It’s a Small World After All – The Economics of Office Technology

From an outside perspective, the world of office technology might appear to be a dying industry.  With original equipment manufacturers (OEMs) struggling to post results reaching their prior year’s performance, one has to question the staying power of the industry and why there continues to be an interest in investing in the space.

Even with the recent impact of COVID, which set up easy year-over-year comparisons for OEMs, many are still finding it challenging to post consistent year-over-year performance, let alone growth.  Xerox’s 2021 results might be the clearest indicator that being a manufacturer is not easy these days.

While the last several years make for some difficult analysis, even prior to the recent challenges associated with COVID, working from home and digital transformation, it was clear that the industry had reached maturity and was poised for a steady decline.  Whether it was a reduction in printed pages, price erosion due to extreme competition, or the shift from traditional A3 to A4 MFP technology, all signs indicated that the industry was on a steady downward trajectory and vendors capable of achieving the same level of revenue as the prior year would be considered “best in class.”

So why the continued interest in the industry from the likes of investment firms, and in particular, private equity?

The office technology industry is an interesting study in economics and economic displacement.  While there is no doubt that the overall size of the industry is shrinking, eliminating most avenues of growth for OEMs already selling to and servicing the entire market, the story is quite different at the micro level of the market where dealers make their living.  If we look at the market from a dealer’s perspective, while the overall market may be mature, the opportunity for dealers is expansive.

For example, when evaluating the majority of today’s OEM providers, we immediately recognize that virtually all of them have full market coverage through a combination of their direct and indirect operations.  As a result, short of a major shift at the macro level of the market, OEMs are forced to take share from competition as a means of capturing growth.  Given the nature of the market, this is no easy task when one considers that in any given year, a third of an OEM’s base is vulnerable to competitive takeover.

By contrast, the vast majority of dealers have limited geographic reach, ultimately providing them with continued opportunities to capture growth through organic geographic expansion or by acquiring other dealers in markets of interest.  At a micro level in the market, this is exactly the scenario playing out and is a core reason why we continue to see dealers delivering high single-digit, and in some cases, double-digit growth results on an annual basis while OEMs are happy to remain flat.

In addition to these growth opportunities, dealers have also taken advantage of emerging market opportunities, particularly those in software, IT services and production print.  Yes, many dealers have been engaged in production print for some time, however, dealers, particularly those with larger infrastructure and capital, have moved aggressively into this space with some even setting their sights on high-end commercial print.  While the production print market, and in particular commercial print, is still a growth opportunity for OEMs, it’s a greenfield for dealers and yet another reason the micro economic scenario in the industry is so appealing.

The micro-economic scenario, in part, explains the significant interest and involvement we have seen in the industry from investment firms and PE in particular.  With strong balance sheets, cash flow, highly predictable revenues and continued opportunities for growth, dealers have become quite an attractive area for PE firms to park their money.  There are, however, a number of questions that arise with respect to private equity’s involvement in the industry.  One such question is how long the favorable micro-economic conditions will remain in the industry as the overall pie continues to shrink?  At what point does a dealer reach a level of scale where they, too, are subject to the same macro-economic challenges facing today’s OEMs?  And maybe the most critical question, what is private equity’s exit strategy?  As we know, all PE investments are made with an expectation of a downstream exit and return on such investments.  While many PE investments in the technology space are geared toward a company becoming a publicly traded entity, this is not a likely scenario in the office technology space given the overall decline of the industry.  So, how does PE ultimately capture return for their investors?  This is a vexing question for all industry players that will have serious implications for both dealers and OEMs alike.

The economic situation associated with the office technology industry shows little sign of changing.  And while the long-term role of private equity awaits clarification, the world of office technology once dominated by the industry’s manufacturers, has truly become a small world after all.