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How Kodak lost its way

Rochester Business Journal
January 27, 2012

Was Eastman Kodak Co.'s plummet from the pinnacle of industry into bankruptcy court inevitable?
 
Probably not, but another outcome would have required successful, visionary leaps.
 
Five leaders-three career Kodakers and two outsiders-steered the onetime photo giant during its 30-year decline. Over that period, it shrank from 60,400 local employees to 7,000.
 
With varying degrees of urgency, Colby Chandler, Kay Whitmore, George Fisher, Daniel Carp, Antonio Perez and their management teams mapped out paths to when film would be replaced by digital imaging. So far, none of those paths has led to the brass ring. The jury remains out on Perez's push to remake Kodak as a digital printing company.
 
"The choices-a couple of them weren't successful. Some were successful and through changing strategies in the company they divested of some successful businesses because they didn't fit the strategy management had adopted," said Lawrence Matteson, executive professor of business administration at the University of Rochester's Simon Graduate School of Business and a former Kodak executive. "They never found a very powerful or profitable substitute for a business that required film."
 
Kodak, he added, has not been led by idiots, as some pundits claim. Such an analysis ignores the magnitude of the task faced by Kodak leadership. In his view, this challenge far eclipsed those encountered in remaking Intel Corp., IBM Corp. and Apple Inc.
 
"It was one of the most difficult transformations any major American company has had to face," Matteson said. "Not only were they dealing with major shifts in their marketplace but they were dealing with major shifts in obsolescence of their core research, production and manufacturing capabilities in the photograph markets that they served.
 
"Customers found entirely different ways of doing things that obsoleted the competitiveness of Kodak. There are not many companies that face the same sort of disruption."
 
Critics love to point to engineer Steve Sasson's invention of the digital camera at Kodak in 1975 as prima facie evidence of Kodak's blunders in the digital era.
 
Back in 1979, Matteson-then at Kodak doing advanced development work on consumer cameras-analyzed the impact of electronic photography on the film business. His study predicted digital would replace film by 2010 across the company's categories, beginning with government and military applications and culminating with consumers. He was off by a few years as the transformation largely was completed early in the 2000s.
 
Starting in the early 1980s, Kodak leadership widely acknowledged the impending transformation and its impact, Matteson said.
 
Its existing lifeblood would dry up as digital imaging replaced the silver halide-based photographic industry that fueled Kodak's success and generated billions in revenues and profits. Kodak's leaders knew digital would be far less profitable: where film generated a profit of as much as 70 cents on a dollar, digital imaging might make a nickel.
 
"We shouldn't look at this as some sort of a surprise because they were asleep at the switch," Matteson said. "It was a reasonable decision by management to look at what point they should introduce alternative technologies and should they. It's not automatic that you do that. ... You don't just chase your market because it's there, whether you are going to make any money on it or not."

The copier option
One possible route to a new future for Kodak began in the 1970s. Kodak in 1975 entered the copier or electrophotographic business with the debut of the Kodak Ektaprint 100 Copier-Duplicator. Ultimately, Kodak and Xerox became the two major players in the central reproduction office business.
 
"There was a product category that wasn't film-based, primarily a hardware product, and they did reasonably well," Matteson said.
 
Ulysses Yannas, a longtime company watcher with Buckman, Buckman & Reid Inc. in New York City, began tracking Kodak in the early 1970s when Walter Fallon was CEO. Kodak should have stuck with copiers and built that business, he said.
 
"They should have stayed with copiers," Yannas said, praising their quality. "But they did not know how to market them."
 
Kodak ultimately sold its copier division to Danka Business Systems PLC-a move that proved disastrous for Danka.
 
Also during the 1980s, Kodak launched Ektachem blood analyzers, based on film technology, which became a successful business, Matteson said. That Kodak division was sold to Johnson & Johnson in 1994. It continues to operate in Rochester, as Ortho Clinical Diagnostics, with some 1,000 employees.

Pharmaceuticals and chemicals
Under the leadership of Chandler and Whitmore, Kodak saw an opportunity to leverage its organic chemistry research capabilities and intellectual property in the pharmaceutical industry, which in the late 1980s was highly profitable, even by Kodak and film standards. In 1988, Kodak made a leap into the arena by acquiring Sterling Drug Inc., a maker of prescription and over-the-counter drugs.
 
Kodak ultimately did not find the hoped-for lucrative pharmaceutical trove in its IP portfolio. In 1994, with Fisher then at the helm, Kodak sold off pharmaceutical and consumer health products subsidiaries and used the proceeds to pay down debt. It also marked a sharp turn away from diversification to a focus on core imaging technologies, including digital imaging.
 
Another firm sold off by Fisher was Eastman Chemical Co., founded by George Eastman in 1920 as a way to provide the chemicals the film giant needed. Some observers point to how well Eastman Chemical is doing now compared with Kodak and suggest the company missed an opportunity to focus there.
 
Kodak spun off the Tennessee-based chemical firm in 1994 as the 10th-largest chemical company. Today Eastman Chemical is a Fortune 500 firm with 10,000 employees worldwide and 2010 sales of $5.8 billion. Its market value is nearly $6.3 billion, compared with Kodak's current market cap of $93.5 million.
 
Matteson said, however, that Kodak began talking about selling off Eastman Chemical in the late 1980s. By then, the chemical operation had ventured into new areas and played a much smaller role in providing chemicals for Kodak. He described it as a lower-profit business-certainly less than film-but well-managed and growing.
 
"Could (Kodak) have kept it and focused on it? Yes, (but) that would have meant saying, 'Stop doing what you are doing in Rochester and focus on the chemical business in Tennessee.' It would have meant not leveraging any of the strengths (of Kodak)-not leveraging the R&D, not leveraging the manufacturing and not leveraging the brand.
 
"You had 100,000 people (in) the photographic business in one way or another," he noted. "If you go into the commodity chemical business with the demand for 10 to 20 percent of the people, and a slow-growing business, does it make any sense? I think it made sense to sell it off in the '80s."
 
Fisher won accolades for shedding Kodak's non-imaging health care businesses, including its pharmaceutical and consumer health businesses. Those sales generated $9 billion and revitalized Kodak's balance sheet.
 
"In the 1970s, (Kodak leaders saw) digital doing away with traditional photography and got into other businesses-and in debt," Yannas told the Rochester Business Journal in 1998 as Fisher was completing his fifth year as CEO.
 
Fisher's decision to shed those businesses also shifted the company's focus to imaging science. Ultimately that move, however, would not bring about the growth he envisioned and did not succeed in finding a profitable path to take the company into the 21st century. It also failed to halt the ongoing layoffs, which took an average of 2,000 local jobs a year out of the company for some two decades.

Going digital
Carp, who succeeded Fisher as CEO in 2001, took the reins as a Kodak insider. Yet as CEO he put in motion efforts expected to sever the direct link with film.
 
Yannas still sings Carp's praises. He credits the former CEO with changing Kodak's culture-out of necessity for the success of the company.
 
"I used to hate Kodak, from the days of Walter Fallon; he had 10 guys following him round," Yannas said. Even in the days of Fisher (it was like that). Carp was the one who changed it."
 
Carp also recognized Kodak needed someone with digital expertise from outside the company.
 
"He told me he didn't understand the digital side; he found someone, Perez, who did," Yannas said.
 
As CEO, Carp ordered a multiyear effort to reshape Kodak Park. The multimillion-dollar project involves demolishing buildings; selling properties, including the Henrietta campus; and revitalizing some sites.
 
Still, Carp misjudged how fast film would decline, company watchers say. But Kodak appeared to be developing into the consumer photographic company many thought it logically should be.
 
Kodak under Carp built a leading brand in digital cameras. Kodak's EasyShare models reached the No. 1 spot in U.S. market share when Carp departed as CEO and were believed to rank No. 3 worldwide. Kodak also had a leadership spot in kiosks.
 
Indeed, Kodak's success shocked many in the industry. Experts pooh-poohed Kodak's chances against consumer electronics rivals Sony Corp., Hewlett-Packard Co. and others. But beneath that success emerged structural issues.
 
Similarly, Kodak built a leading site for online photos, the Kodak EasyShare Gallery, but profits proved elusive.
 
A key element in Kodak's consumer digital strategy failed: printing of images. The company planned to make money off thermal printing ribbons and paper. That was key, in part because despite the market share and ratings, Kodak did not make money on its cameras.
 
In the end, its digital strategy lacked the razor blades necessary for the razor-and-razor-blades model to work, analysts say.
 
"Kodak has never made money on cameras; they made money on film and paper, and marketing them," Yannas said.
 
Kodak leaders also severely misjudged how little demand would exist for hard copies of pictures. Its mantra for years had been that a massive upsurge in the number of photos taken digitally would compensate for a reduction in the percentage of photos printed. However, the Internet made viewing and sharing easier, changing consumer behavior.
 
"The viewing of electronic images is much more acceptable than many people thought it would be. There was a reasonable sense that people would always want a printed copy," Matteson said.
 
The consumer digital imaging market was not ready until at least the late 1990s, Matteson explained, in terms of cost and performance.
 
"Customers were not going to pay $500 or $600 for a camera that takes inferior pictures to a $10 single-use camera," he said.
 
Ultimately, profitable success in the digital camera business may have been moot and unlikely to save Kodak from its current fate.
 
Yannas noted that six years ago Perez warned of cellphones soon replacing digital cameras. Perez was right, he said.
 
In hindsight, was Kodak wrong to pursue digital photography at all?
 
"Possibly. That was another strategic direction they might have gone," Matteson said. "It might have led to a very happy outcome, but it is a significant shift away from the core skills of the company. The batting averages of companies that try to make that transformation ... is pretty small."
 
"There was no silver bullet, no easy path," he added. "This was an extremely difficult transformation. Over the last 20 years they made several strategic decisions on what they would focus on with, I'm sure, less success than they had hoped for, and (it) got them where they are."

Next hope
A lasting legacy of Carp's moves-at least at this point-is a series of deals that built up Kodak's printing and graphic arts foundation. The company acquired printing giant Heidelberger Druckmaschinen AG's share in the Rochester-based joint venture NexPress Solutions LLC, along with Heidelberg Digital LLC. Kodak also purchased Sun Chemical Corp.'s stake in Kodak Polychrome Graphics for some $817 million and acquired Creo Inc. for nearly $1 billion.
 
Earlier acquisitions, including Scitex Corp. Ltd. for $250 million, gave Kodak depth in commercial digital printing. Ironically, Kodak had sold the business-which would become Kodak Versamark-to Scitex in 1993 in an earlier shift of management focus.
 
The deals have hurt Kodak's balance sheet, but they have bolstered its emerging graphic communications segment. Yannas described the moves with KPG, NexPress and Heidelberg Digital as masterful. KPG and NexPress were spun into joint ventures to remove a burden on the balance sheet and share the cost of development with major partners, he said.
 
"Then they brought them all back for tremendous deals," he noted.
 
Kodak eventually began to see it could not fund all of its promising businesses. Its Health Group was sold in 2007 to Onex Corp. The business would become Care-stream Health Inc. Some thought that business, which employs 1,100 people here, could have become part of Kodak's future as well.
 
Kodak divested its remote sensing systems operation in 2004 to ITT Corp.; it employs some 1,300 in Rochester and now is part of ITT Exelis Inc. Kodak also sold various smaller pieces such as organic light-emitting diode and sensor businesses.
 
Yannas still laments the money-billions of dollars-spent by Kodak under Fisher for stock buybacks in the mid-1990s. Yannas, who generally opposes such moves unless a stock is below book value, ponders what Kodak could have invested in with that cash.
 
Another big use of cash came when Kodak invested more than $1.3 billion to tap the massive China market, which offered seemingly boundless potential to extend high-profit film sales into this century. But only seven years after the company launched its China push, Kodak said in 2005 that film sales in China had peaked.
 
Kodak-beginning under Fisher and continuing under Carp-bet that China would follow a path first to film and only later to digital. That proved incorrect or at best overly optimistic.
 
Perez takes a great deal of criticism for failing to make Kodak profitable, yet few can argue that he has boldly chosen a new path for Kodak. Time will tell if his strategy is successful. Film, dating back to the days of Carp, and IP have been used for cash to fund that transformation.
 
The current focus is on a trio of digital initiatives: consumer and commercial inkjet, workflow software and services, and packaging solutions.
 
"It's a printing company," Yannas said.
 
Matteson also sees some opportunities for Kodak's future in the current strategy.
 
Could Kodak's fall into bankruptcy have been avoided?
 
"I don't know if we could say it was inevitable. There are many choices you can make. The ones they made led them in this direction," Matteson said. "Maybe some others would have worked out better, but those are sort of imponderable questions.
 
"You have a change in leadership and strategy, and the resources you need to be successful also change," he added. "At the time, those decisions probably made sense, but looking back you say, 'What the hell were they thinking?'"

1/27/12 (c) 2012 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email service@rbj.net.


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