What Will Develop a Better Kodak

Eastman Kodak, an American institution, is in trouble again. Its impressive three-year comeback from two decades of sleepwalking has stalled. Yet at the same time, the 113-year-old company is geared up for the most intense competitive battle in its history.

Kodak will respond to competitive threats from Japan’s Fuji Photo Film with stern cost-cutting actions that Chairman George Fisher declined to impose on the demoralized company when he took the top job in 1994.

But it will have to do more. Kodak, which last year had $16 billion in sales and $1.8 billion in pretax operating earnings, will have to accept lower profit margins in order to push film sales and recover several percentage points of market share that it lost unexpectedly this year.

Daniel Carp, Kodak’s president, says the company’s ready to fight. “This is a $16-billion company, and if we have to cut costs and get into a pricing battle, we can do it,” Carp says.

Such a cost-and-price offensive will involve layoffs from Kodak’s 94,800-strong worldwide work force. It could further reduce Kodak’s earnings, which the company says will be down 25% from last year, and its stock price--which has already fallen 37% in this year of painful reassessment. Kodak closed at $59.63 on Friday.

Fisher conceded last week that Kodak “would be better off today” had he been more aggressive in cost-cutting years ago. He called that “20-20 hindsight,” but rude awakening to business realities today would be more accurate. Kodak woke up from three years of recovery to find that its cost structure is so uncompetitive that a mild downturn in sales clobbered its profit disproportionately.

Until this year, no regretful hindsight was needed. Fisher, who was chief executive of Motorola when Kodak directors recruited him in 1994, has sold Kodak’s unwise ventures into pharmaceuticals and all but eliminated Kodak’s $7-billion long-term debt.

He has invested heavily in digital photography, the coming technology that combines pictures with computers and printers. Kodak leads the world with $1.5 billion in sales of digital photography devices, but is still losing more than $100 million a year in the new business.

Kodak also took part in a consortium with Fuji, Canon and Minolta of Japan to develop an advanced photo system. Kodak’s product, called the Advantix camera, has been out a year and is still losing money because of promotional expenses.

Still, with the high profitability of its traditional photo business, Kodak’s returns on shareholder investment have risen dramatically in recent years. And the company sailed into 1997 with superior new color films for sale at premium prices--”the first time in over a decade that Kodak and not Fuji has been first with a new product,” says an industry observer. Kodak stock hit $94.75 in February, an all-time high.

Then came trouble. Fuji, the $10-billion-sales Japanese company, cut prices 20% early in the year and gained market share in the $3-billion U.S. market for film. It has also made inroads in the market for film processing.

But Fuji wasn’t Kodak’s only problem. Also gaining share are private-label films produced by 3M Co. of St. Paul, Minn.; Konica Corp. of Japan; and Agfa Gavaert of Belgium. Those films are sold by stores under their own names in special promotions--such as “double prints and free roll of film, $3.99” Store brands now take 18% to 20% of the U.S. market.

Thus Kodak faces the erosion of prices common to most industries today, when there’s a glut of products everywhere.

But film photography is not a fading, commodity-product business. On the contrary, photography is on the verge of an explosion as huge markets begin developing in India, China, Russia, Brazil and other countries.

For Kodak, the high profits earned in the U.S. and other developed countries help finance the slow development of future markets where Kodak lends out cameras and develops pictures one or two at a time. “You have to build a photographic infrastructure,” says Carp, looking toward the day when vast populations around the world earn more money and buy cameras of their own to take pictures of the family.

Those future customers are what Kodak and Fuji are ultimately fighting for in their battles in the U.S., Japanese and European markets. Their larger battle includes a Kodak lawsuit against Japan’s distribution system for restricting Kodak to a minor, 9% share of the Japanese market. Fuji counter-sued, and the case is now before the World Trade Organization, with a decision expected by the end of this year.

Win or lose that case, Fisher, who forced Japan into concessions as head of Motorola, won’t back down in the competitive battle.

Nor will Fuji, which denies it has started a price war. “Fiction and balderdash,” says Rod King, head of Fuji’s U.S. operations. “We wouldn’t undercut our brand name.” Nonetheless, it’s clear that Fuji gave photo dealers extra film for their own profit and other deals to push its brand.

To understand why the present challenge is so critical for Kodak, you should recall how the company lost its way in the 1970s. People began taking family pictures with camcorders, but Kodak didn’t get into that business, explaining that it wanted to avoid the “consumer electronics” field. It failed to see that the business was pictures, not electronics.

Having missed that chance, Kodak--whose founder, George Eastman, invented the Brownie camera that allowed ordinary folks to take pictures--acquired drug companies.

Kodak left itself wide open for competition, and Fuji obliged, grabbing sponsorship of the 1984 Los Angeles Olympic Games and gaining customers among professional photographers. It became such a fixture among professionals that a magazine photographer taking a picture of Fisher at Kodak headquarters in 1996 absent-mindedly took out a green-labeled roll of Fuji film rather than Kodak yellow--to the horror of Kodak executives.

Fuji, in short, made itself a part of the U.S. market. It has now invested $2 billion to build plants in Greenwood, S.C., for photographic paper and film.

“Fisher should have cut prices years ago to discourage Fuji,” says a U.S. business executive, commenting anonymously on Kodak’s problem. “Now it must cut prices when that will hurt development of new products.”

As always with Kodak, history plays a role. When Fisher arrived, the staff was demoralized after rounds of layoffs. Fisher decided not to use layoffs but to go after waste in Kodak’s factories.

Fisher had other priorities, in any case. Having succeeded a Kodak management that had wasted resources on drug companies, he made it a point to invest in digital photography, which remains a commitment for the future.

Still, Kodak’s flab began to show. The company’s administrative expenses continued to rise, indicating an embedded bureaucracy. And high profit margins also funded million-dollar bonuses for Fisher and other executives--even as competitors came in under Kodak’s price umbrella to gain market share.

“Now the time has come: Kodak must cut prices here and overseas,” says analyst B. Alex Henderson of Prudential Securities. Henderson thinks Kodak stock will fall, at least in the short term.

Will the company, having recovered in so many ways from years of distraction, take the hard course of forgoing short-term profit, and executive bonuses and options, to recapture market share?

If it does, a more combative Kodak could be formidable. With its financial strength to back it up, aggressive pricing by Kodak could hurt Fuji’s ability to earn a return on its new $2-billion plants in South Carolina.

Add to that the power of the Kodak brand name. “It still has the most trusted brand name,” says Mitchell Goldstone, president of 30 Minute Photos Etc., an Irvine dealership.

Still, other American icons have faded in confusion as the competitive going in the modern world got really tough. It will take the next year and maybe longer to see if the picture of the new Kodak that emerges will be as focused as Fisher and Carp promised last week.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Negative Trend

Kodak’s share of the U.S. film market has continued to erode, from as much as 80% in recent years to 66% in 1997. Meanwhile, Fuji’s share rose to 15.9%.

1997 U.S. Market Share

Kodak: 66%

Fuji: 15.9%

Other: 18.1%

1997 World Market Share

Kodak: 39%*

Fuji: 34%**

Other: 27%

* Kodak’s estimate

** Fuji’s estimate

Sources: 1997 Photographic Marketing Assn. consumer survey, Prudential Securities