Tiny 'Remanufacturers' of Cartridges Eat Away at a Vital Source of Profit
"We're Not Copying Their Technology"
By PUI-WING TAM, Staff Reporter of THE WALL STREET JOURNAL

To track profits at Hewlett-Packard Co., follow the ink and toner.
H-P, which recently acquired Compaq Computer Corp., is famous for selling sophisticated printers and computers. But in the current high-tech slump, 15% of the combined company's revenue -- and nearly all of its net income -- are coming from lowly ink and toner cartridges that have to be replaced regularly.
Protecting the cash-cow cartridges from discount knock-offs has thus become a top priority for H-P and its full-price printer rivals. That's why when the Palo Alto, Calif., company introduced its H-P 4100 laser printer in March of last year, the machine's $129 toner cartridge included a little something special: a "smart chip" that triggers messages to users about toner level. H-P doesn't say so explicitly, but the sliver of silicon appeared to have another benefit, as well: to make the cartridge difficult to clone.
Unbeknown to H-P, however, Rhinotek Computer Products, a small printer-supply manufacturer in Carson, Calif., had secretly obtained a prototype of H-P's cartridge six months before its public launch. The bootlegged sample allowed Rhinotek to speed up development so that last month it could introduce a cartridge for the H-P 4100 that included a similar smart chip. Willing to tolerate a lower profit margin and using less expensive components, Rhinotek sells its toner cartridge for about $100, undercutting H-P by 22%. (Toner is a type of dry ink used in laser printers.)
Rhinotek and other "remanufacturers" of printer cartridges have grown from a cottage industry in the 1980s to a multibillion-dollar segment of the high-tech supply market. Combining used and new components in their products, these aggressive little companies are gnawing away at the fat cartridge profits enjoyed by H-P and rival printer makers, such as Lexmark International Inc., Seiko Epson Corp. and Canon Corp. Most large printer companies are relying heavily on sales of humble ink and toner parts during these lean times for high-tech.
Scrambling to keep up with the likes of H-P, remanufacturers say they can tap a network of industry moles for advance information about upcoming products. Rhinotek's CEO, David Neideffer, says his company gets tips from H-P retail dealers and employees of outside contractors working with H-P. The small knock-off makers sometimes collaborate among themselves to solve technology hurdles.
The escalating competition from remanufacturers comes at a bad time for the printer makers, especially H-P. The company is struggling to sort out its controversial $19 billion purchase of Compaq in May. The acquisition produced a company with 150,000 employees, who now face a persistent technology recession, as other U.S. businesses keep purchases of computers to a minimum.
Stunted sales in other areas have made ink and toner cartridges all the more vital to the newly enlarged H-P. The cartridge business, which wasn't substantially affected by the Compaq acquisition, brings in about $10 billion annually, or 15% of what industry analysts estimate the combined company's overall revenue will be for 2002. Analysts project that almost all of the new H-P's expected 2002 operating income of $2.4 billion will come from cartridges.
The printer-cartridge business follows the classic model of giving away razors to sell razor blades. H-P sells printers at low prices -- as little as $50 -- and then rakes in money on sales of cartridges that retail for $17.99 to as much as $300. "When people buy one printer, they will buy cartridges for the next three to four years," says Vyomesh Joshi, head of H-P's printer-and-imaging business. As printer prices have tumbled over the past five years, cartridge prices have edged up.
Dominant in the printer market for 18 years, H-P uses intellectual-property law to try to deter knock-offs. For each new cartridge model, the company now typically files patents in the U.S. and 20 or more other countries, up from just a handful of such filings in the past. H-P says it enforces its patents "aggressively" but won't disclose specific targets or how often it goes to court.
Remanufacturers deny they violate patents. "We're not copying their technology," says Rhinotek's Mr. Neideffer, referring to H-P. "We just take the outside plastic shell of a used cartridge, but then we do an awful lot of our own engineering and use many different parts."
Some remanufacturers -- although not Rhinotek -- have in recent years filed counter-claims in patent cases, as well as lawsuits of their own, that accuse H-P and Lexmark of having violated antitrust laws by trying to thwart discount competition. The smaller companies have alleged that H-P, for example, has used technological innovations to attempt to prevent low-price rivals from competing at all. The antitrust claims, filed mostly in state courts, are either pending or have been settled confidentially, spokesmen for both sides say. In May, the European Commission separately began investigating similar complaints against H-P and other printer companies by European remanufacturers.
H-P stresses that no legal action has been resolved with a finding that it violated any antitrust law. It adds that it is "in full compliance with antitrust and competition laws" in the U.S. and overseas. "H-P's general policy is to cooperate with regulators when they inquire about such matters," the company adds. Lexmark declines to comment.
Aiming to Please
H-P says its cartridge improvements are aimed at pleasing consumers. "Anytime you have competitors, don't expect a lovefest," says Pradeep Jotwani, senior vice president for ink-and-toner supplies. "We want to continue to win by serving customers better, [so] we're accelerating the rate of innovation."
Rhinotek and its fellow remanufacturers have about 21% of the overall cartridge market, according to Lyra Research, a business-analysis firm in Newtonville, Mass. Remanufacturers' cartridge sales are growing at about 12% a year, compared with 6.5% for the larger printer makers.
Rhinotek, a division of closely held Omni Computer Products Co., has 240 employees. It introduces new cartridges for H-P printers at a rate of one a month, and it develops a new cartridge from scratch in just three to four months, Mr. Neideffer says. In 2001, Rhinotek generated $33 million in sales, up from $21 million in 1997. The company doesn't disclose its net income.
Dean Lakatosh, supervisor of office services of Mack Trucks Inc. in Allentown, Pa., is a satisfied Rhinotek customer. Years ago, he says he bought H-P cartridges at $90 each. Looking to cut costs, he switched to Rhinotek in 1998 and found its cartridges held up for 10,000 pages of text, as H-P's had. Rhinotek's products cost almost 50% less. When Gerald Chamales in 1979 launched the business that became Rhinotek, he mostly sold old-fashioned printer ribbons. As sales of printers soared in the late 1980s, the company began collecting used cartridges, refurbishing them with new components and ink, and selling them through office-supply catalogues.
In past years, Mr. Chamales, still Rhinotek's chairman, says he struggled with streaky toner and other quality problems. He hired Mr. Neideffer, a former construction-company CEO, in 1998 to set higher standards and recruit employees. The duo renamed the company Rhinotek last year to match the brand name of its cartridges. Mr. Chamales is a rhino enthusiast who says he donates $25,000 a year to a program that protects the animal in Africa.
As the quality of its products improved, Rhinotek began butting heads with larger competitors, some of which were fought back. In march 2001, Mr. Neideffer flew to Bentonville, Arkansas, to pitch Rhinotek's cartridges to WalMart Stores Inc. for its internal use. At the time, the big retailer was using Lexmark toner cartridges that cost around $125 each, Mr. Neideffer says. He offered to sell Wal-Mart Rhinotek cartridges at $75 apiece. But Lexmark later responded by undercutting Rhinotek on price and upgrading Wal-Mart to new printers for which Rhinotek didn't yet offer remanufactured cartridges, he says.
Mr. Neideffer says losing the WalMart sale is just par for the course in the tough cartridge game. Spokesmaen for Wal-mart and Lexmark declined to comment on the incident.
Bestseller
The big company Rhinotek focuses the most on is H-P. Of Rhinotek's 74 cartridge products, 60 are designed to work with H-P printers. Rhinotek's bestseller is its toner cartridge that fits into the H-P 4000 machine, a laser printer used by many corporations.
So alarm bells rang when Messrs. Chamales and Neideffer got a phone call in late 1999 from one of their industry sources, saying that H-P was readying the 4100 model to replace the 4000. Making matters worse for Rhinotek, the new 4100 cartridge would include a smart chip for the first time. When they hung up, Mr. Chamales recalls turning to Mr. Neideffer and asking, "How are we going to survive?"
"We called everyone we knew" in the printer-cartridge world, looking for intelligence, says Mr. Neideffer. This network of contractors and retailers doesn't include any H-P insiders, he says.
By the summer of 2000, Mr. Neideffer says he was receiving information by e-mail from various sources familiar with the new cartridge. He and a team of employees studied the messages in the "war room," a corner office on the Rhinotek factory floor. In August of that year, Rhinotek scored its big coup: An informant passed along the bootlegged prototype of the 4100 cartridge.
H-P says it isn't surprised remanufacturers can obtain a cartridge before its official release date. While H-P requires its contractors and retail dealers to sign nondisclosure agreements, some of them leak information anyway, says Cathy Lyons, a general manager of ink-and-toner supplies. "We're always disappointed when information is leaked, [but] we're never surprised," she adds.
Rhinotek soon discovered it wasn't the only one snooping around the 4100 cartridge. At a remanufacturers' conference in Las Vegas in September 2000, company executives met at the Riviera Hotel and Casino with six rival remanufacturers and component suppliers. When Mr. Neideffer pulled out the prototype, employees of two other companies revealed that they, too, had obtained the cartridge through confidential sources.
Ultimately, the remanufacturers decided to collaborate on designing smart chips for their knock-offs . "All of us competitors would be in on this one together," says Lionel Brown, chief operating officer of Future Graphics LLC, a Canoga Park, Calif., component supplier to remanufacturers, who attended the meeting. Ronald Katz, a Palo Alto lawyer for remanufacturers, says this kind of cooperation doesn't raise antitrust concerns because of the small size of the companies and their lack of a commanding share of the cartridge market. H-P says it hasn't taken any antitrust actions against remanufacturers.
Back at Rhinotek, staffers dissected the 4100 prototype, breaking it into 30 components so they could "re-engineer" a similar version. By September 2001, Rhinotek had figured out where to get all 30 parts, and this February it began testing smart chips. Mr. Chamales says he brought in lawyers to make sure there was enough different about Rhinotek's version so it wouldn't violate any H-P patents. Rhinotek released its product on Aug. 30. Other remanufacturers are putting out their own versions.
"Our life blood is staying ahead of the large printer makers, or at least staying with them," says Mr. Neideffer. H-P says it hasn't taken any legal action over Rhinotek's cartridge for the 4100 but is "constantly reviewing the situation."
-- Brandon Mitchener contributed to this article.