Print is Dead. Long Live Print. (1)

There is a basic assumption in the imaging industry that people and companies will always print, and that therefore the imaging industry is robust, recession-proof and has a bright future. We generally agree with this optimistic assessment and are great believers that while total print volume will gradually decline, a shift from static/analogue to variable/digital content will ensure that key print segments remain stable and may even grow.

Nonetheless, several recent articles have attracted our attention, all of which somehow bring this assumption into question. First, John Dvorak, the respected IT journalist, commented on the recent decision of PC Magazine to discontinue their print publication and provide only digital content: “The venerable PC Magazine going 100% digital coincides with the trend of media and information distribution doing the same, but further emphasizes the fact that the computer scene, in general, is not interesting enough to sustain a printed magazine.” This observation is astounding - you would never believe that the popular and ever-changing computer industry would run out of content (amount and interest level) to fill a regular publication. He goes on to make his case about the quirks of the PC industry that limit the newsworthy content and publications’ interest in reporting, but still the development is remarkable.

Secondly, Dan Costa in PC Magazine comments on the same decision but also extrapolates to more general social trends: “Trouble is, print publishing is hugely flawed. . . . Print media is simply behind the times by design. Print businesses aren't dead, but they do need to change. Printing should be reserved for archival information—artifacts you'll hold on to for years instead of hours or days.” This observation is also interesting, because we know from several sources that a great amount of corporate printing has a short term character, more as a temporary user interface (case in point: printing and re-printing e-mail and documents for review, sharing, taking notes, etc.) than as an archive. We can expect shifts in usage patterns in the office as well, driven either by economic pressures or by generational tendencies.

Lastly, we read in Media Life that the Detroit media landscape is about to shift radically and may signal similar changes in other metropolitan areas:  “Detroit is one of the last major two-newspaper cities, and soon it will become the first to stop home delivery on all but a handful of days and shift some of its focus to the web, in a major overhaul that highlights just how dire things have become for the nation’s major metropolitan papers.”  An animated (electronic) discussion ensued which debated the wisdom of both papers taking the same step, the questionable logic of trying to keep hard-copy versions going on some but not all days, and the public service aspect of supplying news and information to those citizens who do not have an internet connection.  

Taking our basic digital/variable data sentiment to the extreme, it could conceivably be possible for these publishers to continue their print operations with highly targeted and individualized versions. Add value to justify, or even increase, the selling price and expand circulation: if your neighbor prefers sports in his newspaper and engineering applications in his PC Magazine, he can have that, and you can have the in-depth business and programming coverage that you prefer. The technology is there, but the production and delivery processes would need to be rebuilt. It is presumably easier to go electronic . . .

In fairness to Dan Costa, he did touch on this idea: “Big publishers will continue to scale back on their print operations, but there are millions of micropublishers out there with how-to books, cookbooks, memoirs, even love letters that they can now affordably publish and make available to the world.” Further: “Sure, you say, but those are books. What about magazines, you ask. I would argue that the difference between books and magazines is simply about the publishing schedule, at this point.”

The point is that the world of print will undergo drastic changes, but it is not (yet) possible to predict whether digital print will decline as a result. If millions of micropublishers take up the challenge and implement this approach effectively, OEMs can look forward to attractive business for a long time. But every imaging vendor will have to decide how to address this issue, and this will affect their prospects for future success as well. Stay tuned . . .

Kodak - a picture of desperation

It is not news that Kodak is going through an identity (and financial) crisis of considerable proportions, but the news today highlights the point dramatically. Kodak today withdrew their guidance for second-half and full year outlooks and also announced drastic cost saving measures, including canceling 401(k) matching and executive pay raises.

Kodak management some time ago recognized that their core business has to change, or they will be changed (let's say "demolished") by external events. Other companies have encountered similar epiphanies, such as when Xerox stated that their established business was "fundamentally unsustainable" and then went to work methodically rebuild. Results speak for themselves.  Also, when Konica Minolta decided to exit the camera business, it probably tore some people's hearts out. But it was the right thing to do, and while we can still question the judgement and strategies of present management, it would have been suicidal to stay in the camera business.

Now to Kodak, who also faced a similar juncture and decided to rebuild and go digital. Despite some heroic efforts to restructure the company and refocus the business, strategies and results have remained mixed.  They did move quickly into the digital world, which is commendable, but how wise was it to keep such a strong focus on the consumer end of the business?  Yes, there is (or was) the considerable value in the brand, but why try to leverage that in the low-end printer business?  Maybe there was some belief that this would be the best place to transfer the consumer brand and build a new, digital annuity business. The days of film are gone, but here come the days of ink cartridges . . .  The brand is far from dead, but we would not overrate its value in the present-day world of consumer electronics.

Regarding the value of the printing business, we have done some work in that area, building a series of bottom-up business models.  Looking at individual product segments and revenue/profitability streams, you can construct a highly reliable model and work through variable future scenarios. The Kodak business model we have developed is a revelation to understand the dynamics and constraints within the company.  Comparing the usage patterns and output volumes of the respective product segments, we can see the opportunities as well as the cost implications of those business areas.  

It might be (just a bit) overstated to call Kodak desperate, but they clearly need to focus more precisely on their most profitable business areas.  They have some promising products and technologies, for example in the Graphic Communications Group, though results have been spotty enough to make the case that focus and resources have been lacking to date. As Kodak further shifts priorities and resources, today's decision will almost certainly have ramifications for the Consumer Digital Imaging Group.

Who would have thought?

The sign of a good index is when it acts and provides information like a microcosm of the real world. Select a good representative set of companies, avoid the messiness of identifying and tracking the long tail of the last x% of the entire universe. Consolidated, the group serves as a mirror and a magnifying glass for the selected industry. Individually, you can still track and compare the results, strengths and weaknesses of specific companies.

Woodford Group and our partners/predecessors Photizo Group have been tracking and analyzing the operating results of key companies in the imaging industry for 19 quarters now. These companies make up well over 90% of the industry, and one amazing discovery point is how stable this market is. Considering the range of technology breakthroughs and economic swings over the past 5 years, the Imaging Industry Margin Index demonstrates in numbers what we have stated previously: the imaging industry always seems to find a way to maintain earnings momentum.

The imaging industry as a whole is a bit unglamorous, not as attractive as many other tech products and trends.  But in fact it delivers mission-critical products and services throughout the business and private worlds, in various and ever-changing forms. The annuity-based business model, accompanied by new applications and services, delivers consistent returns for those companies best equipped with the right focus on key success factors, namely product portfolios as well as execution and financial management skills.

The Imaging Industry Margin Index is in fact a lagging indicator, examining recent events to discern a trend. But considering the fact that a recession has been pronounced to be in effect since December 2007, the results are significant: the resilience of the imaging industry is evident.  A modest dip is present and not surprising, but there is no dive.  The index has dipped lower in other quarters, and the overall trend is stable and positive.  

If we look into the index in more detail, there are naturally a few stinkers.  But while a few companies definitely put a drag on the overall result, we see these as examples of internal misalignment as opposed to economy-related issues. We can return to the trio of success levers of product portfolio, execution and financial management: the poor results of those companies who were hurting can be traced to some (or all) of those factors. Economic pressure certainly serves to expose underlying weaknesses, and recent earnings calls were indicative of the true influences: as much as some companies tended to blame the external economic or market influences, other companies demonstrated their mastery of the key levers. Even in the context of the current economic difficulties, their results (and those of the industry as a whole) showed a surprising steadiness.

Who would have thought?

The One-Eyed Leading the Blind?

Recent industry events such as the InfoTrends Office Document Strategies Conference and the Xerox Investor Conference have emphasized the importance and emerging prevalence of MPS (Managed Print Services) as a vital component of the vendors' future business models. Interestingly, while vendors and research analysts are more or less unanimous in their conclusion that MPS is a key development for the imaging business, they seem to be missing an obvious implication: the unavoidable reduction of and intensifying competition for hardware placements.

The mantra of a generation of copier and printer executives has been: "maintain your MIF." The hardware, the Machines In Field, are what directly drive the back end of the business, namely the services and consumables revenue. Without the machines to feed, the annuity-based business model is that much less attractive. And as we know from our industry financial models, even slight shifts in installed units, product mix, output volumes and margins will have significant influence on all the financials.

So what's new? This (and every other) market has always endured pretty aggressive competition. What's new is that MPS provides focus, transparency and accountability where (to the great benefit of the imaging companies) they were missing in the past. Companies will now identify and control print volumes and, most importantly, restructure their printing environments. They will establish target output volumes and device ratios to streamline and rationalize their document flows and costs. They will install fewer printers and MFPs and manage them much much more rigorously.

The typical reaction and strategy of any individual company is totally unamazing: develop attractive MPS offerings to win the business and gain a higher document share at each customer site by taking away installations from the competition. Take a bigger piece of a smaller pie. Maintain, or even expand, your MIF.

There is some truth to this approach at vendor level, and we can debate who will really win out. But a further, no less certain, implication is that total MIF numbers will decline. But here is where we see a disconnect: industry forecasts expect future hardware sales to be flat, possibly even rising slightly. Even if we saw a slight unit decline, that would still not match the trend indicated by the MPS developments. When these assumptions were challenged at the recent events, the responses got squishy: print rationalization can take many forms, and hardware installations will not actually be affected so much . . .  Hmm.

Forecasting is far from exact and never pretty, especially in retrospect. But in light of these trends, the available forecasts do not match up and need revision. Follow those forecasts if you have to, but be wary of how good the sight and foresight is of those analysts showing the way. You may discover that the one-eyed leading the blind (no disrespect intended) is not as helpful as you might have expected. 

Recession-proof? Only if you know how . . .

Yesterday we joined the Xerox investor conference and by coincidence (?) HP also reported their quarterly / annual results on the same day.  These companies are good illustrations of the capabilities of well-positioned companies to perform well even in a difficult economic environment.

Someone may argue that these companies can keep business and positive results rolling because of their size.  But we would argue that HP and XRX are big because they are successful, not the other way around.  In fact, a few years ago nobody would have given XRX any credit for being big.  Their CEO, Anne Mulcahy, put it bluntly:  a few years ago, they were suffering a business model crisis, and size was neither the cause nor the solution.  What is driving their business now is a combination of revitalized execution, strong products, broad sales and service capabilities, and new additional offerings which leverage different aspects of the imaging equation.

In fact, we hear from other smaller companies (for example, dealers and solutions providers) who are doing just fine and are optimistic about their prospects in the current economic climate.  The product offerings and sales approach may need to be adjusted, but the imaging industry always has an angle to offer.  Buy new equipment, they earn; retain and keep using the old equipment, they earn; implement a print management program, optimize the fleet, even go electronic, amazingly they can still earn.  Not all can exploit such opportunities equally, but the opportunities are definitely there.

At the same time, some less than stellar results are getting blamed on the economy, when the real cause can probably be found closer to home: missing offerings, neglected market segments or sales channels, or pure and simple execution discrepancies.

So while we wouldn't really want to say that the imaging industry is essentially recession-proof (but there you go), you can find some good opportunities even in the bad times.  

And while we wouldn't really want to call some companies whiners for blaming the economy (but there you go), it would be prudent to take a closer look at any company's fundamentals and their chosen markets and strategies if this argument arises.  We can think of a few choice examples . . .

Extending the Ecosystem

We recently attended a key industry conference hosted by the research company InfoTrends, and it was interesting how often the phrase “ecosystem” came up. This was not related to the topic of saving or killing trees, although that is inherent in the discussion as well (save that item for a separate posting). This discussion was referring to the development of an imaging company’s offerings and support structures.  

The simple fact is that the imaging space has grown exponentially in its diversity and complexity, and will continue to do so. The results: regardless of the results reported in financial statements and anticipated outlooks, if the portfolio and support capabilities of any company do not map to key future user expectations, they will suffer in the short or the long term. And it is worth stressing again: any company can benefit or suffer, depending on how well they are meeting or missing expectations for document imaging.

Not only because of the economic situation (but that too), customers are more than ever aware of the great potential now available to optimize and control their document flows and improve their output cost structures. Statements about saving users 30% sound like a stab and a stretch. In fact, they are well documented and are actually conservative estimates.

But to meet these expectations, you have to deploy a sophisticated range of hardware, software and consulting skills. Any company which is not covering all the topics and skill sets will be highly exposed, and that is the “ecosystem” that needs to be cultivated. To address this situation, there are just a few alternatives for vendors:  

1)  Build a strong internal portfolio through organic development or acquisitions.

2)  Build a strong “virtual” portfolio through external partnerships.

3)  Watch your business and key business opportunities shrink - rapidly.

We can see prominent examples in each category, and each of these have obvious challenges to deal with:

• If you build our own portfolio, are you really expert enough in all of these diverse areas?  Can you maintain, manage and deploy all that internal expertise?
• If you collect partners, how do you coordinate and articulate your “virtual” offering and manage the necessary knowledge? We heard one vendor proudly state that they sell NO software, but are well positioned to sell embedded solutions. Noble (and maybe wise), but who knows and who says what your actual offering is? Case by case and in general?
• If you address only some market and volume segments, are you prepared for dwindling opportunities and possible survivability issues?

Point 3) is basically a red herring. Obviously, there is little or no alternative to offering a more complete portfolio.  Anybody expecting to thrive (or even survive) with a limited offering which addresses only part of the total market is seriously compromised.  These companies will have to be searching for partnerships, or they will become prime takeover targets.  We can think of a few in this category . . .

Graph Expo: Where's the Next Wave?

Last week we visited Graph Expo, one of the premier exhibitions for the printing industry, especially for high end production-class systems. Although many business sectors report waning interest in major live exhibitions as  regional and 'virtual' alternatives provide sufficient information and value to both vendors and users, this segment continues to attract healthy and even increasing participation. There are several understandable reasons for this ongoing interest in attending such events live: first, the systems in question involve investments of tens and often hundreds of thousands of dollars, and these decisions must be prepared with live demonstrations and expert discussions. 

Second, the real judgement about the quality of the product, namely the final output, can not easily be represented in any way other than in a direct encounter. The exhibition was full of vendors working hard to demonstrate their products' benefits: huge systems with no exhaust piping (implying more environmentally-friendly workplaces), print output being trampled underfoot by design and not by accident (showing the durability of the print output and media), new applications, improved color, new speed and size formats, etc. All of these simply must be seen to be believed (and bought).

Also, the pace of product development and technology transition is increasing dramatically. Since there are not that many outlets to see a production system the size of a bus, you have to be there to get the picture. So Graph Expo (and related events such as DRUPA and IPEX) is and will remain a draw.

So we can report healthy participant rates and a number of significant new developments. Digital systems were of course everywhere, and the newly emerging "light production"and wide format inkjet systems are clearly active and increasingly competitive spaces. But those trends were already evident years ago. With all due respect to the massive development efforts and long timeframes required to bring such systems to market, the vendors who were showing these systems were not really on the cutting edge.  

To anticipate key future trends, it is necessary to look closely for what is not (yet) so prevalent in the booths and show reports. In this vein, we noted a number of key developments that will further facilitate the transition from analogue to digital and empower print providers to match offset output quality in smaller print volumes and to profit in areas never before possible. For example, until recently, you needed a high end press to produce the most impactful documents with beautiful images and specially defined "spot" colors on coated/glossy media, with special visual and even tactile effects. Key developments shown at Graph Expo indicated how quickly this will become possible for smaller, highly targeted and even individualized print runs. These developments will affect (in both positive and negative directions) future business prospects of established vendors and open new opportunities for relative unknowns.

For those readers who missed the chance to visit live, feel free to contact Woodford Group to discuss how to get the full picture from this key event.

Sub-Prime . . . What?

One of the most frequent questions we have dealt with in recent client discussions is how the credit squeeze is affecting the imaging business. The surprising answer is . . . not much! Of course, we need to put that statement into perspective. We have no intention to play down the seriousness of the present situation, as no corner of the economy is left untouched by the current crisis. But the impact is still less than one might expect when observing the "mainstream" events and commentaries.

Especially since some sectors of the imaging industry involve major investments, financing is often  part of the business and a key facilitator for most vendors in the mid- to high end of the business. A digital press, a corporate installation of dozens or hundreds of systems, or even the purchase of a single midrange MFP will often be financed through a leasing arrangement. So how could it NOT be that the vendors are seriously affected?

On the one side, that corner of the financial world has been and has stayed notably conservative. Overall, credit checks for imaging equipment are thorough and the decision processes are (in retrospect, thankfully) stodgy. Credit requirements for potential customers have always been strict, sometimes to the point of frustration for the selling companies. Just like the imaging industry as a whole, their financial partners seem to have been maybe a bit boring on the surface, innovative only within limits but certainly profitable if their portfolio was well structured.  

On the other side, the financing for imaging equipment has by definition been well securitized. The hardware is reasonably valued and, as a response to some "playful" calculations in past years, there is rarely any effort to leave any residual value on the books to lower payments. If monthly volumes are included, they also tend to be fairly estimated. One reason is that the contract partners typically have enough knowledge of historical usage levels to provide a good baseline. The other reason is that while lock-ins are good, overage, which is usually charged at a premium, is better. So the volumes tend to be realistic and often even a bit low.

With such a notoriously low tolerance for risk in this space, the market for sub-prime financing for imaging equipment, while theoretically possible, never emerged. If times had stayed good, maybe these players would have been tempted at some stage to get creative and find ways to loosen credit. But we are sure that those players are currently thankful that they stuck to the established credit parameters.

Imaging Industry Insights for the Financial Community

Many analysts, especially those serving Wall Street, cover the printing and imaging industry because they have to.  In the world of IT and beyond, other topics appear more attractive and interesting.  Did they draw straws and lose?  

The difference:  at Woodford Group (and our partners Photizo Group), we cover the imaging markets because we want to.  Quirky as it may sound, we like what we do!  And by the way, there are excellent earnings opportunities to be found as we work together to discover attractive investments:  companies, sectors and technologies, both in up as well as in down markets.

Our enthusiasm, combined with our collective century+ of high-level industry experience, ensure that we can provide Wall Street with fresh information and actionable insights.  Try us out and enjoy the ride!