Online Extra: Can HP Protect Its Printer Kingdom?

Dell is quickly taking share in the low end, so Fiorina & Co. are going upstream. Despite some early successes, HP has much to prove

When Hewlett-Packard Co. (HPQ ) began blazing trails in the nascent printer industry two decades ago, few realized what the business could mean for the Silicon Valley icon. Today, the printing and imaging business is HP's heart and soul. In 2004, its $3.8 billion in operating profits represent over three-quarters of HP's total.

But even though this cash cow has carried HP through some tough times, many analysts and investors are beginning to wonder if it can withstand a gathering threat. Dell's two-year-old foray into the printer business is building more momentum than many expected. Through the first nine months of this year, the Round Rock (Tex.) computer-seller has gobbled up 13% of the U.S. inkjet market, according to researcher IDC. "For not being in the market two years ago, that's pretty significant," says Tony Ursillo, analyst at Loomis Sayles & Co., which owns just under 1 million shares of HP.


  But as Dell chips away at the low end of the printer market, HP is unleashing a volley of bets aimed at both expanding and fortifying its stronghold. In August, HP announced new printing technology, dubbed Vivera, which includes fade-resistant inks designed to boost the life of photo prints beyond 100 years. In November, it unveiled a new multifunction digital copier to better compete in the broad market for corporate document management. In addition, HP continues to chase high-end digital publishing, which includes industrial labeling for things like wine bottles.

All these moves are based firmly on technology -- a front where HP believes it can stay convincingly ahead of Dell. After all, HP spends about $1 billion each year on research and development for its printing and imaging group. That's more than double Dell's entire R&D budget. "We're coming from our strengths," says Vyomesh Joshi, executive vice-president of HP's printing and imaging business. "Our job is to really talk about this with our customers."

When asked about the big picture, Joshi becomes animated. Flipping over a manila envelope, he begins scribbling charts with a few numbers. Fifty trillion pages are printed around the world every year, he says. HP now handles about 4% of that total. Joshi's goal is to eventually double that figure, creating an additional $20 billion or so in annual sales. "I'm very confident I can add $2 billion a year to this business," he says.


  Some of Joshi's strategies look more promising than others. Foremost, is the intersection between ink technology and HP's foray into digital photography. The computing giant is the sixth-biggest seller of digital cameras, according to IDC. But HP is less concerned with rivaling Sony (SNE ) and Olympus, as it is with seeding the market for its photo printers and ink. With the price of printing digital photos from home coming down, HP would like to become the photo developer of the future.

So far it appears to be working, with HP already handling about two-thirds of all photos printed at home, according to CEO Carleton S. Fiorina. "The direction of digital imaging plays to HP's strengths," says IDC analyst Christopher Chute.

But other bets appear much more challenging. A year ago, as HP ratcheted up competition with the likes of Xerox (XRX ) and Canon (CAJ ), it vowed to snatch 10% of the $24 billion market for digital copiers. So far, HP says it has gained a couple of percentage points of market share, but the fledgling product portfolio hasn't been there to support more.

Although HP launched a new multifunction digital copier in November, it's a different business than printers, often with unique sales channels and distinct buyers inside of companies. "HP's performance has been mixed at best," says Ursula M. Burns, president of business group operations at Xerox. "Their focus is uneven and their implementation is uneven."


  Victories in these high-end markets will be crucial for HP, especially with Dell's fast gains in the lower reaches. Sure, the sheer number of printers that HP ships is still several times greater than Dell's. And that primes the most lucrative piece of HP's business -- selling expensive ink cartridges, which carry gross margins above 60%. But as Dell begins to build its base of installed printers, it could gradually begin to erode HP's cash-spewing ink business. "In two to three years, Dell will probably be able to compress inkjet margins to a greater degree," says JP Morgan analyst Bill Shope.

With such a scenario really not that farfetched, Joshi's big plays on high-end printing become even more critical. Hanging in the balance is nothing less than the luster of HP's crown jewel.

By Ben Elgin in San Mateo, Calif., with Nanette Byrnes in New York

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