Streaming Revenues

Many companies earn more revenues from selling replacement parts than selling the complementary products.

Everybody knows that Hewlett-Packard is in the computer business. Indeed, three quarters of its 2004 sales came from the computer-related divisions. But few know that it derived more than 50% of its profit from its ink and toner supplies (Business Week).

In fact, the profit margin on ink and toner cartridges is so high (estimated to be at least 60%) that HP could afford to give its printer away just to sell replacement cartridges. And it does when the low-end printers are on sale or bundled with its personal computers. Sometimes, the price of the low-end printers is no more than the prices of the replacement cartridges.

Printer and ink cartridges are one of the classic examples of complementary goods¹ where the revenue stream depends more on selling replacement supplies than selling the products that work with the replacement parts. We can easily think of the razor and razor blades, the Polaroid camera and film cartridges, and the Swiffer duster and refills.

This combination of a durable product with perishable replacement parts is a celebrated business model first made famous by IBM’s attempt to tie its punch-card reader to its own punch cards. IBM gave out its readers practically for free on the condition that the readers must use its own punch cards. IBM was ruled to be violating the Sherman Antitrust Act by the U.S. Supreme Court in 1936.

Because of the high profit margin of the replacement parts due to its exclusive complementariness, third-party vendors are eager to break into the market. The path of least resistance is refilling the original cartridges. Already refills are a $34 billion market (c/net), some 23% of the North American market for ink cartridges (WSJ). In addition, there are third-party “compatible” cartridges. But there is lingering doubt on the quality of the third-party ink.

Cheaper ink cartridges are not an unmixed blessing. Lower profit from replacement cartridges might have to be made up by charging more for the printer itself. This is bad news for the low-volume users who do not use much ink but must pay more for the printer (differentriver.com).

Not unexpectedly, Dell smelled blood in the ink-cartridge market. Using its superior supply-chain distribution technology and building on its large customer base, Dell started distributing Lexmark printers in 2003. It sold 1.5 million printers in the first 9 months and its revenues from printers and ink cartridges have grossed more than $1 billion a year as of May 2004.