Ever Wonder Why Ink Costs So Much?

So did upstarts that are refilling printer cartridges -- and nipping at the big boys

Printer makers have long known that ink is as good as gold. Just ask the folks at market leader Hewlett-Packard Co. (HPQ ) Analysts say ink and toner supplies made up more than 50% of fiscal 2004 profits for the computer giant, although they brought in less than a quarter of the company's $80 billion in sales.

But now a new breed of fast-growing upstarts is out to crash the profit party. Across America, retail stores are cropping up in strip malls among the Gaps (GP ) and Wal-Marts (WMT ) where consumers and small-business owners can go to have empty printer and toner cartridges refilled -- usually for half of what it costs to buy a new one. The largest of these outfits, Cartridge World, based in Australia, just passed 1,000 stores worldwide, and its North America affiliate has opened 275 stores in the U.S. since mid-2003. The company is signing up a new U.S. franchisee daily and plans to top 3,000 stores in the country by early next decade.

What's driving this latest franchising craze? Prices that draw nearly as much ire from consumers as does a trip to the gas station. Burt Yarkin, chief executive of Emeryville (Calif.)-based Cartridge World North America, likes to point out that the ink inside a new cartridge from HP, Lexmark (LXK ), or Canon (CAJ ) costs more per ounce than Chanel No. 5 or Dom Perignon champagne. "People know they're getting ripped off," says Yarkin. "We're giving consumers and businesses a choice."

Most Cartridge World outlets offer refills and clones that are cheaper than brand-name cartridges. The cost of refilling typically runs 40% to 60% of the cost of a brand-name product. An HP 45 inkjet cartridge sold through HP's Web site will set you back $30, while the Cartridge World in Conroe, Tex., will refill an empty one for just $16.50. "Our service has been unbelievably well received," says store owner Jim Spillman, a former Electronic Data Systems (EDS ) executive. "Everyone likes to save money."

There have been ways to reduce printing costs for years for shoppers willing to deal with messy do-it-yourself refill kits or buy from online outfits with iffy-quality products. But the new retail chains will make reuse an option for millions of mainstream PC owners. Customers can either wait for a few minutes for their cartridge to be refilled, or pick up a "pre-filled" one in stock. Rapid Refill Ink International Corp., based in Springfield, Ore., even sets up drop boxes at coffee shops and dry cleaners. Most refill franchisees also have their own vans to do pickups and deliveries to local businesses, usually at no extra charge.

QUIET LEGAL PRESSURE

How can these operations undercut the printer giants by so much? Mostly, it's because those giants have been careful to maintain their ink profit margins at sky-high levels, even if it means selling some printers at a loss. And while they spend lavishly on research and development -- HP, for example, has 4,000 patents and 2,000 full-time engineers in its printer supplies business -- the chains' costs are much more pedestrian. They buy inks made by third-party suppliers, often for less than $1 per cartridge. After paying rent and salaries for a few staffers and buying some low-tech equipment, they can easily clear 20% net margins, say industry sources.

This results in a tricky balancing act for HP and its ilk. If they cut prices, they sacrifice margins. Yet if they make a big show of trying to shut down this fast-growing industry -- say, by creating technologies that make it impossible for refillers to reuse cartridges -- they risk raising the ire of consumer advocates and regulators, not to mention drawing attention to a low-cost alternative to their products. So far, HP has chosen to maintain quiet legal pressure to make sure the chains play fair. On Oct. 20, it sent a letter threatening litigation against Cartridge World, alleging that some of its inks infringed on patented HP ink formulations. Says HP printer supplies chief Pradeep Jotwani: "We support fair and free competition. All I want is to make sure there's a level playing field."

The question is whether HP will be able to maintain that stance or be forced to scrap with this new class of rivals. Analysts at Lyra Research Inc. figure that refillers already have grabbed roughly 5% of the $59 billion global market. Together with knockoff brands, this aftermarket could rise from 23% in 2004 to 31% in 2009.

VAST POTENTIAL

To be sure, most consumers will still pay up for brand-name ink and toner cartridges. While the quality of refilled cartridges has improved, some independent analysts say a tangible difference still exists. "I use aftermarket ink all the time," says Lyra Research analyst Jim Forrest. "But when I print a photo of my grandson, I'll use the genuine ink. HP guarantees it for 100 years on their paper, and the quality is a bit better. You can see it."

And the printer makers are by no means sitting still. They're continually coming up with better printers, most of which have their own ink or toner cartridges. That forces aftermarket rivals to race to keep up with the latest innovations. "This business is driven by technology," says Jotwani.

Still, even a few points of market share mean years of vast growth potential for refillers. Cartridge World, which got its start in 1997, now has franchises in 30 countries and generated roughly $300 million in sales last year. And it has honed a model that's attracting a wide range of franchisees, who can earn $80,000 per year per store, even after paying the 8% franchising fee. Many are now scrambling to open their second or third stores.

That includes 29-year-old Matt Rissell, a former salesman for Verizon Communications Inc. (VZ ) whose first store is Cartridge World's top-selling outlet. The location: Boise, Idaho, home of HP's laser printer division. "We get quite a few HP employees in here," says Rissell. "They're usually skeptical when they first come in, but then come back and say, 'I can't believe it. The cartridges worked perfectly."'

By Peter Burrows

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