Imaging Industry Profitability Rebounds in Q2:06

After a disastrous 2005, imaging industry profitability has rebounded in the first half of 2006. The Photizo Group’s Imaging Industry Profitability Index showed slight growth to 1.025 versus 1.02 in Q1 of 2006. Most importantly, this is a marked improvement from Q2 of 2005 when the index dipped to 0.86 due to the intense price war in the second quarter of the year. In terms of absolute values, the operating profit margins for the industry were 12.1%, flat from Q1, but up 2% from 10% in Q2 of 2005.

The positive results have been driven by a relatively benign pricing environment during the first half of 2006 as vendors "lick their wounds" from the intense ’05 price war. Additionally, several vendors have pulled back from their aggressive strategies of gaining market share by offering the lowest price points (Lexmark (LXK) in ink jets, Konica Minolta in color lasers, and Samsung in monochrome lasers).

Hewlitt Packard's (HPQ) willingness to selectively target these vendors and neutralize their price advantage has shown this tactic to be a no win strategy. While these vendors may still have slightly lower prices than HP (typically 15-20%), HP has effectively dropped prices to a point that these vendors cannot compete by offering greater than 20% price discount. The hardware losses just become too large.

The Imaging Industry Profitability Index, shown in the graph below, was developed by the Photizo Group to track the profitability of this market. The base period for comparison is the first quarter of 2006. The index includes supplies, hardware, and services profitability for the imaging divisions of 14 of the top industry participants. Calendar quarters are used instead of fiscal quarters to provide a common comparison basis.

So who is benefiting most from this positive environment? Is everyone winning, or are just a few? In our view, the most important measurement of who is winning is the share of the industry operating profit that each firm captures. From this perspective, four firms are the clear leaders: Canon (CAJ), HP, Ricoh (RICOY.OB) , and Xerox (XRX). These four firms collectively captured a resounding 84% of the industry’s profit share.

HP and Canon have managed to stay on top by using HP’s pervasive channel presence and strong brand reputation with Canon’s technology base (at least in the laser market; HP owns their own inkjet technology). Conversely, Xerox has benefited from growth in color revenues in the production printing space / digital press space, while Ricoh has maintained a laser sharp focus on winning in the profitable MFP market space.

So will this positive environment last? Not likely! During the second quarter, the promotion activity in the inkjet market has already started to increase as HP offers rebates to clear inventory and make way for new models. We expect HP to announce a new lineup of laser printer products with new MFPs (multi-function printers) in the second half, which will increase price pressure in the workgroup MFP and monochrome laser printer space. The digital print/production printing segment will be under increasing pressure as Canon’s new ImagePress products begin shipping, along with Oce’s new VarioPrint product and Ricoh’s new high performance Aficio products.

So, the question is, will this just be a brief lull before the storm, or will stabalization bring a more profitable price structure? The Photizo Group’s view is that there is too much competition given the industry’s maturity. Continued price pressure is inevitable until consolidation whittles the business down to a few major players.

So, this will be a lull before the storm (or perhaps the "eye" of the hurricane!) During the second half we expect significant increases in price pressure and subsequent reductions in operating profit margins. Hang on as it is sure to be a bumpy ride!

This report contains data from the Photizo Group’s “TrendLine”, a quarterly report tracking the imaging industry for the Wall Street investment community. For more information visit www.photizo-financial.com. The author, Ed Crowley, can be reached at [e-mail].