Kinko's Goes Corporate

With buyout firm CD&R on board, the laid-back chain of copy shops is heading toward an IPO

The mood was buoyant as the partners and store managers of Kinko's Inc. arrived in San Diego for the company's 26th annual meeting and picnic on July 11. As always, the attendees heard presentations, watched skits, and applauded employees cited for creative ideas. But this year, there would be something new: outsiders.

As Chairman Paul Orfalea introduced bankers from New York buyout firm Clayton, Dubilier & Rice Inc.--which on June 10 announced plans to take a 30% stake in Kinko's for $200 million--employees applauded loudly. Still, they knew the deal would forever change the copy-shop chain, based in Ventura, Calif., from a quirky, loosely managed group of private partnerships to a more buttoned-down company on the road to an initial public offering. Joked Tim Stancliffe, a longtime Kinko's partner: "Back in my college days, I would have called [CD&R] the creme de la creme of the capitalist-pig insect world. Now that I want their money, they're savvy."

The transition from counterculture casual to mainstream mature is one few Kinko's managers thought they would ever have to make. Under Orfalea, who founded Kinko's in 1970 with one copier in a converted taco stand, the privately held company grew--without outside help--into the country's largest chain of 24-hour photocopying stores. Orfalea created an unorthodox structure by forming a separate partnership in each market Kinko's entered--all 128 of them. Decisions were made by consensus, and even store clerks had a say.

GROWING PAINS. For years, the system worked. Today, Kinko's has 851 stores--18 of them overseas--and holds an estimated 25% to 30% share of the $5 billion to $6 billion retail copy market, says Prudential Securities Inc. analyst Alex Henderson. The company doesn't disclose its financials.

But mounting competition, rising costs, and the constrictions of Kinko's management structure have caused growing pains and hurt profits. Orfalea concluded that Kinko's needed help to profitably expand its customer base beyond students and entrepreneurs to national businesses with sophisticated technology needs. So Orfalea interviewed some 15 investment firms last year, finally choosing CD&R for its probing questions. The investment firm will centralize Kinko's partnership structure, help choose outside managers, and bankroll the company's plan to reach 2,000 stores by 2000. Orfalea, 48, nicknamed Kinko for his curly red hair, says the decision reminded him of his wedding day. "It's scary and happy at the same time," he says, "but it's the right thing to do."

Duplicating Kinko's early successes will be tough for CD&R. Thanks to its near-monopoly position in the college market, Kinko's grew rapidly, financed by Orfalea and his partners, who owned pieces of their own stores. Orfalea put a premium on rewarding innovation. One example: Each year, employees of the store with the best new idea--this year, a user's guide to Kinko's computer stations--win an all-expenses paid vacation to Disneyland or Walt Disney World. Kinko's board--Orfalea included--stays behind to man the counters.

CROWDED FIELD. Yet as Kinko's became a national powerhouse, the structure became unwieldy. Expansion was uneven, with strong partnerships making the most of their markets while weaker operations sometimes didn't open enough stores. And the consensus-based style meant that Orfalea spent much of his time haggling over niggling details. After losing a 1989 copyright-infringement suit over the reproduction of texts, Kinko's sped up its move toward its new target: small and self-employed businesspeople who couldn't afford high-tech equipment but needed premium services such as color copying. Yet it's a crowded field, full of franchisers such as Quick Copy and Sir Speedy Inc. Now, companies such as OfficeMax and Office Depot are expanding copy services.

The competition has squeezed profits across the board. According to the National Association of Quick Printers, the industry's average net profit margin fell from 17.9% in 1983 to 13.6% in 1995, driving many mom-and-pop shops out of business. Most of Kinko's sales still come from low-margin photocopying services, and the availability of cheap laser printers that can provide high-quality copying at home is eating into that business. At the same time, Donald J. Gogel, co-president of CD&R, says it's now three times more expensive to open a Kinko's than it was just five years ago. That's because of rising labor costs and the costlier new technology needed to reach Kinko's expanded target market. It's also one reason some 30% of Kinko's stores aren't profitable.

To get Kinko's printing more profits, CD&R will centralize operations. This will help Kinko's save on purchasing and cut interest costs by $20 million to $30 million as partners' debts--now often personally collateralized--are consolidated. CD&R's capital will also be used to expand overseas and interconnect all the Kinko's stores.

The linkup will help Kinko's compete in digital electronic imaging, a new market that Prudential's Henderson thinks will grow 50% a year. This service, still less than one-half of 1% of industry sales, lets customers send in information electronically, which Kinko's can then print out anywhere, anytime. A business traveler, for example, might send documents over the Internet to Kinko's in Las Vegas, San Francisco, and Tokyo for pickup at a later date. Yet investing big bucks in high tech brings risks. Videoconferencing, introduced in 1995, is a smash with New York ad executives, but the equipment is rarely used in Ventura stores.

In the meantime, Kinko's is pursuing large customers, such as Wyeth-Ayerst, the $8 billion pharmaceutical division of American Home Products Corp. In January, Jackie Franke, purchasing manager for Wyeth-Ayerst, opened a national account for her 3,000 traveling salespeople. They've spent $200,000 on jobs so far. "Everyone's been happy," she says, noting she chose Kinko's for its reach. "The more stores they open, the better."

IDEA MAN. To make the plan work, Kinko's is counting on CD&R's seasoned management--led by partners Gogel and Andrall E. "Andy" Pearson. Gogel successfully reshaped IBM's $1.6 billion typewriter business into $2 billion printer maker Lexmark International Inc., and Pearson, the ex-president of PepsiCo Inc., won kudos for the company's success in foods. But the key to success will be keeping Orfalea happy. With approximately 34% ownership of the new Kinko's--conservatively valued at $226 million--he will be the largest shareholder and a board member. Still, he has no official title and says vaguely that he will be the idea man, working on such new concepts as airport kiosks.

For its $200 million, CD&R gets about 30% of the company, 6 of 11 board seats, and veto power over the company's soon-to-be-named CEO and CFO. The partners will be folded into one group owning one-third of the company, and the estimated 3% who want to be bought out by CD&R will be paid out of a $75 million fund. Most should stay, charmed by the prospect of striking gold when the company eventually goes public. "CD&R likes to invest where there's strong opportunity," says Lloyd Grief, a Los Angeles investment banker. "This will be a sweet deal."

Still, no one thinks the shift will be free of snags. "There will be turmoil in the transition," admits Tom Parrish, a board member who started at Kinko's as a clerk. Dennis Itule, Orfalea's cousin and one of the first Kinko's partners, says he went through a mourning period after the change was announced. "Once in a while you have a twinge," he says. "But the other side is, we can gain a lot." If CD&R can reproduce the Kinko's magic, it's a sacrifice worth making.

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