5. 5
Executive Summary:
Lexmark International, Inc. has received attention over the last four years due to their
ambitious acquisition strategy of several software and services-based companies. They have
started the transition from predominately hardware-based solutions to software and services-
based solutions, and they took the first step in selling off their inkjet technology in 2012 after
several years of noticing a decline in consumer print business.
Lexmark’s new strategy focus has been predominately on expanding their content and
process technology, industry expertise in healthcare, and geographic reach. This can be seen by
their most recent acquisition of Kofax Ltd., who specializes in content and process technology,
for $1 billion1
and several other acquisitions2
. These acquisitions have increased restructuring-
related costs, and in analyzing Lexmark’s financials, there is an alarming trend in debt acquired
over the last four years.
Lexmark is currently positioning itself to compete in a competitive and growing Software
and Services Industry, and in order to compete with existing rivals, they need to ensure they can
serve the proper industries with their current solutions and services.
The right mix of software solutions coupled with industry expertise and global reach
places Lexmark in a competitive position with some of the largest players within the software
and services industry. Lexmark is well known for their stance on “creating customers for life”
and continues to pursue lifelong connections through understanding the customers and their
needs.
The following case study analyzes Lexmark’s financial position in addition to an analysis
of the software and services industry and the overall environment Lexmark operates in. The
1
: This $1 billion in acquisition funds accounts for approximately half the acquisition cost over the last five
years.
2
: See Acquisition Chart on p. 57 for a detailed look at all recent acquisitions.
6. 6
imperatives and objectives suggested will help Lexmark take a step back and focus on their
position within the Software and Services Industry.
Company Background:
Lexmark International, Inc. was founded in 1991 in Lexington, Kentucky when IBM
chose to downsize and sell its Information Products Division. IBM made a deal to sell Lexmark
(“Lex” represents “lexicon” and “mark” represents “marks on a paper”), its Information Products
Division, through the private investment group of Clayton, Dubillier, and Rice for approximately
$1.5 billion. The buyout was financed mostly through loans which left Lexmark, a newly
founded company, with $1 billion in debt. Martin Dubillier recognized that Lexmark was going
to need aggressive management to survive so he hired Marvin Mann, an IBM vice-president with
32 years of experience, to serve as Lexmark’s chairman, president, and CEO (“Lexmark
International, Inc. History” n.d.).
During Lexmark’s early years, approximately 70% of sales generated came from printers
and printer-related supplies. In this competitive landscape, Lexmark was able to generate $1.8
billion during its second year of operations and reduce its debt to $700 million. Lexmark
continued to push its inkjet printers, made its name in the laser printer market, and grew its
global presence (“Lexmark International, Inc. History” n.d.).
Today, Lexmark sells its products and services in over 170 countries and made
approximately $3.7 billion in revenue in 2014 (57% from international sales). The company has
switched its focus away from printers and hardware and into software and services. They have
acquired 13 software companies since 2010 which has allowed them to provide further solutions
for their clients. Lexmark competes in several software-related markets including managed print
7. 7
services, intelligent capture, healthcare content management, enterprise content management
(ECM), business process management (BPM), financial process automation, and enterprise
search. All of these solutions are “focused on helping Lexmark customers connect employees to
the most relevant information the moment they need it. (“Company Overview” n.d.)”
Mission and Vision Statements:
Lexmark has a “Vision and Values” page that lays out what concepts the company finds
to be most important. They do not have a mission statement and that is very important in order to
see what products and services the company provides as well as outline their purpose. Thompson
says a mission statement, “describes the enterprise’s present business and purpose - - who we
are, what we do, and why we are here”. (Thompson, p. 24)
Vision Statement:
“We, the employees, are Lexmark - a dynamic, global information technology
company. We have a vision: Customers For Life. To earn our customers' loyalty, we
must listen to them, anticipate their needs and act to create value in their eyes. We
want to be known for reliability, flexibility, responsiveness, innovative products and
services and exemplary citizenship. Growth, longevity and financial success will
naturally follow. We will make this happen in an enriching environment of trust,
cooperation and mutual respect.”
The statement describes the direction in which Lexmark is heading; this is important
when establishing a vision. The emphasis on customers and referring to them as customers for
8. 8
life shows that Lexmark is looking forward which is a great foundation. Another strong point is
the part where they state what they want to be known for. The statement: “growth, longevity and
financial success will naturally follow” shows that Lexmark is focusing on the things that will
make them a great company, letting the growth and success happen organically. Lexmark has
passion and a good sense of where they want to be moving forward.
There are two changes that should be made to the statement. The first one being: “We
want to be known for…” to “We will be known for…” This adds confidence and shows that
Lexmark will achieve the goals and objectives they have set, not just make an attempt. The
second change would be moving the first sentence from the vision statement to the mission
statement. The first sentence is stating who they are which would better fit in their mission.
After Lexmark’s vision statement they have different subsections for values, customer
commitment, employee satisfaction, corporate wealth, corporate citizenship, mutual respect,
integrity, long-term perspective, and excellence. There is a short paragraph describing each of
these, which is not needed. If Lexmark feels inclined to keep these values in their vision
statement, a simple list will do. This will remove most of the length, making it more attractive
and easier to understand. The reader will most likely disregard a page long vision statement. For
this reason, a short and concise statement is best.
As for adding a mission statement, this is important in order to show shareholders who
Lexmark is, what they do, and why they are here. The vision and mission are interrelated but
should be two statements of their own as each holds a different purpose.
9. 9
Mission statement:
“We, the employees, are Lexmark - a dynamic, global information technology
company. At Lexmark you will encounter a unique relationship as customers are our
purpose. We work to provide high quality products and personalized solutions to our
consumers.”
Overall, the vision, values, and mission (that was developed) describe Lexmark as a
company. These establish a sense of direction for the company. The statements are related as
they both focus on the customer as the foundation. The customer fits into the aspirations of the
business as well as drives the purpose behind how the company conducts its operations. Lexmark
really emphasizes the consumer in all aspects of the business; without customers there would be
no Lexmark. Also, customers are the source of innovation leading to new ideas, products, and
services.
Imperatives and Objectives:
Strategic Imperative:
1. How can Lexmark use its recent acquisitions to position itself in a way that
promotes competitive advantages relative to industry competition?
From 2010 to the first part of 2015 Lexmark has made 13 acquisitions. In these acquisitions
they have acquired companies with a variety of industry specialties ranging from but not limited
to Business Process Management, Cloud-enabled management software, automated business
process software, Healthcare connectivity, and Medical Imaging Exchange software. Each
specialty promotes a new aspect of the Software and Services Industry that Lexmark can engage
10. 10
in. As key rivals Xerox, Hewlett-Packard, and others actively engage in many of the same
acquisition activities, it is crucial that Lexmark leverage their diversified industry holdings in a
way that strengthens the company collectively.
Financial Imperative:
2. Will Lexmark be able to continue their current pace of acquisitions while still being
able to meet all current debt obligations?
Given the current industry “norm” of making acquisitions, Lexmark has been placed in a
slightly difficult spot due to their current market share size. Rivals such as Xerox and Hewlett-
Packard have much larger balance sheets in connection with their market share size. This gives
each company the potential of making acquisitions without being forced to rely on debt financing
to the same degree as Lexmark. Due to the smaller size of Lexmark, in order to engage in
acquisition activities at a competitive level, the company has had to use a variety of debt
financing activities such as Senior Note issuances and revolving lines of credit. With each new
acquisition the company increases its current debt load. At some point, given the company’s size,
they will no longer be able to continue acquisition activities at a rate consistent with their key
rivals.
Strategic Objective:
1. Lexmark will align current acquisitions in a way that allow synergies to be realized,
promoting a competitive advantage for the company as a whole.
The wide variety of acquisitions that the company has made throughout recent years give the
company both access and proficiencies in a variety of specialized areas of the Software and
11. 11
Services Industry. In many cases, the proficiencies that Lexmark acquired are related. For
example, at the end of 2014 the company acquired GNAX Healthcare which specializes in
medical imaging exchange software. This specialization was enhanced by the company’s 2015
acquisition of Claron Tech, Inc. which specializes in medical image viewing, distribution,
sharing, and collaboration software. Moving forward, it will be important that Lexmark combine
the capabilities of these two acquisitions in a way that creates a core competency in medical
imaging solutions. The company could then take this core competency, and with the support of
PACSGEAR, Inc., an acquisition in 2013, enhance the healthcare connectivity of its medical
imaging solutions software. The alignment of these three acquisitions would create a competitive
advantage for Lexmark as they work to position themselves appropriately relative to their key
rivals.
In additional to the synergies available in the company’s healthcare acquisitions, there are
numerous others that are active in the business process management field. These include Pallas
Athena (2011, specializing in BPM, DOM, and process mining and discovery software), ISYS
(2012, specializing in search solutions, and text mining), and Readsoft AB (2014, specializing in
automated business process software). Each of these companies are engaged in similar activities.
As outlined in the healthcare example above, it is vital that Lexmark align each of these
acquisitions in a way that allow them to combine specializations and create another core
competency for the company through the capitalization of strategic fits.
The two core competencies created above are necessary as the company manages the
wide range and variety of acquisitions they have made in recent years. Combining forces will
allow the company to better position its distinct segments within the Software and Services
Industry and capitalize on the associated competitive advantages the repositioning will create.
12. 12
Financial Objective:
2. The company will continue to make acquisitions that align with the current
company strategy and provide competitive advantages while giving special
consideration to the amount of debt used.
As the company works to position itself competitively relative to key rivals it is crucial that
they make acquisitions of companies with distinctive competencies in the Software and Services
Industry. The company has been successful in this strategy with more than 13 acquisitions since
2010. The problem that Lexmark currently faces is the methods with which they have financed
all of these acquisitions. Unlike some of their key rivals, Lexmark does not have a massive
balance sheet with large quantities of cash available for investment in acquisitions. Because of
this fact, the company has used varies forms of debt financing to complete their acquisition
activities.
Given the current strategy of the company is to reposition themselves within the Software
and Services Industry it is understandable that the amount of debt on the balance sheet has
increased. However, given the company does have to use debt financing in order to make their
acquisitions, the time has come that they look to evaluate how important a new acquisition is to
the company’s current strategy. For example, Lexmark has already made three acquisitions of
medical imaging software related companies. It is unlikely that, at this point in time, they will
need to make further acquisitions in the field of healthcare. That said, there may be other
companies that currently specialize in aspects of healthcare software that could further enhance
Lexmark’s healthcare position.
Therefore, as the company continues to execute on its repositioning strategy it needs to take
special consideration of further acquisitions. As it stands, the company has a debt load
13. 13
approaching two times its current equity position. For this reason, all further acquisitions need to
be both cost justified and help Lexmark realize its current repositioning strategy within the
Software and Services Industry.
Overall Financial Analysis:
Financially, Lexmark is in a tough position. In the past few years they have been making
numerous acquisitions as they shift into the Software and Services industry. In doing so they
have taken on a substantial amount of debt and therefore eclipsed their current optimal capital
structure. Additionally, top line revenues have not seen a steady increase as a result from these
high margin industry acquisitions. In the company’s most recent earnings call top management
forecasted negative total revenue growth for the year 2015. “We expect full year revenue to be
down 3% to 5% …” (Lexmark(b), p. 5). Much of this is caused by the negative impact on the
company’s decision to exit its inkjet manufacturing operations and headwind in foreign currency
exchange markets.
Asset Analysis:
At year end December 31, 2014, Lexmark recorded total assets of $3.633 billion. This is
up slightly from $3.616 billion and $3.525 billion in 2013 and 2012, respectively. Key
contributions to the year-to-year increase come from Goodwill3
and associated intangible assets.
The $76 million increase in 2013 was the result of four acquisitions4
while the $151.1 million
increase in 2014 was the result of two acquisitions5
. It is important to note that all Goodwill
acquired during 2013 and 2014 was assigned to the Perceptive Software segment of the
3
: The excess of the total value paid over the fair market value of the acquired assets.
4
: AccessVia, Inc., Twistage, Inc., Saperion AG, and PACSGEAR, Inc.
5
: Readsoft AB and GNAX Healthcare
14. 14
business. This designation indicates that the company is keen on keeping its computer hardware
services and software solutions services separate. Even so, the increase in Goodwill is expected
to continue in 2015 with the acquisitions of Claron Technology, Inc. and Kofax Ltd. These
increases are expected as Lexmark continues expansion efforts into the Software and Services
Industry.
A second positive influence on the company’s total assets comes from the steady increase
in Cash and Cash Equivalents; $309.3 million, $273.2 million, and $212.4 million in 2014, 2013,
and 2012, respectively. The increase in this quantity strengthens the company’s financial position
as they continue to engage in acquisition activities. With regards to Cash and Cash Equivalents
and Marketable Securities there is one area of concern. As of December 31, 2014, 93.75%6
was
held by foreign subsidiaries. If the company were to need these funds domestically they would
be subject to repatriation taxes amounting to approximately $306.425 million. The silver lining
of this concern is that two recent acquisitions, Readsoft AB and Saperion AG, where of
international origin, indicating the origin of a portion of total cash and cash equivalents as well
as the use of these international funds to acquire Kofax Ltd.
Despite the positive impacts on total assets, the company does report two line items with
a negative three year trend. These are Property, Plant, and Equipment and Inventories. The three
year decline in each relates directly to the company’s 2012 Restructuring Actions7
. These actions
were announced in January and August of 2012. With the inkjet exit the company derecognized
$3.0 million in Inventories and $27.8 million in Property, Plant, and Equipment, net. As the
restructuring actions wind down the company forecasts a 40% year-to-year decline in inkjet
6
: $933.9 million in Cash and Cash Equivalents and current Marketable Securities, $875.5 million held
internationally.
7
: 2012 Restructuring Actions include exiting the development and manufacturing of the Company’s
remaining inkjet hardware, with reductions primarily in the areas of inkjet-related manufacturing, research
and development, supply chain, marketing and sales as well as support function. These actions are expected
to be completed by the end of 2015.
15. 15
related revenue. This current downward trend in Property, Plant, and Equipment and Inventories
is expected to stabilize as the company continues its shift into software and services.
As seen by the varied fluctuations in the company’s various asset accounts it is hard to
determine the effectiveness with which these assets can generate sales revenue. In order to
properly analyze the company’s assets the following ratios were calculated; Fixed Asset
Turnover Ratio8
and Total Asset Turnover Ratio9
. Furthermore, each ratio will be compared to
two different industry averages, the Computer Hardware Industry10
and the Software and
Services Industry11
. These industry averages will be used in all ratio analysis hereafter.
The first ratio, Fixed Asset Turnover Ratio, suggests that the company is nowhere close
in respect to the two industry averages. Specifically the ratio is 4.720, 4.515, and 4.493 for
Lexmark compared to 10.314, 10.365, and 11.239 for the Computer Hardware Industry and
12.422, 13.372, and 13.199 for the Software and Services Industry in 2014, 2013, and 2012,
respectively. The fact that the company’s ratio is only a third of the ratio for each industry
8
: Fixed Asset Turnover Ratio - Measures the extent to which a firm is using existing property, plant, and equipment
to generate sales.
= Sales / Net Fixed Assets
9
: Total Asset Turnover Ratio - This ratio indicates how effectively a firm uses its total resources to generate sales.
= Sales / Total Assets
10
: Computer Hardware Industry – Xerox, Hewlett-Packard, and Canon
11
: Business Support Services Industry – IBM, Pegasystems, Inc., and Open Text
16. 16
suggests that the company struggles to utilize its fixed assets. This struggle is likely due in part
to the current industry shift the company is undergoing. The fixed assets needed to operate in
each industry differ enough that the company has not yet reached a point where they are utilizing
all fixed assets optimally for each industry’s operations.
In opposition to the challenges created by fixed assets, the company shows strength in its
Total Asset Turnover Ratio in comparison to the two industries. Specifically the ratio is 1.021,
1.014, and 1.077 for Lexmark compared to 0.801, 0.769, and 0.773 for the Computer Hardware
Industry and 0.803, 0.747, and 0.736 for the Software and Services Industry in 2014, 2013, and
2012, respectively. A higher ratio indicates that the company is able to convert each dollar’s
worth of assets into more sales. In relation to each industry, Lexmark does a better job of
utilizing its total assets to generate sales revenue.
Recommendations for Asset Analysis:
As the company continues to make acquisitions, the total quantity of assets are going to
increase as can be seen in the Goodwill analysis earlier. The current problem is that the company
17. 17
does not appear to be reinvesting funds internally. A good way of evaluating this is by
comparing the company’s Capital Expenditures to its Depreciation Expense. Over the past three
years, Lexmark has reported $136.3 million, $167.4 million, and $162.2 million in Cap Ex and
$184.5 million, $189.3 million, and $229.6 million in Depreciation Expense in 2014, 2013, and
2012 respectively. The fact that depreciation expense is larger than Cap Ex each year indicates
that the company is not investing internally. Some of this discrepancy can be explained by the
inkjet exit and sale of associated assets. Even so, it may be time for the company to reallocate
some funds away from acquisitions and into internal investment projects geared toward covering
each year’s depreciation expenses and protecting its current assets.
Liability Analysis:
Over the last three years both current liabilities and total liabilities have risen. Accrued
liabilities have provided a portion of this increase. From 2013 to 2014 there was a $6.1 million
increase due primarily to a $33.8 million increase in deferred revenue. This increase is caused by
the company’s conscious decision to increase its subscription based offerings. For example, in
4Q14 the company signed a five year managed print services agreement with Alberta Health
Service in Alberta, Canada worth approximately $100 million in services. The initiative to
increase software subscription revenue translates directly into increased deferred revenue.
Additionally, the company experienced an $11.8 million increase due to its cash flow hedging
activities12
. These increases were somewhat offset by a decrease of $28.1 million and $13.3
million in Compensation accruals13
and Marketing programs, respectively.
The company currently has two issuances of Senior Notes outstanding, 2020 Senior
12
: Cash flow hedges include foreign exchange options generally with twelve month expirations. As Lexmark has
acquired international companies and continues to expand operations internationally, the use of foreign exchange
options helps protect against the potentially negative impacts of changes in the exchange rate.
13
: Legal matter settlement amounting to $14.4 million in expenses.
18. 18
Notes and 2018 Senior Notes. Combined these notes amount to $699.7 million in debt liability
for the company. The 2020 Senior Notes raised $400.0 million. A portion was used to extinguish
the 2013 Senior Notes in the amount of $350.0 million. The remainder will be used to fund share
repurchases, fund dividends, finance acquisitions, finance capital expenditures, and investment in
subsidiaries. Additionally, at the start of 2014 the company amended its current multicurrency
revolving credit facility14
. These two activities combined give the company a sizable amount of
available funds to continue its current acquisition plans. The creation of varied debt instruments
is a positive sign to investors that the company is committed to its current expansion objectives.
In order to understand the impacts of the debt that the company has undertaken the
following ratios will be used and compared to the Computer Hardware Industry and Software
and Services Industry; Current Ratio15
, Debt Ratio16
, and Debt-to-Equity Ratio17
.
14
: Amended current $350 million 5-year senior, unsecured revolving credit facility. New agreement amounts to
$500 million maturing in 2019 with the ability to increase the limit to $650 million if certain conditions and
circumstances are met.
15
: Current Ratio - The amount of cash that each dollar of current assets must be converted into in order for the
company to satisfy the claims of short-term creditors exclusively from existing current assets.
= Current Assets / Current Liabilities
16
: Debt Ratio - Measures the proportion of a firm's total assets that is financed with creditor's funds.
= Total Debt / Total Assets
17
: Debt-to-Equity Ratio - Relates the amount of debt financing to the amount of equity financing.
= Total Debt / Total Equity
19. 19
First, in terms of the Current Ratio, Lexmark is performing adequately relative to both
industries. In the past two years it has produced a current ratio both above each industry average
and 1.0. This suggests that, if at a particular point in time the debt obligations of the company
came due, they would have the resources necessary to pay off their current liabilities.
The debt ratio provides an insight into the degree of debt leverage a company has taken
on and the potential risks the company faces from said debt. In any case it would be concerning
to see a debt ratio above 100%. Fortunately, Lexmark is not to that point. They reported a debt
ratio of 65.2%, 62.2% and 63.6% in 2014, 2013, and 2012 respectively. In comparison to the
industry averages this is several times higher18
. Currently this is not an area of concern though.
The debt that has been taken on by the company has been used to acquire certain companies that
not only result in a larger asset balance for Lexmark but also allows the company to entire new
markets.
.
18
: Computer Hardware Industry: 34.4% in 2014, 34.1% in 2013, and 33.5% in 2012
Software and Services Industry: 22.7% in 2014, 17.6% in 2013, and 17.4% in 2012
20. 20
This debt increase can be seen further in the company’s debt-to-equity ratio. Given
Lexmark has been aggressive in growing the company it is expected that their debt-to-equity
ratio will be relatively high. In comparison, Lexmark far exceeds the two industry averages.
Specifically the ratio is 187.6%, 164.3%, and 175.1% for Lexmark compared to 99.8%, 93.5%,
and 111.3% for the Computer Hardware Industry and 141.6%, 72.2%, and 75.6% for the
Software and Services Industry in 2014, 2013, and 2012, respectively. The year-to-year increase
for Lexmark and the Software and Services industry is indicative of the current shift to software
solutions by numerous companies.
Recommendations for Liability Analysis:
At first glance it does appear concerning that the company has such a large degree of debt
on its balance sheet. However, the level of debt makes sense with regard to the current expansion
activities of the company. In order to finance acquisitions Lexmark has chosen to taken on debt
through Senior Note issuances and Revolving credit agreements. In that regard, their large
portion of debt is justified. However, based on their current financial position their debt-to-equity
ratio (Financial Leverage) is above the optimal capital structure19
of 139.85% calculated using
19
: Optimal Capital Structure Calculation: Ka = [ E / (B + E) ] ( ke) + [ B / (B + E) ] ( ki )
Ke = 18.26% ki = 6.27% E = $1,263.2 million B = $699.7 million
21. 21
the weighted cost of capital method. It may prove beneficial for the company in the coming
months and couple of years to consolidate some of their debt and decrease their financial
leverage to a point that falls closer in line with their optimal capital structure as previously noted
in the financial objectives.
Equity Analysis:
Total Stockholder’s Equity has fluctuated over the last three years; $1,263.3 million,
$1,368.3 million, and $1,281.5 million, in 2014, 2013, and 2012, respectively. There are a couple
components of stockholder’s equity that do not fluctuate but rather show the same trend over the
last three years. Those components are Treasury Stock and Accumulated Other Comprehensive
Loss. Treasury stock has risen as a result of the share repurchase activities20
of the company. In
2013 the company repurchased 2.7 million shares worth approximately $82 million. In 2014, 1.9
million shares worth $80 million were repurchased. These are the latest repurchases in a series
dating back to 1996. Since that time the company has repurchased 112.2 million shares worth
$4.76 billion. Additionally, over time the company has retired treasury stock21
and reclassified it
as authorized but unissued shares of Class A Common Stock.
Accumulated other comprehensive loss has seen a negative trend in the last three years.
From 2013 to 2014 the amount of loss rose 160%. This large increase was due to a $71.2 million
adjustment in foreign currency traslation22
which was offset somewhat by the $15.9 million
20
: One of the company’s objectives is to return 50% of free cash flows to investors. The company has chosen to
use share repurchases as a leading component of their objective. This action not only benefits shareholders but
also the company because, as the number of shares outstanding decreases, the respective Earnings per Share and
Dividend per Share calculations improve due to a decrease in the calculations denominator.
21
: Retirement of 44.0 million, 16.0 million, and 16.0 million shares of treasury stock in 2005, 2006, and 2008,
respectively.
22
: Currency Translation – 11% decrease in Brazilian Real, 12% decrease in Mexican Peso, 12% decrease in
Euro, and 18% decrease in Swedish Krona.
22. 22
impact of the company’s cash flow hedging activities. As the company continues to expand
internationally, the potential for negative foreign currency translation adjustments increases.
Now, in order to compare Lexmark’s Stockholder’s Equity to that of the two industry
averages the following ratios were computed; Payout Ratio23
, Dividend Yield24
, Return to
Stockholder’s Equity25
, Market-to-Book Value26
, and Equity Multiplier27
. When looking at the
payout ratio it is easy to see that Lexmark is far above the two industry averages. This indicates
that they are paying a greater portion of dividends compared to earnings. In 2014 it is interesting
to note that the Payout ratio is above 1.0. This would suggest that the company paid more
dividends per share than earnings per share for the year. This was possible in part because of the
$400.0 million Senior Note Issuance in 2014. As noted earlier, a portion of those proceeds would
be used to pay dividends. Next, similar to the payout ratio, the company’s dividend yield exceeds
the averages of both industries. It has also remained relatively stable at just over 3% since 2012.
In many cases, it is important for the company to show strong dividend yields because Investors
focused on dividend income look to this ratio when making decisions. They may feel more
comfortable investing in a company that shows stable dividend returns.
In comparison to both industries, Lexmark has struggled with their Return to
Stockholder’s Equity. Specifically the ratio is 6.26%, 19.13%, and 8.40% for Lexmark compared
to 14.01%, 14.02%, and -10.7% for the Computer Hardware Industry and 51.92%, 43.3%, and
23
: Payout Ratio - Indicates the percentage of a firm's earnings that are paid out as dividends to its common
shareholders.
= Dividends per Share / Earnings per Share
24
: Dividend Yield - Measures how much cash flow investors are receiving for each dollar invested in the
company.
= Expected Dividend per Share / Stock Price
25
: Return on Stockholder’s Equity - Measures the rate of return that the firm earns on stockholders' equity.
= Net Profit Margin x Total Asset Turnover x Equity Multiplier
26
: Market-to-Book Ratio - Used to determine the value of a company by comparing its book value to market
value.
= Market Price per Share / Book Value per Share
27
: Equity Multiplier - Is a measure of a company's financial leverage. Key in analysis of Return on Stockholders'
Equity.
= Total Assets / Stockholder’s Equity
23. 23
36.67% for the Software and Services Industry in 2014, 2013, and 2012, respectively. The
degree of variance between Lexmark and the industry averages is due in large part to the
difference in Net Profit Margin for each. From 2012 to 2014 the company reported Net Profit
Margins far below the industry average. This has been caused by a decrease in net earnings
relative to sales due to an increase in operating expenses. The increased operating expenses are
likely caused by the current industry transition the company is going through. Therefore, the
lagging returns to stockholder’s equity are currently justifiable given the company’s activities.
24. 24
Since 2012, the company’s Market-to-Book ratio has moved in line with the Computer
Hardware Industry average. Each fluctuates slightly year-to-year but remains between 1.0 and
2.0. Alternatively, the Software and Services Industry reports a ratio of 6.64, 5.39, and 8.50 in
2012, 2013, and 2014, respectively. It is slightly concerning that Lexmark has not seen a steady
rise in there Market-to-Book ratio in light of all their recent acquisitions in the Software and
Services Industry. This would suggest that, given the current level of equity and shares
outstanding in the company, the market does not feel the acquisitions are providing increased
value at a rate that is comparable to companies already in the Software and Services Industry.
Finally, as mentioned earlier, the degree of financial leverage that the company is
engaged in is well above the level that provides the lowest weighted cost of capital. This would
suggest, as recommended, that Lexmark should look to decrease its debt load to some degree.
When comparing the Equity Multiplier to each industry average it is interesting to find that
Lexmark is currently the lower of the three since 2012. Specifically the ratio is 2.75, 2.64, and
2.86 for Lexmark compared to 3.01, 2.74, and 2.83 for the Computer Hardware Industry and
3.42, 3.16, and 4.76 for the Software and Services Industry in 2014, 2013, and 2012,
25. 25
respectively. This is a positive sign for Lexmark given they have completed 13 acquisitions from
2010 to 2015. It shows they have been able to use additional sources of funding such as free cash
flows and cash and cash equivalents rather than relying primarily on debt financing.
Recommendations for Equity Analysis:
Moving forward, Lexmark needs to work on two areas in order to improve their current
equity position. First, Net Profit Margins over the last three years have had a negative impact on
the return on stockholder’s equity. The company should look to reduce operating expenses by
aligning the value chain activities of its recent acquisitions to promote increased earnings.
Second, the degree of cash flow hedging is not adequate enough to offset the negative impacts
the company has been experiencing with foreign currency translation. As the company continues
to expand internationally there is a need to reduce the company’s exposure to exchange rate risk.
26. 26
Revenue Analysis:
While there is no trend in Total Revenue year-to-year it is important to note the current
trends in the company’s revenue segments. Product Revenue makes up 86.3%, 88.7%, and
90.8% of Total Revenue in 2014, 2013, and 2012, respectively. The proportion makeup alone
shows that the company’s revenue streams are moving away from products and into services.
This is supported by the fact that over the last three years, Product Revenue has been declining
from 2012 to 2014 while Services Revenue has increased over the same period. These trends
align closely with the shift into the Software and Services Industry as seen by the inkjet exit and
acquisition of software solutions based companies.
At this time, the small degree of volatility in Total Revenue is not overly concerning
given the company’s industry switch. However, the increase in Operating Expenses year-to-year
are having a negative impact on Net Earnings. As the company makes acquisitions it is
understandable that Operating Expenses are going to rise. The issue is that they are not rising
proportionately with Total Revenue and thereby causing a decrease in Net Earnings. In order to
properly examine these concerns the following ratios were calculated; Gross Profit Margin28
, Net
Profit Margin29
, and Return on Investment30
.
Gross profit margin for the last three years has remained relatively close to the Computer
Hardware Industry average, in both cases ranging from 35% to 40%. However, in the Software
and Services Industry the average is slightly greater than 60% each year. After four years of
28
: Gross Profit Margin - Measures the relative profitability of a firm's sales after the cost of sales has been
deducted.
= (Sales – Cost of Sales) / Sales
29
: Net Profit Margin - Measures how profitable a company's sales are after all expenses, including taxes and
interest, have been deducted.
= Earnings After Taxes (EAT) / Sales
30
: Return on Investment - Measures a firm's net income in relation to the total asset investment.
= Earnings After Taxes (EAT) / Total Assets
27. 27
acquisitions in the Software and Services Industry it is odd that Lexmark has not been able to
increase its gross profit margin to a level somewhat in between the averages of each industry.
This would suggest that the company is not currently experiencing the revenue gains from the
Software and Services Industry in enough magnitude to offset hardware and supplies revenue.
Net profit margin shows nearly the same result. Each year Lexmark is lagging behind
both industry averages. Specifically the net profit margin is 2.13%, 7.24%, and 2.83% for
Lexmark compared to 7.33%, 7.83%, and 2.79% for the Computer Hardware Industry and
28. 28
11.94%, 21.89%, and 10.54% for the Business Support Services Industry in 2014, 2013, and
2012, respectively. The major increase for Lexmark in 2013 was caused by the positive impact
on net earnings of the $100.0 million inkjet sale. From this margin calculation it is clear why
Lexmark is making the shift into the Software and Services Industry. The net profit margin on
sales is drastically higher. Given that, it is concerning that the company has not yet seen a
positive impact on profit margins as a result of their numerous acquisitions.
Return on investment for Lexmark again tells a similar story. In comparison to each
industry average, the company is behind. In 2013 the company’s ROI was 7.24%; relatively
competitive with each industry average. When the proceeds from the inkjet sale are removed the
actual ROI falls to 5.2%. This adjusted ROI falls back in line with Lexmark’s relative
performance in 2012 and 2014. Given the current activities of the company, there are not any
major expectations of a large ROI. The continuous acquisitions are causing total assets to
increase. At this point, there has not been a relative increase in net income to match the increase
in total assets.
29. 29
Recommendations for Revenue Analysis:
It is clear that Lexmark is currently struggling to generate revenues as can be seen in their
Gross Profit Margin and Net Profit Margin. A concerted effort needs to be made to reduce the
current costs of revenue and operating expenses associated with net income. To do this, the
company will need to take special consideration of realizing potential synergies with each
acquisition. These synergies will help the company begin to operate in a manner that will
generate revenues in line with companies currently competing in the Software and Services
Industry. Additionally, the company needs to find ways to increase its ROI primarily through
increased income associated with the assets it currently has on its balance sheet rather than
continuing to add to those assets.
Stock Price Analysis:
Over the last five years the company’s stock price has seen a 21.7% increase.
Alternatively, from August 2012 to present the stock has climbed 149.86%. The reason for this
dramatic difference is that when Lexmark announced the exit from the development and
manufacturing of inkjet technology in August, 2012 the stock plummeted to $17.33 per share, its
lowest level since the Great Recession. Now, since that time the company has completed four
acquisitions in 2012, four in 2013, two in 2014, and two in early 2015. The climb in the stock
price reflects investor’s approval of these acquisitions. This approval was again shown March
25th
, 2015 when Lexmark announced the acquisition of Kofax Ltd. for $1 billion. When the
market opened that morning, the stock price jumped 10%.
30. 30
Although the stock price growth is positive, investment firms such as Zacks currently
rank Lexmark as a Sell citing expected negative EPS growth and Revenue growth. (Quote
Overview, 2015) Analysts at Reuters have a similar outlook. Based on their analyst
recommendation, a majority rate Lexmark as Underperform while a smaller set give the rating of
Hold. (Reuters, 2015) Underperform is supported by the negative expected revenue growth for
2015 while the Hold rating is supported by the steady stream of acquisitions the company
making.
Conclusion:
From the financial analysis above there is one overarching area of concern that the
company needs to evaluate. It would appear that the company has become over-engaged in their
acquisition activities. This can be seen by the debt ratio which exceeds their optimal capital
structure for minimizing the weighted cost of capital. Even though the company has availability
to a large amount of debt financing it is time some of their investment activities shifted
internally. Given the company is showing depreciation expense that exceeds their capital
31. 31
expenditure, it is clear that they are not meeting the current internal needs. Therefore, it is time
for the company to slow down its current acquisition trajectory and focus on improving operating
efficiencies between all subsidiaries.
Additionally, the company’s gross and net profit margins are substantially below both
industry averages. It is expected that, as the company expands into the Software and Services
Industry, the profit margins will climb. The challenge is, Lexmark has been acquiring companies
in this landscape for the past four years and these margins have not risen to their expected level.
This suggests that the company is not currently realizing the full potential of strategic fit between
all subsidiaries likely caused by the blinding focus of simply making acquisitions. Therefore, in
the coming months and couple of years it will be vital that Lexmark wind down the speed of
their acquisitions and begin focusing on properly aligning each subsidiaries within the
organization and promoting increased operating efficiencies.
Remote Environment Analysis:
Economic
There are many factors that fall under the economic environment that a company should
carefully evaluate. They change for every industry and company but there are several main
factors that the majority of companies need to analyze. These include the propensity of people to
spend on a specific product, inflation rates, trends in growth of gross national product and gross
domestic product, unemployment rates, the general availability of credit, and the level of
disposable income for the target market. For example, GDP is the market value of the goods and
services that an economy produces during a certain period. In general, when the economy is
growing there will be greater demand for a business’ products and services thus causing GDP to
32. 32
rise. Of course, there are exceptions to this such as the demand for inferior goods during times of
economic struggle.
One thing that the Fed has done in an attempt to manufacture economic growth is
implementing monetary policies like Quantitative Easing I, II, and III. The Fed began pumping
money into the economy to pull the country out of the recession. These strategies increased the
money supply and decreased interest rates which would, in theory, increase inflation and reduce
the value of the dollar. GDP began to increase and companies started to see growth.
Unemployment rates began to decline and the overall economic environment began to change.
This is when Lexmark began acquiring companies to aid in their major industry transition.
Capitol was easy to find and lines of credit were issued at much lower rates. These economic
conditions encouraged Lexmark to spend money and they did just that, acquiring 13 companies
in four years.
In analyzing the current economic state, market expectations are forecasting a decline in
GDP in coming quarters. This is largely because the health and value of the Euro is declining and
therefore it makes the dollar more valuable. A more valuable dollar hurts net exports and in turn
has a negative effect on GDP. Specifically, net exports are affected negatively because as the
value of the dollar increases domestically produced goods become more expensive in
international markets. Consequently, goods and services produced in the U.S. become more
expensive for other countries to purchase.
The Euro decreasing in value is counteracting the Feds strategies of pumping money into
the economy and decreasing interest rates. With more dollars circulating, one would think that
the value of each dollar would decrease but because “value” is relative, the dollar is actually
increasing in value despite the increase in supply. This chain of events has a strong impact on
33. 33
companies like Lexmark because the decrease in net exports naturally drives international sales
down.
An example of how remote environment analysis affects the way a company is operated
and the direction the company decides to go in is Lexmark’s recent acquisition. The industry that
Lexmark is in is going through a major transition period. Much of the industry, including
Lexmark, is moving from hardware and printing services to software and IT, which is shifting
their industry into software and services. Lexmark, along with other companies, are making this
transition mostly because of the declining growth in hardware services.
Their recent acquisition of Kofax Ltd. for $1 billion solidified and accelerated this
transition in the enterprise software business. Lexmark has made this transition because they
have analyzed the economic environment and recognize that the future of the industry is going in
that direction. Lexmark will double its software business serving corporations and other large
enterprises through the acquisition of Kofax Ltd. According to the stock prices, analysts and
investors seem to like this decision as Kofax Ltd. shares gained $3.43, more than 45%, to $10.93.
Lexmark rose $2.31, or close to 5.7%, to $43.10. IDC Market also named Lexmark as a leader in
smart multifunction products and managed print services three consecutive times. The moves
that top line management at Lexmark is making seem to be moving the already transitioning
company in the right direction. This acquisition is not only a major move into the software
industry but after further research it also brings another benefit to the table that will be touched
on later.
The health of the economy is a factor in almost every industry but how much it affects a
certain industry varies greatly based on the goods and services that are being sold. Software and
Services is right in the middle of the pack in terms of how drastic this affect is. For example, in
34. 34
February 2000, the U.S. economy was booming and Lexmark’s stock reached an all-time high of
$121.63. In contrast to this, in July 2009, the economy was dealing with the recession and
Lexmark stocks sold at an all-time low of $14.43. This is a massive drop, but it is important to
remember that almost every company’s stock took huge hits and stock prices fell drastically
during that time.
Paper production as a global commodity is decreasing and that is a major part of
Lexmark’s transition from paper to software-based services. The world of paper printing is
slowly declining. According to Lexmark, “Based on industry information, Lexmark management
believes that the overall distributed printing market declined slightly in 2014. The distributed
printing industry is expected to experience flat to low single digit declining revenue overall over
the next few years” (Lexmark(a), p. 6) Paper production has been declining and will continue to
decline for the foreseeable future. There are a lot of reasons for this change, a lot of which is
technology based and will be touched on in the next section. Additionally, the world is trying to
become more energy efficient and the “Green Movement” is in full swing31
.
The economy as a whole has a massive effect on any company and Lexmark is no
exception. The monetary and fiscal policies implemented to pull the country out of the recession
greatly altered Lexmark’s strategies. They saw an economy start to grow as the money supply
was being increased and saw capital that was easier to obtain at lower interest rates. Lexmark
began purchasing other companies to assist and accelerate their long-term plan in transitioning to
software and services. Analysts are now forecasting a few slow quarters and with Lexmark’s
high amount of debt and multitude of acquisitions it will be interesting to see how this affects
their strategy. A substantial decrease in spending is encouraged in preparation for the forecasted
31
: See Social Environmental Forces (Appendix, p. 63)
35. 35
economic struggles. With the near-future of the economy looking sub-par, Lexmark cannot
continue acquiring companies at this rate because they already have too much debt to manage.
Technological
Lexmark sold their inkjet technology in 2012 and by the end of 2015 will be completely
out of the inkjet division. Top management has analyzed the technological factors in their
environment analysis and saw that the future of their business was not in inkjet printers, amongst
other things. Lexmark has now fully committed to transitioning from hardware to software. Top
management at Lexmark saw this change coming years ago and started making large changes to
the company’s structure and direction in order to cope with the ever changing world of
technology. The major transition has been in full swing for years, as Lexmark has acquired
many software companies that have skills in the realm of software and services.
The sale of the inkjet technology did not mark the end of Lexmark’s print and imaging
division, but it is declining. Over the last three years, Product Revenue has been declining while
Services Revenue has increased over the same period, as noted in the financial analysis. These
trends align closely with the shift into the Software and Services Industry as seen by the inkjet
exit and acquisition of software solutions based companies. Lexmark knows that paper
production and the need for these printing and imaging solutions is still relevant but the demand
is decreasing. This was the beginning of a long transition period from print and imaging to
software and services and the recent addition of Kofax Ltd. is another step in that direction. With
this being said, Lexmark will continue to manufacture parts and supplies for inkjet and provide
customer service in this area.
36. 36
Another part of the technological environment is the advances in cloud based storage
systems. This somewhat new technology is very popular in storing and organizing information
and what can be seen as an overlap in Lexmark’s products and services which is creating some
cannibalization of current sales. Because Lexmark is making the industry change, they are seeing
their software support services and specifically, things like cloud storage, cannibalize their print
and imaging sales. This is largely because consumers are storing documents, pictures, etc. in the
cloud as opposed to printing them. Although this is not ideal, Lexmark understands that they are
trying to transition from a product based market in paper and printing to a service based market
in software and services so this cannibalization is somewhat expected. Lexmark is also okay with
this overlap because it is temporary and they are moving from a declining industry to a new,
growing industry.
Legal
One thing that Lexmark is aware of and has to account for is the possibility of certain
countries (mostly in Europe) imposing fees on devices that enable the potential reproduction of
copyrighted content. Lexmark says that they have taken the necessary steps to address the risks
related to this issue. Depending on the outcome of European legislation, this could have a large
financial impact on Lexmark. This is something that is out of Lexmark’s control but it appears
that top management is doing what they need to in order to be prepared for the worst-case
scenario. If the legal system were to agree with the publishers and enforce this change, there
would be a fee for every page printed. This would add a substantial expense for Lexmark and
would undoubtedly decrease their profit margins.
37. 37
The Kofax Ltd. acquisition touched on earlier also has some legal benefits for Lexmark.
Kofax Ltd. is based in Irvine, California but originated in Bermuda. This allows Lexmark to
deploy overseas cash without the large tax bill creating a substantial competitive advantage over
many tech companies that don’t have this luxury. This will increase margins for international
affairs and substantially decrease money spent on taxes.
Industry Analysis:
Define Industry
Lexmark’s recent acquisition of Kofax Ltd. solidifies that they are focusing their efforts
on the Software and Services Industry. This industry includes a vast array of companies,
offering a variety of products and services. These include personal computer operating systems,
office productivity suites, network security applications, processing services, information
technology consulting and outsourcing services, among others. In particular, this industry can be
broken down into two main components: software and services offered via perpetual license
agreements and another which combines software and services offered as custom-made solutions
to a vertical market’s reoccurring needs (Clark, p. 1). An important aspect of this industry to
note is how global it is with several of the key players being multinational. This industry has
been consolidating over the last few years due to how concentrated the software industry is with
a few dominate players holding a relatively high global market share. These large players have
been acquiring smaller, niche players to broaden their portfolios (Shields, p. 13). Many of these
companies offer niche products and services, therefore do not often compete with each other
directly. The industry also has a cost structure that is focused in marketing and R&D (Shields, p.
15).
38. 38
Key Characteristics
Market Size and Growth
As stated earlier, the Software and Services Industry is a global industry, therefore the
global market analyzed will include North America, South America, Western Europe, Eastern
Europe, Middle East and Africa (MEA), and Asia-Pacific. This industry experienced moderate
to strong growth from 2010-2014 with a compounded annual growth rate of 6.2%. In particular,
the global software and services industry grew by 3.2% in 2014 reaching a value of $2,946.3
billion. Broken down further, IT services segment accounted for $1,318.1 billion, the Internet
Software and Services segment accounted for $1,309.5 billion, and the Software segment
accounted for $318.7 billion of the $2,946.3 billion in 2014. This growth is expected to
decelerate over the next several years, with an anticipated compounded annual growth rate of
4.9% from the years 2014-2019, driving the industry value to $3,748 billion by 2019 (“Global
Software & Services”, p. 7).
Geographic Scope
North America has been a very strong portion of the global software and services
industry with several key, multinational players (i.e. IBM, Hewlett-Packard, Microsoft, etc.). In
particular, the Americas (North and South) account for 34.8% of the global software and services
value. Asia-Pacific accounts for 31.4% of the global industry, trailed by Europe with 24.3%, and
finally MEA with 9.6% (“Global Software & Services”, p. 10).
39. 39
Market Share by Key Players
To further break down this industry, key players need to be analyzed. IBM is currently
the leader in this industry generating a 2.9% share of the industry’s value, followed closely by
Microsoft (2.4%), Google Inc. (1.9%), Hewlett-Packard Company (1.9%), and other (90.8%).
This may seem alarming considering the majority of the industry’s value comes from “other,”
but the Software and Services Industry is full of small to medium-sized firms. In analyzing
Lexmark International Inc. in comparison to key players, it can be seen that they account for
approximately 0.13% of the global industry’s value32
(“Global Software & Services”, p. 11).
Technological Changes
Due to the rapid increases in data processing speeds, software applications and interfaces
can be developed and deployed, increasing the efficiency and productivity of nearly every
organization. Today, even small businesses depend on an assortment of software and services.
This being said, the demand for software and services is seen to be strong (Clark, p. 1).
Additionally, the “cloud” and “Internet of Things” projects are impacting the industry. The key
players are either buying or building technology to support their client’s cloud and “Internet of
Things” projects33
(Shields, p. 17).
Cost Structure
The primary expenditures of firms in the Software and Services Industry are accumulated
through marketing and R&D. In fact, the marketing expenditure often surpasses the R&D
expenditure with companies spending, on average, 15-25% of their revenues in sales and
32
: Based off Lexmark’s 2014 Statement of Earnings
33
: Appendix, p. 64
40. 40
marketing activities. There is also support costs that include the costs associated with customer
support and help desks (Shields, p. 16).
Five Forces Framework
This section analyzes the five competitive pressures outlined by Michael Porter’s Five
Forces Framework. Attempting to understand the five competitive pressures (buyer power,
supplier power, new entrants, threat of substitutes, and degree of rivalry) and intensity of
competition within the Software and Services Industry will give an indication of profitability and
attractiveness of the industry both now and in the future (Thompson et al., p. 49).
Buyer Power
There are two major factors that play into whether buyers can exert competitive pressures
on industry members: (1) degree to which they have bargaining power and (2) level of price-
sensitivity. Buyers that have strong bargaining power can limit industry profitability by
demanding certain prices or additional services. When a buyer has price sensitivity it creates a
price ceiling for the industry because raising prices could cause additional revenue loss
(Thompson et al., p. 61).
The buyers within this industry differ in size, from smaller, individual customers to
multinational companies and government agencies. The smaller end of the market is more
fragmented, with the smaller, niche firms serving the needs of small businesses while also
targeting specific industries. The larger buyers help strengthen the buyer power because the loss
of business from one of these customers could have a detrimental impact on revenues, especially
for these smaller players that make up 90.8% of the industry’s value.
41. 41
Next, contracts made between firms and buyers lead to potential switching costs for
buyers. Some IT service contracts can last up to several years although consulting contracts tend
to be shorter. In the data processing and outsourcing market segment long-term contracts are
common, meaning potential switching costs for buyers.
For larger customers, there tends to be a bidding war between the key players securing
greater buyer power. If there are several key players offering similar products and services, the
buyer has the power to start negotiating reduced prices, additional services and features, and
overall better payment terms. This can negatively impact industry revenues.
Finally, name recognition tends to be significant for customers, especially when it comes
to electronic data processing and outsourcing. Buyers need to ensure that the company can
provide a reliable service, which often leads them in the direction of the key players within the
industry. This therefore reduces their buying power considerably. Overall, there is a moderate
degree of buyer power within the Software and Services Industry (“Global Software & Services,
p. 14).
Supplier Power
When suppliers have abundant bargaining power they can negatively impact industry
profitability by charging industry members higher prices. The strength of their bargaining power
is derived from several factors: (1) whether the demand for the product is high and they have a
limited supply, (2) whether they provide an input that enhances the overall performance of the
industry’s product, (3) whether switching costs are high for industry members, (4) whether the
item supplied is a bulky fraction of the cost of the industry’s product, (5) whether industry
members are major customers of suppliers (Thompson et al., p. 58).
42. 42
A major input for the Software and Services Industry is staff with technical knowledge
and expertise. Industry players rely on these qualified employees and high rates of turnover can
impact the business and be costly. For example, the average salary for Software Engineers in the
U.S. is $75,000-$90,000 a year. This shows the importance of bargaining power because
suppliers are able to command higher salaries. Also, this would equate to a very high switching
cost for a company, with the employees viewed as suppliers of expertise.
Other inputs would include hardware components and are often purchased form sole
suppliers. These suppliers are often large companies offering differentiated products, resulting in
substantial supplier power. Even so, there are some companies, like IBM, that show some
backward integration in the value chain with their own hardware and software, which does
reduce their reliance on outside suppliers.
Overall, given one of the largest inputs for the Software and Services Industry is human
capital and hardware components are frequently purchased by large suppliers, the supplier power
in the industry is strong (“Global Software & Services”, p. 15).
New Entrants
New entrants to a market can bring several things with them, including production
capacity, the desire to secure their place in the market, and resources. The seriousness of the
competitive threat of their entry depends on two classifications: (1) expected reaction of
incumbent firms to new entry and (2) barriers to entry. Those players who have already been
established may launch defensive maneuvers to maintain their place in the market and make it
difficult for a new entrant to become profitable. Some of these maneuvers include price cuts,
43. 43
increased advertising, and new product features. A barrier to entry exists when it is difficult for
a new player to break into the market (Thompson et al., p. 54).
In this particular industry, entry on a smaller scale is attainable. In recent years, small
players have experienced growth due to government and commercialized institutions turning to
third parties for IT support. Also, buyers are currently seeking to cut costs, and data processing
and other business processes have increasingly been outsourced to specialists so they can focus
on core activities.
The market also has a dominate theme of mergers and acquisitions among public IT
software companies. An example would be the acquisition of Business Objects, an enterprise
software company specializing in business intelligence, by SAP or the acquisition of Taleo, a
database vendor that is known for “talent intelligence”, by Oracle. These smaller, niche players
are attractive to the key players in the industry looking to better their competencies.
Large companies in this particular market have significant economies of scale in
processing and can overall offer more services. Despite this, small companies can compete by
specializing in industries and offering customized services. Unfortunately, established
companies may be unwilling to trust these smaller, niche players. This offers the large market
players a leg up.
Because there are so many players in this market, entry into this industry will have a
more successful outcome by the expansion and diversification of existing products. In fact, this
trend has pushed software product companies to look to diversify from competition, turning
towards a more service-oriented product and solutions market.
Barriers to entry in this market include name recognition of large players who are more
likely to attract and retain a strong customer base. If a company wants to enter this industry, they
44. 44
must have considerable expertise. However, there are new business models that do not require
massive capital investment such as web based to free software models. It is relatively difficult for
these smaller players to compete with the Microsoft and Google’s of the industry, but they can
become a niche player and a go-to provider for their specific area.
Also, because the key players have a strong customer base already, it makes switching
costs high which creates challenges for start-ups. This coupled with a market that is constantly
changing and subject to technical advancements makes it difficult for newcomers. In order for a
company to be successful, they need to be able to anticipate such changes and regulations. For
example, data processing services for financial institutions are often tightly regulated which may
be unattractive for a new player. All of these pieces contribute to strong barriers to entry.
Overall, the Software and Services Industry has low capital investment with popularity in
niche markets. This is balanced by key players having significant economies of scale and name
recognition which keeps some new entrants at bay. A crowding out effect may take place in the
near future due to too many new entrants, but for now the likelihood of a new entrant into this
industry is moderate (“Global Software & Services”, p. 16).
Threat of Substitutes
Companies in any one industry face competitive pressure from companies in a closely-
related industry whenever a buyer views the products of the two different companies as
substitutes for one another. Whether the competitive pressure from the substitute products are
weak or strong depends on three basic factors: (1) whether substitutes are available and
agreeably priced, (2) whether a buyer views the substitute as comparable or better, and (3)
whether the costs a buyer incurs in switching is low or high (Thompson et al., p. 57-58).
45. 45
The leading alternative to many of the services offered in this industry group is to use in-
house staff to provide such services or work on tailored software. In previous economic
downfalls, many companies started to rely on their existing employees rather than third-party
service providers.
Even with a minor threat of substitutes, services offered by industry players provide
several key advantages to buyers. For example, important employees may be relieved from
performing these non-core processes, which in turn allows the company to concentrate on its
core activities. Also, business’ can become more flexible by not investing in the assets necessary
to perform software and related service activities and this can reduce response time to
environmental changes. Essentially, this allows those with the best knowledge to perform
specific activities. The downside to this comes in the loss of internal business process know-
how. Overall, given the occasional economic downturns while simultaneously balancing the
benefits of allowing a company to focus on core competencies, there is a low to medium threat of
substitutes in this industry (“Global Software & Services”, p. 18).
Degree of Rivalry
The degree of rivalry among competing sellers within an industry depends on several
factors such as when buyer demand is growing slowly, when it becomes less costly for buyers to
switch companies, when products become less differentiated, when there is excess supply, when
the number of competitors increase and they become more equal in size, and when exit barriers
are high and keep businesses from leaving (Thompson et al., p. 49-52).
The Software and Services Industry is split, even though there are large, multinational
players (IBM, Microsoft, Hewlett-Packard, Google, etc.) who hold approximately 9.8% of the
46. 46
market share. The key players are experiencing increasing pressure from diversification by other
smaller companies in the industry. This trend has caused large players to attempt diversifying
typically through acquiring smaller, niche companies to attract specific industries. By
diversifying and offering several products and services (i.e. printing products and services,
personal computers, IT infrastructure, software, services, etc.), companies can help ease the
pressures on themselves.
However, many of these large players offer very similar services and offerings, despite
diversification. This causes increasing pressure to battle with pricing and offerings. On a
positive note, the rivalry within this industry is alleviated by positive growth in this area in recent
years. Overall, this industry has a moderate to strong degree of rivalry, especially amongst the
key players (“Global Software & Services”, p. 19).
Strategic Group Map Analysis
The first strategic group map looks at the differentiation of solution offerings in
comparison to market share within the global software and services industry. In analyzing each
individual company’s revenue for the year 2014 in comparison to the $2,946.3 billion estimated
value for the industry in 2014, the results show that Hewlett-Packard (4% market share) and IBM
(3.2% market share) lead in market share and solution offering differentiation. Next, notice how
Xerox (0.7% market share) and EMC Corporation (0.83% market share) share relative market
share size and solution offering differentiation. Finally, Lexmark (0.13% market share) and
OpenText (0.06% market share) come in on the smallest end of the market share and product
differentiation scale. In analyzing this strategic group map, there seems to be a correlation with
the number of solution offerings and market share, although it is not perfect. The larger the
47. 47
solution offerings, the larger the market share is, generally speaking. It is important to note that
approximately 90% of industry value is made up of small to medium-sized firms which are why
the market share percentages seem so small.
The second strategic map focuses on the comparison of Operating Profit Margin (OPM)
and the number of industries served by each company. The OPM is the operating income over
the net sales, and it tells analysts approximately how much a company makes on each dollar of
sales. As expected, IBM leads with the highest OPM which is likely a result of scale economies.
Their pricing can be more competitive because they can afford to lower their pricing while being
able to cover expenses. Also, note that they have the highest industry representation.
Surprisingly, OpenText has an equivalent OPM (18%) to IBM even though it has a much smaller
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market share. This suggests that OpenText has significant pricing power. EMC Corporation
follows right behind with an OPM of 17% even though they have the smallest industry
representation. Perhaps their strategy to focus on fewer industries has given them a leg up, even
when placed next to Hewlett-Packard which has a much larger market share and greater industry
representation. Finally, Xerox, HP, and Lexmark all fall within similar industry representation
and OPM (6%, 6%, and 4% respectively). On the strategic group map, all three companies
overlap therefore their approximate location is marked by a red dot. Note that Lexmark has the
lowest OPM, but this is most likely due to their increased interest on the debt they have accrued
through their numerous acquisitions.
Attractive Industry
In analyzing the five forces, the Software and Services Industry seems to be an attractive
industry, especially for the key and niche players. Yes, there is a moderate level of competition,
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especially among the top players, but this industry is primarily marked with small to medium-
sized players. Being a niche player that specializes in a particular industry creates competitive
power and even makes a company “acquisition-worthy” to a large player. Next, there seems to
be low to moderate threats of substitution. The companies that specialize in software and
services allow other companies to focus on their core competencies instead of pulling their
attention and people away from the task at hand which tends to save time and money in the long
run. Even when there is an economic issue, companies tend to rely on these specialized IT and
software operations. Finally, there seems to be a low to moderate threat of new entrants due to
the large players holding a large amount of market share. Even so, the niche players continue to
succeed in their efforts. Overall, the Software and Services Industry is growing and is expected
to grow 27.2% by the year 2019 which is encouraging for currently positioned software
companies and start-ups (“Global Software & Services”, p. 12).
Internal Analysis:
Lexmark has two types of product lines that they provide to the market. The first market
they serve is Imaging Solutions and Service (ISS). The other product is content and process
management. They provide products as well as services.
Imaging Solutions and Service
The Imaging Solutions and Service segment of Lexmark works to continually provide
high-quality, technologically-advanced products and solutions at a competitive price. They
continue to work with large corporations, small to medium businesses and the public. This
segment of Lexmark works to differentiate itself from competitors to maintain a competitive
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advantage. With the ISS sector they do this by continually looking for issues within the industry.
By addressing these issues, they are able to help customers more efficiently than competitors.
Products
Lexmark offers a variety of monochrome and color laser printers, supplies, software
applications, and solutions to help businesses with their efficiency. “ISS laser products are core
building blocks for enabling information on demand” (Lexmark(a), p. 8). These are key products
for businesses because they can effectively capture documents as well as deliver quality printed
products. The businesses who utilize these products in combination with Lexmark’s other
services have to potential to dramatically improve their business productivity.
Their printers and products can print many sizes and varieties. Their printing products are
the monochrome laser, color laser, dot matrix products, as well as supplies and service parts for
their printers. The printers can print up to 70 pages per minute which is ideal for many larger
businesses. Lexmark no longer produces inkjet MFPs or AIOs but they still provide services and
supplies for consumers continuing to use this technology. “Lexmark management believes that
ISS is an industry leader with regard to the recovery, remanufacture, reuse, and recycling of used
laser supplies cartridges and service parts…” (Lexmark(a), p. 8).
When a business purchases an ISS product from Lexmark, they also receive the expertise
of the company’s employees. Lexmark has substantial customer service. Before a company
purchases products and/or services Lexmark will go through and assess their situation then make
recommendations on the products the particular company should purchase. Later on, customers
are able to see how these purchases have created a more efficient work environment. The
company works to cater to the specific needs of each business customer.
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Marketing and Distribution
Lexmark relies on marketing teams to create demand among businesses for their
products. As stated above, they are reaching out to large corporations, small and medium
businesses, as well as the public. The industries primarily focused on are financial services,
retail, manufacturing, education, government, and health care. ISS is able to reach an extensive
amount of industries because they are focused on customizing their services to meet the
consumer’s needs. With ISS, the business will be able to do a variety of things such as printing
electronic forms, handling media, intelligent capture duplex printing, and other document
workflow solutions. ISS delivers the products once purchased through a distributor and reseller
network. This network includes IT resellers, direct marketing resellers, and copier dealers.
The supplies for the inkjet products are available to the customer at multiple distribution
centers. For Lexmark (in 2014) most of their inkjet supplies were sold through authorized
company suppliers. Customers were not seeking out as many discount store chains, other
distributors, or online dealers. ISS has many alliances in which they also sell their products.
Competition
ISS is continually looking to expand and develop new products to keep up with
competition so they can be competitively priced. Competition in the market is very strong and
Lexmark, at times, struggles to keep up. The company is not able to compete with some of the
larger companies such as the market share leader of laser printing, Hewlett-Packard. The larger
companies have an advantage as they have greater financial, marketing, and technological
resources. Due to the resources larger companies have, they are able to offer lower prices.
Lexmark has a hard time keeping up with the pricing pressure. Other competitors they are
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watching out for include; Canon, Ricoh and Xerox, Brother, Konica Minolta, Kyocera, Okidata,
and Samsung.
Manufacturing and Materials
The ISS section of Lexmark operates manufacturing centers in Lexington, Kentucky,
Shenzhen, China, and Geneva, Switzerland. They also have company owned manufacturing sites
in Boulder, Colorado and Juarez, Mexico. Along with these locations they also have
customization centers in all major locations in which they are currently operating. When it comes
to manufacturing, ISS maintains direct control over many of its more complex processes that are
essential to the business model such as the manufacturing of toner and photoconductors.
Although they keep a lot of manufacturing processes in-house, some are outsourced to certain
partners with technical expertise. These partners have facilities located in China. They provide
ISS with almost all of its printer production capacity. ISS evaluates strategies and their success
so they can continually make adjustments as needed.
For the laser printer, specifically supplies and operations, take place in Boulder,
Colorado, Juarez, Mexico, Zary, Poland, and Shenzhen, China. Geneva, Switzerland is the
control center for these printer supplies. The cartridges are produced by a combination of in-
house and third-party manufacturers. Inkjet supplies are produced in Lapu-Lapu City,
Philippines and Juarez, Mexico. They are also manufactured by a combination of in-house and
third-party. The overall manufacturing control center for inkjet supplies is also in Geneva,
Switzerland.
There are many components throughout the manufacturing process. Some of the
components used throughout the process are semiconductors, electro-mechanical components
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and assemblies, and raw materials. Most of these are available from multiple suppliers, in which
ISS works to create unique supplier relationships. They develop a relationship with a preferred
supplier which, in many cases is the only way to ensure consistency and quality of products.
Some of their printer engines and finished products are sourced from OEMs. They work to
provide continuous supply so there is not a shortage of supplies when they are needed. When
more demand occurs than was projected, ISS can have some shortages in supply. They try to
compensate for this by air shipping, as needed, to make products available faster. In return this
can negatively affect their operations expenses. In a slower market ISS can decrease their
inventory as demand will be lower. To improve these processes ISS works to execute supplier
managed inventory agreements. This helps their supply chain move much more smoothly and
enhance the customer’s overall experience as well. This helps assure products are ready at the
time of purchase for the customer. There were a large amount of printers purchased under SMI
agreements in 2014.
Perceptive Software
Perceptive Software is the software and services side of Lexmark. This allows businesses
to manage their everyday processes and information more efficiently. In 2014 Perceptive
Software acquired two companies, giving them the ability to reach out and help more businesses
and industries. The two companies are ReadSoft and GNAX Health. This allows them to help
with more accounts payable services as well as healthcare. Overall, Perceptive Software offers
solutions to specific industries. There has been a noticeable increase in the amount of healthcare
solutions offered.
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Solutions
The specific industries that they offer solutions in are; healthcare, government, retail,
manufacturing, higher education, and financial services. They also work to provide services for
accounting, human resources, and contracts of these specific industries. Perceptive Capture and
Perceptive Search allow businesses to improve the functionality of accounts payable, accounts
receivable, order management/benefits processing, as well as transcript processing for higher
education. This allows them to extract data and integrate the information with existing business
processes and systems.
Marketing and Distribution
Like the ISS segment, Perceptive Software creates teams to promote and generate
demand for the products. They group marketing teams by industry sector focusing on three large
sections: healthcare, public, and commercial. The headquarters for Perceptive Software is in
Lenexa, Kansas. There are also other offices globally located in Denver, Colorado, Ashburn,
Virginia, Bloomington, Minnesota, Pleasanton, California, Berlin, Germany, and Helsingborg,
Sweden. There are some Perceptive Software employees located in various ISS office locations
as well.
Perceptive Software does allow third party programs to distribute the products as well as
OEM programs. When the customer purchases the software they can pay for the product up front
and then continue to pay for any ongoing charges or services they may want to add. Another
method of payment that customers can take advantage of is a subscription basis, where they pick
a specific period of time in which they will choose to make payments either quarterly or
annually. This is cheaper for the customer upfront and they can continue to focus on their own
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services and customers. Lastly, customers can choose to subscribe on a recurring basis which
takes place quarterly or annually.
Competition
Perceptive Software is a leading developer of content and process management products
and solutions. The company offers “Content in Context” which allows them to automate almost
any business process of a company. Again, they continually work to provide for the specific
business and industry needs to ensure their processes run as smooth as possible. The company is
a leading developer in an industry that is highly competitive. They compete with a large number
of ECM providers specializing in document management, web management, and document
imaging, workflow, and capture. For the Enterprise Content Management (ECM) competition, it
is a little larger with companies like EMC’s Documentum, OpenText, IBM’s FileNet. Business
Process Management (BPM) competitors include Appian, IBM, OpenText and Pegasystems.
Core Competencies
There are many core competencies that Lexmark possesses. One of which is that they are
a global company. This gives them an advantage over companies who are not globally located.
This allows them to operate in different markets with their products at a higher volume. They
also have many locations for customers to receive products and services since they are located in
various geographic locations based on their consumers. Lexmark also does a combination of
outsourcing and in-house manufacturing. They are not set on doing one or the other which
provides them with flexibility down the road. The alliances they have created with other
manufacturers and suppliers allow them to potentially outsource even more in the future, leading
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to possible decreased manufacturing costs and increased productivity. They remain competitive
with larger businesses that provide the same services because they offer a wide range of software
and solutions to a variety of segments including healthcare, government, retail, and many others.
Lexmark is able to maintain a vast amount of services and segments due to extensive R&D.
Evaluation of customer needs and wants is taken into consideration as well as developing new
products to remain competitive in the industry. Lexmark takes pride in looking into its customers
operations and basing their production on the consumer’s current needs.
Current Strategy Assessment:
Lexmark has a business model that is founded on investing in new technologies to
develop and sell printing and imaging as well as content and process management solutions.
This includes printers, multifunction devices and software-based solutions with the overall
objective being growth in their installed-based hardware devices and software licenses and
installations, which helps with recurrent printing supplies sales and software subscription and
services revenue. The profits that Lexmark derives from sales helps fund investments in new
product, solution, services and software technology, all of which allow Lexmark to maintain a
competitive edge.
Lexmark continues to broaden its MPS and content and process management software
solutions and anticipates that their revenue will become predominantly software and services-
based. Their expansion can be seen through their acquisitions of Perceptive Software, Pallas
Athena, Brainware, Isys, Nolij, Acuo, AccessVia, Twistage, Saperion, PACSGEAR, ReadSoft,
GNAX Health, Claron, and Kofax Ltd., all of which add to Lexmark’s technology strength and
provide content and process management solutions for key industries. These acquisitions solidify
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a core strategic component of Lexmark’s future as Lexmark transitions out of a predominantly
Hardware Services Industry focus and into the Software and Services Industry. This is also
solidified through Lexmark’s exit out of the development and manufacturing of their inkjet
technology which they sold to Funai in 2013.
Lexmark’s other segment, ISS, continues to focus attention on capturing supply and
service annuities that are produced by mononchrome and color laser printers and multifunction
(MFP) products. ISS has been focused on printing and document process solutions, therefore has
relied on original equipment manufacturer agreements to pursue further business opportunities
with alliance partners including Toshiba, Xerox, Cannon IV, Dell, and Hitachi. These partners
are considered reselling partners and typically sell add-on solutions that work with their clients
existing user interfaces and platforms.
They have initiatives that include expanding their line of workgroup, color and MFP
devices, strengthening industry solutions including enterprise content management, business
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process management, document object model, and intelligent data capture and search solutions.
All of which will help in growing the MPS business, and expanding the rate of joining in new
market opportunities.
Recommendations and Implementation:
Pulling on the strategic and financial imperatives outlined earlier there are two key
recommendations that Lexmark must consider in the near future. First, Lexmark is actively
working to reposition themselves within the Software and Services Industry through the
numerous acquisitions over the past four years. In order to ensure this repositioning is completed
effectively and efficiently it would serve the company well to split itself into two separate
operating entities. This split will allow each operating segment to better position themselves
within their designated operating industry.
Furthermore, this recommendation is supported by the news of Hewlett-Packard splitting
into Hewlett-Packard Enterprise, focused on software and services, and HP Inc., focused on
personal systems and printing markets. Given Lexmark is currently operating in two segments,
ISS and Perceptive Software, the recommendation of formally giving each segment its own
“company” so to speak, seems possible. By splitting, Lexmark as a whole would allow each
segment to operate in a fashion that is conducive to success and proper positioning within each
industry. Additionally, in nearly every case, the acquisitions the company has made over the
years have all been accounted for in the Perceptive Software segment. Therefore, as it stands, the
company is already aligned in a way that would make the split a relatively easy process to
complete.
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Implementation of this recommendation will either be difficult or simple depending on
how top management chooses to allocate resources and personnel. For example, given all of the
company’s recent acquisitions there are numerous overlaps in management and executive
positions. These overlaps should be the first places the company looks to for individuals who
would be good candidates to fill new executive positions created by the split. Outside of top
management there should not be a great deal of overlap in operations given each segment
competes in different industries and sells different products and services. If personnel can be
properly allocated the split into two new entities should run relatively smoothly.
The second recommendation moving forward is centered around the level of current debt
that the company is dealing with. As mentioned in the financial analysis section, Lexmark has a
current debt-to-equity ratio that exceeds it optimal capital structure. This issue has come about
from the flurry of acquisitions that have been made and the various debt instruments that have
been used for financing. If the company were currently able to see larger percentage increases in
their top line revenues and net profits then it would be arguable that the current debt load is
justified as the company works to shift into a new industry. This is currently not the case though.
The company is taking on more debt while not posting noticeable increases in revenues.
Therefore, based on the financial imperative it is likely time that the company should stop
its current steam of acquisitions. In some respects the rate of acquisitions can be seen as a “land
grab.” There are several large companies all fighting to take market share of the same industry.
To do these, these companies are acquiring large numbers of niche companies currently within
the industry in order to keep their competitors from gaining too large of a market share. The
challenge for Lexmark is that the competition has larger balance sheets and is able to continue
making acquisitions. In order to ensure the financial strength of the company it is time that
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Lexmark shift its focus into developing and integrating its current acquisitions in an effort to
improve the company’s revenues and income streams.
The challenge for implementation will come from the need for each acquired company
and its personnel to integrate with one another. It will take a great deal of leadership at both the
top tier and mid-level management to foster the changes in operations and cultures that may be
necessary to ensure each entity operates as a collective unit. From a financial standpoint the
implementation should be relatively simple. In many cases the funds that were previously being
reserved for future acquisitions will now be used to help train employees and streamline
operations between subsidiaries.
Conclusion:
Over the last decade, the Computer Hardware Industry has seen a large shift in consumer
preferences. These shifts have created large challenges for companies such as Lexmark. In an
age where physical printing is being substituted for cloud based data management and storage
and file sharing, Lexmark has been forced to realign its operations. This has caused Lexmark,
and may others, to expand into the Software and Services Industry.
Lexmark has taken large steps in recent years to keep up with the dramatically changing
business environment. The numerous acquisitions are a testament to the company’s commitment
to a new strategic plan despite the potential concerns regarding the financial implications. For
this reason, it will be imperative that the company focus on the available strategic fits between
subsidiaries as they continue to expand into new niche markets within the Software and Services
Industry.
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As the recommendations noted, it would be beneficial, in the next year or two, for
Lexmark to split its current operating segments. The split would promote further strategic fit
efficiencies and allow the company to be more competitive in a rapidly maturing international
technology industry.
