HP playing printer catch-up

In the race to sell cheap computer printers, Hewlett-Packard Co. is running at the back of the pack.

The printer giant wasn't impressed when Lexmark International Group Inc. started selling a sub-$100 computer printer last year. HP's (NYSE:HWP) research showed that the consumers who bought cheap printers didn't print much and thus bought few ink cartridges, where the big profit margins are.

But the Internet has fueled a surge in PC printing, and that's driving explosive growth for basic printers -- and cartridges. Ink-jet and laser machines costing less than $500 now account for about $5 billion of the $13 billion printer market, and their unit sales are growing at an annual rate of about 42 percent, more than double the rate of overall printer growth.

Compaq Computer Corp., NEC Corp. and Canon Inc. have joined Lexmark in offering sub-$100 models. And last week, under a separate brand called Apollo, HP belatedly entered the fray with a sub-$100 ink-jet printer of its own. The move is widely seen as a concession to the strategic damage HP suffered from competitors.

Other players are also hacking away at HP. Seiko Epson Corp. has a strong lineup of inexpensive printers well-suited to printing Web graphics and digital photography. And Xerox Corp., hoping to jump-start a new business line, has vowed to spend heavily this year to advertise its low-end printers. The company sees a major opportunity and is going to "pound away" at HP, says its new chief executive, Rick Thoman.

Surveys by tech watchers International Data Corp. and Dataquest identify the same trend: Epson and Lexmark gained a combined six or seven percentage points of dollar share in the low-end-printer sector last year, mostly at HP's expense. A third survey, by the Infobeads unit of Ziff-Davis, shows HP's share unchanged but confirms the Epson and Lexmark climb. On average, the surveys reckon HP had 59 percent, Epson 17 percent and Lexmark 6 percent of the low-end market in 1998.

'A huge mistake'
"The bottom line is, HP decided not to go after the low-end market" last year, says Don Young of Paine Webber Inc. in New York. "It was a huge mistake."

Antonio Perez, president of H-P's ink-jet business, maintains the company hasn't lost any market share in the low-end sector. Other officials at the Palo Alto, Calif., company acknowledge some erosion. But "it was not a mistake for HP to ignore the ultralow end of the market, because it was not appropriate to pursue that part of the market with the Hewlett-Packard brand," says Susan Huberman, director of marketing for Apollo Consumer Products. "For HP to have aggressively pursued this segment would have caused dramatic price erosion."

HP still has healthy margins on supplies and strong growth in the midrange market, composed of laser printers. But "these other players are definitely hurting" HP, "and I don't see that changing much," says James W. Lundy, research director of the Gartner Group Inc., a market-research firm in Stamford, Conn.

Average prices in the hotly contested sector fell 25 percent last year to $131 a unit. Lexmark, based in Lexington, Ky., led the way with its $89 1100 Color Jetprinter. It also ran a promotion in which it gave another printer away free to anyone who bought three of its ink-jet cartridges for $90. The company -- a former printer and supply unit of International Business Machines Corp. created in a 1991 leveraged buyout -- says it cut prices by outsourcing its printer assembly to subcontractors in China and South Korea, where labor is cheaper.

Unlike HP and other competitors, Lexmark says it makes all of its own ink-jet printer engines, cartridges and circuit boards, thereby eliminating the markups charged by suppliers. And analysts say the company has designed printers with fewer parts, which makes them easier and cheaper to build. Competitors believe that Lexmark was able to cut prices below $100 by eliminating any profit on its printers-a strategy aimed at getting consumers to buy its printer cartridges.

Big losses on low-end printers?
"Our belief is they do not make any money on hardware," says HP spokesman Jeremy James. "I don't mean to sound snide, but it may have been the only strategy open to them."

Lexmark denies taking a loss on its printers. But its executive vice president, Thomas Lamb, says printer supplies account for more than half the company's profits. He adds that low-cost printers have helped the company, known mainly as a business supplier until last year, expand its consumer market presence. "We're trying to grow our share aggressively," he says.

Lexmark has certainly helped its bottom line. On Monday, it said first-quarter net income rose 37 percent to $68 million, or 96 cents a diluted share, eight cents above Wall Street's expectations. It was Lexmark's 14th consecutive quarter of earnings growth.

Epson has mounted a successful attack on HP from another front. It already had a strong brand name, established in the 1980s when it was the No. 1 maker of dot-matrix printers, those noisy pin-firing machines that have faded from the scene. But Epson retained a broad retail distribution network and recognized before anyone else the potential of selling high-resolution printers that would produce photo-quality images.

Its introduction of the Stylus line of ink-jet printers in 1994 converged with the emergence of the Web, low-cost scanners and digital photography. Recently, Epson also benefited from offering a printer with a universal serial bus, or USB, connection compatible with Apple Computer Inc.'s popular iMac computer. It got a head start because it had continued to provide printers compatible with Apple when the computer company was struggling. Other printer companies, including HP, are now starting to catch up.

Epson claims its printers produce higher-quality images than its competitors' machines because its color-imaging technology uses smaller ink drops and more dots per inch. By marketing directly to the graphic-arts industry through a separate distribution channel, the company has also sought the "halo effect" of professionals' endorsements.

Epson's marketing mantra of better resolution has captured consumer dollars. Competitors dispute its claim to superiority. HP has developed a color-layering technology that it says produces equally high-quality images. And Lexmark offers an even higher dot count.

Xerox, seeking to establish its own presence, introduced low-end printers a year ago, some of which are made by Lexmark. Its industry ranking hardly registers yet, but the company is "going to capture some share just because of its presence," says Lundy of the Gartner Group. "They have enough clout."

Thoman, who ran IBM's PC unit in the mid-1990s, says Xerox is reducing margins on its low-end printers as an inducement to retailers and consumers. Within seven years, he says, he would like the company to be the No. 2 player in the market.