In Plain Sight - An Ink and Toner Cartel or Not?

At the end of November 2016, I concluded an eight-part series of blogs titled "The Aftermarket, Office Supplies, and a Major Tipping Point." During that series, I argued the OEMs appear to have effectively orchestrated a cartel-like structure from which they can effectively control market share and pricing.

 A cartel operates under the radar in developed Western economies in the 21st century. Really! How can this be possible? Well, strictly speaking, we don't have an ink and toner cartel because that would require a formal agreement between a group of producers to regulate supply and manipulate prices, and that would be illegal. I don't, for one moment, believe any formal agreement exists between the various parties or underlies their market behavior. However, as I'll argue, there's no need for a legal agreement because the same results are achieved without one.

The definition of a cartel, according to Merriam-Webster, is as follows:

"A cartel is an organization of a few independent producers to improve the firms' profitability. This usually involves some output restriction, control of price, and allocation of market shares. Members of a cartel generally maintain their separate identities and financial independence while engaging in cooperative policies. Cartels can either be domestic or international. Because cartels restrict competition and result in higher prices for consumers, they are outlawed in some countries. The only industry operating in the U.S. with a blanket exemption from the antitrust laws is major-league baseball".

Definition courtesy of Merriam-Webster

Twelve global enterprises make up the Original Equipment Manufacturers of printers and supplies. They each make their office products that are incompatible with each other, and each of them is a fierce competitor. This is very different, for example, to the OPEC cartel, where their product is oil and oil is oil, with little to differentiate it from one producing member and the next.

Oil from Saudi Arabia works the same in my car as oil from Iran but, a toner cartridge from HP will not work in my Epson printer!

Although the OPEC cartel has been weakened (mainly because of its pricing and production strategies), it still meets to discuss production quotas and manipulate output to influence prices.

The twelve OEMs (Table 1) in the office printing industry (printers and copiers) are not likely to be meeting to discuss production quotas and pricing strategies. They are fierce competitors, and each constantly works against the others to increase its market share. Just imagine these twelve companies organizing a meeting and collectively agreeing to cut back production of ink and toner to raise prices. It's such a ridiculous concept it must be dismissed out of hand.

Table 1:  The 12 Global Printer and Copier OEMs
NameGlobal Sales ($M)Market ShareUS Ink & Toner ($M)Market Share
Hewlett Packard$48,00028%$9,60046.6%
Kyocera Mita$12,3007%$1,2306.0%
Konica Minolta$8,5005%$8504.1%
Seiko Epson$8,5005%$8504.1%


However, the OEMs don't need to arrange a meeting to achieve their goals because they, and the significant resellers of their products, have a common interest. The top three OEMs have a 58% share of the global market and a 65% share of the more narrowly defined market for ink and toner consumed in printers and copiers in the United States.

Imagine if one of these top three decided to nudge up prices for ink and toner. What would the inclination of the other OEMs be? Would they look at the long-term opportunity for increasing market share by keeping their ink and toner prices at existing levels, or may they follow suit, raising costs and short-term profits?

What about the authorized resellers of OEM products? Do they care if the OEM cartridge is $100 or $105? At some point, maybe, but only if a price increase led to their significant customers seeking alternative, lower-cost cartridges. When the OEMs increase prices, the resellers blame the OEMs, shrug their shoulders, and say, "Yeah, what can you do? Those OEMs are naughty guys!" But, they're saying (from Wall Street to the individual salesperson commissioned for top-line sales performance), "Thank you, Mr. OEM, for increasing prices!"

Now, while the resellers may enjoy the top-line sales from OEM ink and toner, unfortunately, the OEM holds the balance of power, and the reseller only gets a small portion of the profits. If the OEM price increases from $100 to $105, then the OEM gets to keep most of the extra margin dollars, not the reseller.

This disproportionate allocation of margin dollars led to the introduction of aftermarket alternatives to the Tier-1 distribution channels in the 1990s. This was how the resellers reacted to try and keep the OEMs "honest," and, as a strategy, it worked brilliantly. Instead of making only a 5-10% gross margin on the sale of an OEM cartridge, they could make 60%+ on an aftermarket cartridge. Their customers saved 30% over an OEM cartridge; the only losers were the OEM and the reseller's top line!

This development was a big problem for the OEMs.

So, what did they do to overcome it? Well, they leveraged what they knew about the reseller's drive for top-line sales, what they knew about sales compensation plans, and that they knew it was "easy" to sell an OEM brand cartridge compared to selling the "story" of aftermarket alternatives. The OEMs knew the resellers must be able to sell their branded products and that any reseller breaking ranks (for example, only aftermarket of sale) would perform the equivalent of a business "suicide."

So, armed with this knowledge, they introduced quotas and fine-tuned their back-end rebates to perform against quota.

Table 2 - example of how rebates control market share
 QuotaGM on SaleRebateTotal GMGM %Change in GM $
OEM Plan (quota)$1,000M$50M$75.0M$125.0M12.5% 
Reseller (actual)$800M$40M$37.5M$77.5M9.7%-$47.5M


In the example, I've shown a quota of $1 billion and an actual performance of $800 million, or 80% of the allocation. This, below plan performance, may lead to only 50% of the rebate dollars being paid, representing a loss of nearly $50 million.

The OEMs know they control retail prices by only allowing the reseller a small margin on the initial sale to ensure no room for discounting. They also know they hold market share by assigning quotas and offering rebates tied to performance.

In the case of the United States' $25 billion market for ink and toner (where the OEMs have around an 80% market share), you can be sure those collective reseller quotas (assigned by the OEMs) add up to 20 billion dollars. Missing the sales quota means missing a disproportionate amount of the rebate dollars the resellers count on to hit their budgets.

So, I've explained the ability of a relatively small group of OEMs and resellers with aligned interests to control pricing and market shares. Furthermore, this control is achieved without restricting production or having any formal [illegal] agreements, as typical in a conventional cartel!

However, there's usually a consequence of market distortions. For example, consider what's happened in the oil industry.

Saudi Arabia extracts oil at the industry's lowest cost, around $5 per barrel. For a few years, prices were over $100 generating mammoth profits. Profits attract competitors; think U.S. shale producers, with costs of maybe $60-70 per barrel - still not bad profits when oil is $100+.

But, the cartel doesn't like the competition and decides to increase its production to deflate prices. They believe prices come down to $40 per barrel, which should put the shale producers out of business. Sure, it reduces their output, but the shale guys also figured out ways to reduce costs and protect themselves by hedging prices into the future.

Furthermore, the Saudis have legacy social programs equivalent to $60+ per barrel to keep its citizens compliant. If these social programs are compromised, it may lead to unrest. So, the rulers can't afford to compromise them, and Saudi oil costs $65+, comparable to the U.S. shale producers.

Why is all this relevant to the OEMs in the ink and toner business?

Well, the OEMs have collectively distorted the market. Printers are underpriced (to achieve scale with the installed base), and cartridges are overpriced (to subsidize losses on the hardware). In aggregate, the OEMs don't make [cartel] profits.

However, the high cartridge prices attract competition and, most problematic for the OEMs, that competition has cartridge build costs similar to the OEMs. Still, it doesn't have to fund losses on hardware.

If Saudi Arabia didn't have to fund its social programs then it would win the battle against U.S. shale producers!

The Chinese aftermarket cartridge builders are the equivalent of the Saudi oil producers without the social programs, and it's this parallel explains the opening for the aftermarket. However, this opening cannot be exploited through the Tier-1 distribution channels through which 90% of the $25 billion is currently spent. As I've explained, the OEMs control market share through these channels and block the distribution of Chinese products.

I am going back momentarily to my oil parallel.

While oil prices were $100+, the U.S. shale producers raised billions of dollars to drill wells. While ink and toner cartridges are $100, the Chinese aftermarket manufacturers raised billions of dollars through IPOs and started buying distribution in Western markets, recognizing the Tier-1 distribution channels were blocked. Think Ninestar, Static Control, Ninestar and Lexmark, Goldengreen Tech and Cartridge World, HNA Group, and Ingram Micro.

The Saudis cannot defeat the U.S. shale producers, and the printer OEMs cannot beat the Chinese aftermarket cartridge manufacturers. It's now only a matter of time before market shares for ink and toner cartridges shift toward the aftermarket.

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