|
ONE-ON-ONE - November 2003
by Ed G. Lane
'Our Business Plan Sets Lexmark Apart from Other Technology Companies'
Gary Morin explains Lexmark's business strategy and recent intellectual property case
 |
Gary E. Morin
Gary Morin joined Lexmark International, Inc. in January 1996. In addition to financial operations, he is responsible for Lexmark’s investor relations, corporate communications, strategy and development, and audit and security functions.
Morin previously was executive vice president and chief operating officer of Huffy Corp. in Dayton, Ohio. He also held a number of positions with Huffy, including president and general manager of the Huffy Bicycle Co. and president and general manager of Washington Inventory Service. Morin also served in several financial management positions with Tambrands Inc., General Foods Corp. and The Pillsbury Co.
Morin is a member of the board of directors of Citrix Systems, Inc. He holds a bachelor’s degree in finance and a master’s in business administration from Ohio State University. |
Ed Lane: Between 1998 and 2002, Lexmark’s sales increased from $2.98 billion to $4.36 billion, a 46 percent increase. What is the key factor driving Lexmark’s strong growth?
Gary Morin: If I had to point to one factor, I would always give credit to the company and its people. Lexmark happens to be in an industry that is growing, but we are a company of very smart engineers who are well schooled in technologies. Lexmark owns three technologies – color laser, mono laser and color inkjet. Lexmark has been able to maintain pace, and in fact lead at times in technology in the industry, even though our competitors are significantly larger.
EL: How do Lexmark’s U.S. and foreign sales compare?
GM: In 2002, about 45 percent of Lexmark’s sales came from the U.S. About one-third was in Europe and the remainder was in Latin America, Asia-Pacific and Canada. Asia-Pacific is the fastest growing market, percentage-wise. Latin American sales are growing faster than sales in the U.S. and Europe.
EL: What are the ratios between printer sales and supplies (toners, etc.)?
GM: First of all, let me explain Lexmark’s business model. The competitive battleground is at the sale of the printer, whether it be a laser or an inkjet printer. The technology involved in the printer and the print-head are very important in making the sale.
Each sale adds to Lexmark’s installed base of printers. Building an installed base of printers is a very expensive proposition because the margins are less on printers. As a matter of fact, in inkjet printers Lexmark doesn’t make money on average.
Lexmark earns a return on its research investment by selling aftermarket supplies. An owner of a printer will usually buy two or three cartridges per year. If you do the math, the sales increase in supplies is larger than in hardware because of growth in the installed base. As a market matures, the installed base growth will slow, but supply sales will grow on a lag basis. It’s a mathematical equation, but supplies have become a greater part of Lexmark’s total sales. Supplies in the last quarter were about 56 percent of Lexmark’s total revenues. That’s very important because supplies are consumed rather routinely. Supply usage, growth, and volumes are very consistent and predictable whereas the sale of hardware is not necessarily predictable. Lexmark’s business plan drives sales, growth and a relatively consistent profit stream. Our business plan sets Lexmark apart from other technology companies.
 EL: Lexmark is in litigation with Static Control Components relating to the remanufacture of Lexmark’s toner cartridges.
GM: That case involved intellectual property (a chip) that is on some toner cartridges. Certain Lexmark cartridges, which we call “return cartridges”, come with a license that is for a one-time use. Lexmark requests that the cartridge be returned to us so it can be remanufactured. It cannot be remanufactured by anybody else because the license is based on an upfront discount provided to the customer. The chip helps Lexmark enforce that intellectual property.
The company in question reverse engineered the chip, including even Lexmark’s logo – and wanted to sell the chip into commerce so other manufacturers could take Lexmark’s cartridge, replace the chip, remanufacture it and put it back into commerce.
This is a violation of intellectual property because the license stipulated nobody else could remanufacture the cartridge except Lexmark. The judge, assuming that Lexmark had a high probability of prevailing, granted an injunction. So, Static Control Components cannot copy Lexmark’s chip and put it into commerce. Lexmark is very pleased with the judge’s ruling because we have invested a lot of money into intellectual property.
EL: As part of long-range planning, does Lexmark project the size of its installed printer base?
GM: Absolutely. But it’s very difficult to determine. Many people keep their printers for three to five years. So, there’s a replacement cycle. Our intent is to keep the base growing. Each year usage on existing and replacement printers is also increasing. The internet just keeps expanding and growing and more information is being printed closer to the end-user. That will keep Lexmark growing and, of course, that’s a profit for the future as well.
EL: Does Lexmark have any brand loyalty data showing how well it is doing with existing Lexmark printer owners when replacement time comes?
GM: I can’t tell you what percentage of Lexmark’s current owners actually turn over, we’ve not done that kind of extensive market research. The best way to judge loyalty is market share – in terms of how many printers you sell every year. If you sell more every year, obviously you’re growing the installed base. Hewlett Packard (HP) still is the dominant player – when Lexmark wins or gets more business from an account, it’s usually coming from HP.
EL: Part of Lexmark’s strategy is to be in partnerships with computer manufacturers and your latest report indicates that Legend, IBM and Dell are the three big partners. How is this portion of Lexmark’s business doing since Compaq, one of Lexmark’s big partners, merged with HP?
GM: First of all, our primary objective is to build the Lexmark brand. Secondly, to the extent that we can work with partners and grow the overall business, we’ll do that. And Lexmark probably does that better than anybody else. We had a good relationship with Compaq. For obvious reasons, when HP bought Compaq, we lost that business.
Our OEM business – meaning that Lexmark sells to another manufacturer and puts their brand on the printer – will probably be selling more with other brands like Dell or Legend by the end of the year than we were with Compaq. We have other partners as well.
In certain areas of the world, not so much the U.S. and Europe anymore, PC penetration continues to grow. It’s important for Lexmark’s printers to be bundled with a PC package, because that’s usually a consumer’s first use. In Asia-Pacific and Latin America, that’s an important business strategy. Lexmark can hook up with almost any PC manufacturer that’s competitive with HP. We’re an attractive partner.
EL: Lexmark outsources much of its manufacturing to foreign countries. Where are Lexmark’s major plants located?
GM: First of all, Lexmark owns all of its inkjet cartridge facilities. They are located in Lexington; Rosyth, Fife, Scotland; Juarez and Chihuahua, Mexico; and Lapu-Lapu on Mactan Island in the Philippines.
When you talk about the assembly of inkjets and lasers, the design is created in Lexington; the software is written in either Lexington, the Philippines, or in India; and the printers are assembled in Asia, and for the most part in China. Contract manufacturers assemble the printers and our laser cartridges.
EL: What about sub-assemblies?
GM: Oh sure, there’re lots of sub-assembly contractors. In many cases, they are Asian or Chinese sources. Japan has a lock on certain types of optics. The components are sourced to achieve the lowest cost and the quality specification.
EL: How important is geographic location versus manufacturing costs (labor)?
GM: It just so happens within China you not only get lower cost labor, but you also get well trained labor. When most of the componentry and the sub-assembly supplies are very close or co-located, that’s the place where it’s best to do assembly. As you can imagine, there is also a world-class transportation system out of Hong Kong, China and Asia to the rest of the world. And of course, Asia has what appears to be an endless supply of labor.
All of our competition is there. You can look at almost any brand today and it comes from China. If you want to have a good quality product at the lowest cost possible, you don’t have much choice but to go there. That’s why Lexmark was the first to go over with the majority of its production, but HP, Canon and Epson are all over there now.
EL: Does that mean that a lot of the manufacturing Lexmark used to do in Lexington is outsourced to be competitive in the marketplace?
GM: Yes. It was a difficult decision to make, but it was inevitable. Lexmark has a limited number of people working on manufacturing in Lexington today.
EL: Is it a matter of remaining competitive or going out of business?
GM: Yes, there’s no question. Lexmark still employs hundreds, if not thousands, of engineers and development engineers and administrative people, and Lexington is our worldwide headquarters. That’s not going to change. Those are also the higher paying jobs and Lexmark continues to hire. If it weren’t for Lexmark’s ability to compete in the world market, we wouldn’t be able to support our operation in Lexington.
Lexington is a very attractive environment. Before Lexmark constructed its new research and development facility in Lexington, we actually did consider a number of different locations in other states. There are markets where the pool of engineering talent is much larger, like Boston or the Valley in California. The lifestyle is good in Lexington, people like it here. Occasionally we’ll have some difficulty recruiting employees, but once they come they don’t want to leave. Lexington is a very good place to do what we do.
EL: Is the typewriter an obsolete product like the buggy whip?
GM: Lexmark doesn’t make or sell typewriters. We did until a couple of years ago. We slowly got out of that business. It was once a very profitable business, but obviously it was totally replaced by PCs and printers.
EL: How about the dot matrix printer?
GM: There are still some applications and certainly some countries that prefer a dot matrix printer because they make very good multiple copies. Lexmark still sells quite a few, but every year volume declines. Over time they will go out of business. In fact, much of what Lexmark is doing today in terms of document workflow and solutions is replacing it.
Out of a Lexmark laser today, you can have the form stored electronically, you can pull up the form, you can complete the form and you can move the form electronically. You don’t have to move it on paper. So, more and more we are engineering the dot matrix out of business.
EL: During the last two years, Lexmark has restructured its workforce: 2,500 employees were separated from Lexmark. Employees worldwide declined from 13,000 on 12/31/00 to 12,100 on 12/31/02. How has restructuring of its workforce benefited Lexmark?
GM: There were two restructurings. In 2000, it was manufacturing restructuring. In 2001, it was administrative restructuring. Much of that was an incentive for people to retire early. In most cases, the people who left here were happy because they were going to retire soon and they were provided an incentive. Lexmark reduced the size of its administrative workforce to continue to be competitive in the market. Lexmark’s strengths are in technology, but the company is also very flexible and relatively quick. We are not bureaucratic. We’re inexpensive. I would say inexpensive, other people would say we’re cheap. We just don’t spend a lot of money like other companies spend. That allows Lexmark to price our product appropriately so we can be competitive.
In the future, the shifts will be not so much a restructuring but a change in trend. In other words, some of the less sophisticated software will probably be written outside of Lexington. That doesn’t mean we’ll downsize in Lexington, but that growth may need to occur someplace else.
EL: Does this mean Lexmark will be outsourcing some of its engineering and software writing to India?
GM: Lexmark actually has its own software company in India. We also hire some contractors as well. This is a change in trend rather than restructuring. In other words, no workforce in Lexington was downsized because growth occurred in India. Lexmark outsources a number of different things – IT, call centers, the assembly of printers – but we’re not unlike most other companies around.
EL: At the time Lexmark was launched as a spin-off of IBM, all printers were IBM products. How did Lexmark create a new worldwide brand in 13 years?
GM: It has been difficult. Lexmark approached it two ways. In the corporate market, in order for Lexmark to have a point of difference against HP (selling through distributors, value-added resellers) Lexmark developed its own direct sales force and focused on specific industries. Because of our industry expertise, Lexmark really developed its business that way. Lexmark didn’t, in a traditional sense, build the brand. For a while there was some co-branding; the people selling IBM were also selling Lexmark. That transition was relatively smooth – it’s easier for me to say it in retrospect than I’m sure it was at the time.
When Lexmark got into the inkjet business, which is basically a consumer business, it offered a much better value than its competitors. It was a very attractive value and retailers supported Lexmark in their co-op ads. That’s basically how we built the brand – plus good PR. Lexmark didn’t do very much traditional advertising and really kind of sneaked in the back door.
Lexmark does not have the brand awareness that most of our competitors have. Lexmark is the only printer manufacturer that only sells printers. HP, Canon, and Epson sell a lot of other products. Those brands were built by advertising a multitude of products. Lexmark has not branded in the traditional sense. There’s always been a lot of internal discussion about whether or not we should do that.
EL: What are some of the industry niches Lexmark has targeted?
GM: Certainly pharmacy with the printing of prescriptions and other peripheral materials. Lexmark is big in retail with shelf labeling and store signs; state, local and federal governments; and the world of finance, whether that’s insurance, brokerage, or branch banking. These categories are very attractive to Lexmark because they’re high usage situations.
EL: Lexmark’s 2002 advertising budget was only $76.2 million. How is it possible to market a worldwide brand on such a small budget?
GM: It is small. That’s why advertising is always a subject of internal debate, including Lexmark’s board of directors. We reassess it all the time. The small and medium business advertising campaign that Lexmark is currently testing in five markets is really an assessment of what advertising could potentially do for Lexmark.
If Lexmark sets off on a course to build a brand, that’s not an annual effort, that’s a long-term effort. You really have to start spending a lot of money. We’re uncertain if it would really do that much on the corporate side of the business. On the consumer side, it would probably be very helpful. It would certainly inch Lexmark up the scale, but when you put us up there against HP, Canon and Epson, it would be a long time before Lexmark could really put a chink in their armor with regard to brand awareness.
EL: Although Lexmark’s sales increased each year during the last five years, net earning in 2000 and 2001 declined. Why did earnings fall and how did Lexmark management create record earnings in 2002?
GM: Interesting question. Leading up to 2000, 1999 in particular, Lexmark put a lot of printers into place as parts of significant sized IT projects in anticipation of Y2K. The heart of our product line is basically the higher end mono-lasers. It’s where Lexmark has made the most money and offers the best value. When Y2K came, those major projects were complete. After that everybody’s budget dried up. Lexmark did not suffer the harm that most tech companies suffered and that’s because of our supplies business. That really helped carry us through.
That’s why Lexmark restructured in 2000 and 2001. When the sales volumes slowed down, the world got to be much more competitive in terms of the willingness to reduce price to get business. Lexmark made the manufacturing change and then we had the administrative change, so we could reduce our costs and become more competitive. As you know, when prices come down, at least in the world of technology, they don’t go back up. They only ratchet down. Lexmark had to fight to get its costs down as fast as the prices were coming down, and we’ve not done that. Our printer margins have declined over this period of time from 2000. Now printer prices are starting to stabilize.
EL: Your printer base for supplies kept Lexmark profitable during the IT downturn?
GM: Right. If you were a PC manufacturer and your profit was dependent upon selling another PC you were in tough shape. That is what happened to a lot of the tech companies. They didn’t sell another PC because people said, “you know what, this one works fine.” They said that about printers too. They said, “I don’t need to replace it, this one looks fine,” but they kept on printing. That’s the beauty of Lexmark’s business model versus somebody else’s.
EL: In 2001, shareholder equity increased $299 million, but in 2002 it increased only $6 million. What restrained the growth in shareholder equity?
GM: Most of it is primarily the repurchase of several million shares of Lexmark’s common stock. Whatever dollar amount expended to repurchase shares reduces equity by that amount.
EL: Lexmark’s capital expenditures declined from $214 million to $112 million over the last two years. Does the reduction indicate less research and development effort by Lexmark?
GM: If you take a look at Lexmark’s development expense on the P&L, it really continues to grow. Much of our capital spending is in development. If Lexmark has a new project, we have to buy tooling and a number of test machines. When we have adequate facilities, which we do today, we don’t have to build another manufacturing plant. When we are not building facilities, capital expenditures are going to be around $100 million annually.
EL: Kentucky’s Office of the New Economy (ONE) is endeavoring to help create more technology and research employment opportunities in Kentucky. As Kentucky’s top technology company, how can Lexmark assist in this effort and what suggestions for ONE do you have?
GM: Lexmark believes the opportunity is for higher-level development in technology. Incubation of that kind of technology opportunity in Kentucky would be very attractive. It would build the community and educational opportunities. The higher level of technology is what Lexmark is doing in Lexington. That would be exciting, actually. On the other hand, trying to recruit more manufacturing is a tough struggle.
EL: How can the Lexington community help Lexmark continue its strong growth and success?
GM: Every year Lexmark invites local community members to a breakfast. Actually it’s very helpful event because we talk about issues of importance to our employees. Lexmark’s answer to this question has consistently been to improve the local school system. When Lexmark recruits people to Lexington, most have probably never considered sending their kids to private school. Many of Lexmark’s employees decide to send their kids to private school. I think many would prefer to send them to public school. Whether or not it’s deserved, the public schools just aren’t as attractive as they should be to the families of our employees. So if there’s anything Lexington could do to improve the quality of secondary education, that would be a major help. Lexington’s educational system is very important and our prospective employees evaluate it carefully.
Secondly – I will try to say this diplomatically – prospective employees visit the Lexington newspaper on the internet and review some of the articles it has published. In many cases, the articles are not very supportive. If somebody’s on the fence, the article could push them away from a decision to come to Lexington. And I wish that the paper – I’m not suggesting for it not be honest and candid – would be careful about what it is doing to support the people who live here, who could benefit by other quality people wanting to join our community.
Those are the two things that really came up at that meeting and that’s the way we feel. By and large Lexington is a very comfortable place to live. People make the difference. You can say that any way you want to say it, but if we don’t have good leadership and good people, Lexington won’t be able to stay competitive. Those things are important to Lexmark.
EL: Does Lexmark have any difficulty in recruiting qualified employees?
GM: Lexmark probably gets turned down more frequently than it would like. I don’t think recruiting is necessarily a major issue. At the outset people say, “I never considered moving to Kentucky.” By and large, people outside of Kentucky don’t know Lexington and Louisville so they need to come and experience it. But, that’s not a difficult hurdle, it’s just the initial impression.
EL: Louisville has merged all of its economic development entities into Greater Louisville Inc. and there’s been discussion in Lexington about merging Lexington United with the chamber, the mayor’s economic development office and other economic development agencies. Would you favor having one entity to promote economic development in Central Kentucky?
GM: Yes. People that are better qualified than I am should probably answer this question. But just on the surface, the idea that there’s a united front and people are working together for one common good will work better than several organizations that may not share all the same objectives. Look at Lexington/Fayette Urban County Government, it works pretty well. The idea of merging and working together as one could really help push economic development forward.
EL: How would you rate Lexington to other places you have worked?
GM: I grew up in Ohio. I lived in New York for eleven years – Long Island and Northern Westchester. I’ve also lived in California and Minnesota. Lexington is the place where I want to live the rest of my life. I think that says quite a bit.
Ed G. Lane is chief executive of Lane Consultants Inc. and publisher
of The Lane Report.
edlane@lanereport.com
Back to One on One Index
Back to the November Issue
|
