In our previous article, while exploring the weak points of the office products and equipment industry, we focused on the independent resellers and the competitive forces currently squeezing the life out of them. We introduced the concept of the stronger Office Equipment (OE) resellers acquiring resellers in the Office Product (OP) channels, making this a key component of their survival strategy.
But, we also pointed out that OE resellers buying into the OP channel would ultimately fail to secure their futures unless they implemented strategies to increase market share. Two declining businesses will never automatically equal one successful company - it will do no more than provide temporary relief on the top line!
What sector of the competition will independent resellers have to look to take market share and what capabilities will be necessary for them to maximize their chances of success?
The Market Sectors:
- The OEMs
- The Big-Box Resellers
- The Internet Retailers
We looked at the financial strength of Staples and Office Depot from a balance sheet perspective in our recent article "Amazon & Office Products - Who's Equipped to Fight Back." We noted that once Sycamore Partners complete the privatization of Staples, then it's likely that Office Depot will have the stronger of the two balance sheets.
We know Amazon is already having a significant impact on the performance of both these companies, and we know this competitive pressure is not likely to let up.
As EBITDA shrinks then borrowing capacity is reduced, limiting options to invest in business development strategies.
In this article, we're looking at the income statement and the combined impact of the loss of market share, price compression, and market shrink on Staples, Office Depot, and Hewlett-Packard.
Based on overall market shares, we believe around 80% of Staples and Depot's ink and toner sales are OEM brand cartridges and estimate their combined sales of OEM cartridges to be $7.3 billion.
A concerted effort by a group of office equipment and products resellers to convert a portion of this $7.3 billion to aftermarket alternatives would have a significant impact, not just on the financial performance of Staples and Depot, but also on their [Staples and Depot's] OEM suppliers of ink and toner cartridges.
With this scenario in mind, we built a financial model to measure the impact of independent reseller channel consolidation when combined with sales and marketing efforts targeted at the Staples and Depot customer base and designed to help the independent resellers win market share.
Model Assumptions:
- Staples sales of OEM ink and toner - $4.5 billion (of which 50% is HP brand)
- Depot sales of OEM ink and toner - $2.75 billion (of which 50% is HP brand)
- Hewlett Packard's total sales ink and toner - $10 billion
Download assumptions underlying the model here.
Staples Conclusions:
5% market shrink, 10% customer churn, and 10% price compression (passed through from OEMs attempting to defend market share) eliminate almost 75% of EBIT in a $700M swing!
Office Depot Conclusions:
5% market shrink, 10% customer churn, and 10% price compression (passed through from OEMs attempting to defend market share) turn a profitable business unprofitable in a $530M EBIT swing!
Hewlett Packard Conclusions:
5% market shrink, 10% customer churn, and 10% price reduction passed through to resellers to defend market share, eliminating almost 70% of EBIT in a $2.5B swing!
SUMMARY
What does this model tell us?
First, we already know market shrink is taking place. We all intuitively know we print less, and, to back up what we intuitively know, we only have to look at the recent financial performance of Staples, Depot, eveHewlett-Packardrd, and other OEMs to confirm the market is getting smaller.
Second, we know churn is taking place. Staples and Depot are losing business to Amazon as their retail sales crash, and even their B2B comes under attack. Perhaps not 10% churn yet, but probably 5% and climbing!
Third, while we've modeled 10% price compression on OEM cartridges, this is the least likely of the key events to occur. It's in the model to demonstrate that OEMs cannot reduce prices on their cartridges because of its devastating impact on their profitability!
Because of the profound negative implications, OEM cartridge price reductions will only ever be a last resort action to defend market share.
EXPERIMENT WITH THE CALCULATORS TO SEE THE IMPACT ON THE P&L THAT RESULTS FROM CHANGING THE PRICE COMPRESSION ASSUMPTIONS!
However, it is this limitation for using the price to defend market share that translates to create incredible opportunity for resellers who perfect conversion selling [OEM to aftermarket] in new business situations, as well as selectively within their existing customer base to reduce churn (customer loss) and improve profitability.
Fourth, a massive consolidation of the independent reseller bastille continues. However;
- There is no guarantee that e a group of "super-elite" Office Equipment resellers will emerge to sweep up struggling Office Products resellers, subsequently up their ante to win business away from the big-box resellers.
- There's also no guarantee that e a large group of the stronger OP resellers (not yet ready to sell up) will successfully acquire the best of their struggling OP competitors before they leave the business.
Regardless, it's not difficult to foresee an overall reduction of 65% or more in the number of independent office products & equipment resellers, with a best case outcome resulting in a 7% reduction in retail dollars sold through the channel!
The impact of shrink, churn, and price compression issues faced by Staples and Depot flows upstream. It can potentially become a significant issue for the OEMs and their profitability. In light of this, it shouldn't be surprising that they [the OEMs] are likely to accelerate their direct selling strategies to mitigate the potential loss of market share incurred by their big box resellers.
How can independent resellers exploit the opportunity?
What will it take for the independents to take $1.7B in sales away from Depot and Staples and convert that into $850M in new sales for their businesses?
Staples and Depot may represent the soft underbelly of the Office Products Industry - two giant big-box resellers facing limited options!
In short, it will take a significant upgrade in capability; in fact, it will take a whole series of digital business transformations. Every service that Staples and Depot routinely provide to their business customers, and more, will be necessary before there's a realistic chance of a widescale shift in market shares.
These include:
- Conversion selling
- Marketing and brand awareness
- Information technology
- Feet-on-the-Street
- Internet-savvy sales reps
- Digital comp plans
The business opportunity we've described is a big prize, but even with significant upgrades to their business approach, it won't be easy for the independents to win. This is so despite the;
- Therareng limited options for Staples and Depot to defend their business.
- Their limitations are a significant and exploitable opportunity.
- Amazon simultaneously attacked and unweakened both Staples and Depot.
Amazon, in weakening Staples and Depot can, in fact, indirectly help the independent resellers achieve their objectives!
Just like we've previously explained how the independent resellers are being squeezed from all directions, now's the time to fight back, turn the tables, and put pressure on the increasingly soft underbelly that Staples and Depot have developed!