Turning the Page: Lexmark's Next Chapter

In the grandstands of Lexington, Kentucky's Keeneland Racetrack, the old guard sips the local bourbon and places $2 bets on thoroughbreds that tear up the dirt. Despite the dark clouds and occasional showers, there's an air of optimism. Everyone jumps with excitement at the sound of the starting bell, believing their horse will beat the odds, break from the pack and bolt past the finish line.

It's a fitting backdrop for Lexmark International, the region's second-largest employer behind Toyota. The beige buildings that dot its corporate campus reflect the post-winter doldrums, but signs of life abound, bringing hope that the clouds will clear to reveal a bright and healthy spring and summer. Lexmark, also the world's second-largest printer manufacturer, is investing more in R&D, releasing more color-laser and multifunction printers, diving deep into managed services and stirring the secret software sauce that will transform its endpoint devices into end-to-end solutions.

But Lexmark's future isn't as certain as Kentucky's lush bluegrass or rich bourbon.

During the past five years, the company's top-line revenue has soared more than 37 percent, but profitability has shrunk from 34 percent in 2001 to roughly 30 percent in 2005. While Lexmark ranks second to Hewlett-Packard in monochrome-laser printers, that's a declining market. Color-laser printers (priced at $700-plus)--the future of the print industry--are dominated by HP, Oki Data and Xerox, according to research firm Gartner. In terms of units shipped, Lexmark ranks behind Canon, Konica Minolta, Ricoh and Epson. And as for MFPs--an emerging growth market--Lexmark shipped only 1,200 color units and 105,000 monochrome units in 2005, compared with 122,000 color and 562,000 mono for HP, according to Gartner.

Lexmark boasts that it has the most innovative print technologies, that it owns all of its technology and that it has the most generous reseller margins in the business. Nevertheless, resellers consistently give the company low scores for partner loyalty and technology in the VARBusiness Annual Report Card (ARC) survey. In the most recent quarterly VARBusiness State of Technology Innovation survey, Lexmark ranked fourth in technical innovation, barely edging out Canon.

Turning the page of Lexmark's future is chairman and CEO Paul Curlander, who has been an instrumental character since the company was spun off from IBM 15 years ago. He and his team of printer veterans believe they have the right technology, marketing and channel plans not only to retain the No. 2 spot but also to entrench Lexmark deeply enough in the printer market to make it the only viable alternative to leader HP.

"We want to be a much broader-based company," Curlander said in an exclusive interview with VARBusiness. "We want to be a strong alternative to HP. For us to do that, we've been ratcheting up our investment in products and technology to expand our base of products beyond just workgroup mono lasers or entry inkjets."

Brand: A Competitive Disadvantage

In a recent Fortune interview, HP CEO Mark Hurd targeted the enterprise printer market--a place where Lexmark is particularly strong--as a growth opportunity. While Lexmark is downplaying the defection of its longtime executive Bruce Dahlgren to HP, the company is waging a pitched legal battle to keep Dahlgren from heading its rival's worldwide printer and imaging sales. (Lexmark and HP won't comment on the litigation.)

Analysts say the court fight could be a harbinger in the printer market. Dahlgren was hired by HP to oversee and grow its enterprise business, which could shift the balance of power in the printer market.

"Bruce knew this stuff, and he was helping them lock in all these customers in the enterprise," says Peter Grant, Gartner's lead printer-market analyst. "If he helps HP and HP figures this out, it limits the upside for Lexmark."

NEXT: Challenges for Lexmark beyond Bruce.

Curlander is confident that Lexmark's enterprise business will sustain itself, despite the increasing competition, and is bullish on gaining share in the SMB market, where Lexmark is viewing its channel as key. But Lexmark faces a greater challenge than just the defection of a key executive (and midlevel departures) in its fight against HP; brand recognition and purchase consideration are huge problems, partners say.

"HP is still No. 1. It's simply more popular," says Floyd Eden of New York-based solution provider Ready Data. "It's a perception thing. More people look to HP than Lexmark." Here's the dilemma that faces printer resellers: Do you expend effort to push Lexmark or sail virtually trouble-free through an HP deal?

Comparatively, HP's brand awareness is much stronger because it's selling more than just printers. Pick up any magazine or major newspaper, or surf through TV channels, and you'll see HP ads for everything from digital cameras, desktops and notebooks to high-end storage arrays.

The perception problem isn't lost on Lexmark. In fact, Curlander admits that low brand awareness and poor public perception are what have kept Lexmark a tertiary player in the SMB space. "This is one of the reasons why we didn't engage aggressively with the channel in tapping SMBs the first 10 to 11 years of Lexmark," he says. "We weren't there; we didn't focus on it. We didn't think we could compete because we didn't have that brand awareness."

That lack of SMB penetration has hurt Lexmark over the years, and it's certainly coming back to haunt the company now. Analysts say Lexmark not only has conceded the SMB space to competitors but has lost its opportunity to create a beachhead from which to expand its SMB presence.

"They just haven't been able to make any significant progress against HP," Gartner's Grant says. "They've been stuck in their niches. They've worked verticals very well, but almost to their detriment, and during the expansion of the U.S. and worldwide markets over the past four years, they haven't been able to get into that SMB growth play. Out of HP's $24 billion [Image and Printer Group] revenue, $10 billion of that comes from SMBs. Unfortunately for Lexmark, only a small amount [of its revenue] comes from the SMB market."

While branding is important, Curlander believes the key success factors are better technology, products and services. Since 2003, Lexmark steadily increased its annual R&D spending by more than $100 million. Last year, the company pumped more than $336 million into its labs. The result is the forthcoming release of new products and technologies. Innovation, coupled with demand for midlevel color printers, is fueling Lexmark's SMB growth, which the company reported at 30 percent from 2004 to 2005.

Curlander concedes that the company's SMB growth could be more robust if the company's brand were stronger. In the coming year, Lexmark plans to increase its marketing--particularly its TV and cable advertising in the United States and radio campaigns in Europe. "We'll work on it over time, and we'll work consistently," he says. "It won't change overnight, but I hope it will over the next five years."

NEXT: Thinking beyond the printer.

Hidden in Lexmark's executive building is the Product and Solutions Showcase (PASS), a demonstration center that shows how printers are evolving beyond simple endpoint output devices to complete solutions. The different verticals Lexmark plays well in--banking, education, government, health care and retail--are represented. At PASS, Lexmark shows partners and end users how they can improve workflow, increase productivity and decrease printing costs with the vendor's hardware and software sets.

That vision, however, is not exclusive to Lexmark. Many vendors are looking beyond the printer, creating document- management systems that provide users with greater functionality and value. But Lexmark sees this as its competitive advantage and a stepping stone to services--managed and maintenance--that partners can provide.

"What we're planning to bring to market is almost a hosted capability for our channel partners, where those partners leverage any of the services that they want to deliver directly," says Marty Canning, vice president and general manager of Lexmark's worldwide printing services and solutions division.

Lexmark has offered these capabilities for years to some of its largest enterprise customers; now the plan is to bring them downmarket. "We're modifying these capabilities to bring them to the channel as rapidly as possible," Canning says.

Lexmark is working now with some partners to develop printer-management services, and the vendor intends to bring them to market next quarter. Many of the specifics are still being worked out--most notably, how Lexmark will enable channel partners to deliver the services. Also, Lexmark has entered into agreements with N-able Technologies and Level Platforms, two companies that help solution providers deliver managed services.

Upfront investment will involve training, certification and some infrastructure costs. Lexmark is still trying to determine what those will be, but execs say they will depend on the type and scope of services partners choose to offer.

Beyond managed services, Lexmark is pushing its software as a competitive differentiator. Independently and with partners, the company has developed a host of software offerings that simplify user workflow by putting associated processes behind the scenes. Most of those software offerings are developed for specific verticals. For the education market, for instance, Lexmark has integrated its scanner and printer hardware with software for creating test forms for schools. The printer can output the form, while the scanner can read and score the tests. The software embedded in the printer can even output key statistics and trending data without ever touching a workstation.

Providing managed and value-added services is critical to the evolution of Lexmark's business and the printer industry as a whole, Curlander says. Everyone is competing on price. While Lexmark boasts some of the strongest printer margins in the channel, partners say falling hardware prices are hurting it. It doesn't matter if Lexmark gives 35 points on printers; resellers lose money when prices continue to fall. Getting customers to realize the value of printer solutions and the services provided by resellers is critical to offset plummeting prices.

"When you can bring that type of value-added service, you're not [fazed by] low-end prices because you bring unique capabilities to figure out [a customer] problem," Curlander says. "It's how you can solve it and deliver a set of solutions to do it."

Channeling Growth

As Lexmark looks to reinvigorate its business and channel, it faces a host of challenges beyond rival HP. Curlander shrugs off suggestions that competitors in his rearview mirror are an equal threat, even though Konica Minolta, Oki Data and Xerox have topped Lexmark for the past four years in the ARC survey of partner satisfaction with vendor technology, support, partnership and loyalty. And two of those "minor" rivals, as well as Ricoh, are promising a fight over color-laser printers in the midmarket. As Curlander seeks to solidify Lexmark's position as the sole alternative to HP, other vendors are telegraphing their goal of knocking Lexmark out of the No. 2 slot.

Regardless of the competitive landscape, Lexmark knows its future rests with the channel. Whether talking about new products, services or promotions, Lexmark executives refer frequently to "our channel partners." Those execs are fully aware that they have to address partners' concerns and complaints, and improve the ratings partners give them for loyalty, technical innovation and support.

Lexmark has more than doubled its channel team--sales, marketing, management and industry consultants. The vendor's channel execs say they're expanding marketing, technical and sales support for partners. And as the company expands into managed and professional services, it will provide more training, enabling solution providers to take advantage of the tools that allow them to offer managed services. Ultimately, Lexmark wants to create channel programs that are flexible and dynamic to meet the specific needs of its various partners and market niches.

"We have the strongest technology ever, and we have the strongest channel ever," says John Linton, vice president of Lexmark's solution-provider channels. "I think you're going to see a significant increase in our [ARC] scores. Mark my words on that."