Embattled Kodak enters the electronic age (Fortune, 1983)January 8, 2012: 9:00 AM ET
Editor's note: Every Sunday, Fortune publishes a favorite story from our magazine archives. This week, as Eastman Kodak prepares for a possible bankruptcy filing, we look back as the company that Fortune called "the slow, deliberate master of the photographic industry" prepared for the fast-paced digital age.
The going was tough for Kodak, even then. This story provides a backgrounder on some of its most innovative technology, as well as the internal issues that kept it struggling, for so long, to keep its head above water.
By Thomas Moore
Inside the neat, period-piece brick buildings of Eastman Kodak's headquarters and manufacturing plants, spread over 3,000 acres in Rochester, New York, the slow, deliberate master of the photographic industry is whipping itself into a war frenzy. Kodak is arming to take on the combined might of the Japanese, Silicon Valley, IBM, Xerox, Du Pont, and a host of other forces that are threatening its profitability. The $10.8-billion-a-year company has finally decided, after ten years of watching and waiting, to enter the burgeoning electronics and video businesses in a big way. By its annual meeting next spring, if not sooner, Kodak will announce the formation of an electronics division that it has been quietly and carefully nurturing for the past seven years.
The company is counting on products from the new division to lift its sagging fortunes. Competition from upstart film companies has sent its profit margins into an extended decline and it faces an even greater long-run challenge from new technologies. Kodak's plan is to hang on to its markets, and profits, by combining electronics with its optics and film know-how. Down the road, the company plans to use electronics to enter new markets as well, as it already has so successfully with its high-speed copier machines. Kodak's Ektaprint machines have made serious inroads on Xerox's dominance in the top end of the copier business. Three out of every four dollars spent on new research projects next year will go into electronics, and the company is adding ten electrical engineers for each new chemical engineer it hires. The operative word among its executives, after a token protestation about not abandoning photography, is "imaging." Says research director Leo Thomas, 46, "We have a mandate to integrate electronics into the fiber of this company over the next five years."
Talk like that signals a veritable reformation at Kodak. The company viewed its cofounder, George Eastman, as deserving a place in the pantheon of the gods and elevated the chemical film technology he pioneered into a religion. Long after Eastman's suicide in 1932, Kodak clung to his cautious ways. If George didn't do it, his successors didn't either. The company passed up an invention called xerography, leaving the new technology to a then tiny Rochester company called Haloid. Kodak let Polaroid have the instant-camera business to itself for nearly 30 years. Wags joked that Eastman's ghost presided at board meetings.
The conservative strategy paid off despite the missed opportunities, at least through the Sixties. Kodak continually extended the frontier of film chemistry. Its technological edge, coupled with economies of scale from huge production runs, gave Kodak a virtual monopoly in photographic film and paper and made it one of the most profitable blue chip companies in the world.
That approach plainly isn't working anymore. Over the last decade Kodak's profit margins have declined from 15.7% of sales in 1972 to 10.7% last year. But it wasn't until the first quarter of this year, when the company announced a shuddering 73% decline in earnings, that outsiders realized how seriously Kodak's situation had deteriorated. Most of the decline was due to the onetime costs of a special early-retirement program, much of which will be made up in payroll savings during the remainder of the year. But operating earnings alone fell 24%, a decline that continued in the second quarter and may persist for the entire year. The company's stock, once a superstar, has been the worst performer among the Dow Jones industrials lately. In a raging bull market, Kodak has fallen 27% from a high of $98 last October. The stock is at less than half its price of a decade ago.
Kodak's inner peace was rudely disrupted in the Seventies when Japanese film manufacturers broke its lock on the lucrative color film and paper markets, which historically accounted for 75% of the company's profits. The Japanese, led by Fuji Photo Film, improved their production efficiencies and quality to the point where most consumers couldn't see much difference. At the same time, Kodak did little to improve its own productivity in the face of rising costs. When the Japanese began to compete aggressively in price, they not only cut into Kodak's market share but also squeezed its margins. Some analysts estimate that its share of the U.S. photographic paper business plummeted from 92% to 50% during the Seventies. The Japanese gains in the film market came mostly at the expense of secondary companies like GAF, but Kodak is now feeling the pressure as well.
The advent of video cameras and recorders unsettled Kodak's markets even more. Despite being priced much higher than Kodak's latter-day Brownies, video products have been selling faster and faster ever since Sony introduced its Betamax machine in 1975. Home video is now a $3-billion business in the U.S.--already a fifth the size of the photographic industry. For the first five months of this year, according to Mark Obenzinger, a security analyst with Lehman Brothers Kuhn Loeb, shipments of video recorders are up 104% and video cameras 22%. The recorders and cameras don't use any film, of course, and Kodak doesn't make videotape. Photo specialty stores are adding video equipment to their wares to make up for lost sales in conventional photography.
Former Kodak chairman Walter Fallon, the tough technocrat who was heralded at his retirement party this June as the man who made the elephant dance, attributes the company's poor performance to adverse economic conditions rather than false steps. In particular he bemoans the markets outside the U.S., where Kodak makes 40% of its sales and has achieved much of its growth in recent decades.
Kodak's new chairman, Colby Chandler, 58, an amiable Down Easter who drives a pickup truck to work, says profits will recover with the world economy. Wall Street is less sanguine. The first-quarter earnings decline, following a 6% drop in 1982, sent previously upbeat analysts scurrying to their calculators to revise their estimates for the year. Kodak earned $1.16 billion, or $7.12 per share, in 1982. Some analysts now figure it will be lucky to make $5 per share this year--little more than half what they were predicting 12 months ago.
Kodak's record over the last decade suggests that recovery alone won't be enough to restore prosperity. Of four major product lines launched under Fallon, only the high-speed copiers are paying off. The Ektaprint copiers, which receive top marks in quality and reliability, have become the company's fastest-growing product line. Kodak executives say the seven-year-old Ektaprint business, if spun off as a separate company, would make the FORTUNE 500.
The company wasn't so lucky with the Kodamatic instant camera, basically a Polaroid clone that came out just as instant cameras were losing popularity. Analysts doubt that the Kodamatic has made any money for the company. Kodak's president, Kay Whitmore, 51, says the camera's future will depend on whether a new feature that allows users to peel the photo from its bulky chemical backing boosts sales.
The Ektachem 400, a two-year-old blood analysis machine that uses dry chemical slides rather than liquid solutions, got off to a poor start because it performed only a limited number of tests and proved unreliable. The machine was supposed to preserve Kodak's faltering presence in the health care market. Sales of X-ray film, under pressure from competitors like Du Pont and from filmless scanners, have gone nowhere for three years. The company is hoping for better results with a new blood analyzer, the Ektachern 700. The machine performs 25 series of tests, half again as many as its predecessor can do. An operator can order up a test simply by touching a word on a video screen. The machine can be tied in to computerized patient records and clinical data sources. Kodak foresees smaller versions of the machine for use in doctors' offices.
Kodak's disc camera, launched with much hoopla last year as a replacement for the phenomenally successful pocket Instamatic, has also proved disappointing. The company shipped eight million disc cameras last year, a first-year record for a new camera format. But more than a million of those cameras were sitting on dealer shelves after Christmas. Hot-selling 35mm point-and-shoot cameras are now priced as low as most disc models, and pictures from the tiny disc negatives are grainier than buyers expected. The graininess has cut down picture taking by photo enthusiasts who bought the disc as a secondary snapshot camera. Says Sean Callahan, editor of American Photographer, "The disc has charming cosmetics, but after four or five rolls the quality of the pictures outweighs the convenience."
The disc has sold poorly in Europe and Japan, the two largest markets outside the U.S. and ones that are more accustomed to 35 mm quality. "To say the disc has not met company projections abroad," says one industry source, "would be inaccurate. It's getting murdered."
Kodak denies that sales in those two markets, where its regular cartridge-loaded cameras have never sold well, are worse than anticipated. "The novelty factor has worn off in Europe," says Phillip Samper, 49, the new head of the photographic division. "Now we just have to get out there and move the cameras." The company's research shows 90% of disc users in the U.S. are satisfied with the camera, and that its high "yield rate"--93% of the pictures are printable as opposed to 75% for the pocket Instamatic--more than makes up for the graininess.
The disc's future is being decided this summer. Picture taking is heaviest in summer and dealers gauge the activity to determine their camera orders for the Christmas selling season. But the camera already seems unlikely to enjoy the eight- to ten-year life cycle of its popular predecessors--and may last only half as long. A shorter life would give Kodak less time to recover its development costs, which security analysts estimate at over $ 300 million.
The uneven performance of its new products and the most serious competition in its history have stirred the Kodak elephant into action--even into uncharacteristic flashes of anger. Walter Fallon is said to have pounded the table when he learned that Fuji had snatched the sponsorship of the 1984 Olympic games while his negotiators dithered. If somewhat belatedly, the company has launched a major program to coordinate planning around the world, increase productivity, and reduce costs. Two years ago the company reshuffled some of its foreign production. Many of Kodak's international divisions were manufacturing identical products for their regions, often at higher costs than at the main factory in Rochester. Kodak brought the high-cost foreign manufacturing home--just in time for part of the $55 million in productivity gains to be offset by the strong dollar, which boosted the cost of the products when exported.
This year Kodak instituted a special early-retirement program, announced it was postponing next year's pay raises for six months, and made its largest layoffs in a decade. Says Whitmore, "We are looking less at reducing a given percentage of people than whole functions."
Chandler, who made his mark by leading Kodak's assaults on Polaroid and Xerox, criticizes what he says was an ad hoc approach to product development and has ordered up the company's first corporate-wide strategic plan. "We can no longer be all things to all people," he says. "Kodak is a little like the government in that it takes things on much easier than it can get rid of them."
Traditionally dominated by its technical side, Kodak has given its marketing departments a louder voice, if not the final say, in the company's direction. Kodak's two marketing stars, Samper and Wilbur Prezzano, 42, manager of worldwide marketing, have moved up to the second and third spots in the unofficial line of succession after Whitmore. Kodak has never allowed a marketer to run the company. Gerald Zornow, chairman from 1972 to 1976, got closer than any other, but still was No.2 to Fallon.
Kodak also has abandoned some of its fusty ways and finally adopted tactics that have long been standard procedure at other multinationals. It has created a marketing intelligence group, issued its first significant debt ($275 million of convertible debentures), purchased more than $1 billion in tax-benefit leases, and started hedging its foreign-currency risks in the futures market.
Most important, Kodak has finally decided it would rather switch than fight, and has joined the electronics revolution. Over the last decade the company made sure its research labs kept up to speed with fast-changing video technology. In fact, it developed a video system of its own in the early Seventies. "We had a hell of a good product," recalls Zornow. "We had both a video-movie and a still camera, and the quality of the image was excellent on a TV screen. We killed it off, though, when we found out what the costs were."
To get a window on the video business, Kodak also bought a small California company called Spin Physics in 1972 that specialized in magnetic recording heads for highdensity data storage. But Kodak sat on its video know-how in the Seventies and decided to commit its resources to instant cameras and copiers instead.
The company has now changed its mind. Among other reasons, Kodak was mightily annoyed when Sony, upstaged its announcement of the disc camera last year by unveiling a "revolutionary" video still camera called the Mavica and promising to have it on the market in the U.S. right about now. Kodak knew that current solid-state sensors could not capture anywhere near as much picture "information" as silver-emulsion film. Sony's best sensors last year contained about 280,000 picture elements, compared with the four million-plus needed to match the comparatively poor quality of the ordinary 110-size negative that is used in pocket Instamatics.
The video picture looked all right on a TV screen, but was fuzzy when printed. Given the high cost of the sensors, the camera itself would have to be priced over $1,000, making it too expensive, in Kodak's opinion, for a mass market. But the idea of taking pictures, showing them on a TV set, printing out hard copies, and then erasing the tape to take more, all without having to buy film and send it to a developer, caused quite a stir in the photographic world. The technical problems were lost on a public accustomed to the wonders of electronics.
Instead of ignoring Sony as in the past, Kodak decided to reveal its own electronic imaging capability-and zap Sony's Mavica. Last October at the Photokina trade fair in Cologne, West Germany, Kodak demonstrated a video display unit that allows disc film negatives to be shown in color on a television set. Thomas, the research director, made it a point to give a personal demonstration of the new device to his counterparts at Sony. The video display unit was conceptually inferior to what Sony had in mind: the disc film still had to be sent to a developer and could not be erased. But the demonstration revealed that Kodak had a solid-state sensor with 50% more pictorial capability than Sony's "state of the art" Mavica. "They were very impressed," says Thomas. Today Sony doesn't like to talk about the Mavica, except to say that Japanese newspapers are now experimenting with a black and white version. It has nothing to say about the color version anymore.
That Kodak exhibited its video display unit, which is still under development, was unprecedented for the company. Kodak usually doesn't hint at what it has in the laboratory until the product is ready to sell. Not only did the gesture demonstrate Kodak's strength in electronics, it also showed a new competitive zeal that the company will sorely need in the frenetic electronics business.
Kodak's experiences with electronics haven't all been so positive. It has run into a host of problems with Atex, a manufacturer of electronic publishing systems for newspapers and magazines that it bought in 1981--only its second major acquisition in over 50 years. A typical high-tech success story, Atex was started in 1972 by three entrepreneurs, literally working in a garage, and grew to become the leader in its field, doing $50 million of business a year when Kodak bought it. Since then, the three founding partners and eight vice presidents have departed. Kodak found itself stuck with a system of "dumb" terminals dependent on central computers when the industry was moving to "smart" terminals with computer capabilities built in. Atex is quickly losing its technological lead in the industry.
"The people at Kodak are hardworking but bureaucratic," says Al Edwards, a former Atex vice president who defected to Systems Integrators Inc., Atex's top competitor, because he couldn't abide Kodak's poky pace. "They do not understand the competitive nature of computer technology. You sometimes have to react to the marketplace on a weekly basis. At Kodak, if you came up with an idea, it would be five years before you saw the product."
Edwards estimates Atex shipments will be down about $20 million this year and the company will lose money. Kodak maintains it is still the market leader and that sales will be about the same as the $85 million last year. "Sure, some people have left here and we've had some bad times," says Joseph Quickel, 62, Atex's third chief executive under Kodak. "But that's one of the hazards of the electronics business, and now we've successfully made the transition."
Spin Physics has fared better under Kodak's stewardship. It continues to be a leader in its field, and two of its products will be seminal to Kodak's electronics effort: a new high-density magnetic surface for both tape and computer discs, and a high-speed video system that can play back the action of fast-moving equipment in slow motion so engineers can analyze problems visually.
Spin Physics has been so successful in the magnetic recording business that Kodak, after holding the subsidiary at arm's length for a decade, has decided to embrace it as one of three building blocks of the new electronics program. The other two blocks: a solid-state research laboratory and a facility to design and produce integrated circuits.
One important question about Kodak's electronics effort is whether a big, stodgy company in gray, nonswinging Rochester can attract and hold the notoriously disloyal electronics cowboys who thrive best in Silicon Valley. Kodak has had no trouble recruiting electrical engineers. But finding managers with an electronics background has been tougher. James Lemke, a co-founder of Spin Physics who stayed with the company, was offered a top job at the new electronics division but turned it down because he didn't want to move from California to Rochester. Still on Kodak's payroll, Lemke is helping to set up the Center for Magnetic Recording Research at the University of California at San Diego. The center, supported by Kodak, IBM, and more than a score of other companies, is the country's first pooled research effort in magnetics.
Kodak has yet to name a director for the new division, and hasn't filled other important slots. "We clearly have to attract people into the company who don't exist here now," says President Whitmore. That in itself will be a major departure for Kodak; few if any of its senior executives ever worked for another corporation. Gerald Zornow, for one, doubts that outsiders can successfully adapt to the Kodak culture. "They tried some people from the outside before and it never worked out," he says. "Kodak is like an old family that grows up together, and it is tough for outsiders to fit in."
Venturing into the volatile electronics business obviously is a gamble for Kodak, but the company doesn't have much choice. A competitive electronic still camera is at least a decade away, and electronic imaging technology will probably never fully match the quality of silver-based film. Amateur and professional photography will always be a large business, though possibly a much diminished one. Video has already begun to undercut many of Kodak's consumer and commercial applications. TV news film, for instance, has been eliminated by the immediacy of videotape. To the extent people use the latest generation of small video cameras to shoot movies of the kiddies, still photography suffers.
The biggest question about Kodak is how well it can play in a different and tougher game. Increasingly Kodak will be competing in a business where it is not the worldwide leader, where it does not have a technological edge, and where it does not have a significant cost advantage. And it will not have a unique strategy. The same competitors that have bedeviled Kodak in the photographic business are also going electronic. Fuji, the fastest comer in film, makes videotape. Canon, Minolta, Olympus, and Pentax--companies that bested Kodak in still camera technology--already sell TV cameras.
All corporations must be alert to changes in their technologies and their markets. Its move into electronics, however tardy, indicates that Kodak has the flexibility to adapt to a new world. Considering the company's roots, that's not terribly surprising. The lesser known of its co-founders was a man named Henry A. Strong who decided to gamble that young George Eastman's dry photographic plates might lead to something. Strong made buggy whips.