Kodak Shifts Focus From Film, Betting Future on Digital Lines

By JAMES BANDLER
Staff Reporter of THE WALL STREET JOURNAL

Finally yielding to technology changes that have made its signature product outdated, Eastman Kodak Co. is preparing a big strategic move away from traditional film and plans to bet its future on new digital markets.

In a risky move that the company characterizes as a historic shift, Kodak announced Thursday that it will boost investment in nonphotographic areas and make new forays into digital territory dominated by big, entrenched competitors. It intends to compete head-on with Hewlett-Packard Co., Canon Inc. and Seiko Epson Corp. by launching a line of ink-jet printers for consumers, an effort that could be several years away. Kodak, leveraging an existing joint venture, also plans to expand its product line in the high-end digital-printing market, in a challenge to leaders Xerox Corp. and H-P. Kodak plans to slash its dividend to 50 cents from $1.80 to help fund the revamp.

At the same time, the company says it will make no more significant long-term investments in traditional consumer film -- nothing, it says, as ambitious as its move to develop the alternative-format Advanced Photo System in 1996.

To hold onto as much of its film franchise as it can, Kodak also will begin actively making private-label film that will be sold under non-Kodak brand names abroad. It also vows to be more aggressive in pursuing market share, a shift from its previous strategy of using its premium brand to keep prices high.

Kodak's moves parallel those at many companies whose comfortable business models have been threatened by rapid changes in information technology. The struggle to survive and adapt to this change has become one of the broadest themes on the corporate stage, with success by no means guaranteed.

Among the more spectacular successes, Intel Corp. made a lucrative jump in the mid-1980s from the memory-chip business to microprocessors. But Kodak's longtime rival Polaroid Corp. was forced into bankruptcy protection in 2001 after its repeated new-product efforts failed to find a replacement for its outdated franchise in instant photography. AT&T Corp. still is struggling to find its way after diversifying out of long-distance phone services into cable television and wireless communications. Even the venerable New York Stock Exchange, where technology updates have helped to build market share, is pondering renewed calls to abandon its 211-year-old human-auction system in favor of an all-electronic market.

For Kodak, the risks are at least as sizable as the opportunities for growth. The markets Kodak has decided to emphasize are highly competitive. Consumer printer makers have aggressively cut prices in their quest for market share, making many models available for under $100. And if film profits fall too fast, Kodak won't be able to fund its digital drive.

Indeed, the balance sheet already is a concern to some Kodak watchers. As the company unveils its new strategic thrust, it also announced Thursday that it would slash its stock dividend to 50 cents from $1.80. There has been widespread anticipation of a cut in the payout, now equal to about 6.7% of Kodak's share price. That yield was one of the highest among blue-chip stocks at a time when Kodak's revenue has been falling and its debt is under review for possible further downgrading by Standard & Poor's rating service.

Kodak has been aware of the digital threat to its traditional franchise for years. It has built revenue in other areas, including health care, where it has a profitable digital-imaging business. The company also makes digital cameras and has a big Internet photo business targeting consumers.

Kodak had, however, been counting on steady growth from consumer film sales, especially in emerging markets such as China, to ease its transition to new technologies. The decision to shift into a higher digital gear was motivated in part by a faster-than-anticipated acceleration in consumers' shift from film to digital photographs. In July the company said the drop-off in film consumption is happening twice as fast as Kodak had expected at the beginning of the year.

Kodak Chief Executive Daniel Carp calls the years of uncertainty about when he'd have to make this call "gut-wrenching" and says he now feels like a "burden is off" his back. "Now that the film business has clearly shown its hand, it's easier to get on with the transformation of the company," he says.

The plan won't be executed on the cheap. It calls for $2 billion in moderate-size acquisitions over the next three years and significant further investments in the new growth areas.

The plan, Kodak predicts, will expand revenue by 5% to 6% a year, taking the annual figure to $16 billion by 2006 and to $20 billion by 2010, from around $13 billion. (Kodak is using as its base last year's revenue of $12.8 billion. However, it says it won't make 6% growth this year and is predicting faster growth in years to come.)

It also calls for net debt, a combination of short and long-term debt minus cash, to drop below the $2 billion it held at the end of 2002. The company believes it will be able to achieve annual earnings per share of $3 by 2006, compared with an estimate of $1.78 for 2003 from a Thomson First Call survey of analysts.

Kodak chief executives have made rosy forecasts before, but the riches never materialized. Mr. Carp's predecessor, George Fisher, predicted in 1999 that the company's revenue would be growing by 8% to 12% annually by the end of this year.

Instead, revenue has fallen four years in a row. In the consumer arena, the company's profitable traditional-film business is being overwhelmed by filmless digital photography. The stock, which closed Wednesday at $26.99, is about 70% off its 1997 high, and Kodak's debt now hovers one notch above a so-called junk rating, according to Moody's Investors Service.

But Mr. Carp, a Kodak lifer, already has made moves that have distinguished him from his predecessors and rattled the culture of the company, which is based in Rochester, N.Y. Executive by executive, he has replaced a top management cadre steeped in the ways of traditional photography with a team that has almost a pure digital pedigree. Except for Mr. Carp, almost every senior executive hails from outside, a group that includes new hires from Lexmark International Inc., Hewlett-Packard, General Electric Co. and Olympus Optical Co.

Today, traditional film and photography account for 70% of Kodak's revenue and all of the company's earnings from operations. By 2006, the company says, its traditional business will shrink to 40% of revenue and half of all earnings. Currently losing money, the digital business, meanwhile, will grow to 60% of revenue from its current 30% over the same time frame, and will account for half of earnings from operations, the company predicts.

The plan anticipates that Kodak's traditional-film business will shrink by 7% annually through 2006. The company expects digital revenue to grow over that period by 26% a year -- a brisk rate that may be hard to achieve, as it would mean bigger gains by Kodak than many seasoned technology companies currently are able to generate. Kodak says its overall consumer digital business -- cameras, online photofinishing and ink-jet paper -- will be profitable by 2004.

But creating the new Kodak will require sacrifices. The company says it will sell or close about $1 billion in ancillary businesses, including its decades-old slide-carousel business. It also plans to reduce the number of types of traditional film and photography products it sell at stores, focusing on its top sellers. And Kodak's work force, which has shrunk by 30,000 jobs since 1997, is likely to continue shrinking. In July, the company said it would have to fire as many as 6,000 workers because of the drop-off in film sales.

Kodak President and Chief Operating Officer Antonio Perez has conceded that the company is behind the curve in printers, an area it regards as key to its future digital profits. This is not for lack of effort. A joint attempt three years ago to introduce a desktop photo ink-jet printer with Lexmark flopped, partly because the product's direct-to-camera interface never caught on. Most consumers make their digital prints via PC-to-printer links. Kodak says its newly introduced system for docking a thermal printer with a PC, designed for greater ease of use, is faring much better, and will chalk up a respectable $100 million in sales in its first year.

In another product area that looked promising, retail digital minilabs that make prints from either digital or film-based machines, Kodak had to deal with machines, made by a manufacturing partner, that broke down frequently. Fuji Photo Film Co.'s rival Frontier machines, meanwhile, are gaining market share. Kodak has a new minilab partner, Noritsu Koki Co. of Japan, and says the machines have been "well received."

Phogenix, a joint venture between Hewlett-Packard and Kodak to develop smaller digital photo printers for retail outlets, crumbled this year because the technology already had become passe by the time the machines were brought to market.

Still, Kodak has had some notable digital successes. Kodak's popular EasyShare cameras were the second-best-selling digital cameras in the U.S. in the first half of this year, behind only those of Sony Corp., says market researcher International Data Corp. After successfully focusing on the lower-end of the camera market, Kodak now plans to begin selling more-expensive digital cameras aimed at tech-savvy shutterbugs.

Kodak now claims to be tied with H-P for the lead in sales of photo-quality paper for the home market. It also has the most walk-up kiosks for digital processing in retail settings.

But Kodak's plan to enter the ink-jet market is a tacit admission that its home-printer strategy, which until now has hinged on more expensive thermal-paper technology, isn't sufficient to achieve critical mass. Mr. Perez, who led Hewlett-Packard's printer business, says the home printer market is a "critical" one for Kodak, which he says has a broad portfolio of ink-jet-technology patents. "Our intent is to be a key participant in home desktop printing," he said, declining to provide further details.

In commercial printing, Kodak already has a joint venture with German printer titan Heidelberger Druckmaschinen AG to make high-speed digital printing machines. The NexPress-branded machines are designed to perform short printing jobs and, Kodak says, compete with Hewlett-Packard's Indigo printers and with Xerox's iGen3.

Kodak now intends to be a more-active player in the NexPress joint venture, where it has been a "little bit of a passive investor," says Mr. Perez. James Langley, the new head of Kodak's commercial-printing operation, who formerly headed H-P's commercial printing business, says new plans call to broaden the NexPress portfolio to include less expensive machines.