Nations are in the news: Greece, Portugal, Italy, and soon maybe even France. Greece has a debt to GDP ratio of approximately 150%, Portugal’s ratio is 93% and Italy is 120%. The good old US is right around 100%. How did these countries dig themselves such a large hole that they subsequently crawled into? I realize any easy answer will be an over simplification, but in my mind the answer is by not acting on good data.
In 2003 I was in Prague while participating in a Wharton Fellows Program. We met with some economist from the European Union. This group certainly wasn’t there to meet me but one of the benefits of participating in the Wharton Fellows was that Wharton has pulling power and you get to sit and discuss business with some really smart people. These weren’t any old economists; they were the EU gurus. It would be like talking to Ben Bernanke's direct staff in the US. They had a simple message, and remember this was 2003, the EU was going bankrupt (okay, I am sensationalizing a little but they did demonstrate deep concern about the future) because of the EU birth rate and worker productivity.
Candidly, I never heard birth rate mentioned before in business but here were these really smart people who were concerned about how many babies the average family was producing in Europe. Want to know the countries that most concerned the economists? Italy, Spain, and Portugal. They spoke about, with a marked level of concern, the ratio of adult Italian children who still lived at home. These economists were very clear about their concern: There was no way—none—that the smaller workforce could support the social programs of the growing group of retirees that were going to be on the State’s dime.
So in 2003, a full eight years back, the EU knew that the light at the end of the tunnel was a train and yet apparently didn’t do a thing to get off the track. Why would these really smart people make such a fundamental mistake? Well why don’t you call or e-mail your Congressman or Senator and ask them that question? As you know, US debt was downgraded from AAA and placed on negative watch due to our own (continuously increasing) deficit spending. Last week the “Super Committee” admitted they were s super flop. Instead of reducing the budget by $1.2 trillion they took pot shots at one another. You see that light? It is definitely a train!
So what would you do if you were one of these politicians, or if we simply gave you omniscient power to do whatever you wanted? If I had the power I’d simply say to the Democrats that you can raise taxes by $600 billion and I’d tell the Republicans that they must cut expenses by $600 billion; I’d give them responsibility for what they’re preaching, but they each only get half. The caveat would be that the tax increases and expense reductions had to be enacted without change and the entire committee accepts responsibility for all of the changes. No gaming the system by making recommendations you know will never get enacted.
If you’re an entrepreneur with decreasing revenue and earning low single digit returns each year what is your plan? The European’s were hampered by a socialist approach to labor that made it difficult at best to reduce the workforce and social welfare programs that were unaffordable based on the quantity of workers to retirees. The map was clear: Make it easier for companies to reduce their workforce, therefore making them more willing to hire new employees, and cut the social welfare programs. You’re hampered by decreasing copier unit volume, a plateauing of production print volume, and ultimately, in two to three years, an overall decrease in prints.
The financial crisis and ensuing worldwide recession exacerbated the European dilemma: What is going to be the catalyst to accelerate your problems? That same recession significantly reduced the quantity of devices bought and the overall print volume, but that has bounced back somewhat. Moreover, you had the opportunity to add output from printers, an area ignored by most until they “had to” find revenue. Some won’t be reading this post because they sold their companies, unable to support the cash flow.
One greatly overlooked area of benefit in our industry has been the overcapacity in manufacturing: We all saw this movie before, only the stars were automobiles. GM, Chrysler, Saab, Hummer and others all were trying to keep production up in a market that could not absorb all of the cars being produced. So what did the manufacturers do? They juiced the market with rebates and interest free loans that had your car payments extending out to match your mortgage. Who benefited from these great promotions? You could say the consumer who was able to finance a car for free, but I’m not sure that is accurate. The absolute winner was the owner of the car dealer. You see, people were willing to pay more for their car because they financed it interest free for five years so the dealer earned more profit per vehicle and sold more vehicles; a double up. The irony of this approach was that while the car dealers were printing money the car manufacturers were literally bleeding billions, as evidenced by the bailout of GM and Chrysler and the disappearance of brands like Hummer, and soon Saab.
What does this have to do with the copier industry? Well despite all of the talk about lower margins in our industry we’ve actually witnessed margins increasing. Ten years back if you could maintain a 36% GP ratio on equipment you were doing a great job. Today, we routinely see margins in the low 40% range and have some clients in the 50% range. Why is that? Overcapacity has the manufacturers providing you with the best pricing/promotions of our lifetime to fill our warehouses with their products. That can’t continue forever and the manufacturers will certainly make investment decisions to build or retool their plants based on forecasted unit placements. In other words, production will equal sell through in the long term.
One thing that amazed me about car dealers is how they were not prepared for a change. I read articles, or heard news reports, weekly about the 75-year-old third generation car dealer that was closing their doors. The story usually went something like the town was losing out because of all the money the dealer spent sponsoring local events; the dealer principal was losing his home, and his dealership, because he could not afford the mortgage/floor planning. Hello—you’ve owned a company for 75 years and you’re leveraged up? Over the last five years, while the manufacturers were throwing money at you with interest free financing—did you have to buy the 72 foot Buddy Davis sport fisherman and the 12,000 square foot home on credit? Why didn’t you buy those cars on your lot rather than using floor planning? Did you not read the financial news and see that big brother, your manufacturer, was losing billions and there was no way they could maintain the interest free financing…and once that ended car buying would fall off a really big cliff?!? Maybe you should run for the Senate?
Back to the point: Are you a politician—somebody that wants to keep EVERYBODY happy—or a businessperson: Somebody that wants to earn money? Is your bottom line above 10%? Is your business growing? Are your MPS revenues growing at a significant rate, keeping in perspective that MPS represents 7/9 of the industry revenue? What percentage of your overall revenue is represented by printers vs copiers? Are you focused on the correct measurements of health for your business?
Our industry is solid in that it has a recurring revenue stream that produces lots of cash. MPS provides you the ability to grow revenue while you maintain your legacy copier business. But you also have to make the tough business decisions to get your aftermarket (service and supply) gross margins into the 55% range and your G&A into the 15% range. Pay down your debt as fast as possible and make investments in growth areas. Equipment margins will come down over the next three years so run the analysis today: If your equipment margins dropped by 10 points (38% to 28%) what would your income statement look like? You have time—start to make the changes.
I don’t want to come off like an alarmist but I see too many good people in our industry operating like things aren’t going to change: They are. We’d welcome the opportunity to help you make the transition to the new industry model. There is a lot of money to be made for those companies willing to make the touch decisions. Give us a call or send me an e-mail at Callinan@strategydevelopment.com