Recently, Lexmark International (NYSE:LXK) released information indicating that the firm is basing a significant portion of Executive bonuses on market share. While growing market share intuitively appears to be the right goal in this business where each unit placed drives highly profitable supplies revenues, this strategy may actually drive lower profits!
One of the very subtle, but also very important aspects of the imaging industry is that not all customers are created equal. An ink jet printer placed in the consumer’s home for use as a personal printer may print as little as 50 pages per month. However, a workgroup laser printer with multi-function capabilities (fax, copy, or scan) which is connected to an office network can print as many as 10,000 or more pages a month. As a result, the multifunction laser printer can be as much as 100 times more profitable than the inkjet printer. And when the comparison is to color workgroup printers, or very high performance printers used in print shops (such as Xerox’s DocuColor line), the comparison can be even more dramatic.
So a company that is able to chase more profitable footprints will ultimately be more profitable than the company chasing less profitable footprints, even if it ends up with a smaller market share. So, in short, our premise is market share is not equal to profitability. Our point can be proven by the two graphs listed below. The first graph shows unit share for laser printers, MFPs, copiers, and ink jet printers. HP (NYSE:HPQ) is the unit share leader, followed by Canon (NYSE:CAJ), Epson and Lexmark. However, when one looks at the the same firm’s share of industry operating income (tracked by the Photizo Group as part of the Imaging Industry Advisory Service), the story changes considerably. Suddenly, Canon is the number one firm in terms of share of operating income, followed by HP, Ricoh (OTCPK:RICOY) and Xerox (NYSE:XRX). Lexmark – the number four firm in terms of market share, comes in a distant seventh in terms of operating income market share. Conversely, Ricoh, one of the firms with the least market share comes in as number three in terms of operating income share.
Another way to evaluate this is to look at the difference between each firm’s market share and their operating income by subtracting market share from share of operating income [OI]. If a firm has greater operating income than market share, then they must be doing a better job of capturing the ‘more profitable’ customers and this equation will have a positive result. Conversely, if they capture less operating income than market share, they are capturing more of the less profitable customers and the equation will have a negative result. Based on this analysis, the table below how five firms, Canon, Ricoh, Xerox, Konica Minolta and Kyocera Mita (NYSE:KYO) are gathering the most profitable customers.
While we have identified Lexmark as one of the firms incentivizing executives to chase market share, they clearly are not the only firm which is targeting the wrong metric. Unfortunately, many firms (including firms outside the imaging industry) chase customers who are not profitable for the sake of gaining ‘market share. However, the smart investor will find those firms that are focused on capturing profitable customers and growing ‘profit’ share versus market share.