CASE ANALYSIS: Eastman Kodak Company

Sara Seed March 2, 2006

BUSA 499: Strategic Management Pacific Lutheran University

Dr. Pham

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CASE ANALYSIS: Eastman Kodak Company

Executive Summary

The purpose of this report is to analyze the strategic position of Eastman Kodak Company (Kodak) and discern any sustainable competitive advantages held by the company. Beginning with a discussion of Kodak’s industry and commentary on the political, economic, social, and technological environment in which the company operates, the report then narrows to focus on Michael Porter’s Five Forces: barriers to entry, threat of suppliers, threat of buyers, threat of substitutes, and rivals. Once a thorough analysis of the industry and its environment is complete, it is necessary to detail Kodak’s value chain and identify resources and capabilities specific to the firm. Finally, these core competencies are subjected to a VRIO analysis to determine if they are valuable, rare, and not easily imitable. If the Kodak has the organization in place to utilize these resources and capabilities, they have a sustainable competitive advantage. The Company Kodak Company was founded in 1880 in Rochester, New York and engages in the imaging technology industry. The company operates in four segments: Digital and Film Imaging Systems, Health, Commercial Imaging, and Graphic Communications. For most of its history, Kodak focused on film technology and became a world leader in film and film camera sales. In the mid-1970s, Kodak controlled 90% of the film market. With the advent of and increasing demand for digital imaging technology throughout the 1990s and early 2000s, Kodak faced declining demand for its film products and decreasing market share in the overall camera market. Industry Yahoo! Finance lists Kodak in the “photographic equipment and supplies” industry. Kodak is the second-largest player in this industry, with a market capitalization of $8.1 billion, behind Canon ($58.4 billion); however, Kodak competes with other companies not categorized in this sector, such as Sony and Hewlett Packard. Kodak’s 2004 annual report defines the industry as “imaging technology,” which is a broader, more ambiguous phrase, but it more accurately depicts the field on which Kodak competes. The industry is no longer defined by who can provide the best equipment or supplies. Instead the industry is defined by who has the newest and most innovative technology. It is important for Kodak to view itself as a player in the imaging technology business rather than simply photography. As discussed in the technology section of the following P.E.S.T. (political, economic, social, and technological environment) analysis, digital imaging is seeing growth in areas that traditional photography (point-and-shoot film photography with little versatility) never could have entered. Kodak is in the business of developing, producing, and selling imaging technology in whatever form it requires. While Kodak and its competitors operate worldwide, this report will focus on trends in the digital camera market United States. The company operates in several businesses outside the digital camera market, which will be discussed as pertinent to the analysis, but the case focuses specifically on digital cameras. Furthermore some discussion of international opportunities and markets is necessary, yet a full analysis of Kodak in a global context is beyond the scope of this

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report. Instead, the focus will remain on the political, economic, social, and technological environment of the U.S.. P.E.S.T Analysis Political Environment There are two major issues in the political environment of the United States that directly affect the market for image technology products. While there are likely numerous political issues that could affect Kodak’s business, patent infringement and privacy are two that continuously lead headlines. As technological advancements are made at faster rates, Kodak is faced with an increasing likelihood of involvement in patent infringement suits. Technologies build upon each other, and Kodak may find itself using other company’s technology or vice versa. Furthermore, with the high rate of advancement and large research and development budgets of Kodak and its competitors, it is possible that competing companies may develop the same technology independent of each other. This could lead to patent infringement issues depending on when products are released and how dependant products are on a particular technological advancement. Kodak and Sony were involved in patent infringement suits with each other that could result in payments of hefty licensing fees for either company. Privacy also becomes a prominent political issue as digital technology becomes smaller and more compatible with unrelated equipment already in everyday use. For example, cameras embedded in cellular phones have been used to take pictures underneath women’s skirts on crowded public streets. Phones with cameras are often not allowed in defense facilities or companies that protect extensive research and development with high security. Also, digital imaging allows large-scale distribution of images that was not possible by the average consumer as little as 15 years ago. As privacy laws are continually established and redefined in the age of the internet, Kodak must evaluate the implications of how consumers make use of their products.

Economic Environment From an economic perspective, Kodak’s products are used both as consumer and industrial goods, and this distinction is important to keep in mind when looking that the impact of various external factors on Kodak’s sales. Pocket digital cameras are ultimately purchased by individual consumers (from retailers), but health imaging systems or scanning equipment are capital investments for businesses.

It is possible to make broad generalizations about the impact of various economic factors on Kodak’s business, but one must also be conscious of how such factors may affect certain parts of the business differently. The distinctions become most evident in a discussion of inflation and interest rates. For consumers, cameras are a luxury item. Increasing inflation and interest rates cut into disposable income, and consumers may curb spending if the Fed continues to see inflation as a threat and raises short-term interest rates. Current discussion in the press hints that the Fed has reached a stopping point in rate hikes, and consumer spending numbers have been strong. However, if high oil prices continue long term, consumers may be forced to spend less of their disposable income, which could negatively impact camera sales. This trend could also affect spending in the industrial segment as well. Companies make capital expenditures on borrowed funds. While interest rates (the cost of borrowing) are still historically low, increasing

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rates may encourage companies to postpone expenditures. Kodak may see a slowdown in sales growth in the heath imaging segment for example, if this were the case.

An important trend in consumer spending that will affect Kodak is the decreasing growth of film sales. Film photography is projected to be obsolete by 2008. Kodak’s current strategy has been to invest revenues from film sales into development of digital products; however, as film sales slow, Kodak will need to finance digital research and development from other areas. Another implication of declining film sales is its effect on the Kodak brand name. Kodak was recognized throughout its history as a leader in film engineering and processing, but this brand identity will need to carry over to Kodak’s digital products to be successful.

Also, Kodak is facing changes in the economic strengths of its competitors. Larger consumer electronics manufacturers operate on smaller margins (5%-10%) thank Kodak (30%) typically did. The digital age has now forced Kodak to compete with these electronics manufacturers (who weren’t necessarily in the film market). Kodak will face stiffer price competition against companies who are able to operate on smaller margins than Kodak is used to.

Finally, while this analysis focuses on the U.S. market, Kodak sells product worldwide and thus some discussion of economic trends in an international context is necessary. Kodak’s sales abroad are highly sensitive to the strength of the U.S. dollar. Management cites a weak U.S. dollar as the primary reason for the sales increase in 2004. It is important here to realize that recent sales growth reported by Kodak isn’t necessarily attributable to increasing demand. By contrast, Kodak has potential to see growth in emerging economies. China and Russia are two large markets in particular who are experiencing growth in disposable income. However, these markets likely contain entry-level camera users, and the countries may not have the infrastructure in place (i.e. personal computers for digital-sharing and in-store photo development kiosks) to fully utilize Kodak products. While the level of demand for Kodak products in these economies may or may not be robust, they certainly offer areas of expansion for digital imaging products.

Social Environment One of the largest social trends in recent years has been the growth of internet communities. Sites such as mySpace and facebook.com link millions of members to each other. Users create profiles, leave messages for each other, and host blogs and discussions. These communities have extensive photo-sharing capabilities where users can upload photos to share with their friends, decreasing the need for photo-developing. Technological Environment The technological environment within which Kodak operates is subject to continuous innovation at an increasing pace. Part of this increasing amount of technological innovation has been fueled by a desire for compatibility and “do-it-all” devices. Consumers want their cell phones, personal computers, laptops, televisions, cameras, and mp3 players to all work with each other. Not only must all of these devices be compatible with each other, but some of them must be combined. Cell phones can take pictures, send emails, and store music, and still be plugged into a personal computer or laptop. These devices are highly portable as well. The days of lugging heavy camera equipment are over. A pocket-sized digital camera is lightweight and offers the same quality as expensive 35mm cameras in their heyday.

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With the trend toward integration and portability, we have seen growth of photo processing at in-store kiosks. The total number of prints has remained stagnant over the past six years; traditional prints have declined while the number of digital prints has risen. This shows that demand for printed photos has not fallen; it is just of a different kind. Today, customers can transport memory cards holding hundreds of pictures to their local supermarket or drugstore and edit and develop pictures in less than five minutes. The number of prints made at home peaked in 2005 and is projected to fall in 2006, while the number of prints made at retailers in 2006 will nearly double. With the rapid development of new technology comes a need to replace cameras periodically. Consumer electronics can become obsolete before the customer carries them out of the store. A 1.3 mega pixel camera may have been top-of-the-line in 2002, but today you can’t find one on a Best Buy shelf. If the rate of technological innovation continues, Kodak could expect a comparable growth rate in sales of new products. However, if the rate of innovation slows, consumers will be able to hold on to older models for longer periods of time and still be using “recent” technology. Michael Porter’s Five Forces Barriers to Entry

The substantial barrier to entry in the imaging technology market is brand recognition. An entry level digital camera is priced around $170. With the added cost of a memory card and any warranties, consumers can expect to pay at least $250 for a beginner camera. Consumers are unlikely to try new brands of a relatively expensive product without some knowledge of the company’s reputation. Current players in the market (Kodak, Nikon, Canon, Olympus, Sony, etc.) are highly recognizable and have established quality products. This strong brand recognition and loyalty make it unlikely that new entrants could rapidly gain market share.

Suppliers Kodak does not likely face significant risk from suppliers of materials to its industry. The raw materials for digital cameras include plastic, metal, microchips, etc.. Companies providing these materials have become specialized in their production and distribution. Any forward integration on the part of suppliers would involve a substantial change in business focus. The imaging technology industry, as discussed earlier changes rapidly and requires extensive research and development—an area that would represent a stark change for Kodak’s raw material suppliers. Highly specialized labor also supplies Kodak’s industry. While Kodak requires a certain amount of manual labor for assembly of products, the company must also rely on technological innovation to continue to develop new products. The company must be able to attract bright and talented individuals away from competitors to develop and market products. Kodak’s history of layoff and reorganizations may tend to deter new hires, or result in the loss of valuable employees who search job security elsewhere. In this way, labor poses a threat to Kodak, in the sense that the company must attract and retain good employees. Buyers The ultimate consumers of Kodak products are individual citizens and businesses making capital investments. Kodak principally markets to the end consumer, but sales are actually made

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to retailers. Consumers purchase digital cameras and related products through retailers such as Best Buy, Wal-Mart, Target, and Circuit City, who have considerable control over sales of Kodak products. Salespeople in stores direct consumers to particular cameras, which may or may not be Kodak products. Retailers also choose which products to run sales on and how to arrange displays in their stores. Furthermore, retailers can add value to the product through the sale of store warranties, adding even more control over how the entire product package is conveyed and marketed at the point of sale to the consumer. Kodak also manufactures and sells photo-finishing kiosks to department stores, drugstores, grocery stores, supermarkets and similar facilities. The buyer also has the power here. Stores typically will not display kiosks from several competing brands—the space simply is not available. Kodak must sell and these kiosks to retailers, which may ultimately compete with the retailer’s in-house photo-processing business. However, the buyer has the power here as well, because they choose whether or not to invest in Kodak kiosks for their stores. Finally, businesses investing in capital goods represent buyers of Kodak products. Healthcare imaging systems and digital scanners and copiers are capital goods and inputs for a variety of businesses. Here, Kodak’s follow-up service and customer relationship management is important to success of sales. Buyers in these segments probably to not represent a threat of backwards integration for the same reason suppliers of raw materials did not represent a threat to Kodak—development and maintenance of these products is simply beyond the scope of their business. Threat of Substitutes Kodak faces threats from the substitutes of camera phones, store brands, and video technology. As technology increases the capacities of cellular phones, camera phones could potentially eliminate the need for pocket digital cameras. Cell phones also have extensive sharing capabilities (users can send photos to other phones) that cameras do not enjoy. Kodak needs to establish partnerships with cell phone manufactures to insure that they will not be forced out of business by a proliferation of camera phones. Also, store brands could pose a threat to Kodak cameras and photo-finishing equipment (kiosks). The company felt pressure from store brands in its film camera market when stores such as Wal-Mart or Walgreen’s began selling disposable cameras. As prices continue to fall, mass merchandisers such as Wal-Mart may be able to cost-effectively manufacture digital cameras at high volumes. Furthermore, Kodak photo-finishing kiosks face competition from store-brand kiosks that can provide the same quality at a lower price. Finally, Kodak must consider videos as a substitute to photos. Logically, people take pictures which extract a part of some moment in time to substitute being able to record that time span in its entirety. As storage capacity and the ability to play digital videos grow, videos may become more useable. For example, Apple recently released a version of the iPod that can play videos. Consumers no longer need a bulky, stationary TV set to view videos. Many digital cameras come with video recording capabilities, although often only in 30 second time intervals, and the function uses considerable battery power, making their capabilities limited for video recording.

Rivals

The growth of digital technology has increased the number of competitors in the photography field. In the past, when Kodak enjoyed 90% of the film market share, they focused

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on chemical engineering to create superior film products. This engineering was not easily duplicable and highly specialized. Today, companies in the consumer electronics industry such as Sony, Hewlett Packard, and Panasonic are able to directly compete against Kodak in the camera markets using their existing infrastructure and talent. These consumer electronics giants may have more access to suppliers as well as access to a broad range of expertise and knowledge in other areas of research and development outside of cameras alone, which could be an advantage as electronics become increasingly integrated.

Kodak also competes against other camera makers such as Olympus, Nikon, Canon, and Fuji. These companies are all foreign, which means they are subject to different regulations, and they are growing quickly. These brand names have become increasingly popular in the U.S. with total sales growth in 2003 ranging from 8.8% (Canon) to 47.4% (Olympus). Fuji in particular has been moving into the kiosk market where Kodak had the largest market share. Value Chain Analysis When analyzing the value chain of Kodak two areas in particular emerge where Kodak has strength and adds the most value to its product: Development and Sales and Marketing. Development Digital cameras will continue to see growth if the product remains innovative, easy to use, and compatible with other products (such as computers and cell phones). Kodak adds value to their digital products through continued investment in research and development. Launch of the EasyShare camera line showcased a product that was simple, of good quality, and comparable to existing products on the market. Development of this product helped Kodak increase brand recognition in the digital camera market and move away from its previous stronghold in the film camera market. Production Production is an area that is obviously important to Kodak but is not a key point of added value. The company does not claim to pursue a low-cost strategy, which would indicate a focus on production efficiency. The company is not in the business of operations engineering, and thus doesn’t add considerable value at this link in the chain. Sales and Marketing Kodak has a number of marketing tools (in the form of complementary products) in use that add considerable value to digital cameras. A proliferation of photo-finishing kiosks in high-traffic locations enables users to fully utilize their cameras. Digital cameras and cameras in general are rendered virtually useless without the capability to store, develop, and share pictures. Kiosks, online photo-sharing sites such as Ofoto (owned by Kodak), as well as online developing services enhance the appeal of Kodak digital camera products.

Development Production Sales & Marketing

Distribution

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Furthermore, strategic relationships and partnerships developed with retailers will add value to the product. Customers will appreciate the reliability of a good retailer, and Kodak must work to maintain those relationships in order to see sales growth at the retail level.

Distribution On-time deliveries and good inventory management are important to any business, but distribution is not an area where Kodak adds a significant amount of value. As was the case with the production function, Kodak is not pursing a low-cost efficiency strategy. Value comes from the quality of the product itself, not availability. Digital cameras are not impulse buys, and customers typically spend time shopping at a variety of stores or online before making a purchase. When the time of purchase arrives, customers likely already have a particular model in mind, so instant availability is not as important. This is not to say that Kodak can afford to be late on shipments or not hold inventories, but to acknowledge that distribution is not a large source of added value for the Kodak value chain.

VRIO Analysis of Resources and Capabilities The final step of this Kodak case analysis is to identify resources and capabilities held by Kodak and evaluate them on the basis of the VRIO framework to determine if Kodak holds any competitive advantages. The VRIO framework examines each resource or capability in terms of whether or not it is valuable, rare, costly to imitate, and able to be exploited by the organization. If a resource meets all of these criteria then it can be termed as a competitive advantage for the company. Resources and Capabilities As a result of the preceding industry and company analysis, the following resources and capabilities have been identified for Kodak.

1. Financial Resources: Re-investment of film revenues into digital research and development. Kodak has made a commitment to invest proceeds from existing film segment sales into development of digital products. Value: This strategy will prove to be valuable to Kodak. Film products are in the declining stage of their products life cycle. Sales will drop 10-12% annually in coming years and eventually phase out. Taking revenues from the previous cash cow and directing them to digital products adds resources and thus value to an industry that is growing. Rarity: While other competitors have access to this same financial resource, they do not hold a comparable share of the film market to Kodak. Thus the ability to extract considerable value from a declining market diminishes when one does not have a strong presence in that market to begin with, thus Kodak holds an element of rarity in this respect. Imitable: While competitors could easily pursue a similar strategy without any opposition, they will be unable to extract much value, as stated previously. Organization: Kodak’s organizational structure does not allow it to fully exploit this financial resource. Kodak is organized into four reporting segments: Digital and Film Imaging Systems, Health, Commercial Imaging, and Graphic Communications. All of these sell digital products and conduct their own research and development. How does

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Kodak decide to allocate the revenues from film product sales? While cameras and the Digital and Film Imaging Systems segment accounts for the majority of Kodak’s revenue, net sales in Heath Imaging, Commercial Imaging, and Graphic Communications grew by 10%, 2%, and 109% respectively in 2004. Net sales for Digital and Film Imaging Systems fell 1%. Should Kodak invest in the areas that are growing the fastest of the area that is its core business? Kodak does not have a clear plan as to what area of digital technology it will develop with this financial resource and thus it cannot be a source of competitive advantage for the company. 2. Customer relationship management: Maintaining sales distribution channels. As discussed earlier, Kodak products are primarily sold through retail outlets. Kodak’s success in the film markets has inevitably helped build strong relationships with buyers because they enjoy margins on the sale of Kodak products. Success in digital markets can be facilitated through continued management of these customer relationships. Value: Good, functional relationships with customers will add value to the company in that buyers have considerable amount of control over sales of the product as discussed earlier in the five forces analysis. Strong foundations with the retailers will encourage them to push Kodak products ahead of competitors, adding value. Rarity: This particular element is not necessarily rare because many large consumer electronics manufacturers have established customer relationships in their business areas outside cameras. Imitable: Solid customer relationships are initially costly to imitate, but once established they will be easier to maintain. A company trying to imitate customer relationship will have to be better than the market leader to make any inroads. Getting new customers is always more costly than keeping old ones, so maintaining relationships is important. Organization: Kodak’s organization is set up well to maintain customer relationships. Retailers deal with salespeople who specialize in Digital and Film Imaging Systems, for example, rather than a centralized sales department. Retailers are also interacting with salespeople and departments who don’t have to concern themselves with sales in the Health segment for example, and instead they are held accountable to a particular segment, rather than overall company performance. 3. Cost-cutting capabilities through reduction of manufacturing space and personnel. Kodak has undergone numerous restructuring initiatives since the 1980s. Often, companies operating in declining markets or changing industries can re-organize to establish a business model superior to that of its competitors or implement cost-cutting measures to gain an advantage. Value: Kodak’s re-organization measures primarily involved personnel reductions, and failed to result in increasing sales since the 1980s. Rarity: Competitors have not been undergoing cost-cutting measures to increase sales. Instead, competitor’s sales have been fueled purely by demand. In this sense, Kodak’s cost-cutting measures are rare, but unhealthy. Imitable: Cost-cutting measures and restructuring are easily imitable. They can be costly in the sense that it may be difficult to recruit and retain new talent if there is a constant fear of layoffs, but in the short-term, cost-cutting boosts the bottom line.

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Organization: Kodak’s organizational reporting system has a recent history of restructuring and reorganization. These methods are only effective if they have a history of being successful, or happen so rarely that employees and investors can put faith in a restructuring effort. Kodak’s history of failed restructuring attempts does not offer a competitive advantage because the organization has overused the strategy. 4. Network of digital service and image output capabilities. Kodak has the largest market share in photo-finishing kiosks. These kiosks are increasingly versatile—for example they can receive images from camera-enable cellular phones. Furthermore, Kodak offers online photo-sharing and developing services through kmobile.com and Ofoto, as well as home developing products fully compatible with its product line. Value: Digital service and image output products enhance the perceived value of a digital camera. Demand for digital cameras will continue to grow as long as their features can be fully enjoyed by consumers through photo-sharing and developing services. Rarity: While online photo-sharing services are widely accessible and often free, Kodak’s in-store kiosks hold an element of rarity. Stores typically do not have large numbers of kiosks, so it is unlikely that a Fuji kiosk, for example, will be placed adjacent to a Kodak kiosk. Also, Kodak holds the majority market share, making it difficult for competitors to make inroads. Imitable: The technology for digital service and image output products is easily imitable. Photo-sharing software is available to everyone and is often offered for free, but development and maintenance of kiosks (photo developing) may deviate too far from the core business of a competitor who focuses on sale of hardware to individual consumers. Organization: The preceding value chain analysis showed that Kodak added value in the sales and marketing link of the chain. While digital service and image output capabilities function as products for sale, they are also marketing tools that Kodak can package with its digital cameras. Although this capability may or may not be very costly to imitate, Kodak’s network of digital service and image output facilities likely are a source of competitive advantage for the company. They add value, are rare, and Kodak has the organization in place to capitalize on this capability.

Competitive Advantages In conclusion, a thorough external and internal analysis of Eastman Kodak Company does not yield any solid sustainable competitive advantages. The P.E.S.T analysis five forces investigation detailed key drivers and trends in the industry. From this, resources and capabilities available to Kodak were gleaned and submitted to the VRIO test to search for competitive advantage. Kodak has potential competitive advantages in the areas of customer relationship management and their existing network of digital service and image output capabilities; however, it is unlikely that these advantages are fully sustainable given Kodak’s late grasp of the digital markets. Kodak’s ability to keep up with the fast pace of technology as it moves out of film markets into the digital world will ultimately determine if the company can prosper in coming years.

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Sources Barney, Jay B. and William S. Hesterly, Strategic Management and Competitive Advantage.

Pearson Prentice Hall: New Jersey, 2006. Bush, Jason. “Russia: Shoppers Gone Wild.” Business Week 20 Feb. 2006 p. 46. Eastman Kodak Company 2004 Annual Report <www.kodak.com> “Fujifilm, Konica Minolta and Eastman Kodak Establish EVERPLAY Standard”

<http://biz.yahoo.com/prnews/060222/nyw112.html?.v=46>.