost its profitability. “I don’t care how global they are,” he said. “The customers are not voting on behalf of HP in the current environment.”

Merrill Lynch & Co. analyst Steven Milunovich, who met with Rollins this week, said in a report to investors Thursday that for Dell, “HP is enemy No. 1 in PCs, services, storage and of course printers.”

Although Dell’s nascent printer business is only a small fraction of the size of HP’s, analysts say it poses a serious threat. In fact, HP’s share of the U.S. printer market slipped to 46.9% in the first quarter this year from 50.4% a year earlier, according to IDC. In the same period, Dell built its market share to 9.1% from scratch.

HP’s sales and earnings have been rising as the company digests its $19-billion acquisition of Compaq Computer Corp. But the printing and imaging group is the only one to post consistently strong results.

“Over time, Dell will have a negative effect on HP’s bottom line, because HP’s bottom line is built on the printer and ink business,” said Bill Schaub, vice president of Techtel, a market research firm in Emeryville, Calif. “That printer business is going to be under attack.”

HP Remains Confident

In many ways, HP would seem to hold the advantage. The Palo Alto company is bigger overall, with $73.1 billion in sales last fiscal year and net income of $2.54 billion. But Dell, based in Round Rock, Texas, is more profitable, earning $2.65 billion on sales of $41.4 billion.

Although HP’s market share is shrinking, the overall U.S. market has been growing in terms of units, and the company brushes off the suggestion that Dell presents a threat. HP’s printer revenue grew to $5.9 billion in the quarter that ended April 30, up from $5.5 billion in the same period a year earlier.

“There is no real impact on our profit,” said Vyomesh Joshi, who heads HP’s printer group.

HP says it turns out 1 million printers every week, easily trumping the 800,000 that Dell says it shipped in the entire last quarter. In addition, HP has amassed 9,000 patents covering printing and imaging technologies and adds about 1,000 new patents each year.

Dell’s model is different. It doesn’t spend money designing or manufacturing the printers; they are built by Lexmark International Inc. and stamped with the Dell logo. Dell sells them over the phone and the Internet, at prices ranging from $80 to $360, using its finely tuned distribution system to order and ship printers along with computers, TVs and other electronics.

The printers have proved popular with franchisees of Choice Hotels International Inc., a Silver Spring, Md., company whose chains include Comfort Inn, Clarion and Econo Lodge. One year ago, Choice added Dell printers to the HP models it sells to its franchisees. Since then, about 85% of them have chosen Dell, because the upfront purchase costs are lower and the customer service is better, said Christopher Yellen, vice president of Choice’s property systems.

“We sell Dells with a three-year warranty for the same price as HP with a one-year manufacturer warranty,” Yellen said. And because all of Choice International’s PCs come from Dell, one-stop shopping makes tracking orders easier.

What Dell executives like most about the printers is that they generate sales of ink, the company’s first product line that has the advantages of an annuity.

Dell’s printers come with software that shows when ink cartridges are running low and lets users click to a website to order replacements that usually arrive the next business day.

That system provides Dell with a wealth of customer data -- information that HP and other printer makers can’t know because they don’t stay in touch with their customers.

For example, “we can see that you use photo cartridges and buy photo paper, so I know what it’s being used for,” said Tim Peters, the Dell vice president in charge of printing. Such information helps Dell target customers for special deals, new products and replacement items. It also helps the company anticipate demand and set prices.

Dell’s move into ink sales will also benefit the company as it expands beyond its core computer business, said Greg Davis, vice president of printer sales and marketing.

The company had to find a cost-effective way to make an overnight delivery to a customer’s door while keeping the price in line with that of traditional retailers. Now that it has, Dell can consider adding other annuity-type products to its lineup, such as batteries.

“We’ve had to build a logistics system that’s effective,” Davis said.

Dell’s long-term plan is to turn the printer business into a greatly expanded imaging enterprise. In January it announced alliances with Fuji Xerox Co., Eastman Kodak Co. and Samsung Electronics Co. Dell did not give specifics, but industry observers expect Fuji Xerox and Samsung to produce laser printers for the company and Kodak to throw in a photo printer or two and maybe even a digital camera. Dell sources say an online photo service based on Kodak’s Ofoto.com is under consideration as well.

Battle Has Just Begun

Analysts expect the competition from Dell to go upscale to color laser printers and possibly even photocopiers in the quarters to come, nibbling at HP from even more angles.

In the face of this growing offensive, HP says it isn’t worried, noting that Dell’s gains in printers have come primarily at Lexmark’s expense.

Sales of the most popular type of printers -- all-in-one inkjet models that fax and scan as well as print -- offer some evidence to support that view. According to IDC, Lexmark’s U.S. share in that market segment dropped to 15.6% in early 2004 from 32.4% a year earlier as Dell’s share climbed to 19.2% in its initial year of sales.

As the sole supplier to Dell, however, Lexmark can be seen as coming out ahead. Moreover, its printers are reaching markets in which Lexmark has not had a significant presence, such as small and medium-size businesses.

HP’s market share for all-in-ones slipped to 50.4% from 55.2% in the same period. HP’s Joshi says, however, that most of Dell’s printers are at the low end, less than $100, where not much money is made, while HP has a much greater mix of higher- margin machines.

Michael Cohen, director of research for Pacific American Securities in San Diego, agrees that HP’s printer business is still healthy. “Their margins haven’t even seemed to be suffering,” he said.

But, Cohen added, that doesn’t mean HP is safe: “The future threat of Dell is significant.”

(BEGIN TEXT OF INFOBOX)

Gaining fast

In just a year, Dell has made significant inroads in the printer market.

U.S. printer market share

All-in-one inkjet printers

Hewlett-Packard

First quarter 2004: 50.4%

First quarter 2003: 55.2%

Dell

First quarter 2004: 19.2%

First quarter 2003: 0%