Kodak Refocuses to Keep Up With Customers

By Edward Cone  |  Posted 06-05-2005

Kodak Refocuses to Keep Up With Customers

Eastman Kodak Co. has a really big problem. The photographic film business that sustained one of the world's great brands for more than a century is headed the way of the daguerreotype. Digital cameras and images are the new mass market; in order to survive, Kodak must transform itself into a digital products and services company to replace the revenue lost as its traditional markets dwindle.

Last year, nearly 61 percent of Kodak's $13.5 billion in revenue came from its traditional businesses, including film, paper and the nondigital products used in its healthcare, graphic communications and commercial imaging segments. But the first quarter of 2005 was terrible, with total revenue off 3 percent and a net operating loss of $143 million. The company expects sales from traditional business to drop another 17 percent this year, due in large part to the decline in demand for film.

The good news is that consumer digital sales are racing in the opposite direction, up 44 percent last year. Kodak shipped nearly 5 million digital cameras to pass Sony Corp. as the leading U.S. digital camera vendor in 2004. And Kodak's revenue from digital products is expected to surpass film revenue by the end of this year. But there is a cloud around that silver lining: Margins on digital products are much thinner than those on film, typically 10 percent for digital cameras versus 60 percent to 80 percent for film. So replacing a dollar of lost film revenue with an equal volume of digital sales still leads to lower profits, making the growth challenge even more urgent.

Company Profile
Since its founding in the late 1800s, Kodak has devoted its energies to the mass market.
Corporate Headquarters
Rochester, N.Y.

CIO
Kim VanGelder

Revenues
$13.5 billion (trailing 12 months)

Net Income–
$70 million (TTM)

Stock Price
$26.79 (May 26, 2005)

52 week high-low
$25.19–$24.63

To balance the old business with the new, says Kodak Chief Information Officer and Vice President Kim VanGelder, "we need to drive down cost dramatically and drive up growth. The challenge is to execute on both cost-cutting and innovation concurrently." Information technology, she says, "is fundamental to both," and the dual imperative is redefining her role at the company. "It feels like a different job, to simultaneously manage both a decrease in costs and to focus IT across the globe on changing processes and products as we grow," she says.

Other CIOs are feeling the same pressure as companies move beyond the belt-tightening of the post-bubble era. "There has been a huge shift over the past 18 months, from a focus on cost to a focus on growth," says Graham Waller, an analyst with Gartner Inc. Delivering projects that promote business growth was the top issue cited by CIOs in a recent Gartner survey. "The leading IT organizations are doing more to support innovation," says Waller.

In another recent survey of business and technology executives by Bain & Co., 86 percent of respondents agreed that innovation is more important than cost reduction for long-term success, with 89 percent saying that IT can create significant competitive advantages.

The Ties That Bind

The Ties That Bind

Since becoming CIO in January 2004, VanGelder has tightened the connections between IT and Kodak's research and development group, where she once headed the internal IT staff. At the time, she reported to James Stoffel, the company's former chief technology officer and R&D chief, who retired this year. Now her successor, Vicki Nagy, reports to VanGelder. "IT is much closer to R&D than ever before," says VanGelder, a veteran of more than two decades at the Rochester, N.Y., company. "R&D leverages much more of our IT infrastructure now than in the past, as we work collectively to drive out costs. Given that our growth is in digital products and services, we are also able to leverage our IT expertise, contracts and infrastructure into the commercialization of our digital products and services."

The IT organization doesn't actually write the software that powers Kodak's hugely successful EasyShare cameras and printing docks. Instead, it makes available the computers, software, networks and testing environments to support development, along with expertise on issues such as information security. Says VanGelder: "Developers have to understand how these products will work on a variety of systems, and simulate performance in the real world. That means a greater variety of hardware and software is required in R&D. We help with managing that and keeping it secure—cases where our expertise is portable to the product world."

Current CTO and R&D chief Bill Lloyd expects the relationship with IT to continue to develop as the product mix shifts ever more toward digital. "Future imaging products and services require increasingly sophisticated software to assure that Kodak delivers on our customers' expectations for quality and ease of use," he says.

Using IT to help differentiate products from those of competitors, rather than just looking to it for efficiency, is a key challenge for mature companies, says Geoffrey Moore, managing director of TCG Advisors LLC in San Mateo, Calif., and author of the forthcoming Dealing with Darwin: How to Innovate Forever in Established Enterprises (Penguin, Dec. 2005). But it can be a critical step in moving successfully into new markets and product categories. Established companies often have great difficulties with innovation, says Moore. One reason for this lack of fresh thinking is that many products—think IBM Corp. mainframes—remain highly profitable even as the next generation of products that will replace them begins to gain market share. "But it is hideous when the bottom falls out," he says.

Innovation means more than new products and services. It also involves the way they are produced and marketed, and CIOs are expected to improve those functions by working with different partners across all parts of large enterprises, says Gartner's Waller. "The job for IT is combinatorial innovation, the net effect of end-to-end business processes, not a silver bullet that solves all the problems at once," he says.

Kodak Moments
Since its founding in the late 1800s, Kodak has devoted its energies to the mass market.
1888 George Eastman registers Kodak trademark (it's a made-up word) and begins selling simple cameras that use film instead of plates.

1900 The first Brownie camera. It would be a mass-market favorite for generations.

1928 KodaColor film for color movies introduced.

1935 Kodachrome film introduced, bringing color photography to the masses.

1961 The carousel slide projector makes it easy to torture guests with vacation shots.

1963 The superpopular Instamatic camera is launched.

1989 Disposable cameras introduced; wedding receptions are never the same again.

1990 World's first completely digital consumer camera introduced—the Dycam Model 1.

1993 Former Motorola CEO George M.C. Fisher signs on as chairman and CEO as Kodak looks to uncertain future.

2001 Kodak launches EasyShare cameras, buys Ofoto online image service.

Source: Eastman Kodak Co.

Kodak must build on the success of its digital cameras with products like a simple-to-use docking system that lets users print photos from the EasyShare cameras, and services such as its as-yet-unprofitable offerings for online storage and management of digital images. But to do so it must rethink its business processes as well. The transformation into a consumer electronics company means that everything, from the global supply chain to target markets, is changing, and some of the old formulas that worked in the film industry don't necessarily apply anymore.

"There are differences in the way we look at it for our more traditional businesses versus the lower-margin electronic products," says VanGelder. "Much of our current efforts are focused on such areas as improved end-to-end supply-chain visibility. We are shifting to a much leaner company, capable of quickly commercializing products and services in a rapidly changing marketplace. Rather than simply adjusting to this change and reacting more quickly, IT needs to work with the businesses to help identify the possibilities."

The newer business lines have implications for managing for cost efficiency, too. A massive enterprise resource planning project built around SAP software has been rolling out across the company for several years, for example, but it had to be reconsidered when applied to the lower-margin digital product lines. "With the lower margins in the electronics business, we asked ourselves if what we had been deploying would still work," says VanGelder.

Ultimately VanGelder decided to stick with the system. "It was not a neat, one-day decision, but over time we determined that our ERP would work into the future," she says. "We had to go through the process of figuring out what would work and where we could bolt something on to extend it into the digital business. In the end we determined that we could continue to deploy the back-office systems to take costs out of our operations."

Kodak used cross-functional teams to adapt the systems to a digital business model that involves many more relationships with suppliers than its traditional business. "It's a real horizontal supply chain," says VanGelder. "To bring data from our planning and supply-chain software into the ERP system, we had to put together teams from many different functions, including IT, to understand how it all fits together."

Culture Shock

Culture Shock

Managing for innovation means a major culture shift at once-stodgy Kodak. "For years, the mind-set at Kodak was like the civil service," says analyst Ulysses Yannas with Buckman, Buckman & Reid Inc. in Shrewsbury, N.J. "It was like management from the Dark Ages. Things have changed." That starts at the top, where former Hewlett-Packard Co. executive Antonio Perez—part of an influx of talent into the company in recent years—became CEO and president on June 1. Perez succeeds Daniel Carp, who in 2003 set the goal of getting more revenue from digital products and services than from film by the end of 2005. But such changes were a long time coming. Former Motorola Inc. CEO George Fisher met resistance when he arrived in 1994 as a would-be change agent.

Nowhere were the changes more essential than in R&D. The problem was not a lack of resources—Kodak has more than 4,000 engineers and scientists on staff, and a global network of research labs. But those assets were under-utilized. Kodak has invented great stuff over the years, including a copier system that might have given Xerox Corp. a run for its money a generation ago, had Kodak taken its version to market. But patents and new product lines were allowed to languish as cash rolled in from the film business, and Kodak often disdained technology invented elsewhere.

"What's gotten in the way has always been culture," says Christopher Chute, a senior research analyst with IDC who follows the digital photography market. It took the digital revolution to blow that mind-set away. Now Kodak is willing to buy what it needs, such as the digital sensor technology for cameras and phones it purchased from National Semiconductor Corp. in 2004. And it has rethought its consumer market, too. As competitors like Canon Inc. and Nikon Corp. peddled expensive cameras to technophiles, Kodak decided to market relatively low-cost, easy-to-use products built around the best software in the business. "They reminded themselves of what they came from 100 years ago—making it easy to share images," says Chute.

Resources
Reports
"The CIO's Role in Accelerating Business Innovation"

By David Moschella and -Bettina von Stamm
Computer Sciences Corp.

"Client Issues 2005 for Business Innovation: Imperative for Success"
By Carol Rozwell, et al
www.ponemon.org

Kodak's IT group, which ushered in the era of massive IT outsourcing with its famous 1989 deal with IBM, is part of the change to a more interconnected, forward-thinking culture. "I feel much better prepared for this position thanks to the R&D job I held," says VanGelder. There was at first a fear of change within R&D, says Vicki Nagy, who replaced VanGelder as IT director there. "People wanted to know if they would still get the unique things they needed, or be forced onto look-alike systems. We had to teach our IT help desk to become a one-stop shop for all users. But we've built enough credibility to start playing a broader role in the labs as they work on things like how products scale, integrating security, and Web services." Still, there is more to be done. Says VanGelder, "We have not reached the limits of collaboration in areas like storage, and in product needs such as networking and wireless."

One way of sharing information across the company is the Kodak Technology Council, headed by CTO Bill Lloyd and made up of R&D staff members and managers from the technology and business organizations. It meets to consider issues such as privacy policies for image files and the network architecture needed to share information across the company's globally distributed design organization. "The key is to make sure you have senior, credible IT people working with the businesses and different functions," says VanGelder. "You need that day-to-day interaction in such an extraordinarily dynamic environment."

In the era of online image services, Kodak IT is also closer to the customer than it was in the past. So far, that mostly means tying the Kodak.com online store to back-office systems. "We provide networks and servers and security, and we have to make sure Kodak's online architecture is scalable," says VanGelder. "Ultimately, we see broader opportunities in managing digital assets and providing consulting services to the company's product groups."

Kodak's ability to execute its transformation strategy will determine the fate of one of the most famous names in business history. Wall Street is taking a cautious view, with Kodak shares trading near their 52-week low of $25—less than half their price five years ago. But there is optimism among Kodak watchers, too. Securities analyst Yannas expects new products such as dry inks for printers to help improve profit margins, and says that the growing volume of prints made from digital images will cause Kodak's photographic-paper business to start growing again in 2006.

Innovative products and services such as online image management could propel the venerable company into a successful new era, says IDC's Chute. "Five years into the future, Kodak may be a smaller company in terms of revenue, but a healthier one."