Xerox Corporation

STRATEGIC BUSINESS ENVIRONMENT

Xerox Corporation: Sustainability Evaluation

Executive Summary Xerox, the company known for its ubiquitous photocopiers, reached a crossroads in October, 2000. After years of decline, the company was days away from a potential bankruptcy and would require a dramatic change in strategy if they were going to survive. The COO of the company, Anne Mulcahy declared that Xerox had an “unsustainable business model.” The root of their problems can be found through two analyses: A disruptive technology analysis which demonstrates that consumer demand for their core product, analog photocopiers, is losing strength to newer, multi-function digital machines; and a Tetra-threat analysis demonstrates that they will need to address large imitation, substitution and slack threats to move beyond this point. Recommendations for an improved corporate strategy include 1. Overhauling the Xerox leadership team 2. Adjusting offerings to sell solutions built out of products and services, not just copiers or supplies 3. Driving the Research and Development organization to work more closely with the sales and marketing groups by driving them to create products that better meet the needs of the marketplace

On October 5, 2000, Anne Mulcahy, the recently promoted COO and President of Xerox Corporation stated bluntly on an investor’s conference call that Xerox had an “unsustainable business model.” On the verge of a potential Chapter 11 filing, the 35-year Xerox veteran would need to reevaluate and dramatically restructure the way that Xerox was doing business, as its current business model and processes brought one of the most respected companies of the twentieth century to the brink of collapse. History Founded in 1906 as Haloid Corporation, the company was a fledgling paper and wetcopy machine manufacturer when it agreed to invest in the “xerographic” dry-copy method invented by Chester Carlson, a Queens, NY patent attorney (see Appendix A). Twelve years after Haloid’s initial investment, Haloid (soon to be renamed Xerox) introduced the Xerox 914 in 1959. The 914 model was an instant success, helping to generate approximately $32 million in revenue within the first year of its release. Just 9 years later in 1968, revenues climbed to $1.2 billion. Xerox’s products were like none other in the marketplace and by 1970, Xerox maintained a 95% share of the plain paper copier market with annual margins as large as 80%. Xerox Corporation’s dramatic success was due not only to technical innovation, but also to an elaborate patent infrastructure that protected the company almost completely from competition to their core business. The Xerox patent system was built from the original patents filed by Carlson and his original team of scientists which entitled them to 17 years of patent protection. From that point forward, any time that Xerox’s research and development filed a patent application for new enhancements to the core xerographic process, the extended the patent on their original process, escaping the patent expiration process. Xerox vigorously enforced these patents, creating almost insurmountable barriers to entry for their potential competitors. The patent infrastructure, in combination with policies mandating copier leases rather than sales, requiring all clients to purchase Xerox-brand supplies for their Xerox copiers, and a refusal to license any of its plain paper copying technology, prompted the Federal Trade Commission to file an anti-trust complaint against Xerox on January 16, 1973. A Slow Decline (1975 – 2000) In 1975, Xerox and the FTC reached a settlement ordering Xerox to license its technology to competitors and provide them with consulting services to provide the know-how to implement the licensed technologies. The impact of the settlement on Xerox cannot be overstated: by 1982, Xerox’s share of US copier installations plummeted from 80% in 1975 to 13% in 1982. This market share was lost to domestic competitors such as Eastman Kodak and IBM, and Japanese competitors new to the American market such as Canon, Ricoh, and Minolta. While Xerox was able to recoup some of their lost market share during the 1980s and ‘90s (by 1993, their share of the low-end market was 18% and their share of the mid and high-end market was 35%), they never fully recovered from the ramifications of the loss of their copier empire. New technology development also did not assist the corporation. During this period, Xerox’s Palo Alto Research Center was inventing some of the core achievements of the Computer Age, but they were not able successfully market these innovations. Included in Xerox’s unsuccessful ventures were Ethernet, the Graphical User Interface and the computer mouse;

products that made Microsoft and Cisco Fortune 100 companies, but from which Xerox never realized any significant profits.

The New Century By the time of Ms. Mulcahy’s statement, Xerox was within days of a potential bankruptcy. Xerox’s commercial paper rating was one step above junk, at any one time they only had enough cash on hand for a week, and they were leveraging their last liquidity option, a $7 billion unsecured line of credit held by a consortium of 58 banks She and her team were challenged with how to revive fiscal health without declaring bankruptcy and incurring the organizational, cultural and brand damage that would surely follow such a step. Digital Copiers as a Disruptive Technology Xerographic copiers were a disruptive technology forty years ago when they first arrived in the marketplace, but today are almost wholly a commodity product. These products are now threatened by new disruptive technologies, especially all-in one digital units that copy, scan, and print in volumes that satisfy all but the largest professional publishing houses. Figure 1 illustrates the estimated disruptive technology curves as digital copiers began to overtake the market for analog copiers.

Quality

Digital Copiers as a Disruptive Technogoly

Analog Quality

(p ro je ct ed )

20 06

20 08

20 04

20 02

20 00

19 98

19 96

Digital Quality

Time

Figure 1

When examining the changing market and the lack of adaptations from Xerox, we uncover the root causes of Xerox’s financial difficulties and the reasons for questioning Xerox’s long-term sustainability.

Was Xerox Sustainable? To assess the sustainability of the Xerox business model, we utilize the tetra-threat model addressed by Gnemawat Pankaj in his book, Strategy and the Business Landscape. As shown in Figure 2, Xerox’s threats to sustainability are both their ability to provide added value in comparison to their competitors (represented by imitation and substitution), plus the need to minimize the threats to their internal efficiencies (represented by slack and holdup). We will address each of these threats independently in the sections that follow the diagram.

Figure 2: Tetra-Threat Model

Imitation Xerox prides itself on its research and development groups, particularly at Palo Alto and at its American manufacturing center outside of Rochester, NY. Yet because of the commoditization of Xerox’s core products, the corporation needs to question whether this research and development is in their best interest.. As Professor Pankaj states: Attempts at product differentiation based on R & D as opposed to marketing are vulnerable on several counts; studies indicate that competitors secure detailed

information on most new products within one year of their development, patentbased strategies usually fail to deter imitation, and imitation tends, on average, to cost one-third less than innovation and to get to market one-third faster (pp. 100). While it has been Xerox’s goal since the introduction of the 914 to continuously innovate and spend large sums on research and development, this spending was frequently wasteful because it did not focus on the development of products with strong ties to Xerox’s existing core offerings. Other areas of imitation threats, including divulgence of trade secrets or switching costs from one vendor to another, are less applicable to Xerox today as a result of the FTC ruling and the decreased costs associated with commoditization, respectively. Also, while Xerox maintains large economies of scale between their US corporation, European subsidiary (a joint venture they purchased in 1997) and a joint venture, Fuji- Xerox in the Far East, Xerox needs to examine ways to creating greater efficiencies from these large economies. Substitution Xerox’s most significant external threat is substitution. While occasional upgrades can still take place in the plain-paper copier market (particularly for those targeted at the highly priced publishing market), the copier market is moving to digitally based products inclusive of print servers, laser printers and scanners instead of the xerographic method from which Xerox took its name. To be successful, management must straddle the line between maintaining their legacy client base and actively developing new clients with their latest digital products.. In addition Xerox needs to add a new core competency: consulting. By migrating and harvesting resources from within their legacy groups, Xerox can enhance their relatively small consulting group and built it into the core of their business. Adding consulting to their core or “recombining” their efforts will create more salable value for customers, thus leaving Xerox less open to substitution threat. A successful implementation of this strategy could allow Xerox to leapfrog over other copier makers who depend on business partners or weaker internal consulting organization to implement their solutions. Holdup Whereas some companies need to integrate their manufacturing or supply chains, Xerox divested significant portions of its portfolio to contractors or overseas subsidiaries to cut costs. As a company that still manufacturers many of its own parts, Xerox is less vulnerable to holdup than many other companies of its size. Slack Slack is potentially the largest threat to Xerox’s long-term sustainability. Despite reshaping the organization many times since the 70s, the organization is still extraordinarily bureaucratic, runs on the assumption of lifetime employment (even though layoffs have become common place), and has frequent disputes between management and unions. Furthermore, Xerox still has not effectively organized their sales and marketing teams to best address customer needs. Sales representatives are split by geography, industry, product groups and other categories such that a single client could have in excess of ten sales reps for a single location. To help rectify this situation, management should introduce client teams with dedicated sales reps to act as the main Xerox point of contact. All of these above-mentioned items directly threaten the efficiency that Xerox requires to sustain its business; however three major changes to reduce slack have been made to address these concerns since the late 1990s: The governance of the company was overhauled by replacing many senior officers and installing Anne Mulcahy as COO and later CEO. She and her new team

mobilized for change in a way that had never been seen before at Xerox, because the situation there had never been so dire. Finally, individual and team performance incentives were pushed further downstream to sales, marketing, consulting and other areas where the only previous performance bonuses had been associated with division or company wide profit sharing.

Recommendations  Overhaul the structure and culture of the company Part of this has already been accomplished by recruiting a new CEO and leadership team with a vision of where Xerox should go in the future. They must now tackle bringing the culture and organization of Xerox into the twenty-first century. Retention of high-value employees is critical, but lifetime employment should not be insinuated as a provision of employment. Additionally, from a financial point of view, the company must continue to divest itself of many of its parts manufacturing businesses. While these functions are essential for the success of the business, spinning these off and then allowing competitive bidders to vie for the work (offshore or domestic), will help Xerox obtain larger margins and enhanced long-term sustainability. . Finally, Xerox must make the critical transition from product sales to total business solution partner, selling equipment, training, and consulting services to meet client objectives. By aiming towards this goal, they will find themselves looking deeper into customer concerns, creating offerings that better satisfy clients and establishing customer loyalty that is not obtainable by simply selling off-the shelf products. This strategy, adopted most notably by IBM, has the potential to keep Xerox profitable for many years. 

Drive research and development towards marketable and profitable goals Xerox has been an innovator on a grand scale, but one of the keys to their sustainability will be creating synergies between research and development, marketing and sales. Their new digital products must satisfy the needs of all of these internal groups if they are to produce the best products for their customers. Gaps between these organizations must close if Xerox is to maintain its profitability and brand.

Epilogue How did Xerox escape their organizational and financial quagmire? The senior team at Xerox assembled and implemented a successful turnaround plan, incorporating some of the key suggestions outlined in previous sections of this analysis. (see Appendix B). In summary, they sought major asset dispositions and cost reductions to obtain cash, then worked to generate better medium and long term performance from their research and development group, providing more functional and competitive products to their customer base. While Xerox is still working to address the longer-term challenges to their business, the turnaround has gone well. In FY 2005, Xerox earned $978 million on $15.7 billion of revenue, translating to earnings of 94 cents/share. Xerox maintains a staff of 55,200 employees, 29,700 of whom work in the United States.

Appendix A (Quoted from Reference 1):

How Xerography Works In 1938, Chester Carlson invented xerography out of two natural phenomena already known: materials of opposite electrical charges are attracted, and certain materials become better conductors of electricity when exposed to light. By combining these phenomena in a unique way, he was able to create a new process for making cheap, fast, good copies on plain paper.

Basic Xerography (1) a photoconductive surface is given a positive electrical charge (+). (2) The image of a document is exposed on the surface. This causes the charge to drain away from the surface in all but the image area, which remains unexposed and charged. (3) Negatively charged powder is cascaded over the surface. It electrostatically adheres to the positively charged image area making a visible image. (4) A piece of plain paper is placed over the surface and given a positive charge. (5) The negatively charged powder image on the surface is electrostatically attracted to the positively charged paper. (6) The powder image is fused to the paper by heat. After the photoconductive surface is cleaned, the process can be repeated.

Appendix B: Draft Operational Plan for Operation Turnaround (Quoted from Reference 2) Asset dispositions Goal: To generate $2 to $4 billion in asset area        

Sell China operations to Fuji Xerox. Sell portion of Fuji Xerox to Fuji Film Corporation. Sell around [sic] inkjet business Build strategic partnership for US and Europe paper businesses that would involve partner having most of assets. Sell around [sic] engineering services business. Sell or outsource parts of manufacturing operations Look for a customer financing vehicle that does not burden the balance sheet Leverage asset of Park by seeking joint venture with non-competitive partners, spinningoff non-core technologies and commercializing non-core technology with VC partnerships

Cost Reductions Goal: To reduce additional $1 billion in costs.  

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  

Cut dividend to 5 cents a share, saving $400 million a year [this was later eliminated during the worst of their financial crisis] Cut SGA [sic] by $600 million: Remove industry and product overhead in North America and Europe sales (continue to go to market by industry); reducing headquarters operations; developing markets will resize and go to distributor relationships in nonstrategic geographies. Cut $200 million in supply chain and manufacturing costs. Simply stated, we can no longer afford to be vertically integrated at every step of the value chain across our product line. It leads to a cost structure we can’t support and more importantly, a price structure our customers won’t support. Eliminate worldwide-service staff organization, moving activity into operating companies. Investigate service offerings to match cost to value received by customer. R&D. Narrowing R&D based on affordability and future profitability. Prioritizing high end business and color while rationalizing R&D with Fuji Xerox. Cut infrastructure and overhead $200 million. Reduce headquarters staff, simplify organizational structure and reduce number of P&Ls.

Note: This will require further employment reductions

References 1. ”The Story of Xerography.” Available at http://a1851.g.akamaitech.net/f/1851/2996/24h/cacheA.xerox.com/downloads/usa /en/s/Storyofxerography.pdf . Downloaded July 4, 2006. 2. George, Bill & McLean, Andrew N. (2005) Anne Mulcahy: Leading Xerox through the Perfect Storm (A). Harvard Business School Case #9-405-050. Boston: Harvard Business School Publishing. 3. George, Bill & McLean, Andrew N. (2005) Anne Mulcahy: Leading Xerox through the Perfect Storm (B). Harvard Business School Case #9-405-065. Boston: Harvard Business School Publishing. 4. Kearns, David T & Nadler, David A. (1992). Prophets in the Dark: How Xerox Reinvented Itself and Beat Back the Japanese. New York: HarperCollins Publishers, Inc. 5. Pankaj, Gnemawat. 2006. ‘Sustaining Superior performance’ in Strategy and the Business Landscape, Prentice Hall, pp: 95-116.