June 13, 2003

Editor's Note: In this special two-part discussion, Dr. Joe Webb explores the issue of industry production capacity and its implications for print service providers, equipment manufacturers and other industry players.

Loaded with insight and backed by a strong presentation of supporting data, this is a must-read for anyone involved with the printing industry. It will change the way you think about your business, and may make you wish you never hear the word "overcapacity" again...

Click Here to download a PDF of the entire special report (includes parts 1 and 2 together)

- Are Printers "Improving" Themselves Right Out Of Business?

- Lack of Profitability Drives Establishment Churn

- Does the Industry Really Need More Presses? (That's the Wrong Question!)

- The Realities of Today Paint a Different Picture Than What Everyone Thinks

We received the following question through the Ask Dr. Joe page of WhatTheyThink:

"After reviewing Creo's financial announcements a few weeks ago, I got to thinking about the relative value of improving productivity in the printing industry. With all the print ERP/workflow management software providers trying to improve productivity, isn't one side of the industry working against the other? In other words, since the print industry is so over capacity-some say as much as 50%-won't improving the productivity of printers simply increase the capacity to the point that we will be 75% over capacity or more, rather than 50%?

"Creo's response was that improving productivity was the difference between doing more business with the same equipment, or having to buy new equipment. Creo suggested that by implementing its Networked Graphic Production (NGP) initiative, a printer might avoid buying another $3 million press...

"Seems like some printers might be 'improving' themselves right out of business!"

Here's what I think. The assumption is that there is overcapacity in the printing business, but I have never really seen proof of that in the same way as you see it in other industries. Things are much too fluid for it to really happen. Printing is a pure competition business, and establishments come and go so quickly that they don't hang around long enough to be called overcapacity. Capacity balances itself by basically throwing companies out of business. We've lost 11,000 establishments since 1990, as an example, and now even more are coming out of service.

In fact, over a longer period of time, from 1989 to 2000, the industry has lost about 38,100 printing and related services businesses (yes, that's not a misprint, it's 38,100) and gained 27,700 for a net loss of 11,000 businesses.

Total Establishment Birth/Death Rates for the Printing Industry

Some of these losses were occurring even when print volume was going up, and even occurred in the strong period of 1995-1998. I know that when the Census releases 2001, 2002 and 2003 data, further establishment losses will be evident, since recent data from GraphStats (which is as close to real-time measurement as one can get) indicates a drop of another 1,000 to 2,000 establishments.

So this brings up the real issue: if NO printers disappeared, there would be a watertight case to be made for overcapacity. But the industry is churning firms at a rapid rate, renewing itself, and changing with the times as it understands them. So the overcapacity case is on shaky ground to begin with. There's more to this part of the story. Keep reading.

Lack of Profitability Drives Churn

This turnover in business establishments is a higher rate of change than the Census average for manufacturing industries. Many of these new business entities have the same owners as the ones that went out of business. As professionals, print executives may have one career of ownership, but may own several business entities over their lifetime. This is one way that they unravel a variety of partnership, family, legal, debt, and other issues as a means of staying in business.

The reason for this churn is that 75% of the businesses are not profitable, so the slightest bit of economic hiccup sends them by the wayside. This is pretty obvious in the PIA Financial Ratios if you remove the profit leaders from the "all printers" data. This is very different from the auto industry, or any other industry that is a monopoly or oligopoly, where participants can withstand years of slack demand (or overcapacity) and not go out of business at all. In these businesses, quite often their fixed asset base is incredibly large compared to that of printers, and really can't be changed in the short term. Printers losing money can't hang on for too long. Ford, GM, and Chrysler can-and have!

What Creo cited above is exactly what will be happening. But Creo was suggesting that there is more potential throughput in the systems leading up to the press. I have always felt that the industry was grossly inefficient in its administrative and "backroom" operations, just from stories I hear from consultants who work with printers, who are often able to offer solutions to problems that seem quite simple (like sending out invoices sooner to cut down days outstanding for accounts receivable; sometimes you just have to hire someone else to state the obvious, I guess).

In fact, the number of multicolor presses in the industry's installed base has been going down for the last six years, and there are fewer heatset web offset presses in today's installed base than in 1990. The number of non-heatset presses is down even more dramatically. The inflation adjusted industry shipments peaked in 1998, and the number of presses has been declining since then.

Another hole in the overcapacity argument is the fact that the net number of presses is declining, and declined even during a time of industry growth. And it continues to decline. If the presses were still there, the overcapacity argument would make sense. It doesn't.

Does the Industry Really Need More Presses? (That's the Wrong Question!)

So right now, it does seem that there is what many people claim is "no reason to add new presses," not because of overcapacity, but because of productivity, and two other very significant factors.

First, the slackening of demand reduces the pressure to buy new equipment. There is good anecdotal evidence, and a rational implication through examination of industry financials, that having less equipment and using it more productively is a very profitable strategy. Therefore, adding a shift is wiser than adding equipment.

That is, capacity utilization is a microeconomic measure of great validity on an establishment basis, but is virtually meaningless on a macro basis. In other words, measuring capacity utilization is very important for individual businesses, but for the industry at large has no relevant meaning. Economics is full of these kinds of paradoxes; for example, if everyone started to save at a high rate all at once, the economy would collapse because of lack of demand. The fact that the product mix that the printing industry is offering is stagnant is not doing anything to nurture demand. In the 1980s the declining cost of process color was a strong stimulant when the other alternatives for media mix dollars were not as compelling.

And that leads us to the second item: At a peak of grousing about industry capacity, the 1980s, the industry hit the technology and societal trifecta: more color, shorter run lengths, more jobs. Despite complaints about overcapacity, the industry was buying new presses and new prepress equipment, and the net number of establishments was going up significantly. The change in the product mix to more process color in shorter run lengths stimulated the market.

So why wasn't overcapacity bad then? We had an overcapacity of single color presses. Was it just the lament of people who couldn't afford the right equipment to do the right work? Or was overcapacity meaningless? I'm for the latter.

The point is that product mix is more of a factor in profitability than most people realize. Capacity is meaningless. It's the value of what is being produced, and how different it is from what is produced by competitors; that is the issue. Also, overcapacity is often a sign of obsolete equipment, incapable of competing in the marketplace, and therefore a stimulant to investment. The old saw, "I had to get a new press because my competitor bought one" is better translated in many cases as "My equipment is inappropriate to produce the products needed in my market area."

The Realities of Today Paint a Different Picture Than What Everyone Thinks

Today, however, is a completely different story. There is no demand forcing investment, nor is there a product mix change occurring within the industry. In the 1980s, both demand and mix changes were working in our favor. Advertisers loved switching to color printing, and the broadcast TV audience was fragmenting so badly that print magazines, direct mail, catalogs, newspaper inserts, and other print media flourished. Now, though, competitive pressures from other media are forcing companies to keep prices low.

The gross profit per print employee, adjusted for inflation, has not changed for 30 years (about $69,000 in 2001 dollars) despite the productivity impacts of the letterpress-offset conversion, optical-digital prepress conversion, and now film-direct-to-plate conversions!!! What this means is that despite our investments, we're still in the same relative place financially.

Industry capacity utilization has very little to do with an individual company's profitability; it's what happens within the firm that matters. And then inside the firm, it is product mix that matters, as noted above. With the decline in high profit B2B sheetfed work, companies are really suffering and they are exiting the business. That's a product mix issue, not a capacity issue. When a product is no longer demanded by a marketplace, it is obsolete and replaced by a substitute; this is not a capacity issue. Companies who don't make equipment mistakes (i.e., buying too much equipment) are the most profitable. (Many discussions with Bob Rosen, industry consultant (www.rhrosen.com) have caused this concept to be mashed permanently into my skull.)

So basically, this industry adjusts its overcapacity, actually in a matter of months, which might as well be real-time, by:

• discouraging new participants from entering the business
• encouraging consolidation via bankruptcy sale, or the "we need to merge to survive" attitude
• forcing companies to exit the industry (the industry's economic forces are relentless about that)
• having economic forces that discourage new capital investment (yes, not buying new equipment is a way of managing capacity, but keep in mind the product mix issue).

See Part Two

Click Here to download a PDF of the entire special report (includes parts 1 and 2 together)