Discontinuous Change and Organizational Response ... · Discontinuous Change and Organizational...

Discontinuous Change and Organizational Response: Exploring the Moderating Effects of Resources and

Capabilities – the Case of Kodak

DISSERTATION of the University of St. Gallen,

School of Management, Economics, Law, Social Sciences

and International Affairs to obtain the title of

Doctor of Philosophy in Management

Submitted by Michael Shamiyeh

from Austria

Approved on the application of

Prof. Steven W. Floyd, Ph.D.

and

Prof. Dr. Martin Hilb

Dissertation no. 4373 D-Druck GmbH Spescha, St. Gallen 2014

The University of St. Gallen, School of Management, Economics, Law, Social Sciences and International Affairs hereby consents to the printing of the present dissertation, without hereby expressing any opinion on the views herein expressed.

St. Gallen, October 22, 2014

The President:

Prof. Dr. Thomas Bieger

Table of Contents

Preface ............................................................................................................. i

Acknowledgement .......................................................................................... v

Zusammenfassung ...................................................................................... viii

Abstract ......................................................................................................... ix

Part I Theoretical Background................................................................................ 1

1 INTRODUCTION ..................................................................................... 3

2 BACKGROUND........................................................................................ 7 2.1 Technology and Change ...................................................................... 7 2.2 Technological Change and Discontinuity ........................................ 13 2.3 Technological Change and Resource Requirements ...................... 21

2.3.1 Measuring Resource Relatedness ........................................... 34

3 THEORY .................................................................................................. 39 3.1 Discontinuous Change and Organizational Decline ...................... 39 3.2 Discontinuous Change and the Resource Allocation Process........ 44

3.2.1 Linking the RAP with the Resource-Based View .................. 46 3.2.2 Modelling the RAP to Include Resources and Capabilities .... 48

3.3 Discontinuous Change and Variables Moderating Adaptation .... 52

4 METHOD ................................................................................................. 59 4.1 Research Setting ................................................................................ 59 4.2 Research Design ................................................................................. 68 4.3 Data Collection ................................................................................... 68 4.4 Data Analysis ..................................................................................... 73

Part II Analysis of the Case ..................................................................................... 75

5 CASE ........................................................................................................ 77 5.1 Preamble ............................................................................................. 78 5.2 Eastman Kodak Company ................................................................ 80 5.3 New Industry Environment .............................................................. 84

5.3.1 Changing Factor Markets ........................................................ 84 5.3.2 Changing Product Markets ..................................................... 88

5.4 Diversification and Exploration ....................................................... 96 5.4.1 Improving Efficiency .............................................................. 98 5.4.2 Trusting Partners ................................................................... 104 5.4.3 Exploring New Domains ....................................................... 107 5.4.4 Accessing New Technologies ............................................... 115 5.4.5 Aftermath of Change ............................................................. 118

5.5 Back to Core Business ..................................................................... 138 5.5.1 Management Change ............................................................ 140 5.5.2 New Vision ........................................................................... 141 5.5.3 Strategic Challenge ............................................................... 145 5.5.4 Improving Efficiency ............................................................ 147 5.5.5 Building Capabilities ............................................................ 157 5.5.6 Initiating Growth ................................................................... 163 5.5.7 Interim Results ...................................................................... 170 5.5.8 Another Turnaround .............................................................. 188

6 ANALYSIS ............................................................................................. 201 6.1 Period 1983-1989: Electronic Photography (Colby Chandler) ... 202

6.1.1 Cognitive Framing ................................................................ 203 6.1.2 Structural and Strategic Context ........................................... 206 6.1.3 Realized Strategy .................................................................. 207 6.1.4 Resources and Capabilities ................................................... 212 6.1.5 Realized Strategy .................................................................. 214

6.2 Period 1990-1993: Film-Based Digital Imaging (K. Whitmore) . 216 6.2.1 Cognitive Framing ................................................................ 217 6.2.2 Structural and Strategic Context ........................................... 224 6.2.3 Realized Strategy .................................................................. 225 6.2.4 Resources and Capabilities ................................................... 231 6.2.5 Capital Providers and Customers .......................................... 234 6.2.6 Realized Strategy .................................................................. 237

6.3 Period 1994-1999: Fully Digital World (George M. C. Fisher) ... 240 6.3.1 Cognitive Framing ................................................................ 242 6.3.2 Resources and Capabilities ................................................... 247 6.3.3 Structural and Strategic Context ........................................... 250 6.3.4 Realized Strategy .................................................................. 250 6.3.5 Resources and Capabilities ................................................... 253 6.3.6 Customers and Powerful Investors ....................................... 257 6.3.7 Cognitive Framing ................................................................ 258 6.3.8 Structural and Strategic Context ........................................... 262 6.3.9 Realized Strategy .................................................................. 269

Part III Discussion and Conclusion ........................................................................ 273

7 DISCUSSION ........................................................................................ 275 7.1 Summary and Theoretical Contribution ....................................... 275 7.2 Prioritizing Strategic Resource Allocations .................................. 280 7.3 Reversing Retained Resource Allocation ..................................... s286 7.4 Reinforcing Retained Resource Allocations.................................. 299

8 CONCLUSION ...................................................................................... 305 8.1 Recapitulation .................................................................................. 305 8.2 Limitations and Directions for Future Research ......................... 309 8.3 Practical Implications ..................................................................... 311

References ................................................................................................... 319

About the Author ....................................................................................... 359

Index of Figures

Figure 1 Schematic Illustration of Technological Change ............................................. 9 Figure 2 Schematic Illustration of Discontinuous Change ........................................... 11 Figure 3 Schematic Illustration of Dominant Design ................................................... 16 Figure 4 Substitution of Silver-Halide Photography by Digital Imaging ..................... 18 Figure 5 Substitution of Printed Book by eBook .......................................................... 18 Figure 6 Substitution of Vinyl Records by Compact Discs .......................................... 18 Figure 7 Substitution of Compact Cassettes by Compact Discs ................................... 18 Figure 8 Technological Evolution of Digital Interchangeable Cameras ...................... 19 Figure 9 Schematic Illustration of an Organization’s Response to Disruption ............ 22 Figure 10 Competence Requirement and Type of Technological Change ................... 25 Figure 11 Competence Requirements Kodak Funsaver ............................................... 26 Figure 12 Knowledge Management and Strategies for Corporate Entrepreneurship ... 28 Figure 13 Resource Development in Response to Discontinuous Change .................. 32 Figure 14 Adaptation to Evolutionary and Discontinuous Change .............................. 40 Figure 15 Relationship between Discontinuous Change and Organizational Decline . 42 Figure 16 Elaborated Resource Allocation Process Model .......................................... 49 Figure 17 Bower (1970) and Burgelman’s (1983a) ..................................................... 53 Figure 18 Pfeffer/Salancik (1978) and Christensen (1996) .......................................... 53 Figure 19 Gilbert’s (2006) ............................................................................................ 53 Figure 20 Aim of this Research .................................................................................... 53 Figure 21 Variables Moderating Adaptation to Substituting Technology ................... 58 Figure 22 Worldwide Imaging Industry ....................................................................... 62 Figure 23 US Imaging Industry .................................................................................... 63 Figure 24 Growth (Decline) of Films (rolls) Worldwide ............................................. 64 Figure 25 Growth (Decline) of Films (rolls) US .......................................................... 65 Figure 26 Prints (Film and Digital; 10x15 cm equivalent) Worldwide ........................ 66 Figure 27 Prints (Film and Digital; 10x15 cm equivalent) US ..................................... 67 Figure 28 Change of Imaging Chain by George Eastman (KODAK) .......................... 81 Figure 29 Sales per Employee ...................................................................................... 86 Figure 30 Decrease of Kodak’s Market Share in Film and Paper Business ................. 86 Figure 31 Profit Margin of Film ................................................................................... 87

Figure 32 Sales, Earnings, Employees, and Stock Price, Kodak, 1972-1992 .............. 97 Figure 33 Net Profit Margins ........................................................................................ 99 Figure 34 Return on Equity .......................................................................................... 99 Figure 35 Operating Return on Assets and Properties at Costs .................................... 99 Figure 36 R&D Expenditures ..................................................................................... 101 Figure 37 Gross Profit Margin .................................................................................... 101 Figure 38 Reduction of Workforce ............................................................................. 104 Figure 39 Sources of Revenues .................................................................................. 120 Figure 40 Sources of Earnings .................................................................................... 120 Figure 41 Change of Kodak’s Income Pillars ............................................................. 122 Figure 42 Increase in Debentures (Long-Term Borrowings) .................................... 131 Figure 43 Total Debentures (Long-Term Borrowings) ............................................. 131 Figure 44 Total Liabilities to Equity ........................................................................... 131 Figure 45 Earnings from Operations and Interest Expense ....................................... 131 Figure 46 Cash Flow From Operating Funds ............................................................. 133 Figure 47 Capital Additions in Relation to Sales ....................................................... 133 Figure 48 Kodak’s SGA Costs to Net Sales ............................................................... 135 Figure 49 Increase (Decline) Kodak’s Sales in Photography ..................................... 135 Figure 50 Sales, Earnings, Employees, and Stock Price, Kodak, 1983-2003 ............ 139 Figure 51 Cash Flow from Operating Funds .............................................................. 149 Figure 52 Earnings from Operations and Interest Expenses ...................................... 149 Figure 53 Total Long-Term Borrowings .................................................................... 151 Figure 54 Cash Flows and Long-Term Debts ............................................................. 151 Figure 55 Sales per Employee .................................................................................... 152 Figure 56 Operating Return on Assets and Properties at Cost ................................... 153 Figure 57 Gross Profit Margin and Overhead Costs .................................................. 153 Figure 58 R&D Expenditures ..................................................................................... 153 Figure 59 Capital Addition to Sales ............................................................................ 153 Figure 60 Kodak’s Financial Performance and Efficiency in Comparison ................ 171 Figure 61 Change of Kodak’s Income Pillars ............................................................. 172 Figure 62 Changes in Kodak’s Consumer Photography Sales Worldwide ................ 174

Figure 63 Changes in Film Roll Sales (Units) Worldwide Photography Industry ..... 174 Figure 64 Currency Exchange Rates .......................................................................... 175 Figure 65 Changes in Film Roll Sales (Units) US Photography Industry ................. 175 Figure 66 Market Share of Kodak and Fuji in the US ................................................ 180 Figure 67 Profit (Loss) and Sales Digital Imaging (D&AI) ....................................... 183 Figure 68 Net Profit Margin ....................................................................................... 189 Figure 69 Return on Sales ........................................................................................... 189 Figure 70 Working Capital ......................................................................................... 190 Figure 71 Turnover of Receivables and Inventory ..................................................... 190 Figure 72 Major Workforce Reduction Programs ...................................................... 190 Figure 73 Restructuring Costs in Relative to Earnings from Operations ................... 190 Figure 74 Layoffs and Hires in Kodak’s Core Photography Business ....................... 191 Figure 75 Shareholders’ Equity .................................................................................. 196 Figure 76 Average Return on Equity and Average Change in Equity ....................... 196 Figure 77 Shareholders’ Equity, Retained Earnings, and Treasury at Stock.............. 197 Figure 78 Process Model of Eastman Kodak’s Resource Allocation ......................... 203 Figure 79 Silver-halide Photography Technology and Digital Imaging .................... 203 Figure 80 Eastman Kodak’s Framing of Emerging Technology (Early 1980s) ......... 204 Figure 81 Eastman Kodak Office of Innovation’s Idea Connection Process ............. 208 Figure 82 Eastman Kodak Consumer Business Portfolio Matrix (Mid-1980s) ......... 213 Figure 83 Eastman Kodak’s Framing of Emerging Technology (Mid-1980s) ......... 215 Figure 84 Process Model of Eastman Kodak’s Resource Allocation (Early 1990s) .. 217 Figure 85 Silver-halide (Film) and Electronic Photography (Early 1990s) ............... 217 Figure 86 Industry Trend (1991) ................................................................................ 219 Figure 87 Eastman Kodak’s Framing of Electronic/Digital Imaging (Early 1990s) .. 222 Figure 88 Analog (Chemical) and Digital Imaging Chains ........................................ 227 Figure 89 Kodak PhotoCD System ............................................................................ 228 Figure 90 Hybrid PhotoCD System ............................................................................ 229 Figure 91 Eastman Kodak Consumer Photography Portfolio Matrix (Early 1990s) 230 Figure 92 Eastman Kodak’s Framing of Emerging Technology (1993) .................... 237 Figure 93 Eastman Kodak’s First Major Divesture in Response to Threat ................ 239 Figure 94 Process Model of Eastman Kodak’s Resource Allocation (1990s) ........... 241

Figure 95 Silver-halide (Film) and Electronic Photography (1990s) ......................... 241 Figure 96 Enhancement of Kodak’s Digital Camera Technology .............................. 243 Figure 97 Eastman Kodak’s Framing of Emerging Technology (1990s)................... 246 Figure 98 Eastman Kodak Business Portfolio Matrix (1994) .................................... 248 Figure 99 Eastman Kodak’s New Strategy (1994) Schematic Depiction................... 251 Figure 100 Eastman Kodak’s Revision of Its 1994 Strategy (1997) .......................... 254 Figure 101 Transitions in the Customer Relationship in Photography....................... 264 Figure 102 and Figure 103 Overview: Kodak’s Response to Discontinuous Change 277 Figure 104 2003 Projection of Worldwide Photography Exposure ............................ 288 Figure 105 2003 Projection of Worldwide Total “Photo” Prints by Type ................. 288 Figure 106 2003 Projection of Worldwide Shipments of Imaging Devices ............... 288 Figure 107 2003 Projection of Shipments of Imaging Devices And Actual Data ..... 289 Figure 108 2003 Projection of Total “Photo” Prints by Type and Actual Data ......... 289 Figure 109 Decrease of Kodak’s Earnings from Operations by Restructuring Costs 291 Figure 110 Kodak’s Challenge in the Face of Disruption .......................................... 295 Figure 111 Eastman Kodak Company’s Structure and Autonomy of New Ventures 303

Index of Tables

Table 1 Examples of Past Substitutions with Rates ...................................................... 19 Table 2 Kodak Archival Data ....................................................................................... 69 Table 3 Internal Informants & Interviewees ................................................................. 70 Table 4 External Informants & Interviewees External Informants .............................. 72 Table 5 Sales and Earnings of Commercial and Information Systems ...................... 122

Index of Abbreviations

CEO .................. Chief Executive Officer CCD ................. Charged Coupled Device (imaging sensor) CMOS .............. Complementary Metal Oxide Silicon (imaging sensor) DSLR ............... Digital Single Lens Reflex (Camera) KODAK ........... Eastman Kodak Company MP .................... Megabyte Pixel OLED ............... Organic Light-Emitting Diode RAP .................. Resource Allocation Process RBV ................. Resource-Based View SLR .................. Single-Lens Reflex (Camera) SGA .................. Selling, General and Administrative (Expenses) USD .................. United States Dollar

Preface

This research seeks to enrich current understanding of a problem managers are facing today more than ever: how to respond to discontinuous technological change.

The inability of companies to adapt to a rapidly changing environment when threatened with discontinuous change has been an issue of continuous inquiry in both scholarly research and managerial practice. Particularly the failure of industry leaders to successfully adapt to new conditions – even when they had an awareness of the need to change – seems to generate the keen interest in the topic.

In an effort to solve the problem, growing attention has been directed toward a company’s capability to adjust its competence configuration to the new environmental context, while simultaneously maintaining a tight fit to the traditional one. This research builds on this body of scholarly work by offering a fine-grained view of the requirements companies have to meet in order to successfully manage an organizational change to a new environment.

Contrary to the current scholarly urge to figure out the best practices companies may deploy in order to successfully adapt to particularly those disruptive forces that may render their present businesses discontinuous in the future, findings of this research suggest that such a move is only wise under certain conditions. Point in time of threat perception, threat response, plus the disruptive force’s rate of development and substitution are equally decisive for a company’s success in adapting to a new environment, such as its stock of committed resources and the relatedness of its existing capabilities to the new technology. In certain cases, companies are advised to rather re-orient their operational objectives altogether and leverage their existing competences in other domains, instead of attempting to reconfigure or extend them at all costs to achieve a tight fit to the new and disrupting environment.

Eastman Kodak Company, the former industry leader in traditional chemical-based photography, provided a fascinating and rich case to explore the topic of discontinuous change – simply because it represented an anomaly with respect to current theories: The company’s “failure” to adapt to digital imaging could not be explained on the basis of theoretical findings available in current scholarly research; rather the opposite

ii Preface

was the case: data gathered and phenomena observed suggested that “there is something else going on,” whose detailed analysis promised the improvement of available theories.

Contrary to models that suggest that companies usually fail in the face of discontinuous change because they focus too closely on their most powerful customers and thus direct strategic investments exclusively to their core business, Kodak did not solely invest in traditional film (Christensen, 1997; Christensen & Bower, 1996). Likewise the company did not always perceive digital imaging as a threat to its core business, which would have resulted in rigid efforts to control and increase existing resources in traditional film, rather than promoting autonomous initiatives in digital imaging as suggested by other theoretical contributions on discontinuous change (Gilbert, 2005, 2006). Furthermore, at Kodak it was not the case that the internal bottom-up strategy process failed in the face of institutional barriers (Sull, 1999, 2005) or volatile investment decisions (Eisenmann, 2002).

Quite the contrary, the world’s largest imaging giant actually invented digital photography back in 1975. It also was not arrogant to the extent that it ignored new technological changes. It had promoted multiple electronic-digital imaging initiatives before anyone else in the industry had directed any attention to this issue. Its research labs were full of technological inventions that anticipated many features of today’s devices, such as Wi-Fi-equipped digital cameras or iPod-like designs for imaging devices. The company also was not blindsided by missing business opportunities in low-margin areas or small markets. Kodak was fully aware of the disruptive potential of the nascent digital technology, invested billions in its development, and set up autonomous structures to allow an independent and autonomous proliferation of the business. In 2004 and 2005 Kodak even was no. 1 in digital camera sales in the US. It fell to the 3rd position in 2006.

In fact, the data of this longitudinal study suggests that Kodak wrestled with a completely different problem – a problem that had not been investigated thoroughly in the context of discontinuous change: Adapting a competence configuration to a new environment and trying to gain a dominant market share for purposes of profitability depends primarily on the availability of uncommitted resources. In the case of Kodak,

Preface iii

cash flows of the traditional photographic film and paper business were used to fund digital imaging ventures that required extensive startup-costs and where costs continued to be high far beyond any planned time horizon for realizing payback. This worked well until Kodak’s core business dropped off in a steep and non-linear way because of an unforeseeably quick digital substitution in every part of the imaging chain; that is to say, it was not just that analog cameras were replaced by digital cameras, but that people also unexpectedly changed their behavior with respect to making prints, for instance, preferring to store and view pictures on the Internet. Kodak believed that most digital camera users would still use film for “important” photos, since this had been true of early digital camera users when the digital cameras produced relatively poor quality images. The company’s overhang of absorbed resources, mostly committed to the fast-declining chemical-based photographic film and paper business – all its big, vertically integrated production facilities – then started to burden the balance sheet. A gap between sales and costs emerged, forcing the company to downsize belatedly, which tremendously constrained its response to discontinuous change.

Kodak’s experience provided the valuable opportunity to build and extend theory on discontinuous change in a way that illuminates the preconditions for a company’s challenge to adapt to (or flee from) disruptive environments. Given that a theory’s value depends on its ability to predict events or actions, the aim of this research is to help researchers and practitioners to discern those parameters that might moderate a company’s efforts in adapting to (or fleeing from) disruptive environments.

Acknowledgement

This research represents four years of thinking about Kodak, and the last seven years of investigating and reflecting on core aspects of corporate entrepreneurship. During this period I have worked as a researcher, consultant, and as a facilitator of several mediation projects, offering the opportunity either to a diverse range of experts or a larger public to examine what it takes to innovate. And most importantly, I had innumerable opportunities to learn from many distinguished people who kindly offered to share their valuable experiences. These are the “materials” out of which this research has come.

Prior to entering the world of management, I was an Architectural Theory professor, meaning that I was given the opportunity to teach graduate students while pursuing several architectural design projects all over the world, ranging from luxury hotels in the Caribbean Islands to unpretentious convents in Croatia. Post-professionally trained at two of the world’s most prestigious architectural schools, the Graduate School of Design at Harvard University in the US and the Architectural Association in London, UK, coupled with thorough education at the Technical University of Vienna, I was offered numerous projects abroad. At the same time, I had the opportunity to theorize on practice in an academic context. One of the issues that concerned me most was how we create desired futures. Architecture, here understood in its broadest sense, is very much about the design of conditions underlying any social construction. And by looking to other disciplines, we see that there are multiple approaches to this issue. Hence the most inspiring thing I learned during this period in my life was the importance of using different lenses, borrowed from other disciplines, to understand and explain phenomena observed.

I mention this because I believe it is fundamental to the way in which research is pursued in general and how this work was done in particular. Thomas Kuhn (1962) discovered that the anomalies that led to a fundamental revision of scientific paradigms were discovered by scholars who were “foreign” to the particular scientific community; that is to say, discoverers of anomalies had a different disciplinary background than those who had elaborated and defined the boundaries of the particular paradigm. The innovators were able to attach meaning to a phenomenon that, when not

vi Acknowledgement

viewed through different disciplinary lenses, might be dismissed as just an exception to the general assertion, or overlooked altogether.

By no means do I want to suggest that this research has the potential to topple a prevailing theory – I neither intended this nor do I feel qualified to do so. Rather, I mention my role as an outsider to signify that I didn’t start my journey into Kodak with a set of beliefs about existing theory, about what is legitimate and what is not. Instead I almost “naïvely” observed phenomena and tested the data gathered against existing theoretical models, unless an anomaly popped up that triggered iterative cycles of reversing categorization schemes or articulating new causal statements. As a result, I feel that I have observed something that was not in the focus of others so far. The aim of this research was to find explanations for this circumstance. I hope that the explanations enrich current theories.

I referred to my past also to emphasize that some seven years ago I was offered a generous once-in-a-life-time privilege to explore these issues from a management perspective. Professor Steven Floyd, then chair at the Institute of Management at the University St. Gallen, Switzerland, showed great trust in me and granted me admission to the PhD program. Seen from my perspective, as an architect and teacher who has seen many schools abroad and at home from the inside, his openness towards my different disciplinary background (and lack of any management education) was unparalleled. Here I want to take the opportunity to express my deep appreciation of his confidence and constructive support in helping me to take this path.

Professor Martin Hilb, too, I want to thank for his belief in me, the many words of advice he kindly provided, and his ongoing efforts to bind me to the University of St. Gallen. Since my early days at St. Gallen, he has been a great source of inspiration and a person to learn from. At his annual management symposia, which he generously allowed me to actively participate in, he showed the merits of the great facilitator that every organization requires for innovating. I owe him a debt of gratitude.

Several “Kodakers” have offered ongoing input to and criticism of this research work. These include, among others, Steven Sasson, inventor of the world’s first digital camera, who in 2010 sparked my original interest in Kodak by kindly accepting an invitation to participate in a symposium I organized in the Austrian Alps. Then there

Acknowledgement vii

are Brad Paxton and Ken Parulski, who expended great efforts in supervising the research in conversational and manuscript form. Additional wisdom was provided by many other Kodakers or individuals close to the imaging giant who have provided great support. In particular I want to mention Bob Shanebrook, Berry Brenner, and Terry Faulkner. Todd Gustavson, Technology Curator at the George Eastman House (GEH) provided great support in sharing his historical expertise and granting us to do interviews in the GEH. Thank you to all of you.

Beyond that there are other people without whom this research would not have been possible. The first of these is Rector and Professor Reinhard Kannonier, who in 2003 promoted the founding of the academic Design-Organization-Media (DOM) Research Laboratory, which I am honored to have headed since then. A lot of my workload related to this research was done alongside other agendas, which therefore had to be reduced. Moreover, I was allowed to use institutional funds for financing trips and fees for the film team, for doing interviews. In this respect I am particularly grateful to Erich Goldman and Manuel Bauer, who did a wonderful job of capturing all the interviews on film.

There remains a last group of people, who have been at the center of almost everything: My wife Elke and my two sons Paul and George made countless sacrifices and gave endless day-to day emotional support that made the pursuit of this research possible. I am particularly indebted to Elke, who as the mother of my two wonderful children and also as a credit analyst, gave me thorough-going advice in ”reading between the lines” in balance sheets.

Linz, October 2014 Michael Shamiyeh

viii

Zusammenfassung

In den letzten Jahren hat das von Bower (1970) begründete und von Burgelman (1983c) substantiell erweiterte Modell über den innerorganisatorischen Ressourcenzuteilungsprozess eine umfangreiche Bestätigung als auch Erweiterung erfahren, insbesondere durch Forschungsarbeiten im Zusammenhang mit diskontinuierlicher Veränderung (Christensen, 1997; Christensen & Raynor, 2003; Gilbert, 2005, 2006). Unter anderem gingen Wissenschafter der Frage nach, welchen Einfluss zum Beispiel Kapitalmärkte, ein zu enger Fokus auf profitable Kunden, oder die unternehmensinterne Beurteilung von jenen Kräften, die eine diskontinuierliche Veränderung zur Folge haben, auf interne Investitionsmuster haben und damit auch die realisierte Strategie des Unternehmens im Streben nach einer effektiven Anpassung an die veränderte Umwelt beeinflussen. Im Unterschied dazu erhielt die Frage, welchen Einfluss der Bestand an Ressourcen und deren Einsatz in der laufenden Geschäftstätigkeit auf die Fähigkeit einer Organisation haben, effektiv auf diskontinuierliche Veränderung reagieren zu können, eine geringe Aufmerksamkeit. In der vorliegenden Arbeit wird dieser Frage nachgegangen und anhand einer Studie über den Jahrzehnte langen Versuch der Eastman Kodak Company auf die Substitution der traditionellen, auf Chemie stützenden Fotografie durch digitale Technologien zu reagieren, eingehend erörtert. Mittels des Rückgriffs auf die ressourcenbasierende Betrachtung eines Unternehmens gelang es, das generelle Modell zum Ressourcenzuteilungsprozess substantiell zu erweitern. Jene im Zusammenhang mit unternehmenspezifischen Ressourcen stehenden Variablen wurden identifiziert, die eine Anpassung an diskontinuierliche Veränderungen wesentlich beeinflussen. Die moderierende Wirkung der identifizierten Variablen wird in Form von Thesen zusammengefasst und deren Implikationen für wissenschaftliche Forschung und Unternehmenspraxis diskutiert.

ix

Abstract

In recent years, the Bower-Burgelman Resource Allocation Process Model has received extensive support from scholars concerned with organizational dynamics in the face of discontinuous change. In particular, scholars have addressed the question of how powerful capital markets, an excessively narrow focus on profitable customers, or the cognitive framing of forces leading to discontinuous change, shape an organization’s investment pattern and thus the organization’s strategy to adapt to a new environment; however, the question of how the stock of resources and their deployment in ongoing business operations affect an organization’s capability to allocate resources to new businesses, in response to discontinuous change, has been less explored. I explored this question by using a longitudinal case study of Eastman Kodak Company in its response to digital imaging. In linking the Resource Allocation Process Model with findings of the Resource-Based View, I am able to extend the general model by identifying variables that determine whether the stock of resources and their deployment support or obstruct adaptation to the new environment. In the concluding section, I discuss findings and address consequences for managerial practice and academic research.

1

Part I Theoretical Background

1 INTRODUCTION

Organizations are faced with numerous obstacles when they attempt to adapt to discontinuous change. Scholars aiming to explain an organization’s inertia in the course of environmental shifts have devoted attention to the nature of existing competences (Benner & Tushman, 2002; Benner & Tushman, 2003; Cohen & Bacdayan, 1994; Henderson & Clark, 1990; Kaplan, 2008; Leonard‐Barton, 1992; Tushman & Anderson, 1986), retained resource commitments to address the needs of powerful customers and capital investors (Christensen, 1997; Christensen & Bower, 1996; Danneels, 2003; Pfeffer & Salancik, 1978), and managerial cognition (Baron, Hannan, & Burton, 1999; Gilbert, 2005, 2006; Staw, Sandelands, & Dutton, 1981; Tripsas, 2009; Tripsas & Gavetti, 2000). In an effort to help companies to successfully manage change, scholars of corporate strategy and organizational design have directed an increasing amount of attention towards building dynamic capabilities (O’Reilly III & Tushman, 2008; Teece, 2007). In this research, I expand upon this work by exploring the moderating effects of an organization’s stock of resources and its strategic deployment in an effort “to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments” (Teece, Pisano, & Shuen, 1997).

Research in evolutionary economics reveals a long tradition of investigating how existing capabilities limit an organization’s adaptive behavior (Arrow, 1974; Nelson & Winter, 1982). By “capabilities,” I refer to the valuable utilization of a broad spectrum of resources, including tangible and intangible assets as well as human resources. For instance, March and Simon (1958) showed how an organization’s historical evolution influences its prospective behavior. Organizational learning reveals a tendency to be path-dependent, to invoke search strategies closely related to existing capabilities (Levitt & March, 1988; Teece, 1988), and shows that companies often fall short because of a rigid deployment of their capabilities (Leonard‐Barton, 1992). Scholars have also shown how organizations tend to utilize existing capabilities in response to change (Helfat, 1997; Teece, 1986). For instance, organizations tend to exploit their capabilities based on the existing customer segment and to develop products and services for their particular needs, rather than directing attention to a completely new customer segment (Christensen, 1997). Tushman and Anderson (1986) distinguished

4 INTRODUCTION

between environmental changes that enhance or destroy an organization’s competence, explaining how discontinuities require the mastery of an entirely new set of capabilities. Henderson and Clark (1990) offer a more detailed perspective on the competence-destroying or -enhancing nature of technological shifts, by directing attention to changes in “architectural knowledge,” which is applied for integrating various components in an overall system. Hence scholars concerned with moderating effect of resources and capabilities in an organization’s struggle to respond to new environmental contexts by and large focus on the distinctive nature of existing capabilities; that is to say, they investigate how tangible and intangible assets, resource bundles, and/or routines constrain or direct the development of a new competence configuration.

The aim of the research presented here, by contrast, is to investigate how stocks of resources and their retained strategic deployment to ongoing business operations moderate an organization’s effort to change in the face of discontinuous change. Organizations attempting to respond to discontinuous change are usually faced with a dilemma: Discontinuous change occurs when a new technology disrupts and erodes an organization’s resource base, by getting a foothold in the market of the firm’s traditional business (Abernathy & Utterback, 1978; Christensen & Bower, 1996; Christensen & Rosenbloom, 1995; Dosi, 1982; Foster, 1986; Utterback, 1994; Utterback & Abernathy, 1978). For organizations, the objective is not to change from one state to another in a sequential manner (as may be appropriate in environments with minor changes); rather, an effective response requires an organization to redirect resources (from its profitable businesses) to the development of new businesses (to address requirements of the emerging environment), while retaining resource commitments to existing businesses that must continue their tight fit with the traditional (and potentially disrupted) environment (Christensen & Bower, 1996; Christensen & Raynor, 2003; Christensen, Suárez, & Utterback, 1998; Gilbert, 2005, 2006; Masini, Zollo, & van Wassenhove, 2004; Siggelkow & Levinthal, 2003; Siggelkow & Rivkin, 2006). Organizations are required to reconfigure and orchestrate multiple competences simultaneously, simply because in order to stay viable – unless the new business achieves payback to fund its growth – they must stay competitive, and address the most pressing challenge facing most organizations today: increasing the returns from initial investments.

INTRODUCTION 5

In order to explore the interdependence among discontinuous change, stocks of resources and their strategic deployment, and an organization’s resource allocation process, I analyze Eastman Kodak Company’s response to the rapid substitution of its traditional chemical-based photographic film and paper business by digital photography. This industry leader provides a compelling case in that the extremely fast erosion of the traditional business environment ate away valuable resources required to fund the development of competences necessary to adapt to the new environment. In contrast, most recent case studies available to better understand discontinuous change refer to examples in which a profitable core business remains viable in parallel to the development of new ventures. For instance, Gilbert and his colleagues (2012; 2005) discuss challenges of newspaper companies in the face of online news, or of publishers and book retailers in the face of the advent of e-books. Christensen (2003) discusses the challenges for traditional businesses caused by the emergence of mini steel mills, online banks, and online travel agencies. In all these cases, the slow loss of market share due to disruption only marginally affects the availability of resources to fund development or acquisition of new competences. Moreover, because availability of sufficient funds is presumed but not discussed, the likely need to fall back on existing resources in the face of scarcity has been ignored. In short, in current cases, the moderating effect of stocks of resources and their strategic deployment have by and large escaped notice.

This in-depth longitudinal and multilevel case study yields additional explanations of organizational inertia. Based on the analysis of Kodak, I propose to extend the current model on the Resource Allocation Process to include “resources and capabilities” as an additional component shaping an organization’s response to discontinuous change, depending on two subordinate variables identified: the rate of technological progress and substitution, as well as the time of threat perception and response. This later variable builds on Gilbert’s (2005, 2006) findings for the most part. Contrary to current scholarly intentions to elaborate best practices in an effort to adapt to disruptive forces, my findings suggest that under certain conditions, organizations are advised to leave their traditional business environment altogether and leverage existing resources to more closely related domains, instead of trying to build or integrate completely new and unrelated resources in an effort to achieve a competitive advantage in the new environment.

6 INTRODUCTION

This research is structured in the following manner: First, I begin to define the conceptual scope by exploring two broad sets of questions: How does discontinuous change affect an organization’s resource base, and how does the level of committed resources influence an organization’s resource allocation process (and thus strategy process) in the face of discontinuous change? In this part, I explain the chosen methodology of this research and address particularities with respect to the research setting, site selection, data collection, and how I extended the current findings on the Resource Allocation Process model to incorporate the component of committed resources. In the second part, I analyze the case by using the refined model to draw a series of conclusions. In the third and final part, I discuss findings for evolutionary theory, show directions for possible future research, and address implications for practice.

2 BACKGROUND

The challenges that organizations encounter by adapting to discontinuous change have been well researched across various industries (Christensen, 1997; Gilbert, 2006; Kaplan, 2008; Tripsas, 2009; Tushman & Anderson, 1986). Scholar’s findings have resulted in theories explaining the obstacles organizations are facing in their effort to build, reconfigure or import new resources and capabilities in the face of substantial alterations in the environment that destroy competences (Glasmeier, 1991; Landes, 1984; Rosenbloom, 2000; Sull, Tedlow, & Rosenbloom, 1997); the incumbent’s failure to seize the potential of innovations that disrupt and redefine the product performance demanded by customers in existing markets (Christensen & Bower, 1996; Christensen & Rosenbloom, 1995); and, the consequences of framing environmental shifts as either threats or opportunities for an organization’s response to discontinuous change (Gilbert, 2005, 2006; Jackson & Dutton, 1988; Ross & Staw, 1993; Sitkin & Weingart, 1995; Staw et al., 1981). This chapter aims to extend this literature stream by directing the focus to the source of any organizational effort to adapt – namely, the particular stock of resources and capabilities which an organization can utilize to become adaptive. I argue that discontinuous change threatens the viability of an organization by potentially eroding its resource base and thus the means to become adaptive.

2.1 Technology and Change Change – whether incremental, radical, or discontinuous – requires organizations to adjust their competence configuration (Gilbert, 2006; Tushman & Anderson, 1986). In order to assess their adaptation to a new environment, organizations have to define the extent of required new resources and capabilities (Henderson & Clark, 1990; Kogut & Zander, 1992; March, 1991). In effect, depending on the requirements relative to an existing base of resources and capabilities, organizations either have to leverage, extend, or import new ones (Collis & Montgomery, 1998; Kazanjian, Drazin, & Glynn, 2002). Paradoxically, in the literature stream on discontinuous change little research efforts are devoted to the issue of resource requirements in general and resource relatedness in particular, despite different consequences for competence development in the face of the need to adapt: Developing resources and capabilities

8 Technology and Change

that are new and unrelated to an organization’s stock is certainly more costly and difficult than undertaking small or incremental changes (Hannan & Freeman, 1984; Nelson & Winter, 1982). In the following, I will demonstrate the linkage between discontinuous change and resources required relative to a current resource base..

An elaboration of the linkage between discontinuous change, which is a particular form of technological change, and an organization’s stock of resources and capabilities requires clear definitions. Particularly the term “technology” has too many diverse connotations, ranging from an object of material culture to the pool of applied scientific knowledge (Sahal, 1981). Traditional economic theory conceptualized “technology” as a production function that expressed the causal relationships among a set of factors of production and certain outputs, which were defined in qualitative and quantitative terms (Dosi, 1982). I therefore begin with defining the term “technology,” to continue with a discussion on discontinuous change and its relationship to resources and capabilities.

Building upon the rich work of Sahal (1981), Dosi (1982), Foster (1986), Tushman & Anderson (1986), and Christensen (1992a), I view technology from a systemic perspective, which emphasizes its performance characteristics: Dosi (1982), for instance, defined “technology” as “a set of pieces of knowledge, both directly ‘practical’ (related to concrete problems and devices) and ‘theoretical’ (but practical, applicable although not necessarily already applied), know-how, methods, procedures, experience of successes and failures and also, of course, physical devices and equipment” (p. 151f.). Foster (1986) conceived technology more broadly as “the general way a company does business or attempts a task – the production line versus batch processing or the sidelong high jump technique versus the backward-first Fosbury flop” (p. 33). Tushman and Anderson (1986) circumscribed technology as “those tools, devices, and knowledge that mediate between inputs and outputs (process technology) and/or that create new products or services (product technology)” (p. 440); and, finally, Christensen (1992a) defined technology “as a process, technique, or methodology embodied in a product design or in a manufacturing or service process which transforms inputs of labor, capital, information, material, and energy into outputs of greater value” (p. 336). The achievements of technology, according to this view, are “embodied,” so to speak, in two parts: On the one hand it exists in a

BACKGROUND 9

particular product or process, and, on the other it exists in a “disembodied” part that relates to the particular skills, experiences, and knowledge used in previous technological solutions. In this sense, technology is distinct from knowledge, which is non-specific to particular products and processes.

This performance-based view of technology, as a technique that processes inputs of resources into outputs of greater value, appears useful for discussing patterns of technological change (and thus discontinuous change). Technological change, according to the view presented above, first and foremost means a change in technique and/or inputs of resources that aim to achieve performance improvements of a particular product or process (Sahal, 1981). Consequently, the close association of products and process to technology always necessarily sets boundaries to possible technological variations and paths of progress (Foster, 1986):

Figure 1 Schematic Illustration of Technological Change

Dosi (1982) showed, by referring to the seminal work of Kuhn (1962), that the direction of every technological change follows a “trajectory,” that is, a pattern of actions related to searching and solving problems based on a particular logic or “paradigm” that is immanent to the very technology itself. This “technological

t

p

Upper Boundary Performance

Lower Boundary Performance

Solutiont

Paradigm

Trajectory


paradigm” defines the relevant problems, the patterns of inquiry, and, consequently, the pattern of solutions of the selected problems. In this sense, technological paradigms embody strong determinations in regard to the directions technology can change. Dosi (1982) depicted this trajectory as a kind of conduit of possible directions along which technological change can occur. It is defined by variables related to techniques and matters of input, and the outer boundaries are set by the nature of the technological paradigm itself. Technological change, according to Dosi, means to move along the trajectory and to trade off variables in an effort to solve technological problems; progress, in particular, means to improve the trade-offs (and thus the technology’s performance) [see Figure 1].

In the large body of literature on technological change, there seems to be a consensus that institutional (Gilfillan, 1935), social (Schumpeter, 1954; Taton, 1958), and economic (Merton, 1968; Schmookler, 1966) factors are at work in technological change, and that variety and chance matter just as much as prevailing patterns and structures (Sahal, 1981). What is of interest here is how these factors operate as a selection and “focusing” (Dosi, 1982) or “filtering” (Henderson & Clark, 1990) mechanism, which channels the direction of problem-solving activities along the technological trajectory as soon as the technology has been selected. Once a technology (and thus a technological trajectory) has been selected and established, it takes on a directing momentum of its own (Nelson & Winter, 1975; Rosenberg, 1976).

New technologies are selected likewise in the course of the complex interplay of economic factors with social and institutional factors (Dosi, 1982). Organizations in search of new business opportunities or improved operations search for new technologies given their particular interests and prevailing structures. Tushman and Anderson (1986), for instance, noted that fundamental improvements of a technology may have limits, to the extent that no advancements in performance can render the prevailing technology competitive with the new one. The focus on new technologies then is essential. Foster (1986) and Constant (1980) support this explanation with case studies on technologies that matured and yet were replaced by newer technologies, such as steam technology replacing wind-powered shipping technology or turbojet technology replacing piston-jet aircraft technology. Sahal (1981) put forward a theory of technological discontinuance by arguing that every technology has limits in

BACKGROUND 11

performance improvement; at a certain stage, the technological process becomes either too complex or the effort required too large. The only feasible way to push the limits of performance are to redefine the technological paradigm altogether, argued Sahal. It is in this respect that incremental or continuous changes are related to advancements in technology along the given trajectory that is determined by the paradigm, while discontinuous change is associated with the advent of a new paradigm [see Figure 2].

Figure 2 Schematic Illustration of Discontinuous Change

EXAMPLE 1: A Reflex Camera A’’ Automatic Camera A’ Digital Camera

EXAMPLE 2: A Xerography A’’ Digital Copier A’ Tabletop Copier

EXAMPLE 3: A Mechanical Typewriter A’’ Electrical Typewriter A’ Microsoft Word

Limits of a technology, however, are difficult to predict, especially when they rely on a complex interplay of multiple factors. In his research on “wicked problems,” Rittel (1973) explained the difficulty of finding solutions to problems in which the interdependency of contradictory and changing requirements is difficult to understand. His thoughts about wicked problems addressed issues in engineering as much as in management and other domains. Churchman (1967) introduced Rittel’s concept into management science, and Foster (1986) supports Rittel’s conclusion in discussing the difficulty of engineers foreseeing the performance limits of future discoveries or

t

p Discontinued Technology A

Disruptive Technology A’

New Technology A’’ (Same market as A)

Point of Disruption


creations, because of the complexity of natural laws; their work is characterized more by moving the boundaries than by working towards a well-understood barrier.

Christensen’s (1992a, b; 1995) research on the disk-drive industry offers additional insights on the nature of discontinuous change. His examples support the conclusion that there exists a causal linkage between discontinuous change and the emergence of a new paradigm; however, he specifies that discontinuity of technological progress does not necessarily happen at times of technological maturation. Rather, on the basis of his studies, he was able to show that technologies with different performance attributes are able to “disrupt” the progress of prevailing technologies, even before they reach a state of maturity. These “disruptive technologies,” according to Christensen, have two important characteristics: first, they reveal performance attributes that, at least in the nascent period, are not valued in the context of the prevailing technology; second, they continue to improve their performance to the extent that they suddenly invade the context (or market) of the prevailing technology; that is to say, mainstream users (or customers) of the old technology start to value the new technology and substitute it for the old one. As a consequence, change in the old technology likely discontinues.

Foster (1986), in his study of the wind-powered vessels that were replaced by steamships, made a compelling case. He showed that both technologies continued in parallel for 75 years, despite the fact that the physics of wind and water posed insurmountable performance limits for the engineers of wind-powered ships. In fact, initially the two technologies operated complementarily. In the early days, according to Foster, steam-powered vessels could not be used for transatlantic voyages for reasons of reliability. As a result, the technology was used in ships on lakes and rivers, which led to a completely different customer set and performance demand. Only after the performance of the steam technology had advanced to the point that it became competitive with the technology of wind-powered ships did substitution swiftly occur.

The phenotypical sequence of a (fairly long) period of technological progress that takes place independently from changes in the old technology, as evident in the case of the transoceanic shipping industry, raises a question about the predictability of technological progress.

BACKGROUND 13

2.2 Technological Change and Discontinuity Technological trajectories embody the course of progress in advance within a given technological paradigm (Dosi, 1982). In other words, a technological paradigm defines which directions of technological change to pursue and which to neglect. But neither a technological paradigm nor its trajectory provides information on the speed of technological progress or the rate it potentially substitutes another technology. Rather, factors other than technology come into play.

As noted earlier, institutional, social, and economic and market factors all seem to trigger technological evolution and change. Anticipating the advent of major technological changes or even their rate of progress, therefore, seems difficult. Utterback (1994) noted that the formation of new firms or the changing focus of large enterprises in an effort to exploit new ideas may become a valuable source of information in identifying the advent of technological changes. However, an analysis of firm activities can only signal some very broad directions in which a technology can progress, without providing a clear picture of how fast the technology will change to the point that it reaches wide market acceptance or disrupts a prevailing technology; for example, the advent of electronics in the context of a growing typewriter industry certainly signals the potential that there might be electronic typewriters (or even word processors) in the future, but to predict a definite rate of technological progress would be difficult, due to uncertainties surrounding factors other than the technology itself, such as co-specialized assets described by Teece (1986), the diffusion of the technology in the market as it has been extensively researched by Rogers (1962) since the early 1960s, or the strategic maneuvering by individual firms (Christensen, 1997; Suárez & Utterback, 1995; Utterback, 1994).

Teece (1986) showed that an organization’s particular assets, such as the image of its brand, channels of distribution to reach customers, or customer switching costs tend to reinforce a technology. The experience of Kodak in introducing the new 126 film standard for their point-and-shoot Instamatic cameras is a case in point. In the early 1960s, there were several firms on the market trying to compete against Kodak. For instance, Agfa tried to position its version of a small and easy to load film cartridge on the market and to convince several camera manufacturers to switch to the Agfa Rapid film system. However, Kodak’s brand dominance and extensive global network, which

14 Technological Change and Discontinuity

meant that service would be widely available, encouraged the industry to largely conform to the 126 standard.

How organizations manage communication with customers has been identified as another significant moderator for technological diffusion (and thus its evolution) (Moore, 2002; Moore, 2005). The aim of every communication is to share information between participants, to reach a mutual understanding (Pask, 1975, 1976; Pask & Scott, 1972). Diffusion is a special form of communication though; it aims to spread messages whose content is to be perceived as being related to new ideas (Rogers, 1962). In our case, it is a particular case of market learning, giving customers the opportunity to make up their mind about the benefit of adapting to a particular new technology. Close attention to customers may even inform organizations about how a particular technology succeeds or fails to meet customer demands or how changes in the technology might close the gap between technology performance and customer requirements (Von Hippel, 1986, 1988). Conversely, Christensen (1996) showed that a close focus on customers can blind organizations to the need to change.

Finally, Christensen (1992a, b) showed, in the same thorough research on the disk-drive industry, that the strategic maneuvering of organizations determines technological progress too. In charting the annual evolution of the Ferrite-Oxide technology for disk-drive heads at two companies, Fujitsu and Control Data Corporation, he could show that after several years of performance increase, the technology plateaued, suggesting that it had reached its limit, but continued increasing steeply thereafter. Based on interviews, Christensen (1992a) explained that the sudden flattening slope of the technology’s trajectory was caused by the reallocation of resources to other engineering efforts. Both companies believed, according to Christensen, that the technology had reached its performance limits, and so they started to focus on thin film heads. Because of some technical problems that prevented an early market launch of the new technology, both firms returned to the old technology, spending their efforts to increase – in fact triple – their previous performance.

Given the uncertainties associated with the various factors that determine the emergence and evolution of technological progress, it is difficult to anticipate a rate of technological change (and thus of the potential for substitution), at least in the nascent

BACKGROUND 15

period of the newly emerging technology. This can be recognized only in retrospect, as many scholars have confirmed (Christensen et al., 1998; Suárez & Utterback, 1995; Utterback, 1994). Also Fisher and Pry (1971) confirm, in their seminal work on the substitution model of technological change, that their method “is not to be applied to substitutions prior to their achieving a magnitude of a few percent.”

More assurance about the likely evolution of a technology can be obtained at times when variations of multiple technical solutions for a particular problem are synthesized into a “dominant design,” as formulated by Utterback (1994). To briefly explain the characteristics of a dominant design and its impact on the industry, it is beneficial to shift, at least for the moment, the perspective from a technology to the particular product or process that embodies the achievements of a deployed technology (Dosi, 1982).

Henderson and Clark’s (1990) framework for technological change and its impact on an organization’s capabilities is beneficial for the discussion here. By focusing on the development of new products, they suggested thinking of a product as a complex system of multiple components arranged in a unique architecture. And depending on whether technological change takes place at the level of components or their system’s architecture, or even on both levels, changes in the product’s performance are either radical or incremental. While a change in a component typically entails a change in the technology embodied in the particular part, a change in the system’s architecture leaves the technology of components untouched. Henderson and Clark established this more finely grained categorization framework to show that each type of technological change has different requirements in terms of knowledge.

The essence, which is of significance here, is that the performance of a product is dependent on both the architecture that links the various components into a larger system, and various technologies that are deployed in the components. Christensen (1992a, b) had taken this view in his research on the disk-drive industry, to argue that the notions of “architecture” and “component” are always necessarily relative. While the read-write head of a disk drive, to use his example, may be considered as the architecture of a complex system comprising various components, at the next level the head may be conceived as a component in the overall system of the disk drive. This constitutes “sort of nested systems of architectures” (Christensen, 1992a, p. 341). The


system’s performance, for instance a particular product like a disk drive, then is determined by the performance of each component and/or the system’s architecture at all lower levels.

Figure 3 Schematic Illustration of Dominant Design

The important point I want to make is that the trajectory of a product’s performance (and thus its likelihood of becoming disruptive) becomes better recognizable when the ferment of technologies applied at various levels of the product – architectural or component – synthesizes into a specific product class that wins the race for acceptance in the marketplace (Tushman & Anderson, 1986; Utterback, 1994) [see Figure 3]. Utterback (1994) called this product class a “dominant design”:

“A dominant design drastically reduces the number of performance requirements to be met by a product by making of those requirements implicit in the design itself. Thus, few today would ask if a car had an electric starter and electric windshield wipers, or whether a typewriter could produce upper- and lowercase letters, or whether a personal computer had a built-in disk drive, though these were unique features in models that precede the dominant design. Today, these features are implicit in designs that the market expects and that all producers find themselves compelled to emulate. They are no longer serious issues nor are they advertised as advantages of one or another manufacturer’s product. They are subsumed within the popularly accepted design.”

(Utterback, 1994, p.25f.)

t

p Dominant Design

Various technologies that define coalesce into a product class

BACKGROUND 17

Several studies have shown that the coalescence of several technologies into a dominant design defines a significant milestone for the competitive dynamics in the industry (Abernathy & Clark, 1985; Christensen et al., 1998; Suárez & Utterback, 1995; Utterback, 1994; Utterback & Abernathy, 1975). As soon as the performance criteria of a product (and thus of its underlying technology) change from an uncertain and ill-defined stage to a well-articulated one, the focus of competing organizations shifts from exploration to exploitation, in an effort to enhance economies of scale and market growth (Dutton & Thomas, 1985; Myers & Marquis, 1969). On the basis of a rich data set on the disk-drive industry, Christensen (1998) could support the assumptions of Utterback and Suárez (1993), that after a dominant design coalesced, many firms (are forced to) exit the business, precisely because a dominant design triggers efforts to exploit economies of scale and to build entry barriers to competitors.

The dominant design of digital cameras is an example [see Figure 4]. Invented by Kodak in 1975, it took the industry about 20 years to arrive at a design that won acceptance in the marketplace by basically replicating traditional point-and-shoot 35 mm cameras in design and usability. Earlier variations on the theme led to cameras that recorded the digitally captured information to analog, or digital capturing devices that could be attached to the back of analog SLR cameras, or even e-film, a replica of the traditional 35mm film roll, but equipped with a digital imaging sensor and memory that could be placed in the film slot of a regular camera. At least since the late 1990s, digital imaging technology evolved into a dominant design that quite clearly showed signs of the rate of technological evolution and the potential threat of substitution [see Figure 4 and Figure 8]. Kodak’s DC210 digital camera probably reveals at first the dominant design of digital cameras. It was introduced in 1997 and was the top selling camera model in 1998. It had a traditional film camera shape, zoom lens, LCD display with a rich GUI, used JPEG compression and a removable flash memory card.


Figure 4 Substitution of Silver-Halide

Photography by Digital Imaging

Figure 5 Substitution of Printed Book

by eBook

Figure 6 Substitution of Vinyl Records

by Compact Discs

Figure 7 Substitution of Compact Cassettes

by Compact Discs

TP…Threat Perception; PD…Point of Disruption; DD…Dominant Design

Digital Technology TP I (1981) MAVICA

t

p Silver-halide Technology

TP II (1994)

1970 1980 1990 2000

Still Video Technology

26Y 10Y

First Digital Camera (Kodak)

Substitution 90% (2011)

PD (2001)DD (1996)

Amazon

Sony

t

p

Printed Book

1970 1980 1990 2000

33Y >?Y

eBook


DD, TP (1998)

PD (2003)

t

p

Vinyl Record

1970 1980 1990 2000

6Y 5Y

Compact Disk


PD (1983) DD (1982)

TP (1982)

t

p Cassette

1970 1980 1990 2000

6Y

17Y

Compact Disk


PD (1983) DD (1982)

TP (1982)

BACKGROUND 19

Product Year for the new product to go from 1% to 91% of the

total market Compact Disk player for LP players 4

ICs for Transistors 8

Video cameras/ camcorders for 8 mm home movie cameras 8

Color TV for B&W (early years) 12

Minilabs for wholesale photofinishing 13

35 mm NSLR cameras for Box (110, 126, DSC) cameras 21

Digital Cameras for Film Cameras 17

35 mm for all other cameras 33

Color prints for B&W prints 43

Table 1

Examples of Past Substitutions with Rates Source: Eastman Kodak Company

Figure 8

Technological Evolution of Digital Interchangeable Cameras Source: Adapted from Digital Photography Review, 2013

0 MP

5 MP

10 MP

15 MP

20 MP

25 MP

30 MP

35 MP

40 MP

45 MP

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Max Performance Boundary Min Performance Boundary Trajectory


The collaborative effort in the definition of an industry standard for compact discs is another compelling case [see Figure 6 and Figure 7]. Invented in 1974 at Philips, Eindhoven in the Netherlands, the technology was developed as a sort of skunkworks (Peek, 2010). A small team of engineers thought of an optical audio disc the size of a fragile vinyl record, for purposes of error detection. It was not until 1977 that Philips decided to push the technology and to establish laboratories (Peek, 2010). Around the same time, Sony started to develop their version of the optical disc technology. Both publicly presented their compact disc technology in early 1979 and joined forces to collaboratively develop what they had started independently (2007a; Doi, Itoh, & Ogawa, 1979). A year later, an industry standard was established that was quickly adopted by various international standards. By 1983, the first compact discs and players were globally introduced on the market (2007b). After that, substitution of vinyl records and compact cassettes advanced unevenly. Within less than 5 years, vinyl records disappeared almost completely from the market; cassettes resisted wide-ranging substitution for about 17 years after the dominant design emerged.

In research on strategies that organizations should adopt to survive quickly changing technologies, Christensen, Suárez, and Utterback (1998) concluded that switching to a new technology before it coalesces into a dominant design bears the risk that initially developed competences may become worthless; they also argue that adopting a technology too late after the dominant design has emerged bears the risk that the organization will face strong entry barriers that earlier adopters have thrown up, such as economies of scale, distribution channels, and brand name. Here again, Kodak is a good case in point. In 1997, each of the three tech companies, Hewlett-Packard, Epson, and Canon, started to commercialize their version of a consumer home photo printer on the basis of a low-cost ink-jet technology, basically all confirming a new product class that soon invaded homes worldwide. Kodak too was considering entering the market and evaluated various technologies, including ink-jet printing, thermal printing, silver-halide printing, and electrophotographic printing. They too concluded that ink-jet technology was the lowest-cost solution (except electrophotography, which was even lower-cost, but did not meet the quality standard of those days), but they did not own the technology. Actually, Kodak had sold its ink-jet division just five years earlier, for financial reasons. In 1999 Kodak partnered with Epson to introduce home ink jet printers. However, they were not very popular, and the partnership lasted only a

BACKGROUND 21

few years. Some four years later, in 2003, when Kodak finally decided to make a bold move in the home photography market with ink-jet technology, Hewlett-Packard had already built extensive resources and financially had more at stake than the troubled photography company, whose core business was eroding due to digital substitution. Moreover, Hewlett-Packard had begun to outsource manufacturing of its cartridges and printers to companies that promised lowest costs. Hence a faltering Kodak entered (as a newcomer) a battle against the market leader. The research by Rosenbloom (2000) on National Cash Register and Christensen (2003) on IBM shows how difficult (if not impossible) it is for industry entrants to outmuscle incumbents in their effort to sustain their leading position in a technology trajectory.

To summarize: Forecasting technological evolution and change (and thus substitution) is difficult due to the interplay of institutional, social, and economic factors. Dominant design brings more certainty about the direction of technological progress; however, it too can only be assessed in retrospect. Once a dominant design coalesces, organizations are advised to use a “window of opportunity” – to take a term from Christensen, Suárez, and Utterback (1998) – in order to adapt to technological change most efficiently in regard to deployed resources.

The work of Christensen et al. (1998), Suárez et al. (1995), and Utterback (1994), however, had scant discussion of particular resource requirements to respond to technological change. Therefore, it is the aim of the following section to discuss the most important contributions related to the issue.

2.3 Technological Change and Resource Requirements In innovation research, the finding that technological changes may vary in their impact on an organization’s established resources and capabilities has been an important issue since Schumpeter’s (1911) concept of creative destruction. Change – whether incremental, radical, architectural, component, continuous, or discontinuous – requires organizations to adjust their competence configuration (for an overview see, e.g., O’Reilly III & Tushman, 2008). There is a large consensus within the scholarly field that the development and adjustment of capabilities is difficult (see, e.g., Nelson & Winter, 1982; Tushman & Anderson, 1986). Likewise there is also common agreement that resource development in an effort to adapt to a radically new environment is more

22 Technological Change and Resource Requirements

costly and difficult to achieve than small or incremental changes (Glasmeier, 1991; Landes, 1984; Rosenbloom, 2000; Sull et al., 1997). Steel (1983), for instance, observed that most progress is achieved by pursuing the less risky path of incrementally changing a known technology, rather than developing a radically new one, which he found usually required far more investment and time to develop than initially planned.

Figure 9

Schematic Illustration of an Organization’s Response to Disruption

What is of interest here is the question of how to assess the resource efforts required in response to discontinuous change. As outlined earlier, the discontinuity of a technology does not necessarily happen solely because of the appearance of a radically new technology; (disruptive) technologies that make use of existing technologies but are offered in a different marketplace, at least initially, likewise render prevailing technologies obsolete. In response to discontinuous change, organizations therefore have to define in a more nuanced way the newly required resources and capabilities. Nevertheless, in the literature stream on discontinuous change there has been less attention directed to the specific resource requirements. Scholars tend to oscillate between the two extremes of radical or incremental, competence-destroying or competence-enhancing. Moreover, often the research focus has remained narrowed on the technological aspect, ignoring the fact that changes in technologies may require additional competence in functional areas other than research and development, such as marketing or business modelling in general. In the following, therefore, I link

t

p Performance Technology A

Performance Technology A’

ThreatPerception

Point of Disruption

BACKGROUND 23

theories of discontinuous change with findings of the resource-based view (Kogut & Zander, 1992), in particular one of its extensions, the knowledge-based view (Conner & Prahalad, 1996; Foss, 1996; Grant, 1996; Nonaka & Takeuchi, 1995), which recently offered a more fine-grained view of an organization’s effort to leverage its existing resources in accordance with different innovation efforts (Dess et al., 2003; Kazanjian et al., 2002).

Tushman and Anderson (1986) suggested portraying technological changes from the perspective of their impact on competences, “because they either destroy or enhance the competence of existing firms in an industry” (p. 442). In particular, by drawing on Abernathy and Clark’s (1985) research findings they note: “The former require new skills, abilities, and knowledge in both the development and production of the product. The hallmark of competence-destroying discontinuities is that mastery of the new technology fundamentally alters the set of relevant competences within a product class” (p. 442; italics added). Limited to the technological side of the product, this classification is partially misleading in the face of discontinuous change. Clark’s (1987) observation on Xerox’s experience in response to the emergence of tabletop copiers and Christensen’s (1992a, b) research into the technological evolution of disk drives are cases in point. In the mid-1970s, a number of Japanese companies used the copier technology that Xerox had invented to commercialize small, reliable, and cheap tabletop copiers. The development and “production” of these new tabletop copiers required little new knowledge, but massively threatened Xerox’s product class (Clark, 1987).

Christensen’s (1992b) observation of the continuous replacement of the former rigid disk-drive technology with the next smaller version – from 14-inch to 8-inch disk size, etc. – is even more illuminating, because it truly initiated a discontinuous change. The ongoing substitution by one technology after another did not happen because of the deployment of a new technology, but rather because of its deployment in a different market, at least in their nascent periods (Christensen, 1992b). Both examples of discontinuous change reveal that a classification of the “new” technology as competence-destroying becomes misleading, simply because technical competences remained the same for the most part, while marketing competences were destroyed. Xerox and rigid disk-drive manufacturers failed first and foremost in the marketplace.


Henderson and Clark (1990) offer a model of categorization to address different types of changes and their impact on established capabilities of an organization. As discussed earlier, they differentiate between changes at the system level of products – that is, the architecture of the linkages between various components – and changes in the components themselves. While an architectural change of a product leaves the components and the associated technologies (and thus engineering knowledge) unchanged, a change on the level of components is meant to accompany a new technology. Nevertheless, a change in component does not automatically require redesigning the whole product architecture. Radical innovations change both architecture and component, whereas incremental innovations, according to Henderson and Clark, are concerned with the improvement of components. Their classification provided a useful framework to show that disruptive technologies for the most part are architectural in nature (Christensen, 1992b), and that organizations that aim to compete in new markets tend to be more successful with an architectural innovation than those that innovate in components. However, their framework too is of limited help for organizations in their effort to assess resource requirements in the face of discontinuous change, because of its pure focus on technological competences. With reference to the previous two cases, I will clarify the point.

Both the tabletop copier and the rigid disk-drive manufacturer disrupted prevailing technologies because these were architectural innovations, which, as a consequence, led to their application in a different market. In other words, the architectural reconfiguration of existing technologies led to a redefinition of the product’s functionality (and thus performance). New competence was required first and foremost in bringing the technology to a new market (Christensen, 1992b). Thus, two products that ostensibly rely on the same component technology led to different competence requirements [see Figure 10]. Henderson and Clark’s framework, however, does not bring to bear this fact.

Another case of (disruptive) technology that relies on existing components (architectural innovation) and redefines the technology’s performance (market innovation) was the invention of the disposable or single-use cameras in late-1980.

BACKGROUND 25

Figure 10

Competence Requirement and Type of Technological Change

The “film with a lens,” as Fuji called it, basically relied on existing components (and thus engineering competences). In fact, the idea of a single-use camera was not entirely new. Almost a hundred years earlier, George Eastman built his Kodak company around a similar business model. What was new was the products’ market application. Low cost and inferior in performance compared to 35 mm film and photography equipment, it had all the characteristics of a disruptive technology, which would sooner or later lead to discontinuous change in the superior technology. In fact, to some extent it replaced the conventional film roll market. In the mid-1990s, it was the fastest-growing product in the film market, with growth rates of 40 percent.1 Sales of 35mm film rolls actually stalled, while growth in the total photographic film and paper market continued, increasing 3 to 4 percent, while processing remained flat.2 The point that is of interest here is that Kodak (as opposed to other competitors) did

1 Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 2 Blömer, H. J. 1996a. 1994/1995 Pma Industry Trends Reports. International Contact, 15(3) May June.

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Figure 11

Competence Requirements Kodak Funsaver

Building on these arguments and examples, it becomes evident that technical competences are closely interrelated with other functional competences such as marketing, and that their interplay has an important role in an organization’s response to discontinuous change. The effort to respond to discontinuous change therefore certainly must be accompanied by a vision about the business the new technology entails. That is to say, aside from reflections on the particular technological and functional characteristics a new product or service process should possess, a vision for

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BACKGROUND 27

an organizational response to discontinuous change must comprise thoughts about the markets to be pursued and the resources and capabilities to be deployed. The literature on corporate entrepreneurship (Ireland, Covin, & Kuratko, 2009; Morris, Kuratko, & Covin, 2002; Phan, Wright, Ucbasaran, & Tan, 2009; Schindehutte, Morris, & Kuratko, 2000; Zahra, Kuratko, & Jennings, 1999a, b) and business modelling (Chesbrough, 2013; Chesbrough & Rosenbloom, 2002; Johnson, Christensen, & Kagermann, 2008; Magretta, 2002) has extensively addressed this issue. Each of these attributes of the new business represents potential requirements to develop resources and capabilities that go beyond those currently existing in the organization. I therefore propose to assess the resources an organization requires in order to respond to discontinuous change, relative to its current base of resources and capabilities.

Unlike the industrial organization perspective, which asserts that the market and industry structure determine an organization’s performance (Porter, 1979; Porter, 1991), the Resource-Based View holds that a unique combination of resources and their deployment shapes an organization’s performance and competitiveness (Barney, 1986; Wernerfelt, 1984). There are tangible resources (e.g., physical assets such as machinery and equipment, as well as liquid resources such as cash or cash equivalents), intangible resources (e.g., an organization’s brand, trade secrets, or reputation), and human resources (e.g., knowledge, experience, or skills of managers or employees) (Grant, 2002). Capabilities refer to the skillful combination of resources to generate value (Amit & Schoemaker, 1993; Winter, 2000). Dynamic capabilities enable organizations to build, extend, or integrate new capabilities (Teece et al., 1997). Recent attention to a company’s knowledge base has led to extensions of the Resource-Based View (Nonaka, 1991; Nonaka & Takeuchi, 1995), asserting that organizations are capable of leveraging their knowledge to build a competitive advantage (Conner & Prahalad, 1996; Foss, 1996; Grant, 1996). A core assumption underlying this perspective is that organizations exploit the knowledge they have created in the course of entrepreneurial actions (March, 1991; Nonaka, 1994).

Given the question I am concerned with here – namely how to assess the extent to which an organization has to either leverage or extend its current resource base or integrate completely new ones in response to discontinuous change – current findings from the knowledge-based view offer valuable insights. Building on Collis and


Montgomery (1998), who suggested that resources and not businesses are the appropriate measure to define relatedness in an organization’s effort to diversify, Kazanjian, Drazin, and Glynn (2002) offered an integrative model that defines knowledge requirements for entrepreneurial activities with some degree of relatedness to a current stock of knowledge (see also, e.g., Dess et al., 2003). In particular, they suggest that an organization that aims at developing and commercializing a new product necessarily has to adjust its knowledge base. To give an example, if the additional knowledge needed to develop and commercialize a new product is closely related to the organization’s current base, small or incremental changes in the stock of knowledge become necessary. Alternatively, if the development and commercialization of a new product are largely dependent on the integration of new knowledge, then the effort in learning or acquiring new knowledge is more radical (relative to the organization’s current knowledge base).

Figure 12 Knowledge Management and Strategies for Corporate Entrepreneurship

Source: Adapted from Kazanjian, Drazin, and Glynn (2002)

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Kazanjian, Drazin, and Glynn (2002) portray three major corporate entrepreneurship strategies and associate them with the required types of knowledge development. In the following, I briefly introduce their contingency approach, to show how it could be transferred to the literature stream of discontinuous change. Kazanjian, Drazin, and Glynn (2002) basically differentiate between “product line extensions, new product platforms, and new business creation” and the knowledge requirement related to either technology or marketing [see Figure 12]. Although they stress that the model could be extended by more than these two dimensions, I find this limitation (for the sake of parsimony) constructive in regard to a later discussion of resource requirements in a response to discontinuous change. At any event, discontinuous change embraces a change in resources related to either technology or marketing – as evident in the particular case of disruptive technologies – or both.

The photography industry in general and Kodak in particular provide examples to explain the three strategies for entrepreneurial activities. The first strategy, according to Kazanjian, Drazin, and Glynn (2002), is product line extension. An organization introduces a variation of a product that requires little development of new knowledge in regard to the technology or targeted markets. For example, the launch of the disposable camera, a “film with a lens,” was critical for Kodak and Fuji in the 1990s, when 35mm film photography was flagging. Both companies enjoyed the advantage that they could quickly leverage their existing knowledge for developing and launching the new product.

The second strategy is a new product platform, which is pursued when organizations aim to compete with a current technology in a new customer segment and/or commercialize newly developed technologies in markets they currently service. In this strategy, an organization is either developing some new technology to be taken to its existing market, or is targeting a new market with technologies the organization currently owns. Kodak’s hybrid PhotoCD system is a case in point. The new system targeted existing customers allowing them to electronically store and view their pictures, which they had captured on conventional, silver-halide film, on a regular TV set. Because the product aimed at Kodak’s most important existing consumer market, new knowledge was primarily required on the technical side. To create the advanced technology for scanning silver-halide-based films, correcting electronic images, and


incorporating the compact disc technology from Philips, Kodak redeployed existing technologies and developed new ones. Because of the flop in the consumer market – the PhotoCD system was too expensive – Kodak was forced to develop additional knowledge also in the marketing domain to position the product in a new niche within their commercial market. The central task for Kodak’s knowledge development was to recombine and extend a current stock of knowledge.

Finally, an organization may decide to develop an entirely new business by bringing a new technology to a market that the organization did not serve previously. For instance, the commercialization of digital cameras in the 1990s required Kodak to import new knowledge both for developing the technology and for marketing. The company had to build and acquire engineering and manufacturing skills to fabricate electronic devices, which were completely unrelated to its current stock of chemical-based competences. Opportunities to leverage existing competences were few. For instance, in the early 1970s Kodak stopped manufacturing 35mm single reflex cameras. In an effort to bring digital image capturing to professional cameras, Kodak had to rely on cooperation with Canon and Nikon. Both Japanese companies maintained a respected knowledge base for manufacturing camera lenses and bodies. By the same token, Kodak was required to learn (and thus to develop new competences) to bring their digital cameras to market. Initially, models had been extremely expensive, up to $20,000, and their performance was poor in terms of image resolution. Hence this new technology allowed Kodak to target only a small photography market to which it was more or less foreign. In particular, it joined with the Associated Press to gain direct access to journalists who were required to quickly integrate low-resolution images in document processing.

A conflation of Kazanjian, Drazin, and Glynn’s (2002) contingency model with Henderson and Clark’s (1990) product-innovation framework shows that knowledge management in response to discontinuous change can vary extensively [see Figure 11]. For instance, in an organization facing discontinuous change, the emergence of a disruptive innovation does not necessarily result in complete competence-destruction (Tushman & Anderson, 1986), or, to formulate it in the terms of Kazanjian, Drazin, and Glynn’s (2002) knowledge-based view, does not necessarily lead to a need to import new knowledge. Henderson and Clark (1990) referred to the example of large

BACKGROUND 31

ceiling-mounted fans to explain various types of technological change – incremental, radical, architectural, and modular. Their focus relied exclusively on capabilities related to product development. I will extend their example to show that despite different types of technological changes, the development (technology) and commercialization (marketing) of a product can lead to similar knowledge management tasks.

In an organization that manufactured large ceiling-mounted fans, the upgrade from a spring recoiled hose reel to an electric motor drive certainly sustained the dominant design of the product class, but it meant discontinuous change of the particular technology at stake (except for purposes of nostalgia). Limited in performance, the spring recoiled hose reel sooner or later had to give way to electronics. However, this change didn’t rendered businesses of ceiling-mounted fans obsolete (and thus its associated competences), because the modular alteration barely had any impact on the existing customer base. According to Landes’ (1984) and Glasmeier’s (1991), who investigated the challenges Swiss watch-manufactures encountered in their effort to adapt to electronics, we might suppose that such a modular change from mechanics to electronics required the recombination and extension of current knowledge (e.g., the design of the blades, etc., vs. the newly required knowledge of engineering electronics).

Viewed from a knowledge-based perspective, the development of a portable fan leads to a similar knowledge management task. Despite its little demand for new knowledge, it has the potential to disrupt the business of ceiling-mounted fans: Architecturally constructed according to a different system (e.g., legs instead of a ceiling suspension, smaller size), but engineered on the basis of components similar to those found in the large ceiling-mounted fans, the knowledge requirements are less than in the case of modular change (Henderson & Clark, 1990). In fact, the construction of a portable fan promises the virtues of leveraging current technological knowledge. However, as Christensen (1992a) showed, architectural innovations typically bring about different performance characteristics and thus need to be positioned in a different market, thus requiring new marketing knowledge. According to Kazanjian, Drazin, and Glynn (2002), this then would result in the recombination and extension of existing knowledge, similar to modular changes. However, by contrast with modular changes,


this type of innovation embodies the potential to disrupt businesses of the prevailing product class, while temporarily sustaining current knowledge of deployed technology.

Finally, the radical innovation of a central heating system certainly required manufacturers of fans to integrate completely new knowledge in both technology and marketing. Radical innovation, according to Henderson and Clark (1990), embraces a change in the product’s system architecture of linked components, as well as of the components themselves.

Figure 13 Resource Development in Response to Discontinuous Change

To summarize, discontinuous change leads to different knowledge management requirements relative to the knowledge base an organization currently maintains, and depending on the type of change. Building on the notion that knowledge is a particular form of resource and that other intangible, tangible, or human resources are likewise leveraged, extended, or imported in an effort to develop new products or processes, I propose to generally speak of relatedness of resource requirements (rather than knowledge requirements) for an organization, in an effort to respond to discontinuous change [see Figure 13]. Unlike categorizations that either focus on two extremes, such as competence-destroying/competence-enhancing, or radical/incremental, this fine-grained model illuminates the particular management task associated with resource

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BACKGROUND 33

development. Given my interest in the moderating effects of resources and capabilities on an organization’s response to discontinuous change, the relatedness of current resources to a target domain embodies a crucial variable in adaptation. It defines how much an organization has to leverage or stretch its existing resources, or develop new ones.

The use of this contingency model reveals another virtue. It correlates with recent models of strategic renewal and effects on management roles (Dess et al., 2003). In synthesizing the strategic roles of managers, Floyd and Lane (2000) proposed three primary approaches to renew an organization’s strategy: “competence deployment, modification, and definition.” Competence deployment refers to the process in which managers either reinforce current product markets or deploy existing resources to compete in new markets: “Change is based on an established strategic principle and is guided by an accepted definition of strategic ends and means” (Floyd & Lane, 2000); that is to say, competences to be deployed must have already established a particular set of assumptions about conditions. That said, competence deployment first and foremost leverages existing resources.

Competence definition is the process that maintains the activity, as opposed to deployment. The organization encourages “experimentation with new skills and exploration of new market opportunities” (Floyd & Lane, 2000). Both the definition of strategy as well as deployed competences with which the organization competes is going to be changed. This sub-process conforms to Burgelman’s (1983b, c) description of “autonomous” strategic behavior. Building on Kazanjian, Drazin, and Glynn’s (2002) contingent model, this process entails the development or acquisition (and internalization) of new knowledge on the basis of an emergent strategic intent, which is at the core of this process.

Finally, competence modification recognizes the need for change. Situated between the two other sub-processes, it questions an organization’s existing strategy and motivates adaptive behavior (Huff, Huff, & Thomas, 1992). Hence it acknowledges a current stock of competences, but questions the extent of modification or stretch required to achieve strategic fit with an altered external environment. The reconfiguration and expansion of current competences present new opportunities to compete.


To conclude, the threefold categorization framework of resource relatedness – leverage, recombine and extend, or import – allows a more fine-grained assessment of the recourses an organization requires in its move to a new domain, in response to discontinuous change. The extension from the Knowledge-Based View to a broader perspective of the relatedness of required resources and capabilities, or competences as an organization’s unique resources, capabilities, and routines, conforms to three sub-processes in strategic renewal.

2.3.1 Measuring Resource Relatedness The fine-grained contingency model proposed by Kazanjian et al. (2002) has an informative value for organizations pursuing a new strategy, for instance, in response to discontinuous change. The new business opportunity an organization opts to pursue is defined by the degree of relatedness between an existing stock of resources (or knowledge base) and a targeted one. Depending on whether the organization leverages, recombines and extends, or imports resources, different resource management and implementation strategies are required. Nevertheless, Kazanjian et al. (2002) are not explicit about how to measure relatedness, an issue that has gained extensive attention in the diversification literature with respect to financial performance. In fact, they note that in their framework, the “degree of relatedness is defined relative to a firm’s extant knowledge bases rather than as a business-level construct” (p. 175), as Rumelt (1974) among others did. That is to say, in their model, resource requirements are defined by the relatedness of the strategy to existing firm resources, but issues of available resources, such as the surplus of cash available in the short run to fund development or acquisition of new resources, are not addressed. In the context of the discussion here, however, this matter is of importance for two reasons:

First, resources are difficult and costly to develop. Scholars have shown that precisely for this reason, organizations tend to adjust to those technologies that deploy current stocks of resources and capabilities (Helfat, 1997; Teece, 1986). Nevertheless, in the particular case of discontinuous change, when technologies are altered such that the way things are currently done or have been done previously is no longer of value (Sahal, 1981), organizations need to change their stock of resources and capabilities. In such a circumstance, it makes no sense to try to leverage existing resources. Rather,

BACKGROUND 35

organizations are required to at least recombine and extend, if not import, new resources. The question is then at what cost. Given that organizations facing discontinuous change are likely to face resource constraints due to a performance decline in the traditional business – as will be shown in detail in chapter 3 – issues of available (uncommitted or financial) resources become relevant.

Second, an organization’s response to discontinuous change resembles efforts towards diversification with respect to achieving superior performance by operating multiple businesses. Although this issue will be given more attention in the following chapter, here is it is sufficient to note that under conditions of discontinuous change, organizations are challenged by the dilemma that they cannot simply transform their current business from one state to another, but are required to develop and orchestrate multiple businesses simultaneously. Operating multiple (or at least two) businesses then poses the question of how to exploit any synergies between the businesses in order to achieve a cost or differentiation advantage over rivals – rivals that might even operate as non-diversifiers that do not have a parent that incurs additional costs (Goold, Campbell, & Alexander, 1994). As Hill, Hitt, and Hoskisson (1992) explained, “resource sharing and skill transfers enable the diversified firm either to reduce overall operating costs in one or more of its divisions, and/or to better differentiate the products of one or more of its divisions (thus enabling a higher price to be charged)” (Hill et al., 1992, p.502). This accomplishment usually requires that the organization identify resources required in generating value in each of the businesses and maintain structures and processes enabling them to be used in the others (Hill, 1988; Hill & Hoskisson, 1987). Therefore, achieving superior performance in operating multiple businesses depends on leveraging existing resources rather than extending them or even importing new ones. For this reason, this elaboration on relatedness should, to be comprehensive, include a brief review of the literature on measuring relatedness between businesses.

Traditionally, scholars have measured the relatedness between businesses to identify economies of scope in two basic ways (Montgomery, 1982): On the one hand, an organization’s diversity was measured according to how much two (or more) businesses relied on the same SIC (Standard Industrial Classification) code (Caves & Porter, 1980; Jacquemin & Berry, 1979). This measurement procedure rested upon the


assumption that businesses relying on the same industry code likely share similarities in input requirements or technology function in production. Rumelt (1974, 1984), on the other hand, proposed a mere subjective measure to categorize the extent to which two (or more) businesses are related to each other. Businesses are related, he proposed, “when a common skill, resource, market, or purpose applies to each” Rumelt (1974). In identifying the shortcomings of the different degrees of breadth the SIC code shows and by holding onto a single variable that reflects the degree of diversity, he proposed to measure the relatedness of businesses by using a set of seven categories of diversification strategy. In particular, he proposed to measure the relatedness of one business to another by how much a business shared similarities with the dominant business on the corporate or operational level.

Both approaches, however, revealed limitations: For instance, researchers have argued that neither measure takes into account whether the resources being shared could be obtained at an equivalent or even lower cost for organizations that do not diversify (Barney, 1986; Montgomery & Hariharan, 1991). More recently, Markides and Charitou (2004) showed that diversification enhances performance only when it allows businesses to share strategic resources. Barney (1991) defined strategic resources (or assets) as being valuable and rare for competitors to assess, imperfectly tradable, and costly to imitate. The measurement of relatedness, following Markides and Williamson (1996), then should be based on the opportunities for sharing such strategic resources between two businesses. Certainly such a measure takes into account the organizational structure enabling strategic relatedness. Only by finding ways to allow multiple (or at least two) businesses to exploit strategic resources in a value-generating manner, Markides and Williamson argue, will diversifying organizations be able to maintain superior financial performance over the long run.

There is no reason for going more into detail here. The important point I want to make is that an organization that diversifies – or, to be more precise, that simultaneously operates two or more businesses in response to discontinuous change – can achieve superior performance only when it manages to allow its businesses to capitalize on existing strategic resources. If this is not possible, for instance, in the case of radical technological changes, stretching existing or importing new resources is not just costly and difficult, but presupposes, first, that the organization has the required levels of

BACKGROUND 37

available or unabsorbed financial resources to do so, and, second, that despite the costs a corporate parent incurs, the organization achieves a cost or differentiation advantage (or both) over (non-diversified) rivals.

As will be shown in the particular discussion of the Kodak case, the company’s strategic decision to engage in digital imaging and to pursue electronics-oriented businesses rather than chemical-based engineering as in traditional film and paper production, required financial resources that Kodak was hard-pressed to provide in the face of a declining core business due to digital substitution. Moreover, it will be shown that Kodak barely managed to maintain a cost or differentiation advantage over rivals, despite the fact that it had acquired core resources required to compete in the digital domain. A corporate overhead well beyond the standard in electronics industries rendered superior performance difficult.

3 THEORY

Discontinuous change differs from evolutionary change in that it represent an advance so significant that it drastically alters the way things are currently done or have been done previously (Sahal, 1981). Such discontinuities offer performance improvements over traditional technologies. Neither an increase in efficiency nor a new design can render the old technology superior to the new one (Tushman & Anderson, 1986). Thus, changes in an organization’s stock of resources and the way it is deployed become necessary. In this section, I am concerned with the question of how stocks of resources and their deployment moderate an organization’s response to discontinuous change. In particular I am interested to examine how the level of committed resources determines the alteration of a once selected and retained resource allocation process (and thus an organization’s response to change). For this very reason, it is appropriate to first distinguish between “committed” and “uncommitted” resources, and second, to show how a new technology potentially erodes an organization’s resource base by getting a foothold in the market of the traditional business.

3.1 Discontinuous Change and Organizational Decline Drawing on the literature of slack resources , I use the term “committed resources” as equivalent to “absorbed” slack (Smith, Grimm, Gannon, & Chen, 1991), “low discretion slack” (Sharfman, Wolf, Chase, & Tansik, 1988), or “recoverable” slack (Cheng & Kesner, 1997); for instance, manufacturing, selling, and general expenses. Mone et al. (1998) argued that these resources are entrenched with a particular business and there therefore cannot be freed quickly. “Uncommitted resources,” by contrast, refer to the opposite end of the continuum. Like cash or cash equivalents (e.g., marketable securities), these resources are available, unabsorbed, and thus equal to high discretion slack (Smith et al., 1991).

Many scholars have shown how uncommitted resources enable organizations to explore new business opportunities and to take risks (Bourgeois, 1981; Cyert & March, 1963; Mone et al., 1998; Singh, 1986) or how it enables managers to engage in actions directed towards joint ventures or acquisitions (Barker III & Duhaime, 1997). Drawing on this line of argument, I propose that the availability of uncommitted resources potentially facilitates adaptation to any kind of change.

40 Discontinuous Change and Organizational Decline

Figure 14 Adaptation to Evolutionary and Discontinuous Change

Adaptation to discontinuous change poses a particular dilemma: As soon as a substituting technology gains a foothold in the traditional market, it begins to replace the traditional business. In this sense it affects the performance of the organization’s traditional business. This may lead to reductions in market share (Christensen & Rosenbloom, 1995; Foster, 1986; Willard & Cooper, 1985), destruction of competences (Tushman & Anderson, 1986), financial losses, and/or substantially reduced product sales (Christensen, 1997; Klein, 1984; Solow, 1957). As a consequence, organizations challenged by discontinuous change may become substantially, materially affected and may suffer consequences such as negative net cash flow, or, in the worst case, the death of the organization (Meyer, 1988).

Paradoxically, in the face of discontinuous change the objective is not to change from one state to another in a sequential manner (as may be appropriate in environments with minor changes), but rather to reconfigure and orchestrate multiple competences simultaneously (Christensen & Raynor, 2003; Christensen et al., 1998; Gilbert, 2005; Masini et al., 2004; Siggelkow & Levinthal, 2003; Siggelkow & Rivkin, 2006) [see Figure 14]. In such a setting, a new context emerges that requires organizations to allocate resources to the development of a different competency configuration, while retaining a resource commitment to existing competences. (In the previous chapter I elaborated on the issue that the rate of substitution dependents on multiple “diffusion” factors and that an old technology not necessarily becomes obsolete immediately.)

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In addition, whereas traditional views on organizational change required a measurable evidence of a decline in the performance to motivate a change in resource commitments (Cyert & March, 1963; Levitt & March, 1988), for instance, to invest in new technologies to meet the demand of new customer markets, under conditions of discontinuous change, no immediate impact on performance occurs – precisely because the competence configuration of the old business continues to fit the traditional business environment (Christensen & Rosenbloom, 1995; Tushman & Romanelli, 1985). Thus, an effective response to discontinuous change requires managers to commit resources to multiple and even competing competencies at the same time, while lacking an impetus to do so.

In order to show that discontinuous change threatens an organization’s adaptability by potentially eroding the resource base an organization can draw upon to be adaptive, I will link the literature on discontinuous change with that on organizational decline.

For scholars investigating discontinuous change, the issue of available resources is not of prime concern, because the emergence of a potentially substituting technology does not necessarily affect an organization’s performance immediately (Christensen et al., 1998; Gilbert, 2005); unless the new technology gains a foothold in the traditional environment, an organization’s existing capabilities might still retain a tight fit, and no performance gap may be experienced. Thus organizational adaptation to new contexts is not necessarily constrained, since the organization is not substantially or materially impacted. However, the new technology can threaten an organization’s viability as soon as it gets a foothold in the traditional environment [see Figure 15].

The literature on organizational decline portrays the effects of discontinuity from the other end of technological substitution: Scholars in this field discussed organizations and their potential to change and adapt at a time when they are already facing a performance gap (Cameron, Whetten, & Kim, 1987; Cyert & March, 1963; Levitt & March, 1988; McKinley, 1993). The change – whether it be derived from alterations in the environment or from the organization itself – has already affected the organization’s viability. In such a situation, the organization is substantially, materially affected and may face multiple consequences, ranging from negative cash flows to organizational decline.

42 Discontinuous Change and Organizational Decline

Figure 15

Relationship between Discontinuous Change and Organizational Decline

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Time of breakeven (cumulative cash reaches zero)

THEORY 43

Acknowledging a decreasing resource base, scholars of organizational decline raised the question of how organizations are able to renew their businesses at times of resource scarcity (Mone et al., 1998). Scholars of this literature stream suggested that a decreasing resource base hampers the organization in its effort to engage in actions that would either put it into a new strategic domain or decisively change the way it serves existing customers or constituents. For instance, Barker and Duhaim (1997) reported that companies having unabsorbed resources are more likely to be able to make acquisitions or to introduce new offerings than companies that suffer from having little or no unabsorbed resources. Moreover, scholars have found that actions directed towards bottom-line efficiencies, cost cutting, or downsizing usually cannot be easily converted into uncommitted resources in a way that pushes an organization beyond its current strategy (Cascio, 1993; McKinley, Sanchez, & Schick, 1995; Mishra & Spreitzer, 1998).

The timespan between threat perception – the recognition that a new technology may potentially affect an existing business in the future – and the point of market disruption then becomes a critical factor for organizations aiming to adapt to new conditions, because the availability of uncommitted resources may become limited. In the previous section on “Technological Change and Discontinuity,” I addressed the difficulty of assessing the future development of a new technology, its trajectory, particularly before the coalescence of a dominant design.

In the face of discontinuous change, two additional factors render the availability of uncommitted resources problematic. First, and as outlined in the previous chapter too, discontinuous change drastically alters the way things are currently done or have been done for some time. For this very reason, it begins to threaten causal relationships in the traditional environment. That is to say, discontinuous change alters existing competences of an organization. The traditional competence configuration of the organization, its skills and know-how, which have been built in a tight fit with the traditional environment, suddenly become improper. Depending on resources required to adapt to a targeted new business domain relative to the existing one, opportunities to convert committed resources into uncommitted ones are limited. The current set of competences to develop and commercialize a new technology might be too different from that required in the new context. In other words, the organization cannot just

44 Discontinuous Change and the Resource Allocation Process

leverage its competences, but is required to reconfigure and extend or even import new resources and capabilities. Particularly in the case that newly required competences are entirely unrelated, resources are then available only to the extent that they refer to uncommitted resources such as cash or cash equivalents.

Second, in times of discontinuous change, when basic causal relationships in the environment have changed and the dominant design of a technology is still in flux, a prior, well-learned response can become maladaptive and dysfunctional (Campbell, 1965; Weick, 1969). In such a situation, only a flexibly planned response has survival value. In an iterative action-reaction process, organizations have to learn step-by-step about the parameters of the newly emerging context over time (Alvarez & Barney, 2007; Chesbrough, 2003; Ries, 2011). Certainly, this process entails different timing and resource allocation than a one-time response according to a prior, well-learned rigid plan. The literature on organizational decline and crisis suggests that scarcity or absence of uncommitted resources triggers counterproductive reactions, creating a context that is more conducive to rigid behavior than a context in which resources are available (Mone et al., 1998; Ross & Staw, 1993; Whyte, 1986).

The study of Kodak supports these findings, showing a strong interdependence among the rate of technological substitution, the time of threat perception (and thus response), and the availability of uncommitted resources an organization could use to be adaptive. The tsunami-like speed of substitution of Kodak’s traditional silver-halide photographic film and paper business by digital technologies, as well as the decision to delay discontinuous change (and thus to continue to commit resources to traditional technologies in order to generate investments necessary for developing and importing resources related to digital imaging), quickly eroded the resource base that the company could have fallen back on in its effort to respond.

3.2 Discontinuous Change and the Resource Allocation Process The drivers of innovative activity (and hence technological change) have been well researched (Dosi, 1982, 1988a, b; Foster, 1986; Nelson & Winter, 1977; Sahal, 1981). Scholars have identified two main and distinctive sources for change: on the one hand, internal forces, which stem from autonomous entrepreneurial activities starting at the operating and middle level of organizations. Burgelman (1983a, c, 1991) and Floyd

THEORY 45

(1999) enriched this literature stream by directing attention to the influence of managers at the middle level who substantially shape resource allocations (and thus strategy) by deciding to support or withhold funds from other new ventures (Bower, 1986; Dess et al., 2003; Floyd & Lane, 2000). On the other hand, there are external forces, which are directed by external stakeholders such as customers, investors (Cooper & Schendel, 1976; Foster, 1986; Mowery & Rosenberg, 1979; Pfeffer & Salancik, 1978), users, suppliers, and partners (Chesbrough, 2003; Von Hippel, 1988).

Recent research on discontinuous change has directed its focus on the impetus that drives and reshapes internal investment patterns. For instance, Christensen and his colleagues showed how an organization’s existing customers set can shape resource allocations (Christensen & Bower, 1996; Danneels, 2003; Tripsas, 2008). Industry leaders succeed in coming up with all those technologies that address current or potentially future demands of customers. The very same organizations may fail in new markets, because of a lack of impetus to invest in ventures for which no customer yet exists. Gilbert’s (2006) study explains how a structural differential to enact different behaviors simultaneously, as well as senior-team frame integration to embrace diversity of competing cognitive frames across sub-units, have been identified as successful mechanisms to actively intervene in an organization’s investment pattern (and thus to develop a strategic response to discontinuous change). Sull’s (1999, 2005) research on Firestone’s response to new tire technologies directed attention to top management’s capability to actively reverse a bottom-up process of a vertically integrated manufacturing company in the face of disruptive changes in existing markets, and Eisenman and his colleagues (2002; 2000) bring new insight by investigating the top-down strategic decision making in media firms.

Many of these new findings resulted from the combination of different theoretical perspectives that led to the discovery of anomalies that spurred further theoretical development (Gilbert & Christensen, 2005). For instance, Christensen (1992a, b) showed how theories of modular, architectural, or radical change could not explain incumbent firm failure by linking resource allocation process theory with the theory of resource dependence (Pfeffer & Salancik, 1978). Gilbert (2005, 2006) integrated prospect theory (Kahneman & Tversky, 1979) and the organizational behavior perspective under conditions of threat (Staw et al., 1981) to show how to actively


intervene in and reshape a retained investment pattern. Eisenman (2002) combines agency theory (Fama, 1980) with transaction cost theory (Williamson, 1975) to question the predictability of an organization’s response to risk in diversified companies. The research on Kodak too suggests a synergetic combination, with a different theoretical lens.

While the many findings in evolutionary theory contribute much to our understanding of the resource allocation process, by directing a focus toward the competitive forces shaping and redirecting an internal resource allocation process, the moderating effect of stocks of resources and their strategic deployment has received less attention. In the following section I therefore explore this issue by linking the Resource Allocation Process and the Resource-Based View, which are two comparatively close perspectives.

3.2.1 Linking the Resource Allocation Process with the Resource-Based View Organizations are faced with numerous obstacles when they attempt to adapt to environmental changes: Existing routines and capabilities (Benner & Tushman, 2002; Cohen & Bacdayan, 1994; Leonard‐Barton, 1992), resource commitments (Christensen, 1997; Christensen & Bower, 1996; Danneels, 2003; Pfeffer & Salancik, 1978), and cognitive frames (Baron et al., 1999; Staw et al., 1981; Tripsas, 2009; Tripsas & Gavetti, 2000) constrain the organization to the extent that the very same features that initially helped it to successfully compete in a particular environment become inertial forces, limiting its ability to adapt appropriately and leading to poor performance (Benner & Tushman, 2003; Henderson & Clark, 1990; Kaplan, 2008; Tushman & Anderson, 1986).

In an effort to understand the variables that moderate an organization’s response to environmental change, organizational theorists have referred to evolutionary theory, adopting a variation-selection-retention perspective to explain an organization’s evolution (Aldrich, 1979; Campbell, 1965; Weick, 1969). The evolutionary perspective invites the application of various theoretical lenses. As this study introduces a grounded theory of the impact of committed strategic resources and capabilities in the face of discontinuous change, I propose to combine the Resources Allocation Process model with the Resource-Based View, in which patterns of

THEORY 47

resource accumulation are regarded as the source for competitive success and organizational performance (Penrose, 1959; Wernerfelt, 1984).

The combination of the RAP model and the RBV promises to improve our understanding of inertial responses to major environmental changes for the following reasons: Both theoretical lenses, the RAP model and the RBV, share an affinity to evolutionary models (e.g., Barnett & Burgelman, 1996; Burgelman, 1991, 1994; Helfat, 2000; Helfat & Peteraf, 2003; Lovas & Ghoshal, 2000). Likewise, both are concerned with internal resources and capabilities; however, whereas RAP model researchers direct their attention to the competitive forces for resources internal to the organization, RBV scholars are focused on how internal resources shape external competitive dynamics. Drawing on this distinction, the pattern of resource commitments becomes an indicator of competitive success and performance of a multi-business organization. I explore this linkage in the face of resource scarcity.

Scholars building on the Resource-Based View have shown that organization’s continued success and growth is based on exploitation of distinctive resources and the capability to build new ones (Teece et al., 1997; Wernerfelt, 1984). This holds true particularly in the face of organizational change, as the literature on organizational learning, knowledge accumulation, and capability development suggests (Helfat, 2000). The dynamic Resource-Based View directs attention to “dynamic capabilities” to understand the role of leadership in adapting, building, and integrating existing and new organizational competences to match the environmental change (Eisenhardt & Martin, 2000; Helfat, 1997; O’Reilly III & Tushman, 2008; Teece, 2007; Teece et al., 1997).

Researchers on organizational strategy in multi-business corporations have extensively investigated the question of the optimal positioning of business segments to build competitive advantage (e.g., see the work of Boston Consulting Group; Hax & Majluf, 1996; Henderson, 1979). Acknowledging that internal resources determine external competitive processes and outcomes, the pattern of resource commitments to various business units indicates competitive success and organizational performance. For organizations engaged in various businesses this means to invest available resources strategically (Henderson, 1979). Viewed through an RAP lens, every business unit, each trying to gain a competitive advantage and significant market share due to


experience effects, will compete for available resources. However, managers running multi-business organizations are confronted with the problem that resources needed to capture dominant market shares are probably not available for all the company’s businesses. Fruhan (1972) makes a compelling case for this problem by discussing General Electric’s dilemma of not being able to afford its profitable computer business in the face of IBM’s formidable cash flows. GE would have had to reduce investment commitments to other profitable and competitive businesses to successfully compete against IBM. Hence, choices have to be made regarding investment commitments based on prospective strategic conditions and available resources for the needs of each business unit. Certainly, such choices can be made only by taking into account the company’s viability in the portfolio of all its businesses (Schoeffler & Buzzell, 1974).

3.2.2 Modelling the RAP to Include Resources and CapabilitiesStrategic management scholars have explored the questions of optimal investment comprehensively. Less attention has been devoted to organizations removing resources from an ongoing business operation. Managers from multi-business organizations may have to consider the possibility of reducing productive capacity, such as by closing factories or reducing work force, without divesting the business completely. While there exists an extensive literature that gives us an elaborate understanding of organizations exiting a business altogether – for instance, by divesting a business within a larger portfolio (Burgelman, 1996; Hoskisson, Johnson, & Moesel, 1994; Ross & Staw, 1993) – this study, in contrast, aims to explore how resource commitments that cannot be quickly reversed moderate an internal resource allocation process. I investigate this link in situations in which an organization is challenged by discontinuous change, which threatens its resource base.

I therefore view the process of reversing a once selected and retained resource allocation process from the perspective of the strategic process, which unfolds as an intra-organizational evolutionary process (Burgelman, 1991; Lovas & Ghoshal, 2000). Viewed from this perspective, the reduction of particular investments poses the question of how organizations reverse once selected and retained business units. Building upon the Burgelman-Bower intra-organizational resource allocation process, I propose a model that builds upon previous findings but integrates resources and capabilities as an additional moderating component [see Figure 16].

THEORY 49

Figure 16 Elaborated Resource Allocation Process Model

An organization’s resource allocation process maintains the central component of the framework: Burgelman (1983b, c) distinguishes between a behavior that falls within the boundaries of an institutionalized strategy and one that emerges bottom-up from an operational level, challenging the existing strategic context, to address the importance of autonomous activities for change.

An organization’s strategic and structural context is the first variable that affects internal resource allocations. Bower (1970) and Burgelman (1983c) showed that new strategic initiatives – new product developments or processes changes – typically originate at lower levels of an organization’s hierarchy. Although employees at the operative levels usually are equipped with the experience and know-how to initiate autonomous initiatives, middle managers maintain the critical role in shaping strategy, to the extent that they decide which new initiative to support or withhold from others. This view gets support by more recent work by Steven Floyd and his colleagues (Floyd & Wooldridge, 2000; Wooldridge, Schmid, & Floyd, 2008) Bower also observed that a manager’s risk behavior in deciding which new initiative to support is closely linked to career management, because backing unsuccessful projects can have severe consequences (see also, e.g., Dutton & Ashford, 1993). The following discussion on Kodak’s resource allocation process will show that the company did not

Resource AllocationStrategic-Structural Context Customers & Capital Providers

Cognitive Framing

Resources/ Capabilities

ORGANIZATION ENVIRONMENT

RAP (Bower, 1970; Burgelman, 1983) ↔ ← Resource Dependence (Pfeffer/Salancik, 1978)→ Customer Power (Christensen/Bower, 1996)

RAP & Cognitive Framing (Gilbert, 2006) ↔

Shamiyeh: RAP & Resources/ Capabilities (RBV View) ↔


suffer from a lack of new ideas or project developments. Rather, structures put in place extensively fostered the emergence of new organizational initiatives – even to the extent that CEOs claimed that there were too many of them, which, as a consequence, blurred a clear focus.

The second variable concerns powerful customers and capital providers whom an organization is dependent upon or chooses to serve, because they secure the means the organization needs to survive. Resource dependence, as it was explored by Pfeffer and Salancik (1978), essentially describes a perspective that looked outside the company to explain internal investment patterns with respect to new initiatives. Scholars in this research stream suggested that the strategic alternatives an organization can pursue are usually constrained to the extent that customers and shareholders force managers invest in those initiatives that secure survival. Other work supported this view (see, e.g., Cooper & Schendel, 1976; Foster, 1986). Christensen, on the contrary, observed that resource dependence can develop at a company’s own request. By linking the research on resource dependence with Bower and Burgelman’s intra-organizational variation-selection-retention process, Christensen showed that the impetus for change in investment patterns (and thus innovation) can emerge from an internal and uncoerced desire to address the needs of powerful customers (Christensen, 1997; Christensen, 1992a, b; Christensen & Bower, 1996). This latter view does not really describe Kodak’s behavior until recently, because the company always tended to define standards in the consumer market, rather than to respond to customer needs. In contrast, Capital Markets in general and Wall Street in particular maintained an immense influential factor on the company’s decision making.

Cognitive frames are the third category of important variables that trigger a company’s internal resource-allocation process. Schön and Rein define frames as the “underlying structures of belief, perception, and appreciation” that filter an individual’s reflection of a state of affairs (1995, p. 23). Scholars have shown that differences in cognitive frames lead to multiple behavioral outcomes (Kahneman & Tversky, 1979; Staw et al., 1981; Tripsas & Gavetti, 2000). Of particular interest here are Gilbert’s (2005, 2006) findings on threat versus opportunity perception in relation to an intra-organizational resource-allocation process: In drawing on the threat research in organizational behavior (Dutton & Jackson, 1987; 1988; Staw et al., 1981), Gilbert showed that

THEORY 51

framing an external stimulus as a threat leads to deep organizational rigidity. Incidents that bear the risk of a potential loss and cannot be controlled by the organization itself motivate concentration on the current resource base and limit interest in exploring new ventures (Jackson & Dutton, 1988). Hence, threat framing triggers a high resource commitment, but one that is directed towards existing businesses (Gilbert, 2006). Opportunity framing, on the contrary, can relax rigidities generated by threat, but does not trigger the same level of resource commitment. Rather, by interpreting the event positively, likely to provide benefits and in one’s control, it motivates a flexible course of search activities. This research on Kodak supports the importance of cognitive frames as an influential component of an organization’s internal resource allocation process.

Resources and capabilities are the final variable that influences an intra-organizational resource-allocation process. Resources are a company’s most elementary building blocks, including tangible, intangible, and human assets (Grant, 2002). Companies compete on the ground of their distinctive resource base and its deployment (Amit & Schoemaker, 1993; Penrose, 1959; Teece et al., 1997; Wernerfelt, 1984). Here, considering variables that affect a company’s resource allocation, two aspects are of interest: first, the company’s current resources and their deployment in a particular strategic business. It has been well shown by research that an organization’s competitive advantage rests upon differences in resources and capabilities (Barney, 1991; Barney, 1995; Peteraf, 1993). Research has also shown – in particular the work of the Boston Consulting Group – that because of experience effects, companies have to invest strategically to achieve a leading position in the market (Hax & Majluf, 1996; Henderson, 1979). Empirical research has confirmed a causal relationship between relative market share and profitability (Fruhan Jr, 1972; Ghemawat, 2002; Schoeffler & Buzzell, 1974). According to Bower , these findings have major implications for the strategic allocation of resources, precisely because every business will compete for available funds in its aim to build a competitive advantage. This leads to the second aspect of interest here, the level of uncommitted resources to be used to fund new ventures. As outlined earlier I prefer to use the terms “unabsorbed,” “available,” or “high-discretion” slack as equivalent to “uncommitted resources” (Cheng & Kesner, 1997; Sharfman et al., 1988; Singh, 1986). Those resources are not entrenched in the cost structure of a particular business and thus immediately available – for example,

52 Discontinuous Change and Variables Moderating Adaptation

the amount of cash or cash equivalents such as marketable securities – and therefore do not represent a commitment that cannot be undone immediately, such as manufacturing, selling, and administration. Hence, the level of uncommitted resources sets limitations to a company’s resource-allocation process. As outlined earlier, General Electrics, for instance, could not afford to compete in the computer business because of IBM’s remarkable cash flow (Fruhan Jr, 1972).

3.3 Discontinuous Change and Variables Moderating Adaptation The aim of this section is to briefly review the most important contributions to the field of discontinuous change by scholars of the resource allocation process, to summarize the research gap or problem that has been ignored in the literature so far, and, finally, to synthesize variables that tend to moderate resource development of an organization in its aim to respond to discontinuous change. Propositions and a general model of the interaction between discontinuous change, organizational response, and resource development are presented.

Burgelman’s (1983a) research on the strategic behavior of large and complex organizations illuminated reasons that certain initiatives for driving technological progress are either promoted or dismissed. In particular, he directed attention to an organization’s “autonomous” behavior, which subverted existing strategies. His study on Intel and its transition from memory chips to microprocessors was a case in point (Burgelman, 1994). Burgelman’s findings enriched our understanding to the extent that he identified behavioral patterns that inform an organization’s strategy aiming either to develop a new technology or to remain with their current one [see Figure 17].

Pfeffer and Salancik (1978) and Christensen (1996) showed why organizations tend to sustain selected and retained technologies, even in the face of emerging technologies that potentially disrupt existing ones. Their approaches, however, drastically differed from each other. Pfeffer and Salancik (1978) basically looked outside the company to investigate forces that shape an organization’s investment pattern (and thus the sources for technological progress). Dependency on external resources, such as capital providers or powerful customers, was identified as a factor that constrains a manager’s array of possible decisions in developing alternative businesses (or technologies).

THEORY 53

Figure 17 Bower (1970) and

Burgelman’s (1983a)

Figure 18 Pfeffer/Salancik (1978) and

Christensen (1996)

Figure 19 Gilbert’s (2006)

Figure 20 Aim of this Research

t

p

How organizations define a technological trajectory to be pursued

t

p

Why organizations reinforce a technological trajectory

t

p

How framing of a new technological trajectory affects organizations

t

p

What are the challenges organizations faces in adapting to new technological trajectory


Christensen (Christensen & Bower, 1996), on the contrary, located the causes of continued reliance on current technologies inside the organization. He argued that because organizations focus too closely on their customers and they become blindsided to potential disruptive forces. The sustaining of a current technology, in any case, is central to both perspectives [Figure 18].

Gilbert (2005, 2006) elaborated on the question of how to respond to an emerging disruption once it is recognized. The primary concern of his studies was how cognitive framing of potentially threatening new technologies moderates strategic behavior and thus investment patterns. Gilbert reckoned that organizations are capable of overcoming prevailing dependencies and identified the organizational structures and cognitive frames that are required to promote resource commitments necessary to adjust to new and potentially disruptive technologies [see Figure 19].

My research builds upon the findings of the authors mentioned above and aims to illuminate the moderating effect of resources and capabilities in an organization’s response to discontinuous change. In simple terms, here it is presumed that an organization has recognized a potentially threatening new technology and decided to respond to it. I am reluctant to speak about adaptation, though an organization may decide not to adapt to a disruptive technology at all, but rather to direct its strategic focus elsewhere. Agfa, for instance, decided to leave the photography market altogether and to leverage its competences to pre-press or health-care IT solutions. How resources and capabilities moderate an organizational response to discontinuous change is synthesized in the following.

Once an organization comes to the realization that a retained technology is likely to become discontinuous and that action must be taken for the organization to survive, the level of committed and/or uncommitted resources becomes determining in its response [see Figure 20]:

Other scholars have shown that organizations tend to adjust to those technologies that deploy current stocks of resources and capabilities, because resources are difficult and costly to develop (Christensen & Bower, 1996; Helfat, 1997; Teece, 1986; Tripsas, 1997). Because they are embedded in an organization’s cost structure, I consider, for the sake of parsimony, these resources as committed. Kodak’s decision to install publicly accessible print stations is a case in point. In the 1990s, the emergence of two

THEORY 55

technologies suggested the discontinuity of silver-halide photofinishing technology: the cheap and low-quality ink-jet technology, which was available for consumers in the form of home photo printers since 1997, and the costly but reliable thermal printing technology, which was used in photo kiosks that allowed customers to add text, graphics, and backgrounds to their photos. Throughout the 1990s, thermal dye transfer printing provided significantly better photo image quality than ink jet. Kodak decided to promote the latter technology, because the company could rely on an extensive set of competences. It used thermal dye printing in its Creation Station, which was introduced in the US in 1994 and even earlier in Australia. Adapting to ink-jet technology would have required Kodak to acquire additional competences. That a stock of resources and its deployment moderate an organization’s path of exploring and exploiting a new technology is known, and is mentioned here only for the purpose of completeness.

While committed resources moderate an organization’s choice regarding targeted technologies, it is the level of uncommitted resources that moderates an organizational respons as such. New technologies render existing sets of competences partially obsolete (component or architectural innovation) or completely so (radical innovation). By competences, I do not exclusively refer to those resources, capabilities, and routines that are required to develop the new technology as such, but cover all the obligatory processes, from idea generation to commercialization. Demand for additional resources to effectively adapt to a new technology then depends on the relatedness between competences required for a current technology (and its associated business) and a targeted one. The more closely a currently deployed set of competences is related to those required for the competing with a targeted technology, the more an organization will be able to leverage its (committed) resources. Conversely, the more an organization’s stock of resources deployed in a current technology is unrelated to the new technology, the more uncommitted resources are required to fund expansion of existing competences or acquire new ones. In sum, the higher the level of uncommitted resources to fund development of additionally required resources and capabilities, the more positive the efforts at adaptation.

Aside from relatedness, two other variables moderate the level of uncommitted resources required to adapt to a new technology: time of threat perception and


response, as well as rate of technological progress and substitution. Extending a current competence set or acquiring new competences requires uncommitted resources. Paradoxically, as soon as a new technology starts to substitute for a prevailing technology, it begins to erode an organization’s retained resource base – and thus also its liquid or uncommitted resources. As a consequence, valuable sources of income to fund resource development get lost. Ideally, therefore, a new technology is developed, commercialized, and sized to volume before possible sources of investments ebb away. Time of threat perception and response, coupled with rate of technological progress and substitution, determine the time frame in which an organization ideally should develop and commercialize its version of the new technology and achieve breakeven of cumulative cash invested and earned. Beyond that time frame, the organization risks running short of valuable sources of income to provide start-up and post-launch investments. Hence the earlier an organization recognizes a potentially threatening technology and the slower the new technology progresses, the more positive the effect will be for efforts towards adaptation. In the following I elaborate this proposition in greater detail:

In drawing on Christensen, Suárez, and Utterback’s (1998) findings, I specify that an adaptation before the new (and threating) technology has coalesced into a dominant design may become counterproductive, because uncommitted resources may be used to develop or acquire competences that might become obsolete. Likewise, I specify, in accordance with Christensen et al., that adaptation too late after the dominant design coalesced may result in excessive demands for uncommitted resources, because an organization will face stiff entry barriers from competitors, such as economies of scale or strong brand names. As a result, the organization would require high post-launch investments (and thus uncommitted resources).

Scholars have focused attention (directly or indirectly) on issues that affect the level of uncommitted resources required to respond to discontinuous change. Christensen et al. (1998) revealed that in fast-changing industries many organizations were forced to exit the business altogether, after having missed the opportunity to switch fast enough to a new technology, particularly after the emergence of a dominant design. Those organizations that were able to quickly build resources and capabilities required for speeding up product development and manufacturing in high volumes, they argued,

THEORY 57

had a much higher probability of surviving than those that adapted late. The latter organizations failed to overcome rigid entry barriers that had been built in the aftermath of the coalescence of dominant design. An economy of scale was named as one entry barrier among others. Hence the available period of time for resource development is a crucial moderating factor in adaptation. Regardless of whether the competence set required for new technology is related or unrelated to the current one, the available time frame to bring a new technology to market and to scale it to volume may be too short to be accomplished with the current stock of resources and capacities. Given a short time for response, organizations prefer to acquire additional resources rather than risk long development time and therefore increasing barriers to entry.

Andrew and Sirkin (2003) addressed another issue that is of relevance here. They showed that early adaptation to a new technology or an accelerated development process to enter the markets before others do and to quickly achieve scale can lead to excessive investments (and thus additional demands for uncommitted resources). On the one hand, they showed that an early move into the market may require an organization to educate customers in the use of the new technology. For instance, as a developer and supporter of new imaging technologies from the start, Kodak had to spend excessive budget allocations to promote and explain the new technologies to potential customers. Their new Advanced Photographic System was one example. The company had to spend about $100 million a year for advertising – a sum unparalleled in the photographic industry. The other facet both authors identified is the ancillary effect of an aggressive market entry that may result in poor product or service qualities that affect the ability to achieve scale. In both cases, the demand for uncommitted resources increases.

Figure 21 depicts the causal relationship between relatedness of resources, required resources to adapt to a new technology, and required level of uncommitted resources [please refer also to diagram shown in Figure 15].


Figure 21 Variables Moderating Adaptation to Substituting Technology

(portrayed from a resource-based view)

To explore a possible interdependence of resources and capabilities and an organization’s resource allocation process I pursued an in an in-depth longitudinal and multilevel case study on Eastman Kodak Company at times its core business got disrupted. I analyze the company’s responds to the rapid transition from chemical-based photography to digital imaging. In the following chapter I will describe the research method applied.

Resource Relatedness

Related

Unrelated

Resource Deployment

and/ or Development

Leverage

Import

Level of Resources Required

Committed

Uncommitted

Time of Threat

Perception & Response

Rate of Technological

Progress & Substitution

Early

Lo

High

Late EFFORTS TO ADAPT TO SUBSTITUTING TECHNOLOGY

(+)

(-)

ENVIRONMENTAL LEVEL

ORGANIZATIONAL LEVEL

(+)

(+)

(-)

(-)

MODERATING VARIABLES

4 METHOD

The study of an intra-organizational resource allocation process poses a methodological problem. The dynamics in the internal competition for resources are complex and span various levels of the organizational hierarchy. Many initiatives never reach the status of public announcement or are kept secret for competitive purposes. For instance, Kodak’s invention of the world’s first digital camera in 1975 was kept secret for about thirty years. Moreover, a strategy process can unfold over many years. Measureable strategic outcomes of initiatives and decisions, such as the retrenchment of a business or initiatives to improve a technology, may require an extensive period of observation. Thus, to exclusively rely on external, publicly available sources is precluded. Based on the need to rationalize the past in retrospect, a serious account of an organization’s internal strategy process is always challenged by faulty memories (Golden, 1992; Miller, Cardinal, & Glick, 1997). This research design aims to deal with these obstacles.

4.1 Research Setting Studying the impact of digital imaging on a traditional photography organization supported my research intentions for the following reasons: First, digital imaging technologies were disruptive for the chemical-based photography film and paper business. Initially, digital cameras were used by different customers than those who used analog cameras. Different performance attributes accounted for this difference. For instance, customers of early digital cameras valued features such as electronic transmission, manipulation and publication of images, searchable image databases, immediate visibility of the image on the camera, and so forth. These features differed substantially from those that were available with analog cameras. Similarly, the advent of digital imaging meant a transition of power to personally take part in the complete imaging chain, ranging from image capture to image storage to image finishing. While in analog photography, Kodak’s marketing slogan, “You push the button, we do the rest,” vividly circumscribes the roles and competences customers and photography companies are ascribed, in digital imaging customers could do everything by themselves, excluding photo companies almost altogether: digital imaging rendered the consumable film roll obsolete and partly even the service of photo finishing,

60 Research Setting

because since then there was no need any more to develop negatives chemically in the photo lab to check the quality of the photos, or to get prints. For this very reason, the digital imaging business required the development of a business model that relied on other sources of revenues.

The second reason for investigating the response of a chemical-based photography company to digital imaging is that, unlike previous accounts of discontinuous change, the rapid growth of the new technology threatened the traditional photography film business to the extent of complete extinction within a few years [see Figure 22 and following]. Extensively discussed cases on disruptive technologies, such as online news or e-books, did not introduce an immediate loss of fundamental consumer base (Christensen & Raynor, 2003; Gilbert et al., 2012; Gilbert, 2006; Johnson et al., 2008). The substitution rate of these technologies is relatively low compared to digital imaging, giving organizations an extensive amount of time and liquid resources to develop new competences, while keeping their existing business in a tight fit with traditional context [see, e.g., Figure 5].

Finally, studying discontinuity of analog photography by means digital substitution presents an anomaly to existing explanations of disruptive innovations (Gilbert & Christensen, 2005). By and large, researchers on disruptive innovations acknowledge that incumbents are usually the ones that come up with technologies that are new to the industry, but fail to bring these successfully to market, because of their careful listening to their powerful customers (Christensen, 1992a, b; Gilbert, 2005). Powerful customers impose limitations on organizations in regard to changes that can be pursued or not (Christensen & Bower, 1996). Hence, incumbents fail not in innovating new technologies, but in bringing them to market, because there is no impetus to do so. Unlike the incumbents as described above, Kodak, the global leader of the imaging industry, had always set the technological standards of the entire imaging chain throughout its company history – regardless of consumer demand. Moreover, it was the first company professionally developing and commercializing digital cameras in the world. Leading companies inside and outside the imaging industry, such as Nikon, Canon, and Apple, relied heavily on Kodak’s technologies. Hence, in this case the incumbent did innovate in the laboratory as well as in the market.

METHOD 61

I chose Eastman Kodak Company as a preferred research site for another reason: the company was the world leader of traditional photography, serving all elements of the imaging value-chain. Top global and US market shares rendered Kodak a reasonably representative imaging company. It has made a number of original contributions to the digital imaging chain in an effort to set and sustain their competitive position, including the wireless fidelity for electronic transmission of images among countless other astonishing inventions. Considering the valuable nature of these past inventions, Kodak maintained a lucrative portfolio of intellectual property and patents, which leading technology companies such as Apple, Google, and Microsoft, among many others, made use of.

Finally, I selected the photography company because I was offered valuable access to organizational personnel and archival sources, which allowed me to pursue the research. Data for the research covers the years prior to Kodak’s major period of diversification, extending from the early 1973 to its formidable battle with digital imaging, which found its point of culmination in 2012.

62 Research Setting

Figure 22

Worldwide Imaging Industry Source: Adapted from Photo Imaging News, 2013

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METHOD 63

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64 Research Setting

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METHOD 65

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Growth (Decline) of Films (rolls) US Source: Adapted from Photo Imaging News, 2013

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66 Research Setting

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METHOD 67

Figure 27

Prints (Film and Digital; 10x15 cm equivalent) US Source: Adapted from Photo Imaging News, 2013

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68 Research Design

4.2 Research Design Researching an intra-organizational process requires in-depth data, which suggested studying a single case rather than many (Burgelman, 1996). The longitudinal study was designed to position an organization’s internal resource allocation process at the core of analysis. I regarded this research strategy as appropriate for theory building (Flick, 2009; Glaser & Strauss, 1967; Yin, 1984). The research was pursued in three steps combining inductive, abductive, and deductive methodologies to derive at an elaborated resource allocation process model.

In the first step, I collected public data and conducted semi-structured interviews with company personnel on Kodak’s response to digital imaging. This merely inductive phase resulted in a description of Kodak’s evolution of initiatives related to both digital and analog imaging business.

In a second step, I was searching for theoretical models that could explain Kodak’s trajectory. In this abductive phase, I found confidence in the appropriateness of existing theories on the strategic process (Bower, 1970; Burgelman, 1983c) and intra-organizational ecology (Burgelman, 1996; Floyd & Lane, 2000; Floyd & Wooldridge, 1999; Lovas & Ghoshal, 2000). These seminal readings, plus theoretical extensions on resource dependence (Christensen, 1992a, b; Christensen & Bower, 1996; Christensen & Rosenbloom, 1995; Pfeffer & Salancik, 1978) and social psychology (Gilbert, 2005, 2006; Jackson & Dutton, 1988; Staw et al., 1981), provided the core building blocks I applied to build a model that integrates the variable of resource commitment.

In a third step, I iteratively cycled between collected data and existing theory, which enabled me to test and readjust the proposed model to gain a high level of validity and connectedness to existing research (Eisenhardt, 1989; Glaser & Strauss, 1967).

4.3 Data Collection Getting access to Kodak personnel and establishing a relationship of mutual trust took about three years, starting in 2010. The collection of data itself took approximately one and a half years, commencing at the beginning of 2013. I have taken Jick’s (1979) advice and searched for a variety of data contributing to a comprehensive understanding of the same issue, to improve accuracy of research. Three main sources

METHOD 69

of data helped me to triangulate the survey: archival material, recorded interviews, and public documents:

Kodak’s archival material including a complete set of annual reports ranging from 1973 to 2014, reports to annual shareholders’ meetings, external and internal financial reports, venture initiatives and strategy documents, which provided a basis for documenting each phase of the company’s historical trajectory. Kodak’s filing for Chapter 11 bankruptcy protection rendered collection of internal archival sources difficult for reasons of legal discretion. Therefore, I tried to collect available documents related to intra-organizational evolution as much as possible from individuals involved. (I could not identify situations in which individual withheld sources intentionally.) For instance, I have gotten documents pertaining to Kodak’s strategic quantification process or new venture developments [see Table 2]:

Table 2

Kodak Archival Data

I interviewed twenty-seven individuals affiliated to Kodak and seven individuals outside the company but closely related to the imaging industry. To get a comprehensive picture of Kodak’s evolution, I talked to individuals at all levels of the company, ranging from staff members in multiple functional areas to members of the board of directors. I tried to find personnel present at different points in time, to cover the entire period specified in the survey. For this reason I also talked to retired employees and employees who had left Kodak [see Table 3 and Table 4].

70 Data Collection

Table 3

Internal Informants & Interviewees (current and ex Kodak employees)

Continued on next page

METHOD 71

Continued on previous page

72 Data Collection

Table 4

External Informants & Interviewees External Informants (individuals with close to photography industry but no affiliation to Kodak)

I conducted the interviews in two sessions and in an open-ended and semi-structured manner. Interviews lasted at minimum about half and an hour; however, most of them exceeded two hours. Some individuals were contacted multiple times to continue the interview or to clarify open issues by e-mail or phone. In total I conducted 44 interviews. I recorded all interviews and I hired a professional US transcription service to tape and transcribe them. Every interviewee was given the opportunity to edit the documents.

The interview protocol for the first session was designed to understand Kodak’s internal venturing process. Public sources, such as business reports, press releases, and books on the company’s history and so forth, helped me to develop a profile of the company’s technologies, which subsequently constituted a reliable source for interview questions. Burgelman’s (1983c) definition of “autonomous” and “induced” strategic behavior guided the nature of the questions. A particular set of questions was designed to understand whether ventures towards digital imaging were hampered in favor of improvements in chemical-based silver halide technology and how that was managed. In the second session, I changed the interview protocol, because findings of the first session revealed that Kodak’s challenge was not to spur technological innovation but rather that top management (not middle management) was reluctant to commercialize these developments. In the second session, I therefore asked respondents to address this phenomenon. The interview protocol of this session

METHOD 73

included questions addressing mainly issues related to managerial cognition and strategic decision making. Subsequently, I tried to confirm the accuracy of the data with alternative sources where possible, to uncover potential inconsistencies (Glaser & Strauss, 1967).

Finally, I studied a tremendous number of public sources that covered the survey period between 1972 and 2014, including press releases, business reports, and industry articles. In particular, I plowed through 5,297 Wall Street Journal articles on Kodak, 346 articles from other newspapers (e.g., New York Times, Financial Times) and magazines (e.g., BusinessWeek, Fortune, Forbes), dating back to the late 1970s, 15 case studies, and 18 chronologies on either George Eastman, the founder of Kodak, or the company itself. I found the coverage of Kodak’s evolution by the Wall Street

Journal of particular value. Excluding weekend days, on average the journal reported about Kodak every day and a half. Moreover, the journal published press releases by Kodak and letters to the editor, in which Kodak sometimes clarified wrong “public” perceptions. I summarized these sources, coded them, and imported them into an atlas.ti database, which allowed me to triangulate again what was being said by the interviewees or external parties (Jick, 1979; Yin, 1984).

4.4 Data Analysis The gathering and categorization of data, its study, and the elaboration of a new RAP model have been iterative (Eisenhardt, 1989; Glaser & Strauss, 1967). In a first phase, the collected data led to the pragmatic development of a chronology about Eastman Kodak Company. Data from internal archives, interviews, and public sources, such as business reports, were assembled in a large spreadsheet structured by year. This spreadsheet contained hard facts (financial data, changes in the organizational structure, legacy of CEOs, new technologies, etc.) and soft facts (new strategic directions, new venture initiatives, etc.) and became the basis for the preparation of the interview protocols and a narrative description of the company’s history.

In the second phase I drew on existing theoretical models to identify those elements that enabled me to conceptualize a model descriptive of Kodak’s evolution. It was in this phase that I realized that the question of the level of committed resources and their retention was not present in existing literature on the strategy process.

Part II Analysis of the Case

5 CASE

The currently available literature on Kodak and its founder, George Eastman, is voluminous. Certainly it is legitimate to wonder, why write another historical account about the company. There are a tremendous number of biographies on Eastman, dating back 1930;3 then there are multiple volumes on the company itself, depicting its comprehensive spectrum of technologies and products;4 and there are plenty of business analyses in the financial press and case studies that discuss Kodak’s operative performance.5 However, a valuable perspective that seems to be missing is a longitudinal study of Kodak’s stocks of resources and its deployment. The company’s cash or cash equivalents, assets, equity, as well as the debts that the company was required to amortize, certainly determine to its ability to allocate resources for innovation projects, new ventures, or new initiatives (Barker III & Duhaime, 1997; Cyert & March, 1963; Mone et al., 1998; Singh, 1986). Therefore, a discussion of Kodak’s evolution, in consideration of its financial position, promises to provide a deeper understanding of the company’s scope for action.

3 See, e.g., Ackerman, C. W. 1930. George Eastman. Boston: Houghton Miflin Company, Brayer, E. 1996. George Eastman: A Biography. Baltimore: John Hopkisn University Press, Brooke-Ball, P. 1994. George Eastman and Kodak. Watford: Exley, Mitchell, B., & Smith, J. H. 1987. Click!: A Story About George Eastman: Lerner Publishing Group, Pflueger, L. 2002. George Eastman: Bringing Photography to the People: Enslow Publishers, Incorporated. 4 See, e.g., 1989c. Journey: 75 Years of Kodak Research. Rochester, NY: Eastman Kodak Company, Collins, D. 1990. The Story of Kodak. New York: Harry N Abrams, Ford, C., & Museum, K. 1989. The Story of Popular Photography: Trafalgar Square Pub, Frangos, S. J. 1993. Team Zebra: How 1500 Partners Revitalized Eastman Kodak's Black & White Film-Making Flow: Wiley, Gustavson, T. 2009. Camera: A History of Photography from Daguerreotype to Digital Toronto, Ontario: Sterling Publishing, Lieser, E. 1974. Die Kodak- Und Nagel-Cameras Aus Stuttgart Wangen. Stuttgart: KODAK, Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press, Shanebrook, R. L. 2010. Making Kodak Film. The Illustrated Story of State-of-the-Art Photographic Film Manufacturing. Rochester, NY: Robert Shanebrook Photography. 5 See, e.g., Finnerty, T. C. 2000. Kodak Vs. Fuji: The Battle for Global Market Share: Pace University, Lubin School of Business, New York, Gavetti, G., Henderson, R., & Giorgi, S. 2005. Kodak and the Digital Revolution (a) Case Study 9-705-448. Cambridge, MA: Harvard Business School, Grant, R. M. 2006. Eastman Kodak: Meeting the Digital Challenge (Case Six), Jones, G. R. 2004. "You Push the Button, We Do the Rest": From Silver Halide to Infoimaging at Eastman Kodak. In C. W. L. Hill, & G. R. Jones (Eds.), Cases in Strategic Management: C614-C628: A&M University, Texas, Kanter Moss, R. 1989. When Giants Learn to Dance. New York: A Touchstone Book, Simon&Schuster Inc, Kochan, T. A. 1999. Eastman Kodak (Task Force Working Paper #Wp09): MIT Sloan School of Management, Institute for Work and Employment Research, Lehmkuhl, D., Liebl, J., Lien, L., & Ong, S. 1998. Kodak: The Challenge of Consumer Digital Cameras (Case No. 9): University of Michigan Business School, Passow, S. 1997. Snapshot: Kodak V. Fuji (Case No. Cr1-97-1379.0). Cambridge, MA.: Harvard College/ Kennedy School of Government, Swasy, A. 1997. Changing Focus: Kodak and the Battle to Save a Great American Company: Times Business New York.

78 Preamble 5.1 Preamble The following chapter aims to shed light on Kodak’s stock of resources and its deployment in order to explore how it supported (or constrained) the company in its response to discontinuous change.

The following case description of the Eastman Kodak Company starts with a brief introduction on the origins of Kodak, to establish the context of the company’s business model. Audiences interested in more in-depth information on the pre-1970s era of Eastman Kodak Company or its founder may refer to the literature referenced above. I then move on to the early 1970s, to continue with my thorough description of Kodak’s response to discontinues change. In this period, Kodak was still cash-heavy due to its monopoly position in the US photographic industry. However, that was also the time that Kodak faced the advent of disruptive technologies in photography: In mid-1970, Bryce Bayer of Kodak invented the color filter that later became part of every imaging sensor embedded in digital cameras; and, in the same company but independently of Bayer, the young engineer Steve Sasson invented the prototype of the world’s first digital camera.

The case description is structured along the major strategic directions that various Kodak CEOs set forth, and ends at the turn of the millennium, when the traditional chemical-based photography industry collapsed. Even though in researching the case I investigated the entire period between the 1970s and 2012, the year Kodak filed for bankruptcy, here there I decided to elaborate on the period between 1970 and 2000 in detail, because in this time span I find all the information required to support the arguments put forward in the theory section. Of course, diagrams, financial data, and tables on facts and figures give a full picture of the fully researched period when necessary. Likewise, in the discussion section, the full spectrum of Kodak’s behavior and commitment of resources in response to discontinuous change is presented from 1970 to 2012.

The following chronology primarily relies on three main sources: Kodak’s complete annual reports and more detailed 10-K statements, plus supplements between 1973 and 2014; all Wall Street Journal coverage of Kodak between 1984 and 2014 plus articles from other newspapers (e.g., New York Times, Financial Times) and magazines (e.g., BusinessWeek, Fortune, Forbes), dating back to the late 1970s; 44 interviews with

CASE 79

individuals at all levels of the company and ranging from staff members in multiple functional areas. Interviews with employees, retired employees, or employees who had left Kodak as well as individuals outside the company but closely related to the imaging industry were conducted between 2012 and 2014. In this respect, the chronology of Kodak presented here also poses a limitation. An annual consolidated statement of operations, equities, and cash-flow does provide some fundamental information about a company’s financial position; however, it conceals off-balance-sheet requirements and circumstances that are non-accountable. (Kodak’s filing for Chapter 11 bankruptcy rendered internal sources that might have enriched the analysis of data difficult or impossible to access.) To improve the accuracy of research, the three main sources of data were triangulated (Jick, 1979; Yin, 1984). For ease of reading in this chapter, sources cited are placed in footnotes, including the complete reference.

80 Eastman Kodak Company 5.2 Eastman Kodak Company

“You press the button, we do the rest.” 6 George Eastman

Fueled by personal interest, George Eastman became acquainted with photography as a teenager in the 1870s, when daguerreotype and calotype technologies had given way to new methods of capturing pictures.7 Photography was still a skilled craft, requiring extensive experience and expertise in chemistry and mechanics. The coating of glass plates with liquid emulsions before a picture was taken, as well as controlling the time of exposure, depended upon highly skilled workmanship.8 Eastman, like many other amateur photographers, was frustrated by the inconvenient and messy procedure – a leaking bottle of emulsion, carried in his luggage, once soiled his belongings.9 Endowed with frugality and a love of tinkering with chemical and mechanic processes, he soon started to search for more convenient solutions. He acquainted himself with the new dry-plate technology that was being extensively discussed in European photography journals.10 In the US, however, photographers were slow to adopt this process, which had many operative as well as economic virtues. Unlike the time-consuming and messy wet-emulsion technology, in which photographic plates had to be processed while still wet, gelatin dry plates could be prefabricated, stored, and shipped to customers on demand. Moreover, dry emulsion shortened the exposure time to seconds (thus allowing snapshots). In 1880, two years after his demonstration of the convenience of gelatin dry plates, Eastman’s company was one of the few in the US that manufactured dry plates.11

6 Eastman, G. 1888. Camera Advertisment. Scientific American, September 28. 7 Brayer, E. 1996. George Eastman: A Biography. Baltimore: John Hopkisn University Press. 8 Jenkins, R. V. 1975. Images and Enterprise: Technology and the American Photographic Industry 1839 to 1925 (Reprint 1987 ed.). Baltimore, MD: The Johns Hopkins University Press. 9 Collins, D. 1990. The Story of Kodak. New York: Harry N Abrams. 10 Ibid. 11 Kodak, "History of Kodak: Milestones- Chronology," http://www.kodak.com/ek/US/en/Our_Company/History_of_Kodak/Milestones_-_chronology/Milestones-_chronology.htm, accessed on April 14, 2013.

CASE 81

Figure 28 Change of Imaging Chain by George Eastman (KODAK)

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82 Eastman Kodak Company In the course of establishing his first company, the Eastman Dry Plate Company, Eastman also formulated his four fundamental business principles, revealing his conviction that photography promises vast business opportunities, in particular when adopted by the masses: “(1) Production in large quantities by machinery; (2) Low prices to increase the usefulness of his products; (3) Foreign as well as domestic distribution; and (4) Extensive advertising as well as selling by demonstration.”12 While all four principles guided the company throughout its 130 years of existence, it is important to note that it is no. 1 upon which the others depend.

Parallel to his belief in the potential of photography for the masses, Eastman’s subsequent entrepreneurial actions reveal another important aspect that accounted for the company’s success: To bring photography to broad layers of consumers (which, from an economic perspective, was a prerequisite for mass production), the process of taking and developing pictures had to be easy; that is to say, photography had to be unburdened of the need for chemical and mechanical skills. Hence, the whole photographic system had to be redesigned, including the device for capturing images (camera), the media for storing images (film), and the finishing process for replicating images (prints) [see Figure 28].

After George Eastman succeeded in making photography more convenient by the use of dry plates, it was still a skilled craft. Amateur photographers were still obliged to use to the same devices that professionals were using, and, above all, dry-glass plates were heavy, lacked tensile strength, and were expensive to manufacture.13 It was Eastman’s patented film that paved the way for popular photography.

The term “film” originally referred to the gelatin coating on paper, a technology that Eastman explored, to investigate the potential of paper as a carrier of negatives. Paper negatives promised an economical and convenient substitute for glass dry plates on several grounds: First, paper was cheap, light, and could be rolled, unlike glass plates, allowing photographers to load the camera with light-sensitive material for more than one shot; second, there was no need to develop the exposed material immediately as long as it remained in the (dark) interior of the camera.14 Paper negatives therefore

12 Ackerman, C. W. 1930. George Eastman. Boston: Houghton Miflin Company. P. 42. 13 Collins, D. 1990. The Story of Kodak. New York: Harry N Abrams. 14 Ibid.

CASE 83

enabled Eastman to conceive of a proprietary photographic system in which amateurs could take some hundreds of pictures without ever bothering about chemicals.

George Eastman’s first engineered camera, a wooden case that contained a simple roller mechanism wound with a fifty-foot length of film, completed the system.15 Easy to use, amateurs could take pictures by pulling a string to cock the camera’s cylindrical shutter and then pressing a button to exposure the film. Fresh film was then brought into the focal plane by twisting a clock key. When the photographer had finished shooting the pictures, the camera was boxed and mailed back to the factory. There the film was developed and the camera loaded with new film to be returned to the customer, along with the prints.

Eastman’s photographic system, which he commercialized successfully under his trademark “Kodak” since 1888, quickly received international acclaim.16 By bringing together film, camera, and photofinishing service in an easy-to-use system, he made photography convenient and affordable for the masses without requiring skills in chemistry or mechanics. The then newly renamed Eastman Kodak Company sold over 5,000 cameras in the US, and was printing up to 6-7,000 negatives a day.17 Just five years later, the company released its tiny pocket camera, selling over 100,000 in the first year at a price of $5.18

As a consequence, the heavily capitalized company expanded its operations, opening retail and wholesale outlets in the US and Europe. One innovation followed another. Paper negative film was replaced by transparent film made of cellulose; pictures started to move; and finally, color triumphantly entered the scene. Perhaps one of the most efficient, foolproof, and popular cameras ever marketed by the Eastman Kodak Company – the Instamatic – sold over 70 million worldwide.19

15 Gustavson, T. 2009. Camera: A History of Photography from Daguerreotype to Digital Toronto, Ontario: Sterling Publishing. 16 Kodak, "History of Kodak: Milestones- Chronology," http://www.kodak.com/ek/US/en/Our_Company/History_of_Kodak/Milestones_-_chronology/Milestones-_chronology.htm, accessed on April 14, 2013. 17 Ford, C., & Museum, K. 1989. The Story of Popular Photography: Trafalgar Square Pub. 18 Ibid. 19 Gustavson, T. 2009. Camera: A History of Photography from Daguerreotype to Digital Toronto, Ontario: Sterling Publishing.

84 New Industry Environment 5.3 New Industry Environment

“We’ve come out of an environment where we were the single world leader; we had a technology that nobody else could really match, and we were able to dominate that

field. The world doesn’t allow companies to do that anymore. So we’ve got to change, and that's a very hard lesson to learn.”20

Kay R. Whitmore, President, Kodak, 1985

For almost a century, consecutive innovations placed Eastman Kodak Company in the position to lead technological development in the photography industry, indeed holding a virtual monopoly in the photographic market in the United States for most of its existence. With more than 90 percent of the market for conventional color film, and pre-tax earnings of about 60 percent, sales of the company went beyond the $10 billion mark in 1980 – a century after its foundation.21 Nevertheless, environmental changes, coupled with a series of disappointing product launches suddenly began to affect the company’s performance.

5.3.1 Changing Factor Markets In the 1980s, three unforeseeable environmental changes depressed Kodak’s sales and earnings: the rise of a strong US dollar along with higher prices for raw materials, the aggressive capture of market shares by rivals, and the lost patent-infringement lawsuit against Polaroid Corporation.

Already early in the early 1970s, Kodak had begun to realize that there were shortages of some raw materials (and thus higher prices for them). For example, in 1974 the average cost of propane and ethylene glycol doubled in one year, which put a great stress on earnings from the company’s chemical division.22 In the early 1980s, Kodak’s earnings were depressed even further by the price of silver, which soared to

20 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 21 Numbers on market share and profitability are stated, e.g., in 1982b. Kodak Fights Back. Everybody Wants a Piece of Its Markets. Business Week(February 1) 36-38.; or, Rudnitsky, H. 1982. Snap Judgments Can Be Wrong. Forbes(April 12) 106-107. For data related to Kodak’s financial position see Eastman Kodak Company Annual Reports, e.g., 1981b. Eastman Kodak Company Annual Report. Rochester, NY, 1982a. Eastman Kodak Company Annual Report. Rochester, NY, 1983a. Eastman Kodak Company Annual Report. Rochester, NY. An overview of Kodak’s financial position throughout the years of 1963 to 2013 can be found in the Appendix. 22 1974. Eastman Kodak Company Annual Report. Rochester, NY.

CASE 85

$50 an ounce.23 Silver was one of the company’s main raw materials in the making of photographic film.24 The company had never paid so much; thus, the prospect shocked management.25

Another external factor that impacted Kodak’s financial results in the mid-1980s was the strong dollar.26 For Colby Chandler, then CEO of Kodak, the strong dollar made it a “challenging task” to match results from previous years:27 “Earnings would have been $0.60 [or about 10 percent] higher if exchange rates had prevailed the same,” and, the company’s annual report continues, “the upward surge of the dollar reduced the company’s earnings by more than $500 million in the last four years.”28

The strong dollar also increased the attraction of imports, which were sold in the US at lower prices. Between 1973 and 1984, Kodak’s sales outside the US grew continuously from 35 up to 47 percent.29 Accounting for the loss by competitive adversity at home and abroad Kodak, estimated a total loss in annual earnings between 1980 and 1984 of about $1 billion because of the strong dollar.30 A Fortune analyst estimated Kodak’s fall in profits at about $3 billion in the same period.31

Kodak’s conservative business strategy was threatened on another ground too: Highly efficient Japanese film and photographic paper manufacturers entered the lucrative US market. In the past, a number of companies, including DuPont Corporation, tried to enter the photography market in the United States; but they either became discouraged by Kodak’s market dominance or failed to develop film matching Kodak’s quality, which consumers had long accepted as standard.32 In the 1970s, however, Kodak faced some of the same attacks other US corporations had been suffering earlier: intense competition triggered by a number of Japanese firms that aimed at the US photographic market. Although Kodak and Fuji are not entirely comparable –Fuji

23 Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 24 Shanebrook, R. L. 2010. Making Kodak Film. The Illustrated Story of State-of-the-Art Photographic Film Manufacturing. Rochester, NY: Robert Shanebrook Photography. 25 Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 26 1985c. Kodak Posts Drop of 28% in Profit for Its 2nd Period. Wall Street Journal, 1985 Aug 01: 1. 27 Ibid. 28 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 29 Annual Reports between 1972 and 1984. 30 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 31 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3). 32 1982b. Kodak Fights Back. Everybody Wants a Piece of Its Markets. Business Week(February 1) 36-38.

86 New Industry Environment originally did not maintain manufacturing sites abroad – the Japanese sold almost twice as much per employee [see Figure 29].33

In the photographic paper franchise, the sales pitch in the US of Fuji Film, Konishiroku, and Mitsubishi was compelling: The Japanese offered products that were almost comparable at a discount of up to 20 percent.34 As a consequence, by 1977 the Japanese had captured almost half of the US photo paper market and Kodak was forced to cut prices and its pretax profit margins from about 60 percent to as low as 45 percent.35

Figure 29 Sales per Employee

Source: Eastman Kodak Annual Report and FujiFilm Annual Report 1986/198936

Figure 30 Decrease of Kodak’s Market Share in

Film and Paper Business Source: (Taylor & Caminiti, 1986)

33 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3). 34 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 35 Ibid. 36 See also Pae, P. 1989c. Kodak to Again Restructure Operations --- Earnings Plunge Spurs Latest Round of Cost Cuts. Wall Street Journal, 1989 Aug 18: 1.

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CASE 87

In the film market, Fuji pursued a similar strategy. It improved the quality of its film to the point where it appealed to consumers’ preferences in the US. By cutting profit margins and keeping prices 10 percent below Kodak, Fuji did not gain immediately substantial market share, but its pricing policy forced Kodak to keep its margins low.37 However, as a consequence, Kodak’s US photography market share plummeted from 100 percent to about 85 percent, and its share of the paper business fell from originally 92 percent to about 50 percent in the 1970s. 38

Figure 31

Profit Margin of Film Source: Adapted from Merrill Lynch, Pierce, Fehner & Smith Inc.

Estimates of 1981 results; see also Rudnitsky (1982)

37 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3).; see also Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 38 Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128.

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88 New Industry Environment While Kodak did little to increase efficiency in the face of rising costs for raw materials, a continued strong dollar, and competition, its technological superiority had still made the company all but invulnerable. Figures on the profitability of the amateur photography business illuminate the impact of Japanese rivals upon Kodak’s earnings. In the early 1980s, about one-third of Kodak’s sales centered on amateur photography.39 Significantly, the amateur photographic business, which includes film and paper, accounted for about two thirds of the company’s total earnings before taxes, with profit margins of about 60 percent [see Figure 31].40 As Ty Govatos, an analyst at Bache Halsey Stuart Shields, explained, “There is where the money is, and there is really no consumer product quite like it. [In 1981] Kodak’s amateur film sales were about $900 million, but the operating profit was nearly $530 million.”41

Perhaps the biggest sign that Fuji was a real threat came when Kodak lost the tendering procedure for sponsorship as the official film partner of the 1984 Olympics to its Japanese rival. The organizing committee of the 1984 Los Angeles Olympic Games asked potential sponsor to pay a rights fee of at least $3 million.42 Kodak, however, was only willing to spend some $1 million and provide film.43 Fuji offered to pay $7 million and was awarded the contract, which Peter Palermo, Kodak’s senior vice president of imaging at this time, called “Kodak's Pearl Harbor.”44

5.3.2 Changing Product Markets Kodak’s lost chance to sponsor the 1984 Olympics made another aspect clear to the world leader in imaging: Ever since George Eastman had introduced the first portable camera in 1888, which used his own patented film and was tightly bound to his proprietary method of photo finishing, Kodak had become so powerful that it controlled the US market for photographic products, rather than the other way around. 39 1981b. Eastman Kodak Company Annual Report. Rochester, NY. 40 See, e.g., estimates by Merrill Lynch, Pierce, Fenner and Smith Inc. cited in 1982b. Kodak Fights Back. Everybody Wants a Piece of Its Markets. Business Week(February 1) 36-38. or Snyder Hays similar estimates a year earlier cited in Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. Following his notes sales of the amateur photography segment, which includes cameras aside of film and paper too, accounted for about 40 percent of Kodak's 1980 revenues of $9.7 billion and almost two-thirds of earnings before tax. Sales for color film and paper are the flashiest moneymakers - they account for 15 percent of the company's total sales. 41 Rudnitsky, H. 1982. Snap Judgments Can Be Wrong. Forbes(April 12) 106-107. 42 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 43 Ibid. 44 Palermo, P. 2013. Personal Interview. November 22. With M. Shamiyeh. Palermo’s reference to Pearl Harbor can be found also in a commentary published in Swasy, A. 1997. Changing Focus: Kodak and the Battle to Save a Great American Company: Times Business New York. page 29.

CASE 89

But after the bid for Olympics, the market started to gain control – a possibility that had long been ignored by Kodak. Late or disappointing product launches confirm this assessment.

For instance, Kodak was late with the introduction of “mini labs.” Mini labs are small and relatively inexpensive photo-finishing machines that develop and print photos on the spot within an hour.45 In contrast to “macro labs,” large photofinishing facilities that process thousands of rolls of film a day on behalf of commercial dealers or consumers that drop off their rolls of film in the nearest drop-box, mini labs can be installed almost anywhere.46 The great virtue of mini labs was their convenience – customers received their prints in less than an hour – as well as their unprecedented profitability. After installing a mini lab, department stores, drug stores, and food chains and the like reported an increase in net profitability for their photo-finishing business of about roughly four times, compared to contracting it to wholesale labs.47 In addition, the convenience of mini labs increased the number of people visiting the stores.48

In 1984, the Photo Marketing Association assessed the rapid growth rate of the US mini lab market and estimated that since 1980, some 8,000 mini labs had been installed, capturing about 20 percent of the photofinishing market originally served by macro labs alone.49 Although the growth rates of installed mini labs were lower than initially estimated – in 1984 there was a base of some 5,200 installed mini labs, according to a 1988 survey by the Photo Marketing Association – it was clear to the industry that the small one-hour-processing units were the wave of the future.50 Kodak, in contrast, was late with the introduction of mini labs because it “underestimated the potential” of minilabs, as Wilbur J. Prezzano, then the company’s group vice president of photographic products, admitted.51 When mini labs captured an estimated 36 percent of the massive $5 billion US photofinishing market in 1988, Kodak’s sales

45 1984d. One-Hour Film Processors Leave Photo Kiosks in a Blur. Business Week(January 23) 28. 46 Neblette, C. B. 1977. Neblette's Handbook of Photography and Reprography: Materials, Processes, and Systems (Seventh ed.): Van Nostrand Reinhold. 47 Omura, G. S. 1988. Mini Labs: Strategies for the Future. In P. M. A. International (Ed.): 80. Jackson, Michigan. 48 Sasson, S. 2013b. Personal Interview (Follow-up). November 22. With M. Shamiyeh. 49 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3). 50 Omura, G. S. 1988. Mini Labs: Strategies for the Future. In P. M. A. International (Ed.): 80. Jackson, Michigan. 51 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3).

90 New Industry Environment plunged to $60 million, from $200 million in 1982.52 Kodak’s late introduction of mini labs is not the only case that demonstrates the company’s reluctance to quickly adapt to new trends (or to set new trends, as it had done originally).

Kodak did not enter the copier business at the time it was invented and developed into a multimillion-dollar market by Xerox. Only in 1975 did Kodak finally enter the copier market, with its Ektaprint 100.53 Kodak spent a decade of research and an estimated budget of $100 million in bringing this copier to market. The company simply did not want to risk glitches in performance, since it had always branded its focus on quality and reliability.54 The machine employed a series of new technologies that Kodak employed before anyone else in the industry.55 When the Ektaprint was brought to market, it received immediate public acclaim and caught Xerox at a very vulnerable moment.56 Xerox, which dominated the market with its expensive and powerful machines, was focusing on the disruptive force of cheap and poorly performing tabletop copiers, which Canon and other Japanese companies began to develop in the early 1980s.57 Xerox did not offer any copier in the Ektaprint segment, and Kodak therefore quickly gained market share in an industry that grew some 46 percent between 1978 and 1983.58

Kodak’s annual reports of the early 1980s tirelessly highlighted the growing demand for Ektaprint copy products and pointed to their impressive growth. According to a Kodak executive, the Ektaprint copier product line was the fastest growing business in the company, which could, if run as a separate firm, maintain the status of a Fortune 500 firm.59 Likewise, the Wall Street Journal acknowledged that the gap between Kodak and market leader Xerox had closed.60 However, Kodak was slow in bringing

52 Ansberry, C. 1987e. Uphill Battle: Eastman Kodak Co. Has Arduous Struggle to Regain Lost Edge --- Beset by Rivals from Japan, Customers' Complaints, It Abandons Its Traditions --- Getting over Disk Disaster. Wall Street Journal, 1987 Apr 02: 1, Ansberry, C. 1988h. On Photography. Wall Street Journal, 1988 Sep 26: 1. In its Annual Report of 1988, Kodak attributes to mini labs about 25 percent of the US market for color prints. 1988b. Eastman Kodak Company Annual Report. Rochester, NY. 53 1976. Eastman Kodak Company Annual Report. Rochester, NY. 54 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 55 Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. 56 See, e.g., 1983a. Eastman Kodak Company Annual Report. Rochester, NY.; or, Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 57 Christensen, C., Craig, T., & Hart, S. 2001. The Great Disruption. Foreign Affairs 80-95. 58 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 59 1983a. Eastman Kodak Company Annual Report. Rochester, NY. 60 1984c. Kodak to Repurchase 'Significant' Amount of Stock as Investment. Wall Street Journal, 1984 May 04: 1.

CASE 91

the next generation of the copier to market: It took the company seven years to come up with the follow-up model, which was launched in 1982. Meanwhile, Xerox had launched a competitive product and Kodak was forced to suffer a loss of market share.61 Kodak also lost market share to IBM, which decided to enter the copier business in the same year. Above all, Kodak’s long-awaited follow-up machine proved to have a poor performance in terms of speed and functions. All these factors, according to an industry analyst, erased Kodak’s competitive advantage in copy quality.62 By 1984, Kodak had lost about 50 percent of its US copier market share, which by then was up to only 25 percent.63

The launch of the Ektachem 400, a blood diagnostic apparatus tells a similar story: Introduced in 1980, it was launched late.64 Until the late 1970s, the market was growing at 15 percent per year; by the time Kodak entered the market, growth rates were flat.65 DuPont had already introduced its Automatic Clinical Analyzer in 1970,66 which performed up to 30 different blood tests, whereas Kodak’s analyzer, which came a decade late, performed only 12 tests and proved unreliable.67 Kodak was hoping for better results with Ektachem 700, the next generation of blood analyzers introduced in 1983. It performed 25 tests, again half the amount of one of Kodak’s competitor’s products.68 People familiar with the market estimated that Kodak never really had a chance to recoup what they had invested in the product line.69

Significantly, during the 1970s and early 1980s, Kodak also suffered from failed product launches in its core market, the amateur photography. The world’s leading

61 See comment by Mark Myers, then head of Xerox Research Labs, who thanks Bradley Paxton, at this time general manager and vice president of Kodak’s Electronic Photography Division, “for coming out with the Ektaprint in 1975:” “it gave us the shot in the arm we needed. And I want to also thank you for letting us catch up!” Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. p. 29. 62 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 63 1984c. Kodak to Repurchase 'Significant' Amount of Stock as Investment. Wall Street Journal, 1984 May 04: 1. 64 1980. Eastman Kodak Company Annual Report. Rochester, NY. 65 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 66 Pont, D., "Innovation Starts Here: 1969 Medical Products," http://www2.dupont.com/Phoenix_Heritage/en_US/1969_c_detail.html, accessed on April 11, 67 1980. Eastman Kodak Company Annual Report. Rochester, NY, Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128. 68 1983a. Eastman Kodak Company Annual Report. Rochester, NY. 69 ”They are very, very late in the game. They've invested at least $600 million, and they don't have a snowball's chance in hell of ever getting their money back”; comment by Donald Sutherland, then director of DuPont’s Diagnostic Systems division, cited in Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192.

92 New Industry Environment imaging company always released technologically superb photographic products which were easy to use and thus were applauded by the consumers. Tremendous efforts at Kodak’s research labs made photography ever more user-friendly and thus more popular, but two important new product launches proved to be disappointing in the 1970s:

The first flop was Kodak’s Instant Camera. The company originally dismissed the idea of instant photography when Edwin Land began to develop it after World War II.70 It just agreed to produce the film for Edwin Land’s “Polaroid” cameras.71 As Polaroid’s success grew, so did the interest of competitors, including Kodak. In 1975, after almost a decade of research and estimated costs of well over $200 million, the company launched an instant camera, which offered performance equal to Polaroid’s camera but used a different finishing process.72 Kodak was forced to aggressively advertise its me-too-product by spending some $13 million annually.73 At the bottom line, Kodak captured only a fraction of the market. In 1985, Polaroid had some 75 percent of the instant camera and film market; Kodak accounted for the rest.74

The final blow came from a decade-long patent-infringement suit between Kodak and Polaroid. In 1985, Kodak was accused of having infringed on seven Polaroid patents for instant cameras and film.75 While for Polaroid the loss of the lawsuit could have had much larger effects, because 90 percent of its business was tied to instant photography, Kodak’s instant photography segment was a disappointing business, accounting for only about 2 percent of sales or $200 million a year.76 Kodak saw great market opportunities in the technical applications of instant photography, including imaging instruments used in hospitals or for producing copies of video stills, which already accounted for some 40 percent of Polaroid’s sales.77

70 Gustavson, T. 2009. Camera: A History of Photography from Daguerreotype to Digital Toronto, Ontario: Sterling Publishing. 71 Ibid. In an interview, Kodak Germany’s former CEO Ernst Lieser confirmed this information. He explained that when Polaroid stopped purchasing film from Kodak, Rochester engineers believed that the company would never be able to do the instant film by themselves. However, they were wrong. Lieser, E. 2014. Personal Interview (by Telephone). April 4. With M. Shamiyeh. 72 1975. Eastman Kodak Company Annual Report. Rochester, NY. 73 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 74 1985d. Polaroid Says Injunction Was Issued against Kodak. Wall Street Journal, 1985 Oct 14: 1. 75 Ibid. 76 Nielsen, J., & Serwer, A. E. 1986. Instant Exit from Instant Cameras. Fortune(February 3). 77 Ibid., Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3).

CASE 93

Ernst Lieser, CEO of Kodak AG Germany between 1980 and 1990, recalled that the patent-infringement suit could have been resolved quickly, with a settlement offered by Polaroid’s former vice president Robson: By paying a lump sum of some $60 million to Polaroid, Kodak would have been allowed to continue its instant photography business; however, Kodak refused the offer.78 Others recalled that Polaroid offered to settle the dispute for $200 million.79

In January 1985, when Federal courts decided on the patent-infringement suit Polaroid Corporation filed almost a decade earlier, Kodak decided to exit the instant camera market.80 Ignoring the loss of brand damage, Kodak’s journey into instant photography burdened the company’s financial position tremendously – even twice. In 1985 the company reported costs before taxes of some $563 million (half of the company’s total operational earnings) for discontinuance of instant photography operations, including the closure of facilities.81 In 1990, its pre-tax earnings were reduced by an additional $925 million as a result of the court award in the patent-litigation suit with Polaroid.82 This time the costs incurred by Kodak amounted to about one third of its pre-tax earnings.

The Kodak Disc camera was the other disastrous failure for Kodak in those days. Kodak Disc was an ingenious camera, developed to replace the company’s profitable and popular Instamatic series, which had been Kodak’s most successful camera for more than 20 years. Released in early 1982, the disc camera was fully automatic: Exposure, flash adjustments, and film advance required no settings by the user; images were recorded on small negatives of Kodacolor HR disc film, which rotated into place after each exposure. It is important to note, that this new camera required Kodak to redesign the complete imaging system, from camera, to film, and finally to photofinishing, which was supposed to transform the negatives into sharp, clear prints.83

78 Lieser, E. 2014. Personal Interview (by Telephone). April 4. With M. Shamiyeh. 79 Parulski, K. 2014a. Email Conversation. June 6. With M. Shamiyeh. 80 1985b. Eastman Kodak Company Annual Report. Rochester, NY.; 1986. Eastman Kodak Company Annual Report. Rochester, NY. 81 1985b. Eastman Kodak Company Annual Report. Rochester, NY, 1990a. Eastman Kodak Company Annual Report. Rochester, NY. 82 1991c. Kodak to Pay Polaroid $925 Million to Settle Suit. Wall Street Journal, 1991 Jul 16: 0-PAGE C13. 83 1981b. Eastman Kodak Company Annual Report. Rochester, NY.

94 New Industry Environment The process that brought the new disc cameras and film to the point of introduction took Kodak six years and an investment of many millions.84 In the year of its introduction, more than 850 photofinishing laboratories around the world had to install special processing machines to develop the disc film and print disc pictures.85 While the Kodak Disc camera was unquestionably Kodak’s most successful launch ever – the company shipped more than 10 million units in its first year, double the number of Instamatic cameras released in that model’s first year – the camera had a big problem: The picture quality was extremely poor. The camera used small 8.2 x 10.6-mm negatives, which accounted for almost one tenth of the area of regular 24 x 36-mm film. An industry insider summarized the problem as follows: “The technical compromise to get the [Disc's] size down was greater than the result was worth.”86

Besides the problem in performance, the disc camera ignored changing consumer preferences. In Europe and in Japan, consumers were more accustomed to the 35 mm standard, and 35 mm cameras offered by competitors were almost as cheap and easy to use as the Kodak Disc camera with its propriety format.87 As a consequence, sales flagged.88 Millions of disc cameras remained on the shelves during its first Christmas season. Six years after its introduction, in 1988, after Kodak had sold an estimated 30 million disc cameras, in the company’s largest marketing campaign ever, the company stopped production of the camera.89 Although the company continued to manufacture Disc film for about 10 years after discontinuing camera production, Kodak never turned on a plant it built in Colorado just to make disc film.90

In summary, during the turn of the 1970s Kodak was challenged by various unforeseeable changes in the environment, for instance, the rise of costs for raw materials and the strong dollar, and internally generated problems such as entering growth markets late or launching products that did not meet market demand. These challenges clearly meant the end of Kodak’s long-term profit trend. In 1983, when

84 Ibid. 85 1982a. Eastman Kodak Company Annual Report. Rochester, NY. 86 Carl Chapman, vice president of Fuji Photo Film U.S.A., quoted in Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 87 Competing cameras were, for instance, Canon’s AE-1 or Konica’s C35AF. Buell, B., & Aikman, R. 1985. Kodak Is Trying to Break'out of Its Shell. Business Week(June 10) 92-95. 88 Taylor, P. 1983. Kodak Loos to a Leaner and Meaner Future. Financial Times(Wednesday November 16) 22. 89 Ansberry, C. 1988g. Kodak Suspends Its Production of Disk Camera --- Poor Sales Cited by Firm; Analysts Note Problems with Picture Quality. Wall Street Journal, Feb 02: 1. 90 Parulski, K. 2014a. Email Conversation. June 6. With M. Shamiyeh.

CASE 95

Colby Chandler was appointed Chief Executive Officer, the company reported losses for the first time in decades. Kodak was required to take action.

96 Diversification and Exploration 5.4 Diversification and Exploration

“It was clear to us that it would take more than a new Kodacolor film or a new disk camera. It would take a whole new area – like life sciences – or it would take massive

expansions into areas we hadn't participated in very much before.” 91 Colby Chandler, Chief Executive, Kodak

“It's very hard to find anything with profit margins like color photography that is legal.” 92 Leo Jack Thomas, Director of Research, Kodak

In the early 1980s, Kodak aimed at “making the elephant dance,” as Walter Fallon, long-serving CEO, liked to say.93 Aware of the challenges posed by the changing industry environment, he forwarded the following statement to shareholders before handing over his job to Colby Chandler: “We [Kodak] are making fundamental changes in the way we do business. We'll continue to look for opportunities. But one thing we don’t want to be is a conglomerate going in directions that have nothing to do with photography.”94 Two broad strategic directives guided the company’s course of actions between 1983 and 1992: On the one hand, protection and growth of core business by improving efficiency and entering new markets; and, on the other, diversification into new fields. Kodak’s new strategy led to mixed results: First, net earnings remained equal or even below those of the early 1980s despite a doubling in sales. Likewise, the stock price languished at some $45, one third of the price paid in the early 1970s. Second, massive investments into electronics did not pay off. Commercial and information systems like copiers or print and publishing systems burdened annual income. One of Kodak’s biggest innovations, the PhotoCD system, which involved the scanning of ordinary silver-halide photographs into digital form and their transfer onto compact discs, had failed to take off in the company’s most important consumer market. And, finally, the move into pharmaceuticals promised benefits after a decade or more, but got Kodak heavily into debt, limiting its liquidity and making it difficult to flexibly respond to emerging threats.

91 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 92 Ibid. 93 Walter A Fallon quoted in 1982b. Kodak Fights Back. Everybody Wants a Piece of Its Markets. Business Week(February 1) 36-38. 94 Taylor, P. 1983. Kodak Loos to a Leaner and Meaner Future. Financial Times(Wednesday November 16) 22.

CASE 97

Figure 32 Sales, Earnings, Employees, and Stock Price, Kodak, 1972-1992

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98 Diversification and Exploration For many decades, at least throughout the 1960s and ’70s, Kodak’s conservative strategy paid off. Sales and earnings moved ahead each year, each reaching record levels. The company’s competence in chemical engineering, combined with economies of scale from massive manufacturing plants, gave the imaging giant a monopoly position in the photographic film and paper industry, allowing it to become of the world’s Fortune top 500 companies.

On July 1, 1983, when Colby Chandler, newly appointed chairman and chief executive officer, began to direct the Kodak’s future, the trend of long-term profit was clearly down. Earnings and profit margins had been cut in half [see Figure 32 and Figure 33], and return on equity had fallen below average [see Figure 34].95 And while expensive ventures into copiers, blood analyzers, and new camera systems doubled Kodak’s capital investments, the operating return on these assets had fallen to one third [see Figure 35]. Kodak was certainly forced to take action. Comforted by prosperity and lack of competition, the company was forced to change its corporate habits, to improve its costs, and to enter volatile markets it was unfamiliar with.

5.4.1 Improving Efficiency In the early 1980s, Kodak invested heavily in its manufacturing facilities to benefit from economies of scale. The company aimed for added reliance upon its distribution channels, to enhance its service quality to customers worldwide, and to generate savings in manufacturing.96 In Europe, for instance, Kodak utilized a pair of modern high-rise central distribution facilities – one at Chalon, France, which opened in 1982, and the other at Swallowdale, England, which opened in 1983.97 However, Kodak’s facilities operated uneconomically for several reasons. First, at many manufacturing sites a full line of products was pursued, even though their runs were so small as to be inefficient. The plant manager, following Neil Murphy, then group vice president in charge of the international photographic division, “[had] to prove that any product he makes cannot be made somewhere else, and shipped to his territory, for less.”98 As a consequence, the company’s gross profit fell by half [see Figure 37].

95 1983a. Eastman Kodak Company Annual Report. Rochester, NY. 96 1982a. Eastman Kodak Company Annual Report. Rochester, NY. 97 Ibid. 98 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91.

CASE 99

Figure 33 Net Profit Margins

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100 Diversification and Exploration Second, Kodak’s research lab employed more than 2,000 scientists and technicians with an annual budget of about 6 percent of sales, which in 1983 accounted for some $746 million [see Figure 36].99 There was scarcely another company in the US that invested so heavily in research.100 At Kodak, however, there was a weak translation of research findings into commercialized offerings.101 Puru Purushotham, who served in the early 1980s as a scientist at Kodak’s research lab, compared the unit with a country club: “It was so comfortable, you had infinite resources, literally infinite resources to do anything that you wanted. And then, at lunchtime, most of us would go play some tennis in one of the local clubs, take a two-hour lunchtime, come back and work for an hour, go back to the cafeteria again for coffee. It was like a thousand people are doing this.”102 Although Purushotham’s depiction may not be representative for all research lab divisions, as other Kodakers noted,103 certainly there was a need of massive restructuring. For the first time in its history, a manager was required to downsize the workforce extensively – a procedure which would be repeated again and again until 2012, when Kodak filed for bankruptcy.

Kodak’s investment in people was well recognized by those who had joined the company to pursue a life-long career at the “Yellow Family.”104 For instance, among its top officers, more than 90 percent had dedicated their entire careers to Kodak, and the company boasted an employee turnover rate one-fourth the industry average.105 Colby Chandler, who started out as an engineer, had spent some 34 four years at Kodak before being appointed CEO; Kay Whitmore, who reported to Chandler in his capacity as president of the company, was trained as an engineer and had worked there some 27 years.106 Absorbing Kodak’s culture during their entire professional lives, both manager then suddenly had to make sharp cuts in the workforce.

99 1978. You and Kodak in Perspective: Careers in Engineering, Science, Administration and Marketing. Rochester, NY: Eastman Kodak Company. 100 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 101 “There was a lot of innovation taking place, but there was weak translation into commercial products.” Jack Thomas, quoted in Purushotham, P. 2013. Personal Interview. November 19. With M. Shamiyeh, Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 102 Purushotham, P. 2013. Personal Interview. November 19. With M. Shamiyeh. 103 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 104 This life-long investment was confirmed by every interviewed employee or retired employee of Kodak. 105 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 106 Buell, B., & Aikman, R. 1985. Kodak Is Trying to Break'out of Its Shell. Business Week(June 10) 92-95, Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192, Holusha, J. 1989. Click: Up, Down and out at Kodak. The New York Times, December 9.

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Figure 36

R&D Expenditures Expenditures in millions

Figure 37 Gross Profit Margin

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In 1983, when management suddenly announced an early retirement plan, Kodak’s “family” feeling was rudely shattered. To balance manufacturing schedules with volume expectation, some 11,000 of the 136,000 employees worldwide, or 8 percent, had to leave the company, either “voluntarily” or by layoff.107 Kodak justified the reduction of the workforce by the realities of the business.108

People close to the 1983 layoffs recall that these were almost certainly due, at least in part, to the fact that Disc film sales were way below expectations. From 1981-1982, Ken Parulski remembers having spent one week each fall interviewing prospective employees on college campuses such as MIT. In 1983, according to him, the planned trip was cancelled at the last minute, along with all other college recruiting. Some offers to new employees were rescinded. “Of course, Kodak was not going to admit

107 1982a. Eastman Kodak Company Annual Report. Rochester, NY. 108 1983a. Eastman Kodak Company Annual Report. Rochester, NY.

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102 Diversification and Exploration publicly that the layoffs were due to Disc, since this would be further evidence that Disc was a failure.”109

While Kodak’s first retirement plan had affected its income moderately, the reduction of costs amounting to some $200 million, or about 20 percent, from $1 billion in total earnings before tax, the 1986 layoff lowered pre-tax earnings significantly, by some $520 million. Excluding companies acquired, a total of 12,765 employees were asked to leave to meet the goal of a 10 percent personnel reduction; about 70 percent left on a voluntary basis.110 The latter workforce reduction surprised even analysts, who had not expected such tremendous cuts.111 Some industry analysts, however, contended that Kodak was in need of even further workforce reductions to stay competitive. They argued that Kodak generated sales only four times that of its rival Fuji, despite the fact that it employed seven times more employees [see also Figure 29].112 Although Fuji still served its foreign markets from Japan, Kodak’s sales remained literally flat after four consecutive years.

Parallel to its reduction of employees, Kodak also began to drastically reduce its portfolio of deliverable products. In 1987 it eliminated one third of some 20,000 products.113 The cuts in the workforce and other costs finally paid off in 1987, when after five years of stagnation, sales began to climb and to exceed the 1982 results.

Nevertheless, the benefits of effects of cuts in the workforce and improvements in efficiency did not last for long. In 1989 Kodak announced another massive layoff, designed to generate some $1 billion in savings in the following year.114 Stiff competition in the photographic industry, unfavorable currency exchange, and Kodak’s engagement in the information and commercial businesses again led to

109 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 110 1986. Eastman Kodak Company Annual Report. Rochester, NY. 111 “We had expected cuts in 1986 and 1987 as the cost structure was too high,” said Eugene Glazer, an analyst with Dean Witter Reynolds Inc. “But I'm surprised [the cuts] have been accelerated. The company must have realized it didn't have the luxury to drag [cost-cutting measures] on.” Quoted in Ansberry, C. 1986c. Kodak Unveils Plan to Reduce Work Force 10% (Feb 12). 112 Ibid. 113 Ansberry, C. 1987c. Kodak to Unveil Still-Video Photo Line, Shed Many Marginal, Outdated Items. Wall Street Journal, 1987 Jun 04: 1. 114 Ansberry, C., & Carol, H. 1989. Last Chance: Kodak Chief Is Trying, for the Fourth Time, to Trim Firm's Costs --- Chandler, to Retire in May, Faces Takeover Rumors and Polaroid Settlement --- Boost from New Color Film. Wall Street Journal, 1989 Sep 19: 1, Pae, P. 1989c. Kodak to Again Restructure Operations --- Earnings Plunge Spurs Latest Round of Cost Cuts. Wall Street Journal, 1989 Aug 18: 1.

CASE 103

disappointing operating results.115 Kodak first moved to consolidate its decentralized photographic divisions – consumer products, photofinishing systems, and sales – into a single imaging division.116 Rising costs for the management of autonomously run business units forced the company to restructure its operations.

The bottom line was that “more than” 7,500 employees were asked to leave, endowed with generous severance packages.117 The Wall Street Journal reported the elimination of some 10,000 employees, or roughly 8 percent of the total workforce worldwide.118 Restructuring efforts reduced earnings before tax by an (incredible) $875 million, or one third of earnings from operations.119 The layoff was also followed by a change in compensation. Kodak began to link pay more closely to financial performance and to place more of management's compensation at risk, with as much as 40 percent of annual compensation dependent on corporate performance; for middle managers, less than 15 percent of annual compensation was linked to the company’s results.120

Finally, in 1991, Kodak announced its fourth massive employment reduction program, as part of the company’s de-emphasis on electronic imaging technologies. Ongoing poor performances in the commercial and information systems segment compelled Kodak to focus on its traditional consumer photographic business and hybrid technology such as the PhotoCD system. Initially the company announced a reduction in its US workforce by some 3,000 employees.121 To render early retirement attractive, Kodak offered high incentives to employees, at an average cost of about $120,000 per employee.122 Kay Whitmore, then Kodak’s Chief Executive Officer, conceded that the program was “too rich.”123 The early retirement plan was signed by a total of 8,354 employees, and Kodak lost even many top executives.124 The cost of the early

115 Pae, P. 1989b. Kodak Is to Take $225 Million Charge, Signaling Bigger Restructuring Plans. Wall Street Journal, 1989 Jul 25: 1. 116 Ansberry, C. 1989a. Kodak Consolidates Core Operations into One Division in Bid to Trim Costs. Wall Street Journal, 1989 Jun 19: 1. 117 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 118 Hirsch, J. S. 1990. Kodak Hopes Electronic Imaging Clicks, as Company Faces Fuzzy Photo Future. Wall Street Journal, 1990 Jul 16: 0-PAGE B5. 119 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 120 Ibid. 121 Rigdon, J. E. 1991d. Kodak Shuffles Executives, Operations, Announces Plans to Cut 3,000 Workers. Wall Street Journal, 1991 Aug 13: 0-PAGE A3. 122 Rigdon, J. E. 1993c. Kodak Is Said to Plan Layoffs of 2,000 to 4,000. Wall Street Journal, 1993 Jan 08: 0-PAGE A6. 123 Ibid. 124 1992b. Kodak's Early Retirement Plan. Wall Street Journal, 1992 Oct 05: 0-PAGE B5.

104 Diversification and Exploration retirement plan was some $1.6 billion before taxes or $1 billion after taxes!125 In fact, the program reduced two thirds of the company’s earnings from operations!

Figure 38 Reduction of Workforce

5.4.2 Trusting Partners Since its early days, what Kodak sold was made by Kodak.126 It was one of the most fully integrated manufacturers in the US. It operated this way so as to ensure the quality standards it had valued ever since its founder, George Eastman, began commercial production of dry plates and experienced tremendous problems when customers returned their plates due to a supplier’s faulty gelatin base.127 Since then, the company was reluctant to rely on outsiders, but rather to be in full control of its products. For this reason, Kodak produced its own gelatin to secure the high quality of its photographic film and paper, ran its own chemical division to produce every component of the film brought to market, and engineered its own manufacturing plants.128 Kodak even decided to generate its own electricity, purify used water, and

125 1991a. Eastman Kodak Company Annual Report. Rochester, NY. 126 Chandler, C. H. 1986. Eastman Kodak Opens Windows of Opportunity. Journal of Business Strategy, 7(1) 5-8. 127 Collins, D. 1990. The Story of Kodak. New York: Harry N Abrams. p. 43 128 Kodak, "History of Kodak: Milestones- Chronology," http://www.kodak.com/ek/US/en/Our_Company/History_of_Kodak/Milestones_-_chronology/Milestones-_chronology.htm, accessed on April 14, 2013.

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CASE 105

operate its own steam power plant at the Kodak Park in Rochester.129 During Colby Chandler’s tenure, the company got more reliant on outside help to cut costs and to be able to compete quickly in new domains.

Since the 1970s, Kodak’s capital additions had tripled, while return on assets had not kept pace [see Figure 35]. Changes in the industry and the malaise resulting from a series of disappointing product launches affected Kodak’s financial position. Hence, in the advent of electronic technologies, which more and more affected Kodak’s businesses, the company could not afford to take further risks.130 Rather than proving wrong again, it decided to partner with other companies and to leverage its brand and distribution channels. As Kodak’s President Kay Whitmore, who reported to Colby Chandler, put it: “We've come out of an environment where we were the single world leader; we had a technology that nobody else could really match, and we were able to dominate that field. The world doesn't allow companies to do that anymore.”131

First of all, Kodak outsourced the production of its new non-SLR 35-mm camera to Chinon Industries Inc. in Japan.132 After 17 years of absence from the market, during which it left the 35-mm camera business entirely to the Japanese, Kodak announced its return in 1986.133 The new single-lens-reflex camera, which featured a fixed focus, automatic flash, and film sensing, was aimed at young buyers who demanded high-quality photos without the necessity of mastering sophisticated adjustments of the camera. Accordingly, the price was set to meet these demands, between $88 and $140, as compared to 35-mm SLR cameras, which sold for at least $200.134 Although Kodak entered the market late, and Canon and Minolta as well as other Japanese producers already dominated it, the company’s globally respected brand name and wide distribution network triggered quick and effective market diffusion. Within two years

129 Kirkpatrick, D., & Sookdeo, R. 1991. Why Not Farm out Your Computing? Fortune September 23. 130 Dennis Deleo, responsible for Kodak’s Corporate Commercial Affairs division between 1976 and 1985, extensively elaborated the reasons for Kodak’s risk aversion. Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh. 131 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 132 Ansberry, C. 1988e. Kodak Introduces Four New Cameras, Expanding Both Ends of Its Model Line. Wall Street Journal, 1988 Jan 22: 1. 133 Lieser, E. 1974. Die Kodak- Und Nagel-Cameras Aus Stuttgart Wangen. Stuttgart: KODAK. 134 Ansberry, C. 1986d. ...While Kodak Confronts Doubts About Its 35-Mm. Wall Street Journal, 1986 Mar 25: 1.

106 Diversification and Exploration of rejoining the 35-mm camera market, Kodak had become a market leader for 35-mm non-SLR cameras in the US.135

Kodak also turned to Japanese suppliers to quickly get involved in the consumer video recorder market. In 1984 the company released the Kodavision camcorder.136 The 8-mm system was developed in concert with Matsushita Electric Industrial Co. and TDK.137 In the copier business, Kodak settled an arrangement with Canon to quickly enter the mid-volume copier marketplace. Canon designed and manufactured the Ektaprint 85, which Kodak sold under its brand name.138 For the development of the Ektaprint electronic publishing system (KEEPS), which was introduced in 1985 and aimed at companies that wanted to edit, print, and update text and graphics for their own publications, Kodak utilized Canon printers.139 The system also incorporated a computer from Sun Microsystems Inc. and software from Inter Leaf Inc.140 Over a short period, Chandler’s strategy promised success. In 1986, when the non-impact printer business was growing at a rate of 20 to 25 percent, it provided some 40 percent of Kodak’s total revenues.141

In entering partnerships, Colby Chandler hoped to shift manufacturing only temporarily to the Far Eastern suppliers.142 By claiming that Kodak’s manufacturing skills still existed, he publicly announced in 1986 that he would return to production as soon as it became economically viable in the US again.143 In subsequent years, however, Chandler actually broadened partnerships with other companies, either to jointly pursue product development or to outsource internal workflows. For instance, in 1988 Kodak began to partner with the Matsushita Electric group to establish a jointly owned and operated manufacturing facility for the production of alkaline batteries, and with Olivetti to jointly develop, manufacture, and market optical disc

135 1988b. Eastman Kodak Company Annual Report. Rochester, NY. 136 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 137 Ibid. 138 Ibid. 139 Buell, B., & Aikman, R. 1985. Kodak Is Trying to Break'out of Its Shell. Business Week(June 10) 92-95. 140 1986. Eastman Kodak Company Annual Report. Rochester, NY. 141 Ansberry, C. 1986a. Kodak Introduces High-Volume Model for Growing Electronic Printer Market. Wall Street Journal, 1986 Sep 04: 1. 142 Taylor, A. I., & Caminiti, S. 1986. Kodak Scrambles to Refocus. Fortune(March 3). 143 Ibid.

CASE 107

drives for personal computers.144 In the same year, Kodak joined with Fuqua to create the world’s largest photofinishing company, to better service customers.145

Likewise, many corporate information services had been outsourced with the aim of allowing Kodak to focus its resources on its core operations. For instance, IBM was handed the responsibility to operate Kodak’s data center, and Digital Equipment Corporation was put in charge of Kodak's telecommunications services.146

5.4.3 Exploring New Domains Parallel to the necessity for efficiency improvements, Kodak also started to consider extending operations beyond its traditional photographic business. There were several reasons for this: Growth in traditional photography had slowed down to some 4 percent a year, from 8 to 10 percent in previous years.147 Home video, however, had become a profitable $3 billion market in the US, accounting for some 20 percent of the entire photographic industry.148 New electronic image-capturing technologies became available, technologies that did not rely on Kodak’s traditional chemical-based competences, and showed signs of threatening its life-long cash cow. Hence, Chandler decided Kodak should switch to rather than fight the electronic revolution, which had finally caught the imaging industry. New ventures and acquisitions ought to fill competence gaps in Kodak’s technology base.149

The other reason for Kodak’s entry into new domains was its base of some 500,000 chemical formulations and extensive capabilities in biotechnology, which it aimed to leverage.150 For more than a hundred years since its foundation, the root source of Kodak’s success was its proficiency in chemicals and engineering. To apply the company’s traditional core competence in chemical engineering to the health and pharmaceutical industry promised strong revenue streams. But Kodak never identified

144 1987. Eastman Kodak Company Annual Report. Rochester, NY, 1988b. Eastman Kodak Company Annual Report. Rochester, NY, 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 145 1987. Eastman Kodak Company Annual Report. Rochester, NY, 1988b. Eastman Kodak Company Annual Report. Rochester, NY, 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 146 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 147 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 148 Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128. 149 Chandler, C. H. 1986. Eastman Kodak Opens Windows of Opportunity. Journal of Business Strategy, 7(1) 5-8. 150 1985b. Eastman Kodak Company Annual Report. Rochester, NY.

108 Diversification and Exploration a product or business in the burgeoning electronic photography market that could compete with the proprietary position of its color film, which had generated blockbuster profit margins at a minimum of 50 percent.151

To move rapidly and position the company successfully in electronic imaging and pharmaceutical business, Chandler embraced a massive restructuring process, to launch a venture program and to engage in massive acquisitions.

In August 1981 Kodak was annoyed when Sony unveiled its prototype for a “revolutionary” new electronic still video camera; the Japanese firm presented its MAVICA (MAgnetic VIideo Camera) in a triumphant publicity tour in the United States, and promised to bring it to market soon.152 The single-lens reflex camera was able to store the analog video signal of up to 50 color shots on a rotating magnetic disc and show it instantly, without processing, on a standard TV set. Although Kodak was familiar with some of the technologies integrated in Sony’s MAVICA, it had only developed a breadbox-sized prototype, which was far from being a “product”; that is to say, Kodak was nowhere near ready to make such a small, integrated electronic camera:

Already in 1972, Kodak had focused on devices that could capture images electronically, the so-called charged coupled devices (CCDs).153 Roger Van Heyningen, then director of Kodak’s Physics Division, convinced management that a full-scale commitment would be required for the company to seriously explore the potential of CCDs in future products, which finally led to the development of a “world-class electronics research facility” in 1975, even before the Japanese got into the business.154 Kodak Research scientists quickly began making sensors with ever greater numbers of pixels, or picture elements, and began to develop electronic still cameras that were able transfer images to TVs; however, Kodak declined to commercialize these products because of their production costs.155 Certainly there

151 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 152 Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f. 153 1989c. Journey: 75 Years of Kodak Research. Rochester, NY: Eastman Kodak Company. 154 Ibid., Van Heyningen, R. 2013. Personal Interview. April 14. With M. Shamiyeh. 155 See comment by Gerald B. Zornow, who served as the President of Eastman Kodak Company from 1970 to 1972 and as Chairman of the Board from 1972 to 1977: “We had a hell of a good product. 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,

CASE 109

were also concerns about launching products that would reveal the potential of cannibalizing Kodak’s profitable traditional silver-halide business.

For instance, in 1975, when Kodak engineer Steve Sasson invented and patented the world’s first digital camera, the R&D project basically did not progress beyond the prototypical stage.156 The 8½-pound camera captured pictures in black-and-white with a resolution of 100 x 100 pixels (0.01 megapixels).157 The images were stored on a tape recorder and could be shown on a TV set or printed on a dot-matrix printer. Sasson recalled that after an internal presentation of the camera to Doug Harvey, then head of the Kodak Apparatus Division, Harvey allowed the project to continue but said he hoped it would fail.158 The camera clearly revealed the potential for an upcoming threat to Kodak’s core business, while raising too many issues that could not be resolved at that time.

A Kodak product that employed an electronic imaging sensor and which made it to the market was announced in 1980. The Kodak SP2000 motion analysis system captured images at high speed and allowed review in slow motion.159 However, it addressed the needs of the commercial market and was not designed for consumers.

The other reason for Kodak’s initial reluctance to push electronic photography was the poor quality of the image sensors. Kodak’s management by and large regarded the quality of electronic imaging sensors as inferior to the silver-halide film technology for use in consumer photography. In response to Sony’s announcement in 1982, Chandler made his thinking clear:

“An electronic sensor with one million individual elements (pixels) could produce an acceptable 3R print. That’s almost four times the number of elements in currently available sensors, and even that falls far short of current film standards. A single 110-size frame of Kodacolor II film has a resolution equivalent to a hypothetical sensor with over two million elements, and a 35-mm frame of the same Kodacolor II film offers the equivalent of more than 10 million sensor elements. We have on the drawing

when we found out what the costs were.” Quoted in Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128. 156 Sasson, S. 2013a. Personal Interview. April 9. With M. Shamiyeh. 157 Sasson, S. 1977. Technology Report: 47. Rochester: Eastman Kodak Company. 158 Sasson, S. 2013a. Personal Interview. April 9. With M. Shamiyeh. 159 1980. Eastman Kodak Company Annual Report. Rochester, NY.

110 Diversification and Exploration boards new products that have the potential to increase those numbers by 50 percent.”160

Kodak’s towering presence in the consumer marketplace, coupled with its carefully cultivated reputation for high picture quality, rendered an early engagement in electronic imaging, with its mediocre quality, risky. In fact, in the early 1980s, image sensors were far inferior to every type of film system. Therefore, the development and commercialization of consumer digital cameras would have been a bigger failure then the Disc film was. From this perspective, Kodak’s decision not to develop and market digital cameras in the 1970s and 1980s was understandable – a view that was widely shared by other photographic companies at the time.161 Kodak had done much to make quality a vital element in its reputation. Since its founder, George Eastman, recalled a large shipment of products – enough to nearly bankrupt his fledgling business – because of an unsatisfied customer, Kodak had carefully managed its brand and the quality it stands for and for which it was well known and respected in the worldwide photographic community.162

It is also important to note that the advent of electronic still cameras in the early 1980s was not considered as an immediate threat to traditional chemical-based photography –not even after first cameras were brought to market, such as the Canon RC-701 in 1986. 163 Photographic journalists and industry leaders remained undecided for a long time about the progress of the technology and its potential for the future. Casio, for instance, was convinced that consumers would be attracted quickly by the advantages of still video cameras, because pictures could be stored in just a few inches of shelf space or erased if they were not appealing; moreover, there was no need for consumers to go to photofinishers to look at their pictures.164 Others were skeptical, because of the picture quality and the considerably higher costs compared to media used in

160 Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f. 161 See commentary by Polaroid scientist Conrad H. Biber who explains, “[T]he prints [from electronic still video cameras] aren't very good. A true photographic company can't come out with a product that mediocre.” Quoted in Beam, A. 1985. The Filmless Camera Is Here, but Will It Sell? Business Week(April 15) 151f. 162 Collins, D. 1990. The Story of Kodak. New York: Harry N Abrams. See also notes in the annual reports of 1985 and 1986 on the maintenance and enhancement of the company’s quality image. 1985b. Eastman Kodak Company Annual Report. Rochester, NY, 1986. Eastman Kodak Company Annual Report. Rochester, NY. 163 Leavitt, D. 1985. Imaging Materials: Electronic Innovations Made News, but Conventional Photogrpahy Showed Steady, Solid Improvements. Popular Photography(January) 62f. 164 Ansberry, C. 1987d. Makers of 'Still-Video' Cameras Refocus Marketing Efforts on Commercial Users. Wall Street Journal, 1987 Jun 24: 1.

CASE 111

traditional photography: Casio charged about $7 per disc or 14 cent an image; 35-mm color slides, by contrast, were about 35 to 40 cents apiece, including processing.165 Still others expressed doubts about people’s interest in watching their pictures on a TV or getting low-quality prints from video signals: Polaroid, for instance, was skeptical about the quality of the filmless still video cameras that many Japanese companies believed would revolutionize traditional picture-taking, because of the poor quality of the image reproduction – an assumption that was echoed in surveys.166 Nevertheless, in the late 1980s, when Canon and Sony were already selling several thousand still video cameras a year, half of the people asked about their interest in seeing pictures on a TV said they were not interested; only some 19 percent of those surveyed said they would accept prints at a quality inferior to those of 35-mm film.167 Some companies, including Kodak, did not believe that electronic cameras would succeed in the consumer market due to the lack of affordable devices to make paper copies of video images.168 In this regard Kodak was right as history has shown.

In any case, in the early 1980s, when it became clear to Kodak that its traditional chemical-based film and paper business would be increasingly affected by electronics in the future, the company decided to enter the burgeoning electronic-imaging businesses – after watching and waiting for a decade. But unlike its Japanese competitors, it decided to strike a balance between electronics and chemistry; that is to opt for a hybrid system, the best of both worlds: for example, to use a video converter to allow consumers to see their chemically produced color images; edit and enlarge them electronically on a TV; encode instructions on a magnetic strip on the edge of the film; and then transmit the film back to the photofinisher, where an automatic printer would turn out prints to Kodak’s specification at an affordable price.169 Kodak showed such a system for the first time at the Photokina in Cologne in 1992, by its demonstration of a Disc film-to-video player. Although the system was never commercialized for several reasons, the main purpose was to demonstrate how, if consumers continued to take pictures on film, their images could later be shown on TV

165 Ibid. 166 Beam, A. 1985. The Filmless Camera Is Here, but Will It Sell? Business Week(April 15) 151f. 167 Harrand, B., Lewis, B., Matsumoto, Y., & Fox, T. 1993. 1993 Photo Marketing Association International U.S. Consumer Photographic Survey. In P. M. A. International (Ed.): 158. Jackson, Michigan. 168 Ansberry, C. 1989c. On Photography. Wall Street Journal, 1989 Feb 28: 1. 169 Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f.

112 Diversification and Exploration – and the TV picture would look better than if it had been taken with an electronic/digital camera.170

To implement electronics in every sphere of photography, or “imaging” chain as it is now called, Kodak decided to spend one-fourth of its research budget on electronics and for every new chemical engineer, 10 electrical engineers would be hired.171

The strategic decision to enter electronic photography was followed by massive structural changes. One of Kodak’s two traditional divisions, the Photographic Division, was split into 17 independent and autonomously managed business units; the Chemical Division remained untouched.172

Each of the 17 business units became independent and autonomous in the sense that each business unit was in charge of its own financial analysis, business planning, marketing and sales for the US, product development, equipment manufacturing, materials manufacturing, and international operations. For each business unit, Kodak made one general manager in charge for the unit’s financial performance, product development and marketing, coordination with functional and geographic units, manufacturing activities, and strategic planning.173

One of the new business units, the Consumer Electronics Division, was created to directly focus on the development of electronic cameras equal to the Japanese ones. The separation of the company’s traditional consumer products division was expected to ensure independence of the interests of traditional photography.174

By breaking Kodak into smaller business units, the company abandoned a decades-old management structure in which marketing and manufacturing executives reported along separate chains of command. At the old Kodak, a suggestion from a marketing manager for altering a manufacturing process would have to filter all the way up the management ladder and back down the manufacturing ranks. By opting for

170 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 171 Leo Thomas, then Kodak Research director, quoted in Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128. 172 1984a. Eastman Kodak Company Annual Report. Rochester, NY. See also 1984b. Kodak Reorganizes Photographic Division Along Business Lines. Wall Street Journal, 1984 Nov 19: 1. 173 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 174 See comment by Wilbur J. Prezzano, quoted in Beam, A. 1985. The Filmless Camera Is Here, but Will It Sell? Business Week(April 15) 151f.

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decentralization, Chandler aimed to promote innovation, speed to market, and adherence to clear profit goals.175

Kodak’s new age of entrepreneurialism received immediate acclaim for its effectiveness from within the company, in the industry, and in academia. For instance, the time from product idea to market for Kodak’s Create-a-Print Machine, a do-it-yourself photo enlarger, had been reduced from four years to only 22 months.176 Other benefits of Kodak’s decentralization had been well documented in the manufacture of black-and-white film.177 The transfer of the primary responsibility for the entire workflow resulted in impressive reduction of production costs by some $40 million and inventory by about $50 million; moreover, the time required for certain film-finishing routines was reduced to two days from six weeks; routines in film coating to about half the time.178 The increase in the number of innovation reports created by Kodak scientists documents another payback of the restructuring process: Within five years, Kodak's research laboratories, which had been aligned with the business units to focus their aim and speed to the process of commercialization, nearly doubled the number of patent applications filed by the company's technical community.179

Industry analysts commented positively on the remarkable turnaround of Kodak’s core business.180 For instance, Harvard professor Rosabeth Moss Kanter praised the success of Kodak’s restructuring process in her book When Giants Learn to Dance, to support her arguments in favor of corporate change.181

While Kodak’s restructuring process aimed to make the way clear for new approaches to markets served by the company already, the goal of the newly establishment Venture Board was to nurture ideas that did not fall neatly into existing lines of business.182 A board of managers was set up to review promising ideas for new business opportunities outside the company's mainstream business. The Offices of

175 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 176 William J. Janawitz, then manager for manufacturing equipment of the photofinishing systems division, quoted in Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 177 Frangos, S. J. 1993. Team Zebra: How 1500 Partners Revitalized Eastman Kodak's Black & White Film-Making Flow: Wiley. 178 Ibid. 179 1987. Eastman Kodak Company Annual Report. Rochester, NY. 180 Flint, J. 1988. Faces Behind the Figures. Forbes(March 21) 174. 181 Kanter Moss, R. 1989. When Giants Learn to Dance. New York: A Touchstone Book, Simon&Schuster Inc. 182 1984a. Eastman Kodak Company Annual Report. Rochester, NY.

114 Diversification and Exploration Innovation maintained drop-in centers.183 At these offices, which were located all over the company's premises, including in Europe and Asia, employees were asked to hand in ideas that were not directly related to their daily work.184 These were then screened by company staff and external consultants and checked for their viability and objectives for growth in revenues and earnings. Kodak promised to provide preliminary grants of some $25,000 for work on a laboratory-scale project to determine the viability of new initiatives.185 In 1985, one year after its commencement, the office recorded some 28,000 submitted ideas on productivity and efficiency, translating into $18.5 million in savings; about one third of employees’ suggestions were adopted, resulting in payments of nearly $4 million to Kodak people, according to the Annual Report 1985.186

Dennis Deleo, who was running Kodak’s venture portfolio as corporate vice president at the time, recalled a series of diverse ventures that either made use of the company’s technologies or required the acquisition new ones. Among others he named Pathtech, a venture which had a technique for molding parts that contained electrical conducting paths; and Videk, an operation that applied high-resolution image scanning for product inspection for industrial purposes.187

In 1987, Kodak was glad to report the establishment of three new businesses that promised opportunities outside the company's mainstream businesses.188 One venture that even encouraged the creation of a new division at Kodak, was the Lamdek Fiber Optics Division. The unit leveraged core capabilities in optics, developed in the wake of Kodak’s Disc Camera. The venture grew to a global business with its own brand identity and worldwide manufacturing, marketing, distribution, operations, and product development.189 Another venture that made it to market was Kodak’s innovative nine-volt lithium battery, which was designed to have a 10-year shelf life

183 Chandler, C. H. 1986. Eastman Kodak Opens Windows of Opportunity. Journal of Business Strategy, 7(1) 5-8. 184 Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh. 185 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. In an interview the number had been confirmed by Dennis Deleo. Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh. 186 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 187 Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh. 188 1987. Eastman Kodak Company Annual Report. Rochester, NY. 189 Brenner, B. S. 2013. Personal Interview. November 20. With M. Shamiyeh.

CASE 115

and last twice as long as its alkaline counterpart.190 The new product made use of the company’s expertise in chemical engineering. Coupled with Kodak’s strong brand name and distribution network, Kodak managed to bring the product to a $2 billion-a-year market, with annual growth rates of 10 to 12 percent, in just two and a half years.191 Nevertheless, the product suffered from quality problems and Duracell’s strong market position.192

5.4.4 Accessing New Technologies The other big change Colby Chandler initiated was to abandon Kodak’s historically strong vertical integration, by aggressively acquiring new technologies through cooperative arrangements. There was a clear awareness that electronic businesses in particular have a rapid rate of obsolescence; thus there is a need to rapidly acquire technical capabilities that Kodak did not have in-house or would require a long time to build up internally.193 Moreover, there was a clear sense of the cost savings the company could generate by acquiring technologies from others, rather than relying on “slow and meticulous” internal capacities to develop and market new products.194 For this reason, Chandler embarked upon an acquisition and investment program that was unprecedented for the photographic giant. In less than five years, the company spent some $6 billion, or four times its annual net earnings, to buy into companies that made everything from computer work stations to anti-cancer drugs.

Until 1983, Kodak had acquired only three companies: In the 1930, facilities in Peabody, Massachusetts, which manufactured gelatin; Spin Physics of San Diego in 1972, which developed for Kodak high-performance magnetic heads; and Atex in 1981, which developed computer-based newspaper publishing systems.195 Within four

190 Ansberry, C., & Robert, L. R. 1986. Kodak's Entry into the Battery Business Includes First Mass-Market Lithium Cell. Wall Street Journal, 1986 May 23: 1. 191 Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 192 Ansberry, C. 1990. Eastman Kodak Is Pulling Plug on Its Ultralife. Wall Street Journal, 1990 Apr 10: 0-PAGE B1, Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 193 “One of the things we've learned is that one company can't do everything,” Mr. Whitmore said. “We're prepared to acquire if it fits our strategic plan and gets us there sooner, or gives us a technical capacity we don't have in-house, or buys a market share that would be hard to build.” Quoted in Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 194 “Kodak can no longer afford to go alone,” said Chandler to security analysts; quoted in 1983c. New Kodak Policy: Grow from Outside. Schenectady Gazette, Nov 11: 48. 195 1973. Eastman Kodak Company Annual Report. Rochester, NY, 1981b. Eastman Kodak Company Annual Report. Rochester, NY, Kodak, "History of Kodak: Milestones- Chronology,"

116 Diversification and Exploration months after Chandler was named chairmen of Kodak in 1983, the company acquired two additional companies: Mead Digital Systems, an Ohio-based manufacturer of ink jet printers, which Kodak later renamed Diconix; and the Datatape division of Bell & Howell, which developed high-tech digital tape recorders.196

Two years later, in 1985, the imaging giant made seven acquisitions. Among these were: Eikonix, a design and manufacturing corporation for digital image-processing equipment, which was bought for approximately $53 million;197 and Verbatim Corporation, a manufacturer and marketer of flexible disc for use in computers and word-processing systems, bought by Kodak for about $175 million.198 The following year, Kodak acquired Fox Photo Inc., a large photofinisher which operated wholesale photo labs and mini labs in 23 states, for approximately $95 million; and the photographic distributorship business of Nagase & Co.199 In 1987, the company acquired, for $43 million, American Photographic Group, a privately held wholesale photofinishing company operating in 17 states.200

In 1988 Kodak agreed to acquire IBM’s copier business in the US.201 IBM had entered the copier business quite late, in 1982; however, the company quickly gained one fourth of the market due to Kodak’s cautious expansion nationwide.202 The acquisition of IBM’s copier business – to service all existing IBM copiers in the US and sell IBM-made copiers and supplies – opened for Kodak a window to woo a broad customer base for future sales. Kodak was well known for its attention to quality and customer service.203 In the late 1980s, IBM was in a transitional phase, and the company was seriously considering withdrawal from the copier business; for Kodak, it was the right time to pick up the pieces.

http://www.kodak.com/ek/US/en/Our_Company/History_of_Kodak/Milestones_-_chronology/Milestones-_chronology.htm, accessed on April 14, 2013. 196 1983a. Eastman Kodak Company Annual Report. Rochester, NY, 1983b. Kodak-Mead Pact. The New York Times, November 8. 197 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 198 Ibid. 199 1986. Eastman Kodak Company Annual Report. Rochester, NY. 200 1987. Eastman Kodak Company Annual Report. Rochester, NY. 201 Ansberry, C., & Paul, B. C. 1988. Kodak Agrees to Purchase Most of Ibm's U.S. Copier Business; Terms Undisclosed. Wall Street Journal, 1988 Apr 20: 1. 202 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 203 1986. Eastman Kodak Company Annual Report. Rochester, NY.

CASE 117

Kodak also used acquisitions to reduce its dependency of its traditional photography and information-imaging business. Leveraging its core capabilities in chemical sciences, it searched for applications beyond imaging. With some half a million chemical formulations in its files, Kodak thought it owned a big asset worth exploiting.204 Life sciences, in particular health and pharmaceuticals, promised a natural extension of the root of its success, and the $110 billion-a-year worldwide pharmaceutical industry alone promised profit margins as high as Kodak has received from silver-halide film.205

Kodak’s established its Life Sciences Division in 1984, with the goal of developing and commercializing new pharmaceutical products growing out of Kodak’s capabilities in chemistry and biotechnology.206 Leo J. Thomas, then general manager of the Life Sciences Division and former director of Kodak Research, was aware that the division could not entirely rely on its hundred years of work in the chemical sciences for photography.207 Kodak had neither experience in the legal approval process necessary for new drugs nor an adequate distribution network for medical products. The company knew that help from outside was necessary and therefore aggressively surveyed the market for possible acquisitions.208

In a series of investments and joint ventures with bio-technology companies, Kodak aimed at backing its efforts with third parties. In particular, it targeted companies that had products nearly ready for clinical trials and looking to bring forward drugs relating to the immune, cardiovascular, and central nervous systems. For instance, it acquired Bio Image Corporation, a Michigan-based and privately held company supplying instrumentation and software for medical and biotechnology applications.209 In 1987, the acquisition of International Biotechnologies Incorporated expanded Kodak's capability to produce biological agents and molecular instrumentation for universities, hospitals, and research firms.210 However, it was the $5.1 billion acquisition of the

204 Koenig, R., & Clare, A. 1988. Kodak Seeks New Drug from Its Shelves --- Firms Hired to Test Inventory of Compounds. Wall Street Journal, 1988 Jul 07: 1. 205 1987. Eastman Kodak Company Annual Report. Rochester, NY. 206 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 207 Ansberry, C. 1988a. Dreams Come True for Kodak's Thomas. Wall Street Journal, Jan 26: 1. 208 Ansberry, C. 1987b. Kodak Exit from 8mm Camera Business Reflects Disappointing Sales in Market. Wall Street Journal, 1987 Oct 26: 1. 209 1986. Eastman Kodak Company Annual Report. Rochester, NY. 210 1987. Eastman Kodak Company Annual Report. Rochester, NY.

118 Diversification and Exploration New York-based Sterling Drug Inc. that at first glance promised to give Kodak what it coveted. Sterling and its Lehn & Fink division, then a well-known supplier for household goods, had a number of blockbusters on the market, including Bayer aspirin and Lysol disinfectant;211 moreover, it was experienced in international drug registration and maintained marketing infrastructure that promised Kodak to be able to commercialize its own research findings quickly.212

5.4.5 Aftermath of Change Kodak’s strategic diversification, which was accompanied by an extensive restructuring and acquisition program, was not without drawbacks. While sales climbed to $20 billion compared to some $10 billion a decade earlier, earnings on average remained below the income of the early 1980s. Kodak’s many restructurings and efforts to ease the pain for those who had to leave the company certainly translated into increased costs for retirement and separation benefits, extensions of life insurance and health care coverage, and outplacement counseling services [see Figure 32]. In 1983, costs associated with the Optional Retirement and Separation Program cut earnings before tax by some $200 million;213 the weak financial performance in 1985 reflected the impact of $563 million (or half of Kodak’s total earnings from operations!) spent for the discontinuance of instant photography;214 and the bad result in 1986 was due to charges relating mainly to the company's employment reduction program, which reduced earnings before taxes by some $520 million, primarily because of $434 million spent for the reduction in force program, and $78 million for facilities closures.215 Expenditures of some $875 million in 1989 and $1.6 billion in 1991 depressed pre-tax earnings again.216 Kodak’s quarterly announcement of depressed earnings was observed by Wall Street with concern and the stock price fell [see Figure 32].217

211 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 212 1988b. Eastman Kodak Company Annual Report. Rochester, NY, Ansberry, C. 1988b. Kodak Agrees to Acquire Sterling Drug --- Offer of $5.1 Billion Ends Roche Bid, Would Give Buyer Major Drug Role. Wall Street Journal, 1988 Jan 25: 1. 213 1983a. Eastman Kodak Company Annual Report. Rochester, NY. 214 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 215 1986. Eastman Kodak Company Annual Report. Rochester, NY. 216 1989a. Eastman Kodak Company Annual Report. Rochester, NY, 1991a. Eastman Kodak Company Annual Report. Rochester, NY. 217 See e.g.,1991b. Kodak Is Expecting Information Systems Division to Improve. Wall Street Journal, 1991 Mar 28: 0-PAGE C18, 1992c. Kodak's Imaging Sales for July, August Undermine Hope for Rebound in Sector.

CASE 119

Several factors contributed to the company’s poor performance:

First, its lack of extensive experience in volatile electronic businesses, coupled with the promise of low profit margins in that domain compared to the its experience with the chemical-based film and paper business, encouraged Kodak to focus on its core, traditional photographic business, thus losing valuable time that could have been used to build a competitive position in the new electronic domain. As a consequence, high investments were never paid back and many of the new electronic ventures were shut down or sold.

Second, Kodak’s bureaucratic and centralized management style was not a good match for the culture of newly acquired or established organizational units, and thus constrained any new entrepreneurial spirit; quite often managers had to be changed or had to report negative results.

And, third, the massive acquisition program put great stress on the company’s financial position and thus its flexibility to pursue costly innovation projects or to embrace new initiatives, such as efficiency improvements in the production process or new product development. The actions of Chandler’s successors, Kay Whitmore and especially George Fisher, were greatly affected by this burden.

All three factors will be discussed in detail in now:

Kodak’s trouble with electronic businesses: Since its early days, Kodak’s income had relied on two revenue streams: the photography business, which was launched in 1880, and the chemical business, launched in 1918.218 The latter was at the beginning of World War I, which caused a scarcity of raw materials, and Kodak’s founder, George

Wall Street Journal, 1992 Sep 17: 0-PAGE B4, 1993e. Kodak Has $299 Million 4th-Period Net, Cites Sales of Certain Small Businesses. Wall Street Journal, 1993 Feb 03: 0-PAGE B4, Ansberry, C. 1986b. Kodak Reports Profit Fell 58% for 1st Quarter --- Net Included $77.3 Million Pre-Tax Charge Related to Cost-Cutting Effort. Wall Street Journal, 1986 May 01: 1, Rigdon, J. E. 1991b. Kodak Posts $118 Million Loss in Quarter after $435 Million Restructuring Charge. Wall Street Journal, 1991 Oct 29: 0-PAGE A2, Rigdon, J. E. 1991c. Kodak Reports 4th-Quarter Net of $326 Million --- but Turnaround from '89 Doesn't Satisfy Analysts, Who Cut '91 Estimates. Wall Street Journal, 1991 Feb 07: 0-PAGE A4, Rigdon, J. E. 1992d. Kodak Reports 4th-Period Loss of $400 Million. Wall Street Journal, 1992 Feb 05: 0-PAGE C15. 218 Kodak, "History of Kodak: Milestones- Chronology," http://www.kodak.com/ek/US/en/Our_Company/History_of_Kodak/Milestones_-_chronology/Milestones-_chronology.htm, accessed on April 14, 2013.

120 Diversification and Exploration Eastman, concentrated on securing supplies necessary for his photography business.219 Until 1998, the photographic business accounted for some 80 percent [see Figure 39].

Figure 39 Sources of Revenues

Source: Data adapted from Eastman Kodak Annual Reports

Figure 40 Sources of Earnings


219 Company, E. C., "History," http://www.eastman.com/Company/About_Eastman/History/Pages/Introduction.aspx, accessed on April 17, 2014.

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CASE 121

In the 1970s, Kodak began to generate income by commercializing electronic products that made use of the company’s chemical and optical engineering capability. Electronic products belonged to either commercial information systems, like copiers and publishing stations, or to diversified technologies, such as diagnostic and health instruments. Kodak did not expel financial information on these businesses until 1988, but rather credited sales and earnings to its core business. As of the 1988 and 1989 annual reports, details were disclosed on sales and earnings generated in the health as well as commercial and information systems segments, mirroring the four strategic directions in which Kodak aimed to compete: Photographic (then renamed “Imaging”), Chemicals, Health, and Commercial and Information Systems [see Figure 39 and Figure 40].220

A review of operational figures shows that since Kodak began to disclose sales and earnings of its four strategic businesses, the company relied on only three sources of income: photography, chemicals, and health [see Figure 41]. The commercial and information systems business was not a vital pillar of Kodak’s income. On the contrary, at the beginning of the 1990s, the business impaired the company’s financial position, despite the fact that it received one-fourth of the company’s total allocated R&D funds [see Figure 36].221 During these years, the division developed and marketed, among other things, digital copiers (in a collaborative effort with Canon), document image management systems (computer terminals, scanners), printers (ink-jet, thermal), digital cameras, and the Kodak PhotoCD system – all technologies that are related to the electronic/digital world, as opposed to the company’s traditional chemical-based photography business. Kodak explained its negative earnings in the electronic business on the basis of the heavy costs of restructuring, higher operating costs, higher research and development expenditures, and a weakened capital equipment market in the US [see Table 5].222

220 1988b. Eastman Kodak Company Annual Report. Rochester, NY. 221 Hirsch, J. S. 1990. Kodak Hopes Electronic Imaging Clicks, as Company Faces Fuzzy Photo Future. Wall Street Journal, 1990 Jul 16: 0-PAGE B5. 222 1989a. Eastman Kodak Company Annual Report. Rochester, NY, 1990a. Eastman Kodak Company Annual Report. Rochester, NY, ibid., 1991a. Eastman Kodak Company Annual Report. Rochester, NY, ibid., 1992a. Eastman Kodak Company Annual Report. Rochester, NY, 1993b. Eastman Kodak Company Annual Report. Rochester, NY.

122 Diversification and Exploration

Figure 41 Change of Kodak’s Income Pillars


1989 1990 1991 1992 1993Sales 4.200 4.140 3.968 4.063 3.862 Restructuring costs 417 623 123 278 Earnings (Loss) -360 5 -688 -151 -137

Table 5 Sales and Earnings of Commercial and Information Systems

Dollar amounts in millions. Source: Data adapted from Eastman Kodak Annual Reports

In 1991, Kodak informed Wall Street analysts that it expects its “problem child,” the commercial and information systems division, to achieve 10 percent operating margins in about four years.223 In amateur photography, Kodak generated margins at least five times higher.

Efforts to compete in non-silver-halide film and paper businesses were also burdened by Kodak’s lack of experience in manufacturing electronic consumer products. It always had to rely on other companies, and therefore could not generate lucrative businesses. Product developments of the Kodavision camcorder series in the 1980s and the PhotoCD in the early 1990s illustrate this:

223 1991b. Kodak Is Expecting Information Systems Division to Improve. Wall Street Journal, 1991 Mar 28: 0-PAGE C18.

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CASE 123

Kodak products largely centered on the use of traditional film. The Instamatics and the Disc camera, among other products, aimed at selling more silver-halide film. This was the domain where Kodak had its manufacturing capabilities, recalled Larry Matteson, who, as vice president of Kodak’s Apparatus Division in the early 1980s, was responsible for the company’s 20,000-person organization in charge for R&D and manufacturing of all Kodak's equipment.224 Equipment for taking movies, on the other hand, always encumbered the imaging company. “Movies are fairly complicated compared to taking a snapshot,” according to Matteson. “And some sound movies are more complicated than silent movies, because you’ve got to worry about where the sound’s coming from, and it keeps coming from behind you, and all kinds of goofy things. The last movie camera that we [Kodak] made any serious attempt at doing was in 1976, with the Ektasound movie camera, which was a bust. And we never really made a lot of money on movies.”225

In the early 1980s, when the VHS/Betamax battle was determined and home movies became popular, Kodak had been out of manufacturing movie cameras for almost a decade.226 Nevertheless, available forecasts on industry growth suggested that investments in motion photography were a good idea, because digital still cameras were not a viable alternative from a price and performance standpoint at the time.227 Moreover, the still camera market in the US was completely saturated – in 1981 some 92 percent of all households owned a still camera, compared to some 23 percent who owned a video camera.228 Three years later, one out of three people surveyed was inclined to purchase a video camera – a trend that was actually mirrored in the quadrupling of camcorder sales each year in the mid-1980s.229

When Colby Chandler established the Consumer Electronics Division in 1984 and hired electrical engineers to bring the company into the new era, Kodak was forced to 224 Matteson, L. 2013. Personal Interview. November 20. With M. Shamiyeh. 225 Ibid. 226 For more information on the VHS/Betamax battle see, e.g., Cusumano, M. A., Mylonadis, Y., & Rosenbloom, R. S. 1992. Strategic Maneuvering and Mass-Market Dynamics: The Triumph of Vhs over Beta. Business history review, 66(1) 51-94, Rosenbloom, R. S. 2000. Leadership, Capabilities, and Technological Change: The Transformation of Ncr in the Electronic Era. Strategic Management Journal, 21(10-11) 1083-1103. 227 LaPerle, B. 2013. Personal Interview. November 21. With M. Shamiyeh. 228 1981a. 1981 Consumer Photographic Survey. In P. M. A. International (Ed.): 70. Jackson, Michigan. 229 1985a. 1985 Consumer Photographic Survey. In P. M. A. International (Ed.): 51. Jackson, Michigan, International, M. R. D. o. P. M. A. 1987. Guide to the Photo Market for Mass Merchandisers. In P. M. A. International (Ed.): 140. Jackson, Michigan.

124 Diversification and Exploration rely on partners. It approached the Japanese OEM Matsushita to manufacture an 8-mm compact camcorder with magnetic tapes, to be distributed then under the brand name of Kodak. Matsushita had just won the video recorder battle against Sony, although its VHS system was inferior to Sony’s Betamax. Matsushita had gained extensive market share (and thus market diffusion) by joining forces with other companies in the US and Europe, such as Sears as a distributor and Phillips in the Netherlands. Hence, Matsushita was a perfect partner for Kodak, which was fearful of risking any further product flops.

A year later, the new Kodakvision camcorder was launched under the brand name of Kodak.230 However, the business generated almost no profit margins for Kodak, because the volumes were relatively low and the prices Kodak was being charged by Matsushita fairly high, according to Bob Laperle, who was then head of market planning.231 In considering the alternatives, to either take a billion dollars and develop its own competences in manufacturing or to quit the business altogether, Kodak decided to exit the camcorder business in late 1987.232 Certainly this move reduced its presence and ability to actively engage in consumer electronics, which Kodak’s management considered to be a “defective” business anyway.233

Kodak’s exit from the 8-mm camera business was not entirely unforeseeable. For one thing, the company had not engaged in any initiatives to develop a follow-up model of the compact movie camera; also, in 1984 Kodak quite clearly signaled the public at the Photokina world fair in Cologne, Germany, that it had quietly opted to do things the old-fashioned way.234 Innovative products like the Videk system, which combined optics and electronics to supplement chemical film, then had to make room for products that unmistakably aimed to “extend the lively future of silver halide photography.”235

230 LaPerle, B. 2013. Personal Interview. November 21. With M. Shamiyeh. 231 Ibid. 232 Bob LaPerle recalled that Matsushita offered Kodak to help them develop manufacturing skills in their home country. See ibid. 233 Matteson, L. 2013. Personal Interview. November 20. With M. Shamiyeh, Paxton, K. B. 2013b. Personal Interview (Follow-up). November 19. With M. Shamiyeh, Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. 234 Leavitt, D. 1985. Imaging Materials: Electronic Innovations Made News, but Conventional Photogrpahy Showed Steady, Solid Improvements. Popular Photography(January) 62f. 235 1986. Eastman Kodak Company Annual Report. Rochester, NY.

CASE 125

Kodak’s disinterest in consumer electronics was mirrored in the company’s reorganization of its divisional structure. Kodak’s Consumer Electronics Division, which was founded in 1985, was then renamed the Electronic Photography Division, its manager sent to Latin America, and products still under development, mostly 8 mm-related products, were transferred to the Consumer Products Division, which dealt with general product development related to traditional silver-halide film or photofinishing products, among others.236

It is important to note that Kodak did not stop developing electronic imaging systems completely. They continued exploring the potential of electronic/digital imaging for commercial applications, but developments occurred at “skunkworks” outside the big research labs, and investments remained small.237 For instance, a group of Kodak engineers developed the Still Video System,238 which permitted photographers to view images captured with a digital camera or scanned from a traditional negative film on a TV set, to store them on 3½-inch floppy discs, to transfer pictures electronically via telephone wire to receivers placed in distant locations, to manipulate them on a screen, or to print them on a thermal printer. The system targeted the needs of commercial users such as security dealers.239 One year after its launch, in 1987, the company closed the business. Roughly at the same time, a small group of engineers started to build prototypes of portable digital cameras, at the request of a US government customer. In the wake of Kodak’s development of the world’s first 1.4 million-pixel imaging sensor, the team applied imaging sensors to conventional 35-mm camera bodies.240 The development finally led to Kodak’s line of DCS cameras, which also addressed only the needs of professional users. The high price rendered sales in the consumer market impossible. The program was stopped 17 years later, in 2004, by which time the number of digital cameras sold exceeded that of film cameras.241

236 1987. Eastman Kodak Company Annual Report. Rochester, NY, Ansberry, C. 1987a. Analysts Speculate Kodak Is Considering Leaving 8-Mm Video Camera Market. Wall Street Journal, 1987 Jan 29: 1. 237 McGarvey, J. 2013. Personal Interview. April 10. With M. Shamiyeh. 238 For a detailed account on Kodak’s Still Video System refer to Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. 239 1987. Eastman Kodak Company Annual Report. Rochester, NY. 240 1989c. Journey: 75 Years of Kodak Research. Rochester, NY: Eastman Kodak Company, Gustavson, T., & McGarvey, J. 2013. The First Digital Single-Lens Reflex Cameras. IMAGE(Winter 2012/2013) 5, McGarvey, J. 2004. The Dcs Story: 17 Years of Kodak Professional Digital Camera Systems. 1987-2004, McGarvey, J. 2013. Personal Interview. April 10. With M. Shamiyeh. 241 McGarvey, J. 2004. The Dcs Story: 17 Years of Kodak Professional Digital Camera Systems. 1987-2004.

126 Diversification and Exploration Other electronic product developments for commercial markets included electronic printing, for instance, by employing proprietary LED (light emitting diode) technology, which had never before been used in a high volume; electronic publishing systems (KEEPS); automated document retrieval systems (KAR); and pre-press color proofing systems.242

The PhotoCD system, probably one of Kodak’s biggest electronic product developments under the direction of Chandler and his successor, Kay Whitmore, also failed to take off in the consumer market – Kodak’s most important market.243 Originally considered as a product for millions of US households, the system aimed at establishing a new standard of electronic image quality for television display, transmission, and printing. Images captured on traditional silver-halide film and transferred to a compact disc provided quality superior to even the most advanced electronic still photography systems, while giving both consumers and professionals the convenience of digital storage, display, and manipulation.244 The PhotoCD thus combined the virtues of both the analog and the digital worlds.245 It extended the life of traditional film and thus aimed at protecting Kodak’s core business, while competing with electronic photography. 246 Despite its immediate industry acclaim for its quality, the system was simply too expensive for consumers.247 Kodak charged some $400 for the CD player and some $20 for every roll of film to be stored on the compact disc.248 As a consequence, PhotoCD did not become a profit blockbuster and Kodak had to shift its target group, turning to business users within a year after product launch.249 Throughout the late 1980s and early 1990s, Kodak did not manage 242 1986. Eastman Kodak Company Annual Report. Rochester, NY. 243 Dickson, M. 1993. Focusing on Grander Horizons. Financial Times, Novemeber 1(11), Press, A. 1991. Kodak Bets on Film-Digital Format : Photography: 'Photo Cd' Is Seen as a Bridge from Imaging to Electronics. Los Angeles Times, October 14. 244 1990a. Eastman Kodak Company Annual Report. Rochester, NY. 245 Rigdon, J. E. 1992b. Kodak Focuses on Rolling out Photo Cd. Wall Street Journal, 1992 Aug 24: 0-PAGE C1. 246 “We believe the film business is going to survive much longer than we did before PhotoCD,” said Stephen Stepnes, general manager of Kodak's Worldwide Electronic Imaging Systems; quoted in Press, A. 1991. Kodak Bets on Film-Digital Format : Photography: 'Photo Cd' Is Seen as a Bridge from Imaging to Electronics. Los Angeles Times, October 14. 247 Burgess, J. 1991. Kodak Focuses on the Future - Company Responds to Japanese Electronic Challenge by Developing Cd Technology. The Washington Post, September 15(h.01), Fisher, A. B., & Ehrenfeld, T. 1992. The Big Drive to Reduce Debt with Credit Tight and Bond Ratings in the Tank, Companies Are Pursuing New Strategies to Deleverage. But Good Luck Selling Assets -- Unless an Overseas Buyer Turns Up., Fortune, February 10 ed. 248 Taylor, A. I. 1993. Eastman Kodak Higher Rewards in Lowered Goals, Fortune. 249 Collingwood, H. 1992. Scoping Cd Potential at Kodak. Sepember 06, Rigdon, J. E. 1992c. Kodak Is Aiming Photo Cd Concept at Business Firms. Wall Street Journal, 1992 Aug 25: 0-PAGE B7.

CASE 127

to commercialize any electronic imaging product in the consumer market, its core market.

The second factor that hampered the company’s performance was Kodak’s overbearing management style: Ernst Lieser, engineer and later chief executive officer of Kodak AG Germany, directed attention to several incidents that illuminated Kodak’s overbearing management style.250 The German subsidiary was run to large extent autonomously from Rochester, because it had emanated from the August Nagel camera factory, which had set the origins for the famous 35-mm Kodak Retina. Due to its engineering and manufacturing competence and the success of its cameras, Kodak AG Germany was granted extensive freedom in decision-making, although mangers were asked to attend board meetings in Rochester. Hence, German managers maintained probably the unique position of experiencing the Kodak-Rochester management style from the inside, but as a kind of “outsider.”

Lieser recalled a meeting in which he disagreed with CEO Fallon, which caused immediate turmoil. In Rochester, Lieser said, managers were asked to attend pre-meetings at which the whole session was rehearsed to ensure that the proceedings and final decisions were in line with management’s directives. Likewise, CEOs from Rochester, whether “Mr. Fallon, Mr. Chandler, or Mr. Whitmore,” according to Lieser, never adjusted to foreign cultural norms, which led to numerous gaffes at foreign business meetings, on international marketing tours, and in the organization of fairs abroad. For instance, to promote Kodak shares in Germany, the US headquarters set up a press conference in a (third-class) hotel in Frankfurt, rather than at Deutsche Bank, which was the common procedure, and the company’s local executives were not informed of the fact; in another case, Kodak’s stand at one of Europe’s most important photographic trade fairs, the Photokina in Cologne, Germany, was arranged from a US perspective and therefore received bad reviews.

Similar incidents are known about Kodak’s engagement in Japan. According to a senior manager, the company never adjusted to the Japanese way of doing business,

250 Lieser, E. 2014. Personal Interview (by Telephone). April 4. With M. Shamiyeh.

128 Diversification and Exploration insisting on enforcing its US policies.251 For instance, the company’s Japanese managers were not granted standard benefits such as housing assistance, and imprints on Kodak’s film packaging was written in English until 1985.252

Kodak’s overbearing and autocratic management style also troubled executives in newly acquired subsidiaries. Atex Inc., which commercialized computer-based newspaper publishing systems and was acquired by Kodak in 1981, is an example. Three entrepreneurs had started the business in 1972, literally working in the garage, but it quickly grew to a $50 million business and become the leader in the industry.253 Run as a subsidiary of Kodak, the executives soon grew dissatisfied with Kodak’s management, claiming that it was slow and did not understand the quick pace of the electronic businesses.254 As a consequence, Kodak’s overbearing management style spurred an exodus of a several key people, including the company’s founders.255 The young subsidiary immediately lost its leading position in the industry.

The final and probably most important factor leading to a mixed performance was Kodak’s high indebtedness.

The third and final drawback of Chandler’s urge to diversify the company was the company’s step into the life sciences, which was coupled with the acquisition of Sterling Drug Inc. for $5.1 billion, which definitely affected the Kodak’s future performance.

The purchase of Sterling Drug Inc. fulfilled a long-term Kodak strategy of leveraging its base of some 500,000 chemical compounds into the pharmaceutical industry.256 Kodak had a dozen of chemical formulations in development to treat cancer, cardiovascular illness, and other disorders, but lacked experience in international drug registration and distribution channels. Sterling, on the contrary, had developed a pipeline of important prescription drugs and ran a world-wide portfolio of over-the-

251 Ansberry, C., & Carol, H. 1989. Last Chance: Kodak Chief Is Trying, for the Fourth Time, to Trim Firm's Costs --- Chandler, to Retire in May, Faces Takeover Rumors and Polaroid Settlement --- Boost from New Color Film. Wall Street Journal, 1989 Sep 19: 1. 252 Ibid. 253 Moore, T. 1983. Embattled Kodak Enters the Electronic Age. Fortune(August 22) 120-128. 254 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 255 Ansberry, C. 1987e. Uphill Battle: Eastman Kodak Co. Has Arduous Struggle to Regain Lost Edge --- Beset by Rivals from Japan, Customers' Complaints, It Abandons Its Traditions --- Getting over Disk Disaster. Wall Street Journal, 1987 Apr 02: 1. 256 1988b. Eastman Kodak Company Annual Report. Rochester, NY.

CASE 129

counter drugs. With this structure in place, Kodak’s friendly takeover was intended first and most and foremost to gain access to channels for both, drug registration and distribution.

Kodak intended “to rank among the top twenty pharmaceutical companies worldwide by the year 2000.”257 The pharmaceutical business promised high profit margins and difficult barriers to entry, which was certainly attractive to Kodak, since it was accustomed to those features (and required them to fund its massive cost-structure).258 Perhaps there were also considerations about possible cost savings in R&D that could be result from combined efforts, as Leo Thomas, then Kodak’s general manager of the Life Science division, pointed out;259 however, in the pharmaceutical industry it was well known that Sterling had a rather unimpressive track record in developing pharmaceutical drugs.260

While Kodak was optimistic about finding novel compounds;261 industry analysts remained skeptical, since the company’s main thrust was related to imaging and information storage.262 Analysts and shareholders also expressed concerns about the extensive amount of long-term borrowing required. The $5.1 billion purchase of Sterling Drug Inc. required Kodak to issue a new long-term loan that increased the company’s debentures to about $8 billion, or some $16 billion in total liabilities [see Figure 42 and Figure 43]. Kodak’s long-term borrowing was more than double its shareholders’ equity [see Figure 44].

Throughout Kodak’s history, the company had assiduously avoided debt. At the 1970s, the Kodak’s long-term borrowings had been as low as some $66 million. Kodak’s capital was indebted by some 30 percent, whereas short-term liabilities accounted for

257 ibid., Ansberry, C. 1988b. Kodak Agrees to Acquire Sterling Drug --- Offer of $5.1 Billion Ends Roche Bid, Would Give Buyer Major Drug Role. Wall Street Journal, 1988 Jan 25: 1. 258 See Colby Chandlers note on the pharmaceutical industry: “Health care is the highest-margin business of the future with a high cost of entry.” Quoted in Deutsch, C. H. 1988. Kodak Pays the Price for Change. The New York Times(March 6). 259 Ansberry, C. 1988f. Kodak Predicts Sterling Will Add to Profit by 1990. Wall Street Journal, 1988 Feb 26: 1. 260 Ansberry, C. 1988a. Dreams Come True for Kodak's Thomas. Wall Street Journal, Jan 26: 1, Ansberry, C. 1988b. Kodak Agrees to Acquire Sterling Drug --- Offer of $5.1 Billion Ends Roche Bid, Would Give Buyer Major Drug Role. Wall Street Journal, 1988 Jan 25: 1. 261 Koenig, R., & Clare, A. 1988. Kodak Seeks New Drug from Its Shelves --- Firms Hired to Test Inventory of Compounds. Wall Street Journal, 1988 Jul 07: 1. 262 Ansberry, C. 1988c. Kodak Confirms That It Plans to Retain Sterling's Household-Products Business. Wall Street Journal, 1988 Aug 18: 1.

130 Diversification and Exploration 96 percent of total liabilities; that is to say, Kodak was heavy in cash and lightly indebted.This mindset had changed in the course of many acquisitions and the costs of early retirement plans. Under the direction of CEO Chandler, the company gradually started to rely on long-term borrowings. For instance, in 1982 it issued $275 million debentures for general corporate purposes, including capital expenditures and additions to working capital.263 Four years later, in the face of many investments and retirement programs, the company again increased its debentures by some $647 million. The ratio of long-term borrowing to shareholders’ equity grew to about 85 percent, from 40 percent in 1982, and the company’s total capital became indebted by 6 percent from previously 30 percent. Some even regarded Kodak’s corporate debt as an advantage. Corporate raiders were thought to be after Kodak in the later 1980s and management was worried about the possibility of a hostile takeover. Loading up the company with debt was one way to keep them away.264

Nevertheless, a cash flow analysis of this period shows that with its declining profitability (see Figure 37), Kodak began to rely on its cash or cash equivalents for operations; that is to say, earnings from operations, adjusted by depreciation and other charges, did not provide sufficient funds to pay dividends and to set aside funds for capital additions necessary to support sales, without reducing cash or cash equivalents [see Figure 46]. In 1985, 1986, and 1988, the company was forced to resort to long-term borrowing to be able to pay dividends and provide funds for capital additions, although expenditures for the latter remained average [see Figure 45]. Hence, Kodak began to show signs of little cash momentum – which is a sign for a poor level of diversification – cash that was required to promote new technologies in the electronic/ digital domain.

263 1982a. Eastman Kodak Company Annual Report. Rochester, NY. 264 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh.

CASE 131

Figure 42 Increase in Debentures

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132 Diversification and Exploration Kodak’s $5.1 billion acquisition of Sterling Drug Inc. exacerbated this situation greatly. Whitmore, the newly appointed chief executive officer as of July 1989, considered employment reduction plans as the most suitable means to generate the cash flow required. Kodak estimated that the 1989 restructuring would generate “up to $1 billion in operating cash flow during 1990.”265 In the end, layoffs affected cash flow only marginally; even worse, early retirement benefits again increased the company’s debts and thus interest expenses. In 1992, cash flow was about $146 million compared to some $20 billion in sales! Also the 1993 initiative to cut some 10,000 jobs, or 8 percent of Kodak’s workforce, to increase cash flows by a total of $2.7 billion for the next three years, remained more or less unsuccessful.266

The Sterling Drug Inc. acquisition also added tremendous debt to Kodak’s total capitalization, which became indebted to about 70 percent, while short-term liabilities accounted for only 60 percent. In the early 1980s, Kodak’s indebtedness was some 30 percent, while short-term liabilities accounted for 96 percent. Sterling was paid for entirely from new long-term borrowings, which generated an extraordinary amount of additional leverage on Kodak’s balance sheet and charges for interest. In 1990, Kodak’s interest expenses climbed up to some $900 million per year, from $180 million in 1987, the year before it acquired Sterling. After that, costs for interest payments cut net earnings by about half [see Figure 45].

Sterling’s net income also rendered Kodak’s amortization plan for the acquisition problematic. The drug company barely generated the funds required to pay back debts. Since 1988, Kodak’s and Sterling’s health operations had been united into one business. Assuming that Kodak’s former health business had not grown at all between 1988 and 1992, Sterling generated about $304 million a year on average, which barely covered Kodak’s costs for the interest expenses related to the long-term borrowing, let alone annual amortization of debt itself.267

265 Ansberry, C. 1989b. Kodak Plans to Cut Work Force by About 4,500, and to Sell Units --- Restructuring Is the Fourth since '83, Follows Plunge in Firm's 1st-Half Profit. Wall Street Journal, 1989 Aug 24: 1. 266 Rigdon, J. E. 1993d. Kodak to Cut 8% of Work Force, or 10,000 Jobs --- Move Viewed as First Step as Whitmore Leaves; Spending Cuts Planned. Wall Street Journal, 1993 Aug 19: 0-PAGE A3. 267 This perception receives support by a Wall Street analysis of the early 1990 that estimated Sterling gains of only $29 million a year to pay debts. See Rigdon, J. E. 1992a. Kodak's Changes Produce Plenty of Heat, Little Light --- Extended Series of Restructurings Has Failed to Generate Clear Benefits. Wall Street Journal, 1992 Apr 08: 0-PAGE B4.

CASE 133

Figure 46 Cash Flow From Operating Funds (After Paying Dividends and Setting

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Figure 47 Capital Additions in Relation to Sales Sources all Figures: Dollar amounts in millions. Source: Data adapted from

Eastman Kodak Annual Reports

Analysts expressed serious concerns about Kodak’s weak cash flow and long-term debts, which climbed up to some $8 billion in 1988.268 (A year earlier, Kodak had entered into foreign currency swap agreements that increased its long-term debts by an additional $1.3 billion.)269 For instance, analysts estimated that the company had to pay 22 times the earnings of fiscal year 1988 for Sterling Drug Inc., a company that was not of major interest to Kodak.270 Some 40 percent of Sterling’s earnings came from the pharmaceutical business; the rest came from its household-products operation, sold by the company’s subsidiary Lehn & Fink.271 Other analysts worried about Kodak’s optimism in regard to amortization of the goodwill that occurred in the Sterling acquisition.272 Analysts expected the 40-year amortization of $4.2 billion in

268 Jaffe, T. 1990. Still out of Focus. Forbes, 146(2) 388-389. 269 1987. Eastman Kodak Company Annual Report. Rochester, NY. 270 Ansberry, C. 1988b. Kodak Agrees to Acquire Sterling Drug --- Offer of $5.1 Billion Ends Roche Bid, Would Give Buyer Major Drug Role. Wall Street Journal, 1988 Jan 25: 1. 271 Ibid. 272 Ansberry, C. 1988d. Kodak Enters Credit Accord for $5 Billion --- Pact to Finance Acquisition of Sterling Drug Marks Coup for Bankers Trust. Wall Street Journal, 1988 Feb 08: 1.

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134 Diversification and Exploration Sterling goodwill alone to stress the common share paid by at least 32 cents, or about one third of the shares paid per year.273

As a consequence, rating agencies lowered Kodak’s debt rating (and thereby increased the company’s costs for interest). For instance, shortly after Kodak announced its offer to acquire Sterling Drug Inc., Moody Investors Service Inc. lowered the company’s rating to single-A-2 from double-A-1.274 Kodak’s officials maintained that the anticipated dilution costs were overestimated, arguing that the company would generate savings through consolidation, economies of scale, and selling of assets for appropriate prices.275 Four years later, in 1992, however, Kodak’s level of debts was only marginally altered. The company did not reduce its debts; rather it preferred to use its discretionary cash flow to invest in sales and advertising instead of lowering its debts.276 Faced with a slowdown of sales in Kodak’s traditional photography business, the company increased its investment in sales and advertising continuously by about 1 percent a year [see Figure 48 and Figure 49]. The company allocated money for its cash cow in the hopes of generating growth.277 At the same time it became evident that the hoped-for income generated by Sterling did not take off, and new blockbusters – if any – would require years to come to fruition. Therefore, in the face of a growing concern about Kodak’s debts and its preference for using its available cash, Moody's again lowered Kodak’s debt rating.278 Standard & Poor’s also lowered its rating of the the company’s senior debts.279 S&P believed that it would be difficult for Kodak to improve its cash flow in the face of lower profitability.280 Share prices fell from more than $100 to the unprecedentedly low price of about $40 [see Figure 32].

273 Ansberry, C. 1988c. Kodak Confirms That It Plans to Retain Sterling's Household-Products Business. Wall Street Journal, 1988 Aug 18: 1. 274 1988a. Credit Ratings: Kodak Debt Rating Lowered by Moody's. Wall Street Journal, 1988 Feb 23: 1, Ansberry, C. 1988a. Dreams Come True for Kodak's Thomas. Wall Street Journal, Jan 26: 1, Taylor, P. 1983. Kodak Loos to a Leaner and Meaner Future. Financial Times(Wednesday November 16) 22. 275 Ansberry, C. 1988f. Kodak Predicts Sterling Will Add to Profit by 1990. Wall Street Journal, 1988 Feb 26: 1. 276 1992d. Kodak Debt Ratings Covering $7.6 Billion Are Cut by Moody's. Wall Street Journal, 1992 May 19: 0. 277 Rigdon, J. E. 1992a. Kodak's Changes Produce Plenty of Heat, Little Light --- Extended Series of Restructurings Has Failed to Generate Clear Benefits. Wall Street Journal, 1992 Apr 08: 0-PAGE B4. 278 1992d. Kodak Debt Ratings Covering $7.6 Billion Are Cut by Moody's. Wall Street Journal, 1992 May 19: 0. 279 1993c. Kodak's Debt Ratings Are Lowered by S&P; Unit's Spinoff Is Cited. Wall Street Journal, 1993 Dec 06: 0-PAGE C14. 280 Ibid.

CASE 135

Figure 48 Kodak’s SGA Costs to Net Sales

Figure 49 Increase (Decline) Kodak’s Sales in

Photography

Sources all Figures: Data adapted from Eastman Kodak Company Annual Reports

In its first response to Wall Street’s pressure, Kodak decided to sharpen its focus and to shed all operations that did not add value.281 Hoping to save some $1 billion, the company shut down or sold about 20 businesses,282 including: Floppy-disc manufacturer Verbatim, whose business had been always criticized for generating small profit margins, was sold to the Japanese Mitsubishi Corporation;283 Kodak’s mini-lab equipment business was eliminated precisely when one-hour photo-developing services were capturing some 41 percent of the $5 billion-a-year US photofinishing market, allowing Kodak to focus on selling consumables rather than

281 1989a. Eastman Kodak Company Annual Report. Rochester, NY, Pae, P. 1989c. Kodak to Again Restructure Operations --- Earnings Plunge Spurs Latest Round of Cost Cuts. Wall Street Journal, 1989 Aug 18: 1. 282 1990b. Verbatim Unit to Be Sold to Mitsubishi Kasei Corp. Wall Street Journal, 1990 Mar 22: 0, 1992e. Kodak to Sell 10 Non-Imaging Units, Expand Its Alliance with Canon U.S.A. Wall Street Journal, 1992 Jul 10: 0-PAGE B6. 283 1990b. Verbatim Unit to Be Sold to Mitsubishi Kasei Corp. Wall Street Journal, 1990 Mar 22: 0, Ansberry, C. 1989b. Kodak Plans to Cut Work Force by About 4,500, and to Sell Units --- Restructuring Is the Fourth since '83, Follows Plunge in Firm's 1st-Half Profit. Wall Street Journal, 1989 Aug 24: 1.

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136 Diversification and Exploration equipment; 284 the Ultra-life lithium battery business, which initially promised high growth rates due to Kodak’s breakthrough in designing batteries that were supposed to last 10 years, was shut down;285 the business never took off due to early problems in battery durability. Others businesses Kodak sold included Biolmage Corporation, Sayett Technology, the manufacturer and marketer of Datashow liquid crystal display equipment, Kodak Video Programs, and Aquidneck Data Corporation.286

Then Kodak divested businesses that were creating problems in its commercial and information systems division: Atex, the newspaper-publishing system; Videk, which made digital inspection equipment; Datatape, which made magnetic data-recording equipment; Estek, which developed cleaning and inspection systems for computer chips; and several businesses that supplied imaging systems to the federal government.287

But given Kodak’s continuing lackluster performance and increasing pressure from investors, in 1993, CEO Kay Whitmore decided to shed one of the company’s oldest and most profitable assets: the Kodak Eastman Chemical Company.288 Since his appointment as chief executive officer in 1989, Whitmore had repeatedly promised shareholders to turn Kodak around, but success eluded him. The early leave of the newly appointed chief financial officer, Christopher J. Steffen, rendered the situation worse. Steffen, an industry outsider, enjoyed a good reputation as a restructuring specialist. His abrupt resignation, after just a few weeks in place, due to disagreements with Whitmore, made investors even more edgy.289 Under fire from investors and the board of directors to finally deliver a comprehensive restructuring plan, Whitmore decided to spin off Eastman Chemical.290

Kodak Eastman Chemical contributed 20 percent in earnings to Kodak’s annual income. For better or worse, Whitmore’s demonstration of willingness to manage the company differently did not result in reductions of Kodak’s debts nor did it change the 284 Pae, P. 1989a. Eastman Kodak Plans to Eliminate Minilab Division. Wall Street Journal, 1989 Dec 05: 1. 285 Ansberry, C. 1990. Eastman Kodak Is Pulling Plug on Its Ultralife. Wall Street Journal, 1990 Apr 10: 0-PAGE B1. 286 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 287 1992a. Eastman Kodak Company Annual Report. Rochester, NY, 1992e. Kodak to Sell 10 Non-Imaging Units, Expand Its Alliance with Canon U.S.A. Wall Street Journal, 1992 Jul 10: 0-PAGE B6. 288 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 289 Rigdon, J. E. 1993e. Kodak to Shed Chemical Unit in Restructuring --- Spinoff Is Expected at End of Year, and Chairman Hints at Joint Ventures. Wall Street Journal, 1993 Jun 16: 0-PAGE A3. 290 Ibid.

CASE 137

company’s debt rating; rather as many industry observers had reckoned, it was more or less a “PR response.”291 Kodak shareholders were given the amount of shares in the chemical unit proportional to those they owned in Kodak,292 and Kodak’s assets were reduced by Eastman assets. In setting aside an entity with some 18,500 employees and sales of $3.9 billion, Kodak basically paved the way for the chemical unit to be sold afterwards. After that, Kodak had only two – instead of three – profitable pillars of income: photography and health [see Figure 41].

To conclude, Kodak’s urge to leverage its resources had led to great efforts to diversify the company. Its drive into electronics (commercial and information systems) put a huge burden on the balance sheet. The move into pharmaceuticals did generate additional streams of revenues; however, it did so at the price of massive debts (and thus high interest costs that stressed annual income). Weakening results in the traditional photography business, which Kodak had tried to enhance by pouring its discretionary cash flow into sales and advertising, forced the company to reduce its workforce and to divest several businesses, including its chemical business, which had always been the pillar of Kodak’s income. Moreover, the lack of liquid resources, coupled with the divesture of many businesses related to new technologies, made it difficult to make an effective move into consumer electronic/digital photography.

291 1993g. Why Kodak's Dazzling Spin Off Didn't Bedazzle. BussinessWeek June 27. 292 Rigdon, J. E. 1993e. Kodak to Shed Chemical Unit in Restructuring --- Spinoff Is Expected at End of Year, and Chairman Hints at Joint Ventures. Wall Street Journal, 1993 Jun 16: 0-PAGE A3.

138 Back to Core Business 5.5 Back to Core Business

“Silver halide will be a big business for a long time if we continue to innovate. But everyone in photography must come to terms with digital.

If we don't, there are powerful players who will.”293 Georg M. C. Fisher, Chief Executive, Kodak

And, in a company newsletter he added,

“. . . if this company is going to be healthy, it has to be healthy in the core . . . film business.”294

Georg M. C. Fisher, Chief Executive, Kodak

Kodak’s diversification strategy in the 1980s did not pay off. The company’s income remained equal to or below that of prior years and the stock price fell to a historical low. Moreover, the company’s total liabilities accounted for three fourths of total assets, due to numerous several-billion-dollar acquisitions that rendered any serious pursuit of new initiatives all but impossible. In 1993, after years of frustration, board of directors therefore decided to appoint an outsider, George M. C. Fisher, to manage Kodak. Prior to his new engagement, Fisher successfully transformed Motorola Inc. into the leading pager and cellular manufacturer worldwide. Never before in the company’s history was a manager hired from outside the chemical-based company. The new chief executive redirected the company’s focus on its core business – pictures – while emphasizing a move into the digital world. He divested most of Kodak’s non-imaging businesses, reduced 90 percent of the company’s long-term debts, cut overhead costs to a competitive level, and set the basis for digital imaging businesses. Strategies for growth and product differentiation were aimed at extending the life of the mature silver-halide business until digital imaging could take off and build appropriate sources of income. However, three decisive circumstances thwarted the plan: the fierce competition with Fuji in the US, the slow growth of developing markets, and the continuing losses in digital imaging endeavors. The result: a considerably smaller company with a consolidated balance sheet and an above-average return on equity, but no significant growth in earnings compared to Kodak’s pre-diversification era.

293 Blömer, H. J. 1994b. The Resolution Revolution Kodak Dcs 460; George M. C. Fisher Interview; New Professional Color Negative Films. International Contact, 13(5) September/ October: 36-39. 294 Bounds, W. 1994h. Kodak to Reorganize Imaging Division to Emphasize Electronic Technology. Wall Street Journal, 1994 Feb 24: 0-PAGE A4.

CASE 139

Figure 50 Sales, Earnings, Employees, and Stock Price, Kodak, 1983-2003

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140 Back to Core Business 5.5.1 Management Change Kodak’s 1993 financial position was disastrous. The balance sheet reported a loss (of $1.5 billions), which never happened to the company before.295 The company’s liabilities and overhead costs had grown to a historical high, while profit margin and stock price reached an unrivaled low. Kay Whitmore, Kodak’s chief executive and chairman since 1990, dissipated energies into ever more businesses, while being slow to respond to environmental changes in the core business. Aggressive competition in the US cut Kodak’s profit margins at a time when the photography industry faced stagnation anyway. Stodgy film sales failed to compensate for ever-growing spending. The CEO himself acknowledged that his reluctance to change had fueled the company’s lack of a sense of urgency in these turbulent times: “I regret we didn’t move faster,” he said, and was quick to add, that he was “taken by surprise by the speed with which change has taken place.”296 In a letter to shareholders on August 18, 1993, Mr. Whitmore declared that Kodak is “not in crisis,” but wrote a few lines later that “it is clear we must change more and faster.”297

For a long time, investors had urged management to cut costs and reduce the workforce substantially.298 They contended that Kodak’s continuous restructuring efforts at most amounted to “strategic trimming,” but were not enough to turn Kodak around.299 There was also a lack of trust that Mr. Whitmore was capable of managing the company under new and uncertain environmental conditions. After more than a century of a monopoly position in the US photo film market, Kodak was hurt by fierce competition from rival Fuji and private-label retailers. Furthermore, electronic photography, such as camcorders, started to depress film sales and a sluggish economy

295 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 296 Rigdon, J. E. 1993a. Contrasting Images: The New Finance Chief at Kodak Has a Style Quite Unlike His Boss's --- While Chairman Whitmore Abhors Cutting Workers, Steffen Doesn't Flinch --- Yellow Giant's Little Steps. Wall Street Journal, 1993 Apr 28: 0-PAGE A1. 297 Rigdon, J. E. 1993d. Kodak to Cut 8% of Work Force, or 10,000 Jobs --- Move Viewed as First Step as Whitmore Leaves; Spending Cuts Planned. Wall Street Journal, 1993 Aug 19: 0-PAGE A3. 298 See e.g., Ansberry, C., & Carol, H. 1989. Last Chance: Kodak Chief Is Trying, for the Fourth Time, to Trim Firm's Costs --- Chandler, to Retire in May, Faces Takeover Rumors and Polaroid Settlement --- Boost from New Color Film. Wall Street Journal, 1989 Sep 19: 1, Hirsch, J. S. 1990. Kodak Hopes Electronic Imaging Clicks, as Company Faces Fuzzy Photo Future. Wall Street Journal, 1990 Jul 16: 0-PAGE B5, Rigdon, J. E. 1993a. Contrasting Images: The New Finance Chief at Kodak Has a Style Quite Unlike His Boss's --- While Chairman Whitmore Abhors Cutting Workers, Steffen Doesn't Flinch --- Yellow Giant's Little Steps. Wall Street Journal, 1993 Apr 28: 0-PAGE A1, Rigdon, J. E. 1993c. Kodak Is Said to Plan Layoffs of 2,000 to 4,000. Wall Street Journal, 1993 Jan 08: 0-PAGE A6. 299 Pae, P. 1989c. Kodak to Again Restructure Operations --- Earnings Plunge Spurs Latest Round of Cost Cuts. Wall Street Journal, 1989 Aug 18: 1.

CASE 141

in Europe and Japan cut film sales overseas. As a consequence, Kodak was no longer able to use film sales to offset lagging sales of a stagnating industry. In a board meeting on July 14, 1993, Mr. Whitmore signaled his ineptness by turning to investors for advice on how to deal with particular business problems. Investors were stunned that the person in charge of Kodak turned to outsiders for advice.300 It seemed logical that the board of directors would bow to pressure from investors and start to search for a new manager, after years of frustration.

The new chief executive was expected to be an outsider and a savvy marketer who would be allowed to bring in a new team of senior managers.301 The list of potential candidates to manage Kodak was topped by prominent managers from various industries, including, among others, John Sculley, chairman of Apple Computer Inc.; Goodyear’s chief executive and chairman Stanley Gault, chairman; and former Kodak vice chairman J. Phillip Samper, who was then working as a management consultant.302 In a surprise to people close to the industry, Kodak put Motorola’s chairman George M. C. Fisher at the top of the troubled photo company.303 Fisher, who had been chief executive of Motorola since 1988, had transformed that company into a global cutting-edge communication equipment manufacturer, at a time when the US electronic industry was struggling to compete successfully against Japanese rivals. Evolving from Motorola’s dynamic, fast paced, and flexible culture, Fisher’s capability to combine brilliant assessment of technology with a competent leadership style was lauded throughout the industry.304

5.5.2 New Vision George Fisher’s new vision for Kodak centered on the picture – in particular on the exploration of the five key elements of the imaging chain: “image capture, processing, storage, output, and delivery of images for people and machines anywhere in Kodak’s

300 Rigdon, J. E. 1993b. Kodak's Chief Said to Retire by Year End. Wall Street Journal, 1993 Aug 06: 0-PAGE A3. 301 Rigdon, J. E., & Lublin, J. S. 1993. Kodak Seeks Outsider to Be Chairman, Ceo --- Search for Savvy Marketer, Cost Cutter Follows Dismissal of Whitmore. Wall Street Journal, 1993 Aug 09: 0-PAGE A3. 302 Ibid. 303 Weber, J. 1993. Kodak Puts Motorola's Chairman in the Picture : Executives: The Choice of Fisher as the Troubled Photo Company's New Ceo Comes as a Surprise to Analysts. Los Angeles Times, October 28. 304 Rigdon, J. E., & Hill, G. C. 1993. Kodak Names Motorola Chief to Top Posts. Wall Street Journal, 1993 Oct 28: 0-PAGE A3.

142 Back to Core Business worldwide market.”305 In this sense, he built upon George Eastman’s heritage. The father of modern photography and founder of Kodak had created an entire industry by making it easy for people to take pictures. “Today,” Fisher stated, “Kodak is extending Eastman’s vision to lead a new industry, one based on making it easy for people to use digital technology to make their pictures more useful.”306 And Kodak’s part, Fisher envisioned, would be to generate “the equivalent of the spreadsheet and word processor in the digital-imaging world.”307

Fisher’s vision of the future did not suggest that Kodak’s traditional silver-halide photography business was to be replaced by electronics; rather, he was convinced that traditional film would stay for a while. “Silver halide will be a big business for a long time,” he affirmed, “if we continue to innovate. But everyone in photography must come to terms with digital. If we don’t, there are powerful players who will.”308 “Kodak,” he concluded elsewhere, “always half-heartedly pursued digital imaging – thinking that it would hurt traditional photography.”309 In contrast, digital technologies, according to his credo, rendered it possible to make far greater use of pictures than in traditional chemical photography.310 Pictures in a digital format could be transmitted to remote locations, manipulated, and displayed on a TV or computer screens or printed in hard copy.311 By embracing the digital part of the imaging chain, Fisher intended to enhance picture-taking (and thus traditional photofinishing). “The future is not some hare-brained scheme of the digital Information Highway or something,” he said. “It’s a step-by-step progression of enhancing photography using digital technology.”312 Industry forecasts even supported Fisher’s hold on the traditional silver-halide film business. Analysts estimated sales of digital cameras alone at about $35 million in 1993, compared to Kodak’s total imaging sales of about $7.2 billion in the same

305 1994d. Eastman Kodak Company Annual Report. Rochester, NY, Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 306 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7. 307 1994f. Picture Imperfect. The Economist May 28. 308 Blömer, H. J. 1994b. The Resolution Revolution Kodak Dcs 460; George M. C. Fisher Interview; New Professional Color Negative Films. International Contact, 13(5) September/ October: 36-39. 309 Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0. 310 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7. 311 Holusha, J. 1994a. Company News; Kodak to Consolidate Units to Stress Electronic Growth. The New York Times, March 29. 312 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29.

CASE 143

year.313 In 1997, the figures for sales of digital cameras were expected to grow up to $180 million, including new growth markets such as medical applications or insurance company documentation. 314

Small or home offices and households were still the most important customer segment in the early stage of his digital imaging vision. Kodak estimated that in the US, three fourths of offices and one third of households were using computers or PCs.315 Kodak thought that the installed base of computers and PCs, along with simple equipment and software, would enhance the use of “electronic pictures” – from estate agents and realtors to insurance agents who wanted to document cases of damage, to consumers who would use their PCs to correct, enhance, and make creative changes to their pictures.316 A kind of kiosk system for amateur enthusiasts, like shop-in-shop systems that are propagated in cooperation with retailers, would allow consumers – in his view – to have films developed, enlarged, and put onto PhotoCDs. To think of a region-wide service network of kiosk systems similar to the distribution of ATM terminals was not absurd, given the lack of adequate alternatives to make hard copies of pictures. In the early 1990s, it was clearly understood that electronic photography would be the future, but there were no reasonable methods of producing hard copies in acceptable quality at acceptable costs.317 At the same time, these outlets would offer software for post-processing the pictures on a home computer.318

Thus Fisher’s vision, which certainly was years ahead of its time, was twofold: It foresaw the growth of both the silver-halide and digital parts of the “picture” business; the digital one would become the company’s bright future and the chemical-based one would fund that growth and generate dividends to shareholders as long as possible. The company would push its traditional photography consumer film and paper business, while moving into digital imaging in areas where “Kodak can profitably

313 Bounds, W. 1994c. Fuji Photo, Taking a Cue from Kodak, Plans Digital Imaging Unit in the U.S. Wall Street Journal, 1994 Jul 14: 0. 314 Ibid. 315 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7. 316 Ibid. 317 Blömer, T. 1995d. The Future Lies in Marketing. International Contact, 14(2) March/ April. 318 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7.

144 Back to Core Business compete.”319 This implied that there were substantial growth rates possible in an already maturing photographic film and paper business.

In part, Kodak was confident that it could generate growth by expanding geographically to China, India, Brazil, and Russia.320 Part of this conviction was fueled by the observation that “half the people in the world have yet to take their first picture,” concluding that “the opportunity is huge, and it’s nothing fancy; we just have to sell yellow boxes of film.”321 To expand to China was one of George Fisher’s top priorities. As Motorola’s chairman and chief executive, he had acquired extensive experience in conquering the Chinese market, which then became the world’s largest supplier of mobiles phones. The photography market there was barely tapped. Only one eighth of China’s 1.3 billion people owned a camera at that time, but growth rates of picture taking equaled those of Japan.322 Nations such as Russia, India, and Brazil, where traditional photography was still in its beginning phase, promised dramatic growth rates too.323

Greater product differentiation, especially in the traditional photographic business, was expected to be the other driver for growth.324 The new chief executive expected growth rates between 7 to 9 percent a year over the next decade, while consumption of film in the Western world had slowed from around 10 percent a year to a about 4 percent in the early 1990s.325 A move into bargain film, priced 15 to 20 percent below premium products such as the Kodak Gold film, to make up for the loss of market share to privately branded film labels, was conceivable, as were new product categories in the premium segment, like the company’s Advanced Photographic System (APS) and high-quality Gold Max film.

319 Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 320 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 321 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29, Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16. 322 Smith, C. S. 1996. Photo Frenzy: Kodak, Fuji Face Off in Neutral Territory: China's Vast Market. Wall Street Journal, 1996 May 24: 1. 323 Bounds, W. 1995d. Kodak's Ceo Plans to Avoid Overhaul with More Layoffs. Wall Street Journal, 1995 May 03: 0. 324 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 325 Dickson, M. 1993. Focusing on Grander Horizons. Financial Times, Novemeber 1(11).

CASE 145

5.5.3 Strategic Challenge The move into digital imaging was certainly a bold maneuver, given the big difference between the silver-halide and the digital imaging businesses. The new vision meant that the chemical company Kodak had to find ways to transform at least parts of itself into an electronic company. The chemical silver-halide-based photography industry was mature and slow in growth, with turnaround cycles of several years. Changes in the technology tended to be more evolutionary than revolutionary. By contrast, the electronic industry, which required the conversion of pictures into the language of digital computing, was a fast-paced industry full of start-ups and turnaround cycles measured in months (rather than years). In that industry, existing technologies became obsolete very quickly.326 But profit margins on electronic equipment were thin and opportunities to sell consumables, such as film, with high profit margins were limited. Plus, the fast-paced electronic industry, in particular the nascent digital imaging technology, required a great deal of innovation (and thus investments in R&D) without yet having the promise of viable business models, as Leo J. Thomas, then Kodak’s executive vice president, once observed.327

Kodak had failed to research and buy its way into electronics more than once. For instance, the company acquired Atex in 1981, which developed computer-based newspaper-publishing systems, for $79 million in stock.328 The acquisition promised to arrive at total desktop publishing systems, as they are known today, by merging Atex’s text-editing capabilities with Kodak’s imaging capabilities. Instead, it lost its leading position in the late 1980s. Kodak spent $10 to $20 million a year on the venture and sold the subsidiary for $5 million in 1992.329 Other initiatives, such as Kodak’s entry into the camcorder market, tell a similar story. Of importance here is the fact that Kodak spent as much as $5 billion on to develop digital imaging throughout the 1980s; once it pursued 23 separate digital scanner projects at a time, scattered over several divisions.330 But by the time George Fisher arrived, few projects left the research labs and made it to the market, either because of fear that digital gadgets might cannibalize

326 Partalon III, W. 1994. Betting on Future of Digital Imaging. Democrat Chronicle: 1f. 327 Ibid. 328 1981b. Eastman Kodak Company Annual Report. Rochester, NY, Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192. 329 Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16. 330 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29.

146 Back to Core Business high profit margins from the film and paper business, or because of strategic resource allocations to businesses with superior performance prospects.

Kodak faced another challenge in the electronic domain: It was just one of many competing companies in an emerging industry. Kodak itself counted no fewer than about 600 global companies exploring optical storage technology, which could compete with its PhotoCD.331

At the turn of the 1980s, many companies started to chase after the emerging digital camera market. According to a survey conducted by the editorial team of a journal closely linked to the German based photokina, one of the world leading trade shows for the photographic industry, in 1994 no fewer than 21 digital camera models in differing price and quality categories were on the market, not including systems introduced at the photokina ’94, like the Kodak DCS 460 and the joint development between Fuji and Nikon.332 Two years earlier there were almost no digital cameras available.

The other dilemma Fisher faced was the need for cash to maintain the company’s resource allocation to the digital imaging business he believed to become lucrative. To seriously engage in digital imaging, it was necessary to suck money out of Kodak’s core photography business, which was becoming more and more commoditized and relatively poor in terms of profit margins, and was starting to show signs of stagnation. Hence, the new chief executive had to bet on what most capital providers had given up on – to stem the photography market erosion in the US.

In the US, sales of photography products plateaued, film and paper manufacturers faced fierce price competition, and more and more people turned to video cameras to capture their memories. For instance, in 1992 more than 25 percent of US households decreased picture-taking, according to a Photo Marketing Association consumer survey; and the number of households turning away from photography steadily increased by 7 percent between 1987 and 1992.333 But what was worse, more and more households in the US turned to electronic video camcorders – a business opportunity Kodak had clearly missed, as former CEO Whitmore once admitted with dismay.334

331 Ibid. 332 Blömer, H. J. 1994a. The Photo Sector Puts on a New Face in Cologne. A Digital Photokina? International Contact, 13(5) September/ October: 3. 333 Harrand, B., Lewis, B., Matsumoto, Y., & Fox, T. 1993. 1993 Photo Marketing Association International U.S. Consumer Photographic Survey. In P. M. A. International (Ed.): 158. Jackson, Michigan. 334 ????

CASE 147

Almost every fourth US household that owed photographic equipment owned a camcorder,335 and more than one out of two customers planned to purchase a camcorder rather than a traditional still photo camera.336 Hence, there were clear signs that customers were willing to adapt to electronic photography equipment.

At the same time, fierce price competition continuously eroded Kodak’s market share in the US. Fuji announced that its US film share had soared from 5 to 10 percent, which was noteworthy in the slow-growth market of the early 1990s.337 And privately branded film sellers, such as Polaroid and Kmart, which obtained their film from 3M or Konica, lowered Kodak’s market share from 80 percent to about 70 percent within a decade [see also Figure 66].338 Rivals set their price below Kodak’s; Fuji’s was about 10 percent lower, and retailers of privately branded film set their prices even 20 to 30 percent below Fuji.339 Kodak was facing the dilemma that it was not able to reduce its prices much because of the company’s excessive cost structure. Fisher was therefore asked to refocus and streamline the company’s massive overhead costs.

In May 1994, a turnaround plan was laid out, comprising essentially three strategic actions that were pursued basically in parallel.340 First, management enforced actions aiming at consolidation of the sluggish photographic business. Second, the company’s efforts in electronic-digital imaging were quickly set apart from its traditional chemical-based silver-halide business, and new capabilities were built and acquired by joining with other companies. Finally, Kodak steered for overall growth by product differentiation in the traditional businesses and geographical expansion in the developing world.

5.5.4 Improving Efficiency Kodak’s strategic actions to consolidate its core business and to return to a viable financial position essentially meant the liquidation of most of the company’s long-term

335 Harrand, B., Lewis, B., Matsumoto, Y., & Fox, T. 1993. 1993 Photo Marketing Association International U.S. Consumer Photographic Survey. In P. M. A. International (Ed.): 158. Jackson, Michigan. 336 Bounds, W. 1994j. Photography Companies Try to Click with Children. Wall Street Journal, 1994 Jan 31: 0-PAGE B1. 337 Bounds, W. 1994b. Focus on Photography. Wall Street Journal, 1994 Jun 10: 0-PAGE B1. 338 Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 339 Ibid. 340 1994d. Eastman Kodak Company Annual Report. Rochester, NY.

148 Back to Core Business debts, including the divesture of the most of Kodak’s non-imaging businesses, and the reduction of costs through process redesign.

5.5.4.1 Divestures

George Fisher’s envisioned “total commitment to imaging” (and thus an expansion into electronics) required significant cash flows which the company was lacking.341 Since the late 1980s, the company had shown signs of little cash momentum and was forced to resort to long-term borrowing to be able to pay dividends and provide funds for capital additions, although expenditures for the latter remained average [see Figure 51] “We [at Kodak] were passing up too many opportunities to make small investments because we were so strapped for cash,” he acknowledged. “If we attempted to retain both health and imaging, we would have short-changed both.”342 The former generation of Kodak managers had always weighed the high-margin film business against all other kinds of opportunities, including consumer electronic photography. When several attempts had proven predictably fruitless, the company made the decision to diversify into a potentially profitable pharmaceutical business. The $5.1 billion acquisition of Sterling Drug Inc. in 1988 burdened Kodak’s financial position significantly. At the end of 1993, long-term borrowings of the company stood at about $7 billion and debt to equity was up to 70 percent [see Figure 53].343 Between 1988 and 1993, the company paid 40 percent of its earnings from operations for interest expenses [see Figure 52]. Kodak’s core photography business generated a lot of the cash that was used to pay interest expenses, rather than funding new product development or business initiatives. “We,” Fisher said, “were going to milk the imaging business to death.”344 One of the first priorities, therefore, was to shed non-imaging businesses and to reduce the company’s debt load.345

Earlier, in need for cash to relieve its financial pressure, the imaging giant had turned to its profitable business units. In 1993, it spun off its chemical unit, Eastman

341 Bounds, W., & Moore, S. D. 1994. Kodak to Sell Sterling Winthrop Drug and Two Other Units to Focus on Film. Wall Street Journal, 1994 May 04: 0-PAGE A3. 342 Ibid. 343 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 344 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29. 345 Pulliam, S., & Bounds, W. 1994. Heard on the Street: Investors Are Betting That Kodak Will Shed Drug Line. Wall Street Journal, 1994 May 03: 0-PAGE C1.

CASE 149

Chemicals, along with other non-imaging businesses.346 To gain independence, Kodak burdened its former unit with a $1.8 billion long-term debt, based on the division’s 20 percentage portion of the company’s total sales.347

Figure 51 Cash Flow from Operating Funds (After Paying Dividends and Setting

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Figure 52 Earnings from Operations and Interest

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Dollar amounts in millions. Sources for all Figures: Data adapted from Eastman Kodak Annual Reports

Five months after taking over as Kodak’s CEO, Fisher showed that he was willing to go for even more dramatic measures, by announcing the divesture of Kodak’s non-imaging units, including Sterling Winthrop Inc., which made pharmaceuticals and over-the-counter drugs; L&F Products, which made Lysol and other home and personal-care goods; and Kodak’s Clinical Diagnostics Division, which produced medical testing devices.348 Other medical imaging businesses, such as related to X-ray

346 1993b. Eastman Kodak Company Annual Report. Rochester, NY, Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04, Rigdon, J. E. 1993e. Kodak to Shed Chemical Unit in Restructuring --- Spinoff Is Expected at End of Year, and Chairman Hints at Joint Ventures. Wall Street Journal, 1993 Jun 16: 0-PAGE A3. 347 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 348 Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04.

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Fisher’s first move was to hire Harry Kavetas, who directed IBM’s credit division, to become Kodak’s new chief financial officer.352 By refinancing existing loans, he cut Kodak’s debts by $1 billion right away. By the end of 1994, Kodak had completed the sale of all three businesses, for aggregate gross proceeds of $7.8 billion.353

The pharmaceutical operations of Kodak’s Sterling Whintrop Inc. were sold to Elf Sanofi SA for $1.68 billion in cash.354 Kodak was engaged with the French company in several joint programs, and therefore it was given priority in buying the pharmaceutical part of Sterling Whintrop Inc.355 The other portion of Sterling Whintrop’s pharmaceutical business, the company's over-the-counter medicine business, was acquired by Smith Kline Beecham PLC for $2.93 billion.356

Kodak’s L&F Products business was also sold in two pieces.357 Reckitt & Colman PLC purchased the household-product business, including the popular Lysol brand, for $1.55 billion.358 The investment firm Forstmann Little & Co. acquired the rest of L&F Products for $700 million, which comprised the paints, stains, and sealants lines.359

349 Maremont, M. 1994. The New Flash at Kodak. BusinessWeek May 15. 350 Bounds, W. 1994a. Eastman Kodak Says Net Fell 29% in Second Quarter. Wall Street Journal, 1994 Jul 27: 0-A4. 351 1993b. Eastman Kodak Company Annual Report. Rochester, NY, 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 352 Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16. 353 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 354 Bounds, W., & Stern, G. 1994. Kodak to Sell Pharmaceutical Business to Sanofi of France for $1.68 Billion. Wall Street Journal, 1994 Jun 24: 0. 355 Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 356 1994a. Business Brief -- Eastman Kodak Co.: Company Completes Sale of Health-Products Unit. Wall Street Journal, 1994 Nov 03: 0-B7. 357 Bounds, W. 1994f. Kodak Is Trying to Sell L&F in Two Pieces --- Failure to Receive $2 Billion Sought for Entire Unit Is Said to Drive Decision. Wall Street Journal, 1994 Aug 11: 0-A3. 358 1995c. Eastman Kodak Sells Part of L&F Products to Reckitt & Colman. Wall Street Journal, 1995 Jan 04: 0, Milbank, D., & Bounds, W. 1994. Reckitt to Buy Kodak Business for $1.55 Billion --- U.K. Firm Outbids Rivals in the U.S. That Sought L&F Household Line. Wall Street Journal, 1994 Sep 27: 0-A3. 359 Welch, J. 1994. Forstmann to Buy Part of Kodak's L&F --- Investment Firm Would Pay $700 Million for Paints, Stains, Sealants Lines. Wall Street Journal, 1994 Oct 17: 0-A4.

CASE 151

The sale of Kodak’s clinical diagnostic business completed George Fisher’s first major divesture program. Johnson & Johnson acquired the unit for $1.01 billion.360 Kodak’s unit generated $535 million in sales; together with Johnson & Johnson’s existing diagnostic operations of an estimated $822 million, the new owner became one of the top players in the medical-testing industry.361

Figure 53 Total Long-Term Borrowings

Figure 54 Cash Flows and Long-Term Debts

Dollar amounts in millions.

Sources for all Figures: Data adapted from Eastman Kodak Annual Reports

Kodak’s divesture of Sterling Winthrop Inc., including L&F Products and the company’s unit for Clinical Diagnostics, generated proceeds of $7.9 billion. The company used the cash to extinguish $6.6 billion of their long-term borrowings [see Figure 53 and Figure 54].362 Fisher’s back-to-core-business strategy, which basically reversed previous diversification efforts, paid off – at least for the time being; he basically freed the company of its long-term borrowings, cut annual interest charges by 80 percent, and freed the company’s cash flows. In 1994, cash flow was over $750

360 Hwang, S. L. 1994. J&J to Acquire Unit of Kodak for $1.01 Billion --- Clinical Testing Purchase Furthers Diversification by Big Drug Company. Wall Street Journal, 1994 Sep 07: 0-A3. 361 Ibid. 362 1994d. Eastman Kodak Company Annual Report. Rochester, NY.

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152 Back to Core Business million, and it was over $1 billion in 1995.363 Cash and cash equivalents increased to $2 billion at year-end 1994 from $1.6 billion at the end of 1993.364 Wall Street applauded Kodak for the decisive reduction of its debts and paid tribute to George Fisher.365

5.5.4.2 Cost-cutting

Kodak maintained an extensive cost structure. Manufacturing expenses were equal to those of Fuji, according to Fisher, but overhead was certainly well above the industry standard.366 A Kodak employee generated $144,000 in sales per year, compared to the $385,000 a Fuji employee produced [see Figure 55].367 In 1994, sales, advertising, distribution, and administration diminished Kodak’s total revenues by 30 percent, while a benchmarked best practice showed 22 percent [see Figure 57].368

Figure 55 Sales per Employee

Dollar amounts in thousands. Source: Data adapted from Eastman Kodak Annual Reports

363 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 364 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 365 Bounds, W. 1994i. Management: Kodak under Fisher: Upheaval in Slow Motion. Wall Street Journal, 1994 Dec 22: 0. 366 Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 367 1993b. Eastman Kodak Company Annual Report. Rochester, NY, Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 368 1993b. Eastman Kodak Company Annual Report. Rochester, NY, Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83.

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CASE 153

Figure 56 Operating Return on Assets and

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154 Back to Core Business Kodak’s prosperous years in the 1970s, as well as its diversification efforts, had clearly left marks on the company’s performance. The gross profit margin, increased to 51 percent in 1993 from 38 percent a decade earlier, when Colby Chandler started to diversify operations [see Figure 57]. During the years when the company concentrated almost exclusively on its photography business, operating returns on assets were less than 20 percent. After Kodak’s diversification efforts, in the early 1990s the ratio dropped to 4 percent on average [see Figure 56]. Properties at cost, the company’s resource commitments in assets that maintain value for longer than one year and which cannot be undone quickly, such as land, plants, and equipment, had grown to a historical maximum of $20 billion [see Figure 56]. When Kodak focused exclusively on photography R&D, expenditures per sale averaged 6 percent. During the years of diversification, the company increased its investments in research and development twice. In the mid-1980s, when Kodak tried to move into consumer electronics, the company increased its R&D funds by 3 percent; in the early 1990s, a focus on health and hybrid technologies led to an additional increase of 2 percent. In the decade before George Fisher took over, the company spent an additional budget of as much as $3 billion on R&D (without achieving sustained success) [see Figure 58]. Only capital additions remained essentially flat relative to sales [see Figure 59].

Fisher recognized the need for trimming corporate fat; however, he was circumspect about radical and quick cuts in costs, ignoring in the first instance Wall Street’s pleas for extensive workforce reduction.369 In 1994, the massive layoff of about 10,000 employees, which reduced the company’s global workforce to below 90,000 – an initiative which was launched by his predecessor, Kay Whitmore – was still in progress and he simply did not wanted to risk discouraging employees in the process of the forthcoming move into Kodak’s “total imaging” future. He preferred to chart the riskier path of focusing on growth, expanding the company’s operations in foreign markets and digital products.370 “Rather than simply take an ax to budgets and

369 Bounds, W. 1995e. Kodak Expects Its Unit Volume to Grow 7% to 9%. Wall Street Journal, 1995 Feb 16: 0-A2, Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 370 Bounds, W. 1995b. George Fisher Pushes Kodak into Digital Era. Wall Street Journal, 1995 Jun 09: 0.

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manpower,” Fisher said, “we are trying to change, in significant ways, how this company operates.” 371

In a private conversation with analysts, he conceded that the company’s manufacturing cycle times and the defect rate of products were too high.372 Elsewhere he noted that “decisions are too slow; people don’t take risks.” 373 Chief Financial Officer Harry Kavetas, who joined several teams that Fisher pulled together to explore cost-savings issues such as manufacturing cycle-time improvement and R&D productivity, identified a potential for major savings in Kodak’s sales, marketing, and administrative staff, and in high expenses of several unneeded properties.374 But Kodak’s innovation process, from developing products to bringing them to market, was “a confused process, at best.” 375

Fisher approached these problems with the aim of enhancing the company’s operative performance rather than cutting jobs. He initiated an internal communication campaign, announcing that the company would center around five core values: “integrity, trust, credibility, continuous improvement and respect for the individual.”376 “We will work intensely to reduce operating costs and enhance asset utilization rates,” he said, “improve cycle time and defect reduction, and invest in operations aimed at driving revenue growth as we go forward.”377 Hence, in the first instance his focus relied on basics, hoping to shrink costs and to produce a dynamic culture. The communicated goal was to at least double return on net assets during his leadership.378

5.5.4.3 Compensation

In Kodak’s annual planning process, Fisher and his team tried hard to teach their managers to come up with realistic financial forecasts, because managers generally failed to meet their targets without suffering consequences.379 Kodak’s ingrained

371 Blömer, H. J. 1995b. Kodak Bares Its Soul to Wall Street. International Contact, 14(3) May/ June: 8, Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 372 Bounds, W. 1995d. Kodak's Ceo Plans to Avoid Overhaul with More Layoffs. Wall Street Journal, 1995 May 03: 0. 373 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29. 374 1994f. Picture Imperfect. The Economist May 28. 375 Ibid. 376 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 377 O'Neill, J. 1995c. U.S. Industry News. International Contact, 14(2) March/April: 12-20. 378 Maremont, M. 1994. The New Flash at Kodak. BusinessWeek May 15. 379 Brenner, B. S. 2013. Personal Interview. November 20. With M. Shamiyeh.

156 Back to Core Business culture of venerated authorities, which led to a diffusion of responsibility, was identified as the main culprit.380

The company followed two phases in its strategic planning process: the long-term, which encompassed the current year plus at least three years (the Strategic Quantification Process [SQP]); and the annual strategy review process, which was actually an operating plan which had to take place later in the year.381 The latter basically determined what the company’s quarterly resource commitments were and the information the CEO was giving to Wall Street in regard to of how the unit was going to make required changes or was pursuing its trajectory. Moreover, it also determined a manager’s bonus. Fisher and his corporate staff quickly realized that “the quantification couldn’t be trusted” and concluded that hard work was required to assist (and strictly control) managers in the annual planning process.382 But Fisher was also adamant that he would hold idlers responsible for missed targets and set up a new management compensation plan that increased management accountability: top level managers were required to own a substantial amount of company stocks and wages of executives were linked closely to the financial performance of Kodak.383

Previously Kodak had paid a “wage dividend” directly linked to the company’s performance during the year, but which was independent of the particular employee’s performance.384 Fisher changed this compensation program by tying it more directly to the unit’s and individual’s (not just the company’s) performance. The new compensation plan calculated 50 percent of the bonus based on shareholder satisfaction, including growth in sales and earnings, as well as improved cash flow and return on net assets; an additional 30 percent of the bonus would be based on growth of market-share, better customer satisfaction, fewer product defects, and increased speed in bringing products to market; the remaining 20 percent would be granted to managers for promoting diversity in Kodak’s personnel and for decreasing health, safety, and environmental violations.385 Moreover, top managers were required to take

380 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29. 381 Brenner, B. S. 2013. Personal Interview. November 20. With M. Shamiyeh. 382 Ibid. 383 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 384 Grant, L. 1997a. Can Fisher Focus Kodak? Maybe, but Ceo George Fisher Faces What One Expert Calls "a Howlingly, Horrifically Difficult Challenge.". Fortune January 13, Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 385 1995b. Eastman Kodak Company Annual Report. Rochester, NY, Bounds, W. 1995c. Kodak's Ceo Got $1.7 Million Bonus in 1994 Despite Below-Target Profit. Wall Street Journal, 1995 Mar 13: 0.

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bonuses in the form of stock options.386 The new compensation plan certainly was not very popular – “a lot of people assumed we had a treacherous motive,” Fisher said.387 For him the plan was natural, required by any company intending to drive permanent improvements by awarding a bonus that depended on an employee’s performance.388

5.5.4.4 Culture

A tough task Fisher set out to deal with was the need for changing Kodak’s film-centric and bureaucratic culture, which he believed to be a hindrance to challenging the fast-paced digital world. To push Kodak into a high-tech-firm and to prepare it to compete with Microsoft and the like, he needed to wring resistance to change out of the employees. Given Kodak’s past complacent behavior, this was not an easy endeavor. “My biggest job over the next two years,” he said, “is not how we develop the market, not even how we gain growth; it is how we get people to start thinking of systemic, rather than incremental, change.”389 He broke with Kodak’s tradition of promoting people from within, and turned to Silicon Valley to hire executives familiar with the digital world.

5.5.5 Building Capabilities Besides his efforts to consolidate Kodak’s core business, Fisher started to tackle a long-standing internal problem which he considered responsible for many mistakes: the company’s reluctance to fully engage with electronic photography, or digital imaging as it was called then. In his effort to generate growth in digital imaging, he resolved Kodak’s internal struggle with the new technology by separating the management structure and forming a new digital division.390 New managers closely related to the digital world were hired to run that independently operating unit, and partnerships with industry leaders were created to acquire capabilities where required.

386 Grant, L. 1997a. Can Fisher Focus Kodak? Maybe, but Ceo George Fisher Faces What One Expert Calls "a Howlingly, Horrifically Difficult Challenge.". Fortune January 13. 387 Ibid. 388 Bounds, W. 1995c. Kodak's Ceo Got $1.7 Million Bonus in 1994 Despite Below-Target Profit. Wall Street Journal, 1995 Mar 13: 0. 389 Grant, L. 1997a. Can Fisher Focus Kodak? Maybe, but Ceo George Fisher Faces What One Expert Calls "a Howlingly, Horrifically Difficult Challenge.". Fortune January 13. 390 1995b. Eastman Kodak Company Annual Report. Rochester, NY.

158 Back to Core Business 5.5.5.1 Restructuring

One of Fisher’s first actions after he was appointed Kodak’s new chairman, president, and chief executive was to reorganize the company’s core photography business to emphasize digital technologies.391 Driven by the strong “belief this [technology] can be a very good business for Kodak,” the new Digital and Applied Imaging business unit was established.392 The new unit aimed at putting an emphasis on the new electronic technology separately (and thus independently) from the company’s traditional photographic film and paper business. Technologies such as Kodak’s PhotoCD, software for the digital manipulation of pictures, and filmless digital cameras were allocated to this unit.393 However, the new unit did not exclusively develop or sell all of Kodak’s digital products. For instance, the Consumer Imaging division, which sold film to consumers, also sold photo kiosks to retailers and in the early days even sold consumer digital cameras. The Professional Photography division, which sold film to professional photographers, sold Kodak D-SLR cameras, digital printers, and digital imaging software.394

There were two prime reasons for the split of Kodak’s photographic division. First, there was a clear perception of the dull feeling of unease towards the new technology that permeated the company. Kodak’s past in the late 1980s and 1990s had proven that there was no way, without having an independent business group tied to the new technology, that Kodak’s digital imagining was going to survive. But either there was no permission given to pursue projects related to purely digital imaging, or if permission was given, it was not likely that these projects survived.395 “We need to separate the two,” Fisher explained to Wall Street analysts, because “there’s been too much fear that the new technology would kill the old business.”396 The other reason was related to the difference in culture, speed of product cycles, and the nature of businesses the electronic industry embraced, as compared to the traditional photography industry. In order to compete successfully in the electronic industry, 391 Holusha, J. 1994a. Company News; Kodak to Consolidate Units to Stress Electronic Growth. The New York Times, March 29. 392 Dickson, M. 1994. Kodak Launches Unit for Electronic Imaging. Financial Times, April 5(19), Partalon III, W. 1994. Betting on Future of Digital Imaging. Democrat Chronicle: 1f. 393 Bounds, W. 1994h. Kodak to Reorganize Imaging Division to Emphasize Electronic Technology. Wall Street Journal, 1994 Feb 24: 0-PAGE A4. 394 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 395 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 396 1994c. Eastman Kodak Co.: Computer Industry Partners Sought for Digital Imaging. Wall Street Journal, 1994 Mar 16: 0-PAGE A4.

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Kodak was required to relax its traditional grip on consumables and focus on large royalties, and to cultivate a staff that was willing to commercialize hardware – a challenge Kodak never really felt comfortable with. “This has been difficult for us in the past,” confirmed Jack Thomas, who was initially appointed to oversee both the traditional and digital imaging units. “That’s one reason we are forming this unit – to put a team including marketers into place to function by the rules of the electronic industry we are moving into.”397 Moreover, as Fisher noted, there was a need for people from the outside who understood digital technology from a business standpoint, and not merely from a technology standpoint, which Kodak already had.398

In the early days, the newly founded unit centered primarily on image capture and photography software, leaving aside other parts of the total imaging chain, such as output devices.399 In 1995, a year after Digital and Applied Imaging was established, it was split into five sub-units, aiming to align more appropriately with the various functions and customers of the full imaging chain.400 After that, cameras were allocated to the capture unit, while products such as PhotoCD and printers were transferred to the output unit. Previously, Kodak’s digital products had been scattered throughout the company, without maintaining logical connections. For instance, digital cameras and the sensors used in them were handled in different divisions. Likewise, developments on scanners and digital cameras that both were sold to similar customers and related to the same link in the imaging chain – picture capture – were pursued in different locations within the company. A study by Barry Mazer, editor of Advanced

Imaging magazine, showed that Kodak had 46 separate product lines using electronic imaging, ranging from scanners to document management system.401 The reorganization was intended to reflect customer demand.

In the course of Kodak’s reorganization of its core imaging division, Fisher also changed the structure of its Professional & Printing Imaging Division to become fully versed in the transition to digital imaging.402 The division provided film, paper,

397 Bounds, W. 1994g. Kodak to Ask Computer Firms for Alliances --- Revamp Plan Will Separate Company's Film Line, Electronic Technology. Wall Street Journal, 1994 Mar 29: 0-PAGE A3. 398 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 399 Bounds, W. 1995g. Kodak Reorganizes Its Sales Force at Imaging Group. Wall Street Journal, 1995 Jan 24: 0, Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 400 McCoy, C. 1995. Eastman Kodak to Reorganize Digital Imaging. Wall Street Journal, 1995 May 05: 0. 401 Partalon III, W. 1994. Betting on Future of Digital Imaging. Democrat Chronicle: 1f. 402 Nelson, E. 1996c. Kodak Remakes Its Professional Imaging Unit. Wall Street Journal, 1996 Sep 11: 9.

160 Back to Core Business equipment, and services to professional photographers. Here too, the aim was to better serve customers. Previously arrayed geographically, Kodak’s sales personnel who were related to professional photography had to serve customers with radically different needs, from portrait and wedding photography, to photojournalism and graphic arts. The result was an increase in customer complaints about poor service.403 In response, Fisher split the sales force into groups serving specific types of consumers with particular demands, rather than based on geographical location.404

5.5.5.2 Management

Kodak’s managers historically had a strong background in the traditional photographic film and paper business. Fisher was the first outsider to be brought in to change the company’s fate in a digital world. He understood clearly that he would need to look outside the company for a few key leaders to take charge of the digital side of the company.

After a transitional phase in which Richard Bourns, Kodak’s former director of imaging manufacturing and supply, directed the Digital and Applied Imaging unit, the 43-year-young outsider Carl Gustin was hired to take the lead.405 Gustin had a marketing background and was put in charge to commercialize high-tech products – a capability in which Kodak had a poor record, for obvious reasons.406 John Sculley, former chairmen of Apple Computer Inc., was hired as a marketing adviser.407 Harry Kavetas, who directed IBM’s credit division, became Kodak’s new chief financial officer.408

In the aftermath of Fisher’s first moves to bring Kodak back to its core photography business, he was relieved of some of its centralized power as chairman, president, and chief executive by creating a second-in-command position. In 1995, Daniel Carp and Carl Kohrt were promoted to position of an executive vice president; Carp was also named assistant chief operating officer. A year later, in 1996, Carp was appointed 403 Bounds, W. 1995f. Kodak Plans to Reorganize No. 2 Division --- Professional & Printing Unit Is Target; Complaints of Clients to Play Role. Wall Street Journal, 1995 Jan 17: 0-A4. 404 Bounds, W. 1995g. Kodak Reorganizes Its Sales Force at Imaging Group. Wall Street Journal, 1995 Jan 24: 0. 405 1994b. Eastman Kodak Co. Details New Structure of Imaging Business. Wall Street Journal, 1994 May 17: 0-PAGE B2. 406 Bounds, W. 1994e. Kodak Hires Gustin to Lead Digital Imaging. Wall Street Journal, 1994 Aug 10: 0-B8. 407 Bounds, W. 1994d. Kodak Confirms Scully Will Be Adviser to Firm. Wall Street Journal, 1994 Jun 27: 0. 408 Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16.

CASE 161

president under pressure from the board; this was widely regarded as a signal that Carp was going to become the next CEO.409 Carp, who until then had overseen the consumer and professional photography business and health, was then also put in charge of Digital and Applied Imaging among other units and Kodak’s Chineese market – units that previously had reported directly to Fisher.410 This latter change is noteworthy, because it put a veteran of Kodak’s traditional photography business on top of the company’s digital endeavors.

5.5.5.3 Alliances

Breaking with Kodak’s legendary insularity and unwillingness to form partnerships, Fisher immediately started to work actively with other companies, especially in the computer industry, to form strategic alliances that promised a long-term impact on the availability of imaging solutions for customers.411 The imaging giant was always reluctant to forge such strategic alliances with companies in the electronic world, precisely because it always aimed at having its propriety technology adopted as an industry standard. Fisher felt confident that the opposite holds true in the electronic world: “We used to try to do it by ourselves,” he said, but “we’ve learned very quickly that in this digital world, the opportunities are just too massive for any one company to do it on its own.”412 He was equally explicit about his intention that there wouldn’t be “one master partner” and that constructive collaboration with companies in the electronic world would require the opening of previously restricted standards, such as the imaging compression standard of the PhotoCD.413

Fisher, however, faced a dilemma. In order to push the potentially lucrative digital imaging business, which in the early 1990s was still in its fledgling stage, he required cash that couldn’t be endlessly sucked out of the photographic business. Photographic film and paper, the company’s high-margin business, had become increasingly a

409 1995b. Eastman Kodak Company Annual Report. Rochester, NY, Nelson, E. 1996b. Kodak's Carp Is Widely Seen as Next Ceo. Wall Street Journal, 1996 Dec 06: 0-B, 1:6. 410 Nelson, E. 1996b. Kodak's Carp Is Widely Seen as Next Ceo. Wall Street Journal, 1996 Dec 06: 0-B, 1:6. 411 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 412 Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0. 413 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7, Bounds, W. 1994g. Kodak to Ask Computer Firms for Alliances --- Revamp Plan Will Separate Company's Film Line, Electronic Technology. Wall Street Journal, 1994 Mar 29: 0-PAGE A3.

162 Back to Core Business commodity (and thus less profitable), and photography was starting to show signs of stagnation, requiring larger and larger advertising and marketing budgets. The decision to depend more on strategic alliances – as the company had done even in its silver-halide business, when it began to cooperate with Fuji and other Japanese firms (Nikon, Canon, and Minolta) to develop and promote collaboratively the new Advanced

Photographic System – made a virtue out of necessity.

Fisher confirmed that in the early 1990s, Kodak had also needed to work with others, because the company “did not have all of the digital technologies or capabilities that we needed.” There was no lack of technical knowledge, but there was a considerable lack of competence in manufacturing, marketing, and business model issues.414 To accept this circumstance was very hard in those days, because “Kodak was king.” Fisher explained, “It made so much money on film; therefore, it was hard to get us to talk to other people with a feeling that we needed them.”415

In 1995, Kodak was working with Sprint Corp., IBM, Hewlett Packard, and Microsoft, among many others, to develop a new file compression format for images that would make it possible for users on virtually all platforms to work more easily with pictures in documents and stand-alone applications.416 In particular, Kodak teamed up with Sprint Corp. to develop a process allowing customers to store and distribute pictures over telephone lines; the collaboration with IBM promised to boost capabilities in the domain of networks and data management in the transfer of pictures and documents over the World Wide Web; and the collaboration with Hewlett-Packard Co. aimed at strengthening the capabilities of both parties in printing pictures with inkjet printers.417 To offer faster and more convenient ways to send pictures via computers, Kodak formed a pact with Microsoft, which led to the use of Kodak’s color management in the Windows OS.418

The imaging giant also formed partnerships with start-ups in the industry. For instance, the company made an equity investment in a California-based software concern, Live

414 Faulkner, T. 2013a. Personal Interview. November 04. With M. Shamiyeh. 415 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 416 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 417 Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0. 418 Bounds, W. 1996h. Kodak, in Pact with Microsoft, to Offer Faster Way to Send Images by Computer. Wall Street Journal, 1996 May 29: 1, Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29.

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Picture Inc., which was headed by Apple’s former chairman John Scully. The company developed software that allowed people to edit digital pictures easily on computers with inferior performance.419 A year later, in 1997, Picture Network International Ltd. was acquired, to boost Kodak’s capability to provide services for managing the content of pictures across networks.420

5.5.6 Initiating Growth Fisher believed that the continuation of permanent workforce-reduction programs only led to short-term results and further demoralization of the company’s employees. Instead, he regarded growth in Kodak’s core photographic business as the proper means to get the company’s severe cost problems under control. His vision for Kodak was to become “the World Leader in Imaging.”421 At least three major pathways for growth promised viable long-term prospects:422 first, greater product differentiation (especially in traditional businesses); second, geographical expansion in the developing world; third, digital and applied imaging.

5.5.6.1 Product Differentiation

In the photography industry, every decade a new film format was introduced to make picture-taking more convenient and easier. Kodak, the industry leader, set new standards in 1963 with the Instamatic camera series, which was loaded with an easy drop-in 126 film cartridge; in 1972 with the Pocket Instamatic camera series, which used the new 110 film format; and in 1982, with the fully automatic (and thus foolproof) Disc camera series. However, in the absence of truly new innovations, sales of traditional film and photography paper slowed down to mediocre 4 percent growth rates in the 1990s.423 The popularity of video camcorders added to these low growth rates.424 Disposable cameras, which were merely 35mm films with a lens, accounted

419 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 420 1997b. Kodak Buys Picture Network. Wall Street Journal, 1997 Jul 24: 0-No Page Citation. 421 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 422 Ibid. 423 Dickson, M. 1993. Focusing on Grander Horizons. Financial Times, Novemeber 1(11). 424 Blömer, H. J. 1996a. 1994/1995 Pma Industry Trends Reports. International Contact, 15(3) May June.

164 Back to Core Business for the fastest growing segment in the early 1990s, but could not bolster film sales too.425

For this very reason, Fisher was counting on the new Advanced Photographic System

(APS) technology to trigger growth in the stagnating consumer photography market. The APS film and camera system was developed by a consortium of competing companies including Kodak, its archrival Fuji, as well as Nikon, Canon, and Minolta.426 Development activity for the new technology started in the mid-1980s and was scheduled to be launched in early 1996.427 The easy-to-load film cartridge which solved the problem of misloading also allowed the digital recording of user adjustments like picture size and shutter speed. Kodak’s internal worldwide surveys suggested that the new system would induce people to take more pictures.428

Kodak also instituted a film segmentation strategy to stimulate future picture-taking, based on the recognition that one type of film could not meet the needs of all consumers and retailers.429 For instance, Kodak began to launch a discount film, branded under the name Colorburst to conceal Kodak’s role, and the high-quality Gold

Max film for the premium segment.430 The company also initiated special marketing efforts directed at young families and youth, with the aim of repositioning the traditional yellow label in a more “cool” light.431

In established markets, Kodak set the stage for future growth by putting up digital print stations.432 These free-standing stations with user-friendly controls allowed customers to preview their pictures on a screen, edit them or add special effects, and print them right away (without requiring an hour’s waiting time).433 The self-service concept of the print stations relied on the idea of automatic teller machines that

425 Blömer, T. 1995d. The Future Lies in Marketing. International Contact, 14(2) March/ April. 426 1995a. Business Bulletin: A New Photography System. Wall Street Journal, 1995 May 18: 0, Bounds, W. 1994k. Technology: Photography Companies Hope People Smile over 'Smart Film'. Wall Street Journal, 1994 Jul 25: 0. 427 Atkinson, B. 2013. Personal Interview. November 19. With M. Shamiyeh. 428 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 429 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 430 Murray, M. 1997. Kodak Considers Selling Discount Film to Compete with Private-Label Brands. Wall Street Journal, 1997 Jun 04: 0-A4. 431 Bounds, W. 1996f. Kodak Focuses on Young Buyers, with View to Sharpening Its Image. Wall Street Journal, 1996 Apr 12: 0. 432 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 433 McNamara, M. J., & Myer, T. 1995. Who Needs a Darkroom. Popular Photography(October) 68.

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enjoyed great popularity.434 Then in late 1996, Kodak began testing a new retail identity program in several Fox Photo locations and other retail sites.435 The company rolled out Kodak Image Centers, a sort of shop-in-shop concept by which store owners benefitted from co-branding Kodak products.436 Consumer acceptance of digital print stations was big, increasing the market for reprints and enlargements at some sites by as much as 500 percent.437 By 1997, Kodak had installed some 13,000 print stations worldwide, and in 1999, the company had an installed base of about 19,000 of these do-it-yourself printers.438

5.5.6.2 Geographical Expansion

It was in developing markets such as China, India, and Russia that Fisher saw large potentials for growth.439 China was one of the most important markets for Kodak, becoming its third-largest market for consumer film: The average Chinese household took fewer than 18 pictures a year – less than half a roll of 36-exposure film; in Japan and the US, households were using more than 8 rolls of film per year on average.440

Kodak estimated that if the average Chinese household started using one whole roll of film a year, it would be like adding another entire market the size of Germany.441

In 1997, Kodak started its efforts to get a foothold in China and to build its own manufacturing base for this fast-expanding market.442 Until then, Kodak (as well as its archrival Fuji) gained much of its market share in China only through franchised retailers.443 In 1998, Kodak invested about $1 billion to be allowed to deliver film and paper directly from the US to China, instead of importing it via Hong Kong

434 Bounds, W. 1994b. Focus on Photography. Wall Street Journal, 1994 Jun 10: 0-PAGE B1. 435 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 436 Blömer, H. J. 1997. Kodak Image Centre Solutions. International Contact, 16(1) Jannuary/ February: 38. 437 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 438 1997a. Eastman Kodak Company Annual Report. Rochester, NY, 1999c. Eastman Kodak Company Annual Report. Rochester, NY. 439 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 440 1998. Eastman Kodak Company Annual Report. Rochester, NY. 441 Ibid. 442 Nelson, E. 1997d. Kodak Is in Talks to Make Film, Paper in China. Wall Street Journal, 1997 Apr 08: 0-A, 10:13. 443 Bulkeley, W. M., & Craig, S. S. 1998. Business Brief: Kodak to Invest in China in a Bid to Improve Its Strategic Position. Wall Street Journal, 1998 Mar 24: 1-B4.

166 Back to Core Business subsidiaries.444 This investment equaled the annual earnings of the company and was considered to be a high price for getting direct access to the country.

Likewise, only a small portion of India’s 950 million people were taking pictures.445 It was believed that photography is expensive. Surveys reported that just one fifth of all urban households owned a camera, while in the countryside, only 4 percent of households did. Triggered by India’s free-market reforms that had given more income to Indians (and thus opportunities to travel), the nation’s demand for film was growing 15 to 20 percent a year, constituting another big business opportunity for Kodak.446

Besides Kodak’s expansion into emerging markets, the company aimed at gaining a leading position in photofinishing services worldwide. In the US, Kodak acquired the other half of Qualex Inc., one of the major photofinishers that the company jointly owned, for $150 million.447 In 1996, Kodak acquired the majority of Fox Photo, one of the largest photo specialty retailers in the US, for about $52 million.

448 The company

operated approximately 550 minilabs.449

In the same year, Kodak bought out Nagase, a distributor of chemical goods as well as of Kodak products. The purchase ended the Kodak-Nagase relationship, which went back more than 70 years. Kodak Japan was set up in 1986 as a joint venture between Kodak and Nagase, and over the ten years prior to the buyout, Kodak has increased its percentage of ownership.450

In Europe, Kodak concluded a long-term cooperation agreement with the Belgian Spector Photo Finishing Group, which “sent shock waves throughout the industry.”451 Shortly before Kodak announced the deal, the Belgian company had taken over the majority holding of Germany’s Porst Holding AG, as well as full ownership of 444 Ibid. 445 Bailay, R. 1999. In India, Kodak Seeks to Turn Many into Shutterbugs. Wall Street Journal, 1999 Jan 18: 1-B5B, Shanebrook, R. L. 2013c. Personal Interview (Follow-up). November 21. With M. Shamiyeh. 446 Bailay, R. 1999. In India, Kodak Seeks to Turn Many into Shutterbugs. Wall Street Journal, 1999 Jan 18: 1-B5B. 447 Bounds, W., & Frank, R. 1994. Kodak Is to Buy Actava Group's Half of Photofinisher Qualex for $150 Million. Wall Street Journal, 1994 Aug 08: 0, O'Neill, J. 1994. U.S. Industry News. International Contact, 13(5) September/ October: 42-43. 448 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 449 1996b. Kodak Acquires Majority of Fox Photo. International Contact, 15(5 [photokina '96 issue]) September/ October 1996: 22. 450 O'Neill, J. 1996. U.S. Industry News. International Contact, 15(3) May/June: 12. 451 Blömer, H. J. 1996b. Earthquake in Europe. The Alliance between Spector and Kodak Alters the Map of the Imaging Market. International Contact, 15(5 [photokina '96 issue]) September/ October: 5.

CASE 167

lnterdiscount France. The acquisition positioned Spector Photo Finishing Group to increase the company’s sales of around $270 million to about $1 billion, making it an international retailing and photofinishing concern.452 To the same end, the cooperation agreement secured Kodak a big share of the European photographic paper market and access to more than 3,000 retail outlets.453 Kodak also invested in new manufacturing facilities in Europe: For instance, in 1997 it opened a $167 million plant to manufacture APS film cartridges in Limerick, southwest Ireland.454 It was Kodak’s first APS facility outside the US.

It is important to note that all these resource commitments – which certainly couldn’t be undone quickly in the face of a rapid industry decline – were made at a time when it was widely accepted that digital imaging would take off in less than a decade. However, in 1998, Kodak’s annual report notes that “film will remain a preferred format for consumers for decades; it's easy to use, people like it, and it's economical – yet digital imaging and digitization offer definite advantages, enabling people to do more with their pictures.”455 Kodak’s many acquisitions supported this mindset: first, there was a strong conviction that digital imaging was going to increase rather than decrease the number of prints; that is to say, that digital technologies would start to supplant traditional cameras along with silver-halide film on the capture side of the imaging chain, but that on the output side, photographic paper (and thus photofinishing services) would grow. Second, there was no anticipation of a rapid decline of the traditional photography industry in general. “Even if we believed that there was going to be a systemic downturn in the film business,” Fisher said, “we felt we could deal with it, because we did not think it was going to happen overnight.”456 It is noteworthy that a Forbes online survey of late 1993 supported the assumption that paper prints would survive digital imaging. Sixty-three percent of respondents shared this belief, while only a bit less than the rest was convinced of the opposite.457

452 Ibid. 453 Blömer, H. J. 1996e. Spector, Interdiscount and Porst Go Kodak. Photo Group with Sales of Newaly Dm 1.5 Billion Combines Servies and Retailers. International Contact, 15(5 [photokina '96 issue]) September/ October 1996: 8. 454 O'Neill, J. 1997. U.S. Industry News. International Contact, 16(1) January/ February: 20. 455 1998. Eastman Kodak Company Annual Report. Rochester, NY. 456 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 457 Moreno, K., & Pappas, B. 1997. Digital George? Forbes, 160(10) 40-40.

168 Back to Core Business 5.5.6.3 Digital Imaging

Digital and applied imaging was Fisher’s third major pathway for growth. Until 1994, a few months after Fisher assumed leadership, Kodak’s digital camera technology continued to exist without public awareness. Started as skunkworks in the Federal Systems division, Kodak’s researchers spent a lot of time visiting different government agencies and demonstrating cameras to sell them, but never got a big sale.458 Despite a passing mention in Kodak’s 1992 annual report, the company never made an issue out of digital cameras in public. Wall Street too was quiet about Kodak’s revolutionary technology. Fisher changed all this. His goal was “to enable everyone to use more pictures, more easily, more creatively and less expensively than ever before.”459

The 1994 annual report depicted Kodak’s new digital Associated Press News Camera

2000 [AP NC2000] and presented it in the context of its potential customers – photo journalists – right next to a newspaper.460 The report clearly signaled that the company’s aim was also to offer its advanced digital camera technology to the consumer market by depicting the Apple QuickTake consumer camera, Kodak developed for the computer company. Since then the Wall Street Journal started to cover the technology. For instance, it announced Kodak’s agreement with the Associated Press to jointly develop a filmless camera, “the first of its kind specifically for news photographers.”461 The new Kodak AP NC2000, which was the first camera to bring multi-megapixel image quality to a state-of-the-art 35mm single lens reflex camera, was distributed exclusively by the Associated Press. Jim McGarvey, the chief scientist behind the $26,000 camera, recalled that this was when Kodak’s digital cameras took off. The Rochester Democrat and Chronicle was the first major newspaper to go all-digital, using the NC 2000 cameras, and shutting down the newspaper’s photo lab.462

Then in early April 1994, Fisher took advantage of a huge Photo Marketing Association trade show to present the Apple QuickTake 100 – a digital camera which

458 Gustavson, T., & McGarvey, J. 2013. The First Digital Single-Lens Reflex Cameras. IMAGE(Winter 2012/2013) 5. 459 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 460 1994d. Eastman Kodak Company Annual Report. Rochester, NY. 461 1994e. Kodak, Ap Unveil Camera without Film for News. Wall Street Journal, 1994 Feb 09: 0-PAGE B12. 462 Gustavson, T., & McGarvey, J. 2013. The First Digital Single-Lens Reflex Cameras. IMAGE(Winter 2012/2013) 5, McGarvey, J. 2013. Personal Interview. April 10. With M. Shamiyeh.

CASE 169

was developed jointly by Kodak and Apple; 75,000 units were shipped in 1994.463 This wasn’t the first digital camera on the consumer market; Dycam, Casio, and Logitech, among others, had steered for the market earlier; however, Kodak’s “Apple” camera offered superior features at an affordable price for the first time.464 Other digital cameras made and branded by Kodak followed shortly. In 1995, Kodak launched the DC40, which exceeded the company’s sales projections.465 A year after, Kodak trumped with another mass market camera, the DC25, just a couple of months after introducing the breakthrough digital snap shooter DC20.466

Fisher urged new concepts and software to make photos easily available for processing on home computer platforms, and even lifted them into the virtual reality of cyberspace. For instance, he re-launched Kodak’s poorly commercialized PhotoCD system to allow home computers users to work with it, and started to market a low-cost photo scanner, which offered exceptional value for the money. Under Fisher’s leadership, Kodak also went online, providing users with a platform full of information about recent news and the company’s history, specifications of its products, and samples of PhotoCD digital images, and delivered.467 Here too, it was Fisher who made use of employees’ skunkwork.468

In 1997, Kodak launched its online photofinishing service, to position itself in the digital world and allow customers to view, edit, and make prints of their uploaded pictures.469 Kodak was not the first to offer such a service. In the US, Wolf Camera had introduced its Picture On Disk mail-order photofinishing service already in 1994.470 The Seattle-based company teamed up with other powerful players in the

463 Blömer, H. J. 1996c. Kodak's Imaging Universe - Interview with Dan A. Carp, Kodak Executive Vice President. International Contact, 15(5 [photokina '96 issue]) September/ October, Partalon III, W. 1994. Betting on Future of Digital Imaging. Democrat Chronicle: 1f. 464 Mossberg, W. S. 1994. Personal Technology. Wall Street Journal, 1994 May 19: 0-PAGE B1. 465 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 466 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 467 O'Neill, J. 1995c. U.S. Industry News. International Contact, 14(2) March/April: 12-20. 468 Jahnke, A., "Kodak Stays in the Digital Picture," http://edition.cnn.com/TECH/computing/9908/06/kodak.ent.idg/, accessed on May 4, 2013. 469 1997c. Kodak Is Launching Service on Internet to Store, Print Photos. Wall Street Journal, 1997 Aug 26: 0-B, 18:13. 470 Franz, D. 1997. Wolf Camera on the Internet. Tomorrow's Images for Everybody. International Contact, 16(1) Jannuary/ February: 14-16.

170 Back to Core Business industry, such as Konica Corporation among many others.471 Kodak teamed up with Microsoft to develop Picture It! software that was tied in to Kodak’s Image Magic digital print service. A simple click with the mouse on the “Print to Kodak” button linked the computer automatically to a Kodak Internet site offering digital photofinishing. Kodak’s expectations of the service were small. In the first year it expected only a few thousand customers to use the platform; five years later, the company expected about a million customers.472 Unlike picture platforms established in the new millennium, at Kodak’s 1997 webpage, customers were asked to subscribe for a monthly fee of $4.95 and were allowed to store up to 100 images.473

5.5.7 Interim Results But Fisher’s growth strategy was thwarted: Additional earnings due to increased unit volumes were offset by flagging consumer demand for film, low selling prices because of a fierce competition, and negative effects of currency exchange. As a consequence, Kodak’s sales remained flat, adjusted by the exclusion of revenues from divestures. Efforts to outgrow the company’s cost problem and to build a new supporting pillar with digital imaging were thwarted, and Fisher could not prevent Kodak from making further deep cuts in the workforce and taking measures to shrink the company’s assets.

In 1994, the year after Fisher took over, Kodak was scaled down extensively [see Figure 60]. The company’s net earnings were cut in half compared to those in 1992, before Kodak decided to shed several of its non-imaging businesses, and the total sales as well as number of employees were down to two thirds. The spin-off of Kodak’s chemical operations and the sale of most of its health businesses, which in sum accounted for about $7.6 billion in sales, lowered total sales to $12.7 billion in 1993, compared to $20.2 billion one year earlier [see Figure 50].

471 Bounds, W. 1996a. Big Photo Retailer to Offer Service on the Internet. Wall Street Journal, 1996 Feb 21: 0, Franz, D. 1997. Wolf Camera on the Internet. Tomorrow's Images for Everybody. International Contact, 16(1) Jannuary/ February: 14-16. 472 1997c. Kodak Is Launching Service on Internet to Store, Print Photos. Wall Street Journal, 1997 Aug 26: 0-B, 18:13. 473 Ibid.

CASE 171

Figure 60

Kodak’s Financial Performance and Efficiency in Comparison Data of 1983 is point of reference (100%)


As for net earnings, the company had returned to the size of its pre-diversification era. Its 1994 net earnings of $557 million corresponded to those of 1983, which were $565 million. But the company was quite different. While Kodak a decade earlier rested on two profitable pillars of income, photography and chemicals, which accounted for 80 percent and 20 percent of earnings, respectively, and was on its way to establishing the third one, Fisher basically centered the new Kodak on one single pillar – imaging – betting that the traditional film business would stay around long enough to generate the viable cash stream required to fund the new digital technology that was said to be the substitute (at least on the capture side of the imaging chain) for the chemical-based silver-halide technology [see Figure 61].

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172 Back to Core Business

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For operational reasons, Fisher split the imaging concern into a consumer and a commercial segment. Adjusted by losses or gains due to the divesture of non-imaging businesses, growth rates of Kodak’s total sales remained flat throughout Fisher’s tenure (while general consumer demand for the photography industry declined). Excluding the revenues of the divested non-imaging businesses in 1993 and 1994, Kodak was able to leverage total sales of a year earlier and to realize an average growth rate of about 4.6 percent for both years [see Figure 50, note (1) and (2)]. Increases in sales were primarily achieved in the consumer imaging segment and not in its commercial counterpart. Significantly, here Fisher’s strategy to extend market share in the photofinishing business paid off. The increase in sales was mostly due to the inclusion of revenues from Qualex Inc., a photofinishing concern that was acquired in August of 1994.474

Kodak’s sales in 1995 and 1996 showed signs – at first glance – that the company’s new marketing and advertisement initiatives were making inroads [see Figure 50, note (4)]. Annual reports of those two years presented record double-digit growth figures: Worldwide consumer imaging grew 15 percent in 1995 compared to 1994, and 12 474 1994d. Eastman Kodak Company Annual Report. Rochester, NY.

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CASE 173

percent in 1996, growth rates were about ten basis points above the industry’s average, impressive gains at a time of stagnation.475 In the early 1990s, worldwide growth in sales of film declined to about 4 percent from at least double that the decade earlier [see Figure 63].476 Kodak used this as an opportunity to disparage the skeptics who considered imaging as a “dead” business with marginal single-digit growth rates.477 However, a close look at the reported figures presents a different picture – a prelude to an industry change ominous for the imaging giant. Excluding Kodak’s sales of its Qualex photofinishing subsidiary and effects of foreign exchange growth rates, the growth rate actually fell by more than half [see Figure 62, note (1)]. In 1995, the exchange rate for dollars to German marks and Japanese yen reached an all-time low [see Figure 64]. For European and Japanese photographic film and paper manufacturers, this was of major concern.478 In contrast, unfavorable effects of exchange rates affected sales by about 40 percent in 1995.479 An additional 20 percent share of 1995 sales was buoyed by Kodak’s more recent aggressive acquisition of photofinishing services.480

In the mid-1990s, analysts questioned whether Kodak would be able to achieve growth rates above the industry average in the United States when its archrival Fuji Photo started selling paper in the US.481 In 1995, Fuji opened its first paper-manufacturing facility in Greenwood, SC.482 In 1997, the Japanese company became an even more formidable competitor to Kodak by investing heavily in its US facilities to manufacture film and to bolster its existing capacities related to paper manufacture.483

475 1995b. Eastman Kodak Company Annual Report. Rochester, NY, 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 476 Franz, D. 2014. Cameras + Film Rolls, 1984-2012. In P. News (Ed.). Bonita Springs, FL, Nelson, E. 1997f. Kodak Says Sales Are 'Essentially Flat,' and Stock Price Gets Pummeled 10.5%. Wall Street Journal, 1997 Mar 24: 0-A, 4:1. 477 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 478 Blömer, H. J. 1995a. Higher Prices Are the Only Way Out. Currency Upheavals Cast a Glom over Profits in the Photo Industry. International Contact, 14(3) May/ June: 3, Gerlach, K. 1995. More Prints Than Ever Before. International Contact, 14(3) May/ June. 479 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 480 Bounds, W. 1996e. Kodak's Net Jumped 17% in Quarter, Buoyed by Growth in Photofinishing. Wall Street Journal, 1996 Jul 17: 3. 481 Bounds, W. 1995h. Kodak Third-Period Net Surged 75%; Buyback Plan of up to $1 Billion Is Set. Wall Street Journal, 1995 Oct 18: A3. 482 Bounds, W. 1996c. Fuji Invests $100 Million in U.S. Plant. Wall Street Journal, 1996 Feb 21. 483 Nelson, E. 1997b. Fuji, Challenging Kodak, to Make Film in U.S. Wall Street Journal, 1997 May 08: 0-A, 3:1.


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Figure 62 Changes in Kodak’s Consumer Photography Sales Worldwide


Figure 63 Changes in Film Roll Sales (Units) Worldwide Photography Industry

Source: Data adapted from Photofinishing News

Moreover, in 1997 the tide had turned and the strong dollar started to negatively affect sales; Kodak was forced to cut its prices to stay competitive, despite the dramatic price cuts that had already been taken on photographic film and paper due to the price war with Fuji and discount retailers. Kodak’s sales results in the years after 1996 were disastrous. Year after year, total sales declined by 7 to 8 percent. A big part of the disastrous sales results was the failure of the new APS film system to meet its sales goals.484 Kodak had to focus a large part of its development and marketing dollars on this system, diverting money from other product lines like 35 mm film and single-use cameras. This is similar to the poor results in 1983, which were primarily due to the failure of the new disc film system to reach its goals.

484 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh.

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CASE 175

Figure 64 Currency Exchange Rates Source: Data adapted from

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Figure 65 Changes in Film Roll Sales (Units)

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It was in 1999, Fisher’s last year before handing over direction to Dan Carp, that the company increased sales by five percent. In Kodak’s most important consumer imaging segment, the results were not impressive. In 1997, the company reported sales at the same level as the previous year; 1998 saw a decrease of 7 percent; and only in 1999 was there a sales increase of 5 percent compared to 1998. Even if the negative effects of currency exchanges were excluded, which mostly accounted for 3 to 4 percent of total sales, and losses due to divestures in the photofinishing sector were subtracted, Kodak’s growth rates languished at zero, or about 4 basis points below the

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176 Back to Core Business industry average [see Figure 62, note (2), and Figure 63].485 The consequences were devastating. Kodak massively lost market share.

What happened? Why did Kodak, like an airplane, suddenly lose power and stop climbing? Even with a strong dollar, the company’s sales fell apart for three major reasons: First, Kodak’s competitive disadvantages put Fuji in a superior position in a price war that lowered Kodak’s revenues, market position, and profitability (and thus ability to invest for the future); second, growing markets, such as China, could not compensate for losses in Kodak’s domestic market due to recurring economic setbacks; and third, innovations such as the Advanced Photographic System, which were intended to boost consumer demand for photographic products, came late and were poorly launched.

Since the early 1980s, when Fuji got a foothold in the US market by winning the pitch for the 1984 Los Angeles Olympics against Kodak, the world’s two largest manufacturers of photographic film and paper had each been trying to crack the other’s domestic stronghold. Kodak and Fuji owned some 80 and 70 percent, respectively, of their roughly $3 billion domestic markets.486 By the mid-1990s in the US, Fuji had clawed its way to about 11 percent; in Japan, it was a near mirror image – there Kodak’s market share was about 9 percent.487 However, unlike in the US, in Japan it was difficult for foreign companies to get access to consumers due to a complex distribution system that was largely controlled by Fuji.488

According to Kodak, the Japanese distribution system was effectively controlled by four major wholesalers responsible for the majority of photographic products supplied to retailers in Japan. Since the mid-1970s, each of the four wholesalers distributed Fuji products exclusively. Fuji, in turn, used its leverage to keep the wholesalers and their retailers in a state of financial dependency, establishing a sophisticated system of target bonuses, discounts, capital shares, low-interest credits – even underwriting of 485 Symonds, W. C. 1998. Finally, a Good Kodak Moment. BusinessWeek(3588) 34-34. 486 Chakravarty, S. N., & Simon, R. 1984. Has the World Passed Kodak By? Forbes, November 5 184-192, Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 487 Maremont, M., Bremner, B., & Updike, E. 1995. Next, a Flap over Film? BusinessWeek July 09. 488 O'Neill, J., & Blömer, H. J. 1995. American Government to Support Eastman Kodak. International Contact, 14(4) July/ August: 4.

CASE 177

debts when bankruptcy threatened.489 Retailers, which didn’t belong directly to Fuji, would have been lost without its backing.490 As a consequence, retailers removed foreign products from their shelves or at best banished them to some remote corner.491

Agfa, a large German manufacturer of photographic products, accepted the omnipresence of Fuji in Japan and sold their film at low cost in unbranded packs of three 24-exposure rolls in a Japanese discount chain.492 Kodak, however, did not accept this unfavorable situation. On May 23, 1995, it filed a petition alleging that the Japan government had created a “profit sanctuary” for Fuji by restricting Kodak’s access to the nation’s photographic market.493 Kodak argued that its market share in Japan was as low as 7 percent, compared with some 40 percent in many other countries.494 It accused Japan of maintaining “a tightly-controlled distribution system and other non-competitive practices [which] have hurt our chances to deliver products, infrastructure and marketing programs that meet the specific needs of Japanese consumers.”495 The US government took up the case and Kodak hoped that US trade representatives could persuade Japan to open its market; nevertheless, in 1997 the World Trade Organization rejected the company’s claim that Japan was protecting its photographic market.496

For Kodak, the access to Japan’s photographic market was important for another reason. Japan’s “profit sanctuary” not only protected Fuji from foreign competitors, but also allowed the company to charge above-market prices in Japan, giving Fuji financial reserves which enabled it to subsidize low pricing in other countries.497 In 1995, Kodak estimated that Fuji’s “war chest” totaled nearly $10 billion, while the US photography giant lost about $5.6 billion in revenues from Japan between 1975 and 1993.498 Fisher recalled that Fuji made “a lot of money in Japan and basically subsidized its incursions into the US market, although the profit margins were so high, 489 Köhler, R. 1995. The Kodak/ Fuji Case. International Contact, 14(6) November/ December. 490 Company, E. K. 1995. Kodakery(20). 491 Köhler, R. 1995. The Kodak/ Fuji Case. International Contact, 14(6) November/ December. 492 Ibid. 493 Bounds, W. 1995a. Fuji Photo Lashes Back at Kodak, Says Rival Uses Anticompetitive Ploys in U.S. Wall Street Journal, 1995 May 24: 0. 494 Bounds, W. 1995b. George Fisher Pushes Kodak into Digital Era. Wall Street Journal, 1995 Jun 09: 0. 495 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 496 By James, C. A. 1997. Kodak Is Wrong: Japan's Market Isn't Closed. Wall Street Journal, 1997 Dec 23: 1-A14, O'Neill, J. 1995d. U.S. Industry News. International Contact, 14(4) July/ August. 497 Company, E. K. 1995. Kodakery(20). 498 Ibid.

178 Back to Core Business they made money [there] too.”499 Kodak estimated that the price for a Fuji color film sold in Japan was about 3 to 4 times higher than outside Japan.500

By 1997, when the WTO ruled against Kodak’s petition against Japan, the “war” between Kodak and Fuji wasn’t settled; rather the opposite. The battlefield was transferred to the US, putting the US photo giant under severe cost pressure. A year earlier, Fuji had started to produce color negative paper in their newly established US manufacturing site in Greenwood, SC, a move that earned worldwide recognition.501 A decade earlier, Fuji almost exclusively manufactured in Japan; in 1997 about one third of the company’s total manufacturing was abroad.502

And Fuji’s moves accelerated. To ensure a market for the paper, Fuji started to aggressively acquire the largest US film-processing wholesalers. For instance, in 1996 Fuji purchased the wholesale photofinishing business of 2,252 Wal-Mart stores for the next ten years, plus the paper business of the its 1,200 minilabs, for an estimated budget of $500 to $600 million.503 Until then, Kodak had controlled about 80 percent of the US wholesale photofinishing business; losing Wal-Mart’s business meant a reduction by 15 to 20 percent.504 Kodak countered the move just a few weeks later by taking over 51 percent of the shares of CPI Fox Photo, the fifth-largest minilab and retail chain, with around 550 shops in the USA.505 At the same time, Kodak set up an agreement with the Belgian Spector Photo Finishing Group, one of Europe’s leading retailing and photofinishing concerns.506 Fuji then won a pitch to provide paper to Ritz Camera Centers Inc., the third-largest minilab chain in the US, and, again, Kodak responded with an agreement with Wal-Mart to install its Image Magic Print stations, kiosks that allowed customers to scan, 499 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 500 O'Neill, J. 1995a. Kodak Watch. International Contact, 14(6) November/ December. 501 Franz, D. 1996. New Fuji Photo Photographic Paper Plant Opens. International Contact, 15(3) May June. 502 Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27. 503 Bounds, W. 1996d. Fuji Will Buy Wal-Mart's Photo Business --- Finishing-Operations Pact with Major Retailer Is Coup against Kodak. Wall Street Journal, 1996 Jul 09: 0-A3, Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27. 504 Bounds, W. 1996d. Fuji Will Buy Wal-Mart's Photo Business --- Finishing-Operations Pact with Major Retailer Is Coup against Kodak. Wall Street Journal, 1996 Jul 09: 0-A3, Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27. 505 Blömer, H. J. 1996b. Earthquake in Europe. The Alliance between Spector and Kodak Alters the Map of the Imaging Market. International Contact, 15(5 [photokina '96 issue]) September/ October: 5, Nelson, E. 1996d. Kodak Signs Pact with Price/Costco, Dealing Fuji Blow. Wall Street Journal, 1996 Dec 05: 0-B16. 506 Blömer, H. J. 1996b. Earthquake in Europe. The Alliance between Spector and Kodak Alters the Map of the Imaging Market. International Contact, 15(5 [photokina '96 issue]) September/ October: 5.

CASE 179

edit, and print their photographs in about 1,400 stores in the US.507 Kodak also provided chemicals and papers required for the processing of photos. The deal was settled a year after Fuji clinched the lucrative agreement to obtain Wal-Mart’s photofinishing service of films that customers drop off in the stores.508

The many acquisitions by both firms led to a broad consolidation in the photofinishing industry, basically turning large portions of the business over to Kodak and Fuji. This was not without strategic consequences for both companies. Betting heavily on the longevity of photographic paper, the two photography giants committed extensive resources to a business that could not be undone quickly at periods of rapid downturn. But the two competitors conducted their acquisitions from different financial positions. While in 1997 Fuji had access to low-interest borrowings of about 2 to 3 percent and a high amounts of cash or cash equivalents of $4.5 billion, Kodak was in the midst of a turnaround that burdened the company by $1.5 billion, not to mention the $600 million in long-term debts the company had incurred at as much as 6 to 8 percent.509

But what really troubled Kodak was Fuji’s aggressive cutting of film prices in the US and its capture of Kodak’s market share, which reduced the company’s cash flow when Fisher needed it most for his strategic move into digital imaging. The “price war” clearly helped to stall Kodak’s turnaround.510 In early 1996, Fuji cut its US prices for color films by one fourth, explaining the action by its lost agreement with Costco (which Kodak got). A holdover of 2.5 million film rolls needed to be brought to market at a big discount.511 Nevertheless, Fuji kept prices low in general. Their films were usually 10 to 15 percent cheaper than Kodak’s films. About 18 months later, in mid-1997, a survey showed that discount film had dropped to 25 to 35 percent below

507 1997f. Wal-Mart Picks Kodak Kiosks. The New York Times, August 28, Nelson, E. 1996a. Fuji Beats out Kodak to Win Ritz Contract. Wall Street Journal, 1996 Oct 10: 1. 508 1997f. Wal-Mart Picks Kodak Kiosks. The New York Times, August 28, Nelson, E. 1996a. Fuji Beats out Kodak to Win Ritz Contract. Wall Street Journal, 1996 Oct 10: 1. 509 1997a. Eastman Kodak Company Annual Report. Rochester, NY, Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27. 510 Nelson, E. 1997g. Kodak Stock Falls on Analyst Fears of a Price War. Wall Street Journal, 1997 Jun 12: 0-B, 7:1. 511 Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27.

180 Back to Core Business Kodak’s prices.512 Occationaly Fuji sold packs of multiple film rolls for the half price.513 The manufacturing pace at Fuji’s new plant in Greenwich, SC, had tripled within less than two years.514

Figure 66

Market Share of Kodak and Fuji in the US Source: See Footnote 515

512 Johannes, L. 1997a. Fuji Photo Ties Lower Prices to Bid to Cut Stocks, Not to a War with Kodak. Wall Street Journal, 1997 Aug 25: 0-A9B. 513 Smith, G., Wolverton, B., & Palmer, A. T. 1997b. A Dark Kodak Moment. BusinessWeek(3538) 30-31. 514 Bulkeley, W. M. 1998. Kodak Profit, Helped by Cost Cutting, Hits Forecasts Despite 7% Sales Decline. Wall Street Journal, 1998 Apr 15: 1-A4. 515 Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27, ibid., Johannes, L. 1997c. Kodak Profit Fell 43% in 3rd Quarter on Losses in Digital-Imaging Products. Wall Street Journal, 1997 Oct 15: 1-B3, Johannes, L. 1998a. Kodak Reports Loss of $744 Million Including Big Restructuring Charge. Wall Street Journal, 1998 Jan 16: 1-A4, Klein, A. 1998. Kodak's Share of Film Sales Stabilizes, Leading Analysts to Lift Profit Estimates. Wall Street Journal, 1998 Oct 08: 1-B10, Klein, A. 1999d. Kodak and Fuji Enjoyed Strong December Sales --- Buying of 35mm-Film Rolls Jumped 18%, Reflecting Aggressive Price Cutting. Wall Street Journal, 1999 Jan 12: 1-A4, Klein, A. 1999f. Kodak Losing U.S. Market Share to Fuji --- Surveys Represent Setback Amid Signs Major Rival Is Lowering Film Prices. Wall Street Journal, 1999 May 28: 0-A3, ibid., Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128.

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CASE 181

As a result of Fuji’s aggressive price cutting, its US film sales rose 4 percent, but dropped 8 percent in dollar terms.516 Film prices of the US giant had fallen by 11 percent.517 Kodak estimated that every 1 percent reduction in its film prices leads roughly causes earnings per share to drop by 1 percent.518 And as of 1997, Kodak had to acknowledge that Fuji had finally arrived in the US. After that, Kodak’s market share lost at least 3 percent a year [see Figure 66]. Whereas in the mid-1990s Kodak managed to gain market share in dollars by sticking with high profit margins, in the late 1990s the tide turned. Kodak had to cut its prices.

In 1997, Fisher admitted that “we would have hoped that our growth initiatives would have kicked in by now.” 519 His original strategy called for a three-year period in which Kodak would manage to fix its balance sheet and begin to invest heavily in emerging markets with growth potential. Price pressure by Fuji, however, thwarted his plan. Even worse, sales in the emerging markets grew slowly.

Fisher’s growth strategy brought China into focus, not only for the imaging giant in the US, but for its Japanese rival too. Fuji, like Kodak, entered the Chinese market with the aim of get control of a distribution network.520 In 1997, Kodak gained some 30 percent market share, compared to Fuji, which led the market with more than 40 percent, and Luck Film Co., the local brand, with 20 percent.521 However, sales in the Pacific Rim countries “moderated considerably”; in 1997, for instance, Kodak’s sales in China remained low at about $200 million or 1 percent of total sales.522

In the following years, sales were also poor in markets Fisher was counting on for considerable growth potential. Due to the continuing financial crisis in Asia, sales in

516 Klein, A. 1999b. Eastman Kodak Net Income Falls a Bit, but Operating Earnings Rise by 9%. Wall Street Journal, 1999 Jul 22: 1-A4, Klein, A. 1999h. Kodak Profit Falls 15% after Charge, but Sales Climb for 1st Time in 2 Years. Wall Street Journal, 1999 Apr 19: 1-A4. 517 Klein, A. 1999b. Eastman Kodak Net Income Falls a Bit, but Operating Earnings Rise by 9%. Wall Street Journal, 1999 Jul 22: 1-A4. 518 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 519 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4. 520 Smith, C. S. 1996. Photo Frenzy: Kodak, Fuji Face Off in Neutral Territory: China's Vast Market. Wall Street Journal, 1996 May 24: 1. 521 Bulkeley, W. M., & Craig, S. S. 1998. Business Brief: Kodak to Invest in China in a Bid to Improve Its Strategic Position. Wall Street Journal, 1998 Mar 24: 1-B4. 522 Ibid., Nelson, E. 1997f. Kodak Says Sales Are 'Essentially Flat,' and Stock Price Gets Pummeled 10.5%. Wall Street Journal, 1997 Mar 24: 0-A, 4:1.

182 Back to Core Business anticipated growth markets dropped 14 percent.523 In 1999, Fisher’s last year as Kodak’s chief executive, the Chinese market finally grew by some 45 percent; nevertheless, it merely offset losses in other emerging markets.524

Meanwhile, the new Advanced Photographic System, a product line Kodak was hoping would revitalize the sluggish photography market, was introduced late and poorly.525 Manufacturing problems, miscalculations of consumer demand, and a bad marketing strategy led to a disappointing launch of the new system in 1996.526 While unclear packaging in regard to systems compatibility spurred many consumers to buy film cartridges, in the belief that they would fit in their old 35mm film cameras, many retailers were waiting desperately for the new APS cameras. For instance, Wal-Mart, the largest photofinishing franchise in the US, sold APS film but was desperately waiting for APS cameras, missing even the big summer holiday picture-taking business.527 Fuji, one of the developers of the new system among others like Kodak, trimmed its camera shipments to the US because it was still uncertain about consumer acceptance and therefore feared negative press; Kodak, however, blamed start-up problems and unexpectedly high consumer interest for the shortage.528 In 1997, a year after the system’s launch, Kodak was forced to invest heavily into advertising – some sources mention a $100 million budget and more per year – to re-launch the new product line.529 Fisher conceded that the APS system was “about a year behind” the plan and that Kodak had its “share of screw-ups last year in the Advantix launch.”530 The CEO’s disappointments in the emerging markets coincided closely with disappointments in his efforts to generate growth by product differentiation.

523 Symonds, W. C. 1998. Finally, a Good Kodak Moment. BusinessWeek(3588) 34-34. 524 Klein, A. 1999h. Kodak Profit Falls 15% after Charge, but Sales Climb for 1st Time in 2 Years. Wall Street Journal, 1999 Apr 19: 1-A4. 525 Nelson, E. 1997a. Advertising: For Kodak's Advantix, Double Exposure as Company Relaunches Camera System. Wall Street Journal, 1997 Apr 23: 0-B, 1:3. 526 Bounds, W. 1996i. Marketing: Camera System Is Developed but Not Delivered. Wall Street Journal, 1996 Aug 07: 4. 527 Ibid. 528 Ibid. 529 Bounds, W. 1996b. Don't Blink: Photo Industry Launches Global Blitz to Tout New Cameras, Film. Wall Street Journal, 1996 Feb 01, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1. 530 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1.

CASE 183

Figure 67 Profit (Loss) and Sales Digital Imaging (D&AI)

Dollar amounts in millions. Source: Data adapted from sources in footnote 531

531 1994f. Picture Imperfect. The Economist May 28, 1995b. Eastman Kodak Company Annual Report. Rochester, NY, 1999a. Business Brief -- Eastman Kodak Co.: Digital-Imaging Revenue Is Set to Reach $2 Billion. Wall Street Journal, 1999 Oct 06: 1-No Page Citation, 1999c. Eastman Kodak Company Annual Report. Rochester, NY, 2000. Eastman Kodak Company Annual Report. Rochester, NY, Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0, Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14, Johannes, L. 1997c. Kodak Profit Fell 43% in 3rd Quarter on Losses in Digital-Imaging Products. Wall Street Journal, 1997 Oct 15: 1-B3, Johannes, L. 1998a. Kodak Reports Loss of $744 Million Including Big Restructuring Charge. Wall Street Journal, 1998 Jan 16: 1-A4, Klein, A. 1999a. Costs Hit Kodak Net, and Stock Falls 10% --- Disappointment over Halt in Curbing Outlays Stirs Doubts on Turnaround. Wall Street Journal, 1999 Jan 15: 1-A3, Klein, A. 1999b. Eastman Kodak Net Income Falls a Bit, but Operating Earnings Rise by 9%. Wall Street Journal, 1999 Jul 22: 1-A4, Klein, A. 1999h. Kodak Profit Falls 15% after Charge, but Sales Climb for 1st Time in 2 Years. Wall Street Journal, 1999 Apr 19: 1-A4, Klein, A. 2000a. Kodak Expects Digital-Imaging to Yield 45% Revenue by 2005. Wall Street Journal, 2000 Jun 15: 0-B14, Klein, A. 2000b. Kodak Reports 51% Jump in Earnings, but Revenue Unexpectedly Edges Lower. Wall Street Journal, 2000 Apr 18: 0-A4, Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P, Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29, Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4, Maremont, M., & William, M. B. 1997b. Kodak to Slash 10,000 Jobs, Take Charge --- Moves Aim to Cut Costs by at Least $1 Billion; Shares Still Fall Sharply. Wall Street Journal, 1997 Nov 12: 1-A3, Symonds, W., Smith, G., & Judge, P. 1999. Fisher's Photo Finish. BusinessWeek(3634) 34-36.

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184 Back to Core Business Finally, the digital imaging business did not take off either [see Figure 67]. Fisher’s hope was that it would offset the slack when demand for film declined. In 1994, the traditional consumer photography business accounted for 45 percent of Kodak’s total $13.6 billion revenues and some 75 percent of its profits.532 The company’s digital products, such as digital cameras, CD-ROMS, and some digital printers, accounted for $500 million in revenues or roughly 4 percent of total sales, while generating no profit. Kodak actually lost money on the new business, hoping to reach the breakeven point soon. Challenged by the necessity for the digital business to grow faster than the decline of the traditional chemical-based business in order to provide cash for start-up innovations, he addressed the big questions of how and when the digital business would begin to make money overall.533 The challenge was enormous, as he himself conceded, because “how will companies be competitive in a world [in which] technology will be virtually free?”534

Analysts remained skeptical of future prospects. Alex Henderson, an analyst at Prudential Securities Inc., estimated that even if Kodak managed to push the technology into a $1 billion business within five years and generate respectable operating margins of about 10 percent, profits would remain as low as $100 million – a fraction of the company’s 1995 $1.3 billion earnings from $6.9 billion sales in the traditional consumer photography business.535 Fisher, on the contrary, was optimistic. For him it was not about hardware alone, but the complete imaging business: “If we think our past was film and our future is digital, we’re going to have problems. But if we think of our past being pictures and our future being pictures, we’ll use whatever technologies are available.”536 With his different thinking about imaging, Fisher estimated that by the end of 1997, the digital imaging business would reach the breakeven point, with sales growth rates of about 20 to 50 percent a year [see Figure 67].537

532 1994d. Eastman Kodak Company Annual Report. Rochester, NY, Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 533 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4. 534 Gross, N., Coy, P., & Port, O. 1995. The Technology Paradox. BussinessWeek March 05. 535 Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16. 536 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11. 537 1994f. Picture Imperfect. The Economist May 28, 1995b. Eastman Kodak Company Annual Report. Rochester, NY, Blömer, H. J. 1995b. Kodak Bares Its Soul to Wall Street. International Contact, 14(3) May/

CASE 185

To the disappointment of Kodak (and Wall Street), by 1997 the business continued to lose money, despite heavy investments, and management was uncertain as to when the unit would be profitable.538 Some explain the loss of 1997 by referring to the dramatic drop in the price of CD-R media.539 This had been a high-margin business until then and provided significant and growing revenue. But price cutting from Taiwan in the mid-1990s dropped the price from $5 per disc to 20 cents per disc within a few years, and made this digital business unprofitable. Kodak shut it down in late 1997. In fact, Kodak did not lack a viable stock of knowledge in the field of electronics; however, fear of cannibalization of its profitable film business paralyzed the company, preventing it from accumulating experience in commercializing and marketing its electronic products.

Fisher spent some $500 million a year to develop new digital technologies that could do away with conventional film,540 yet the Digital and Applied Imaging (D&AI) unit had to report operating losses of $440 million.541 Faced with harsh criticism, Fisher responded convincingly: “You call it losses, I call it investment. If this were a stand-alone start-up company, I’d be a hero on Wall Street. I'm growing the business 40 percent a year, and if I were losing $100 million as a start-up, investors would say ‘big deal.’ ”542

In 1998, when $1.6 billion sales for digital products already accounted for 17 percent of Kodak’s total revenues, the D&AI again lost money – a trend that continued well

June: 8, Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0, Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 538 Johannes, L. 1997c. Kodak Profit Fell 43% in 3rd Quarter on Losses in Digital-Imaging Products. Wall Street Journal, 1997 Oct 15: 1-B3. 539 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 540 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4, Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114. 541 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11, Johannes, L. 1998b. Kodak, Intel Join to Make Slimmer, Cheaper Cameras. Wall Street Journal, 1998 May 01: 1-B6. 542 Deutsch, C. H. 1999. Chief Says Kodak Is Pointed in the Right Direction. The New York Times, December 1999.

186 Back to Core Business into the next millennium.543 At the turn of the millennium, sales of the unit’s digital products accounted for $2.8 billion, or 20 percent, of the company’s $14 billion total revenues. The company predicted that digital products would generate about $3.5 billion to $4 billion in revenues by 2004.544 By then Dan Carp, who succeeded George Fisher as Kodak’s chief executive, had adjusted the forecasts on profits of the digital imaging business. He expected the business to grow to 42 percent of the company’s overall revenue by the end of 2005 and to reach breakeven by 2002.545

There were several reasons that rendered it difficult for Kodak to generate profit with digital cameras, CD-ROMS, and some other digital products such as thermal printers.

First, the PictureCD, which Fisher had positioned at the center of his “picture” strategy to offset losses in the digital imaging operations, turned out “not to be a big profit contributor.”546

On the one hand, it did not meet consumer demand. Kodak resurrected Kay Whitmore’s faltering PhotoCD, which was launched in 1992 and poorly marketed as an expensive high-tech gadget for consumers wanting to see their photos on a TV set. The second time, Kodak was aiming at the PC user. The price was much lower than the one of the PhotoCD, and the images were lower resolution JPEG format, rather than Kodak's proprietary PhotoCD format. Moreover, PictureCD pursued an open licensing strategy and added new software, making it easier for consumers to retrieve their photos and to import them into all kinds of electronic documents. However, people were reluctant to pay an addition dollar per picture to transfer it to a compact disc.547 On the other hand, manufacturing costs of CDs had dropped dramatically. A Taiwanese company entered the market and reduced prices by 40 percent, turning Kodak’s profitable $100 million business into a $100 million loss maker.548

543 1999c. Eastman Kodak Company Annual Report. Rochester, NY, Symonds, W., Smith, G., & Judge, P. 1999. Fisher's Photo Finish. BusinessWeek(3634) 34-36. 544 Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P. 545 Klein, A. 2000a. Kodak Expects Digital-Imaging to Yield 45% Revenue by 2005. Wall Street Journal, 2000 Jun 15: 0-B14. 546 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4. 547 Blömer, H. J. 1995c. The Picture Is Just the Beginning. Kodak President/ Ceo M. C: Fisher Devises Global Strategy for Digital Future. International Contact, 14(3) May/ June: 4-7, Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29, Smith, G. V., & Parr, R. L. 2004. Intellectual Property: Licensing and Joint Venture Profit Strategies: Wiley. 548 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11.

CASE 187

Second, Kodak was facing stiff competition that brought along monthly (compared to annual) product cycles in which new cameras were put on the market, with ever better quality and lower prices. When Fisher announced his digital imaging strategy in 1994, there was a handful companies that manufactured digital cameras; in 1997, Kodak was facing ten times as many competitors, including Hewlett-Packard, Sony, Canon, and Epson.549 Kodak had a strong foothold in the business due to its competence; however, competitors aggressively followed the imaging giant with their own innovations. Digital camera sales almost doubled every year, listing some 300,000 units in 1996 and 500,000 in 1997.550 In 1999, Sony was no. 1 in the US market, with Kodak second.551

Third, consumers had been slow to adapt to the technology. Compared to film, digital photography still had been a fairly small market, in 1996 accounting for about $200 million, compared to the $9.5 billion film market.552 Test reports mirrored the problems many consumer photographers were facing: Picture-taking with digital cameras sounded liberating, but transferring images to the computer wasn’t as easy as it is today; the software for editing images was complex and time-consuming, and printing pictures was not cheap.553 Moreover, the resolution of digital cameras was still poor, while their price was high compared to traditional cameras, and access to the Internet was scarce. Hence, consumers weren’t really ready to go for digital photography at the turn of the millennium. Actually, Kodak as the incumbent had to “teach” consumers first.

549 Desmond, E. W., & Kahn, J. 1997. What's Ailing Kodak? Fuji While the U.S. Giant Was Sleeping, the Japanese Film Company Cut Prices, Marketed Aggressively, and Now Is Stealing Market Share. Fortune October 27, Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14. 550 1996d. Polaroid Corp.: Its First Digital Camera Targets Midrange Market. Wall Street Journal, 1996 Mar 12. 551 Smith, G. 1999. Film Vs. Digital: Can Kodak Build a Bridge? BusinessWeek(3640) 66-69. 552 Port, O. 1996. The Digital Camera Finds Its Photo Op. BusinessWeek April 14. 553 Himowitz, M. J. 1998. Kodak's Cool Digital Pix Site Drop Off Your Photos at the Drugstore, Go Home, and See Them Online. Kodak's Got a Hot New Web Service. Fortune September 28, Johannes, L. 1998c. Photography: For New Film, a Brighter Picture. Wall Street Journal, 1998 May 05: 0-B1, Lee, J. 1998. Ipix? What's an Ipix? Digital Photography Gets Fortune October 26, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, Sandberg, J. 1998. Digital Cameras Are Better, but Still Waste a Lot of Time, Money. Wall Street Journal, 1998 Jan 15: 0-B1, Weber, T., E. 1999. The Internet --- Advancing the Film: For Those Who Want to Beam Photos over the Internet, Digital Cameras May Be the Way to Go. Wall Street Journal, 1999 Mar 22: 0-R6.

188 Back to Core Business 5.5.8 Another Turnaround After two prosperous years with marvelous returns on assets, Kodak’s financial position changed dramatically in 1997 [see Figure 68, note (1), and Figure 56]. After Fuji set up its facilities in the US to bypass punitive tariffs, an aggressive price war started to harm Kodak’s performance, with a disastrous outcome. The US imaging giant did not just lose market share, but was also forced to reduce its profit margins on its most important photography film business [see Figure 66]. In its first full year of operation in the US, Fuji cut about three to four basis points of Kodak’s market share. For Kodak, this meant a drop in operating earnings of one fourth.554 “For a while we believed it was tactical and was going to go away,” Fisher conceded. “Now we’re not sure what it is, so we’re going to have a cost structure in the company which assumes it’s real, and assumes it’s not going away; Kodak will have to be leaner to compete in the digital arena, too.”555 Fuji stayed.

Three years earlier, Fisher had hoped to outgrow the company’s problem of maintaining a heavy cost-structure. His original plan had called for a transitional phase in which Kodak would fix its balance sheet while promoting growth through geographic expansion and product differentiation. By 1997, he had arrived at a conclusion Wall Street analysts had been advising for years: to cut costs, which were too high to remain competitive. “We would be much better off today, if we had been more aggressive in cutting costs earlier on,” he noted, “ but that’s 20-20 hindsight; the most significant factor the company failed to foresee was the aggressive pricing by competitors.”556 As a consequence, he advised the company to reduce costs by about $1 billion or about 15 percent over the next two years, to change senior and mid-level managers in the core photography business, and to divest the last remaining non-imaging operations.557 The pragmatic reason for his rough course of action: Conquering the digital world required cash, which had to be earned with chemical-based photography products – because there was no other business left that could provide the needed funds.

554 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11. 555 Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07). 556 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4, Pereira, J., & Maremont, M. 1997. Kodak Warns It Plans to Fire 200 Managers. Wall Street Journal, 1997 Sep 26: 0-A, 3:4. 557 1996a. Eastman Kodak Company Annual Report. Rochester, NY.

CASE 189

(1) Kodak realized positive effects of 1993 turnaround;

return on net assets figures soared to the company’s high.

(2) Return on sales and net profit margins dropped due to an aggressive price war.

(3) Kodak enters its sixth major restructuring program, aiming to cut 20,000 employees and $1 billion in costs. Charges for the restructuring burdened Kodak’s financial position and thus economic ratios.

(4) Price war continued to burden Kodak.

Sources all Figures: Data adapted from Eastman Kodak Annual Reports

Figure 68 Net Profit Margin

Figure 69 Return on Sales

Fisher’s cost-cutting program aimed to reduce Kodak’s expensive overhead from about 28 percent of its $16 billion annual revenues, which was well above the industry average and double the costs commonly accepted in the digital businesses, with 15 to 20 percent [see Figure 57].558 Cutting Kodak’s overhead by half, or bringing it at least close to the 20 percent barrier, required cuts in costs for sales, advertising, distribution, and administration by $1 to $2 billion. This was certainly no easy endeavor, though there was also the need to invest, in the hope of generating greater productivity.

558 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1.

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CASE 191

At the end of Fisher’s legacy, in 1999, Kodak’s overhead was cut by $1.1 billion in absolute terms compared to costs in 1996; however, in the same period, total revenues declined from $16 billion to $14 billion, which leveraged overhead to 23 percent. The company greatly improved turnover rates and inventory patterns, hired fewer consultants, set rigid targets to achieve high quality in manufacturing, and slowed down manufacturing [see Figure 71].559

Figure 74

Layoffs and Hires in Kodak’s Core Photography Business Between 1983 and 1999 [Before and After Diversification Efforts]

Sources: Eastman Kodak Annual Reports and Footnote 560 and 564

Certainly one of the most drastic – but expected – measures was Kodak’s announcement of substantial layoffs in 1997. Initial plans to cut the workforce saw about 4,000 employees leaving; however, during the course of the year the number was gradually increased to 10,000, and finally, by the end of the year, to 19,900 of the company’s worldwide 94,800 employees.560 It is important to note that the layoff plan

559 Bulkeley, W. M. 1998. Kodak Profit, Helped by Cost Cutting, Hits Forecasts Despite 7% Sales Decline. Wall Street Journal, 1998 Apr 15: 1-A4, Klein, A. 1999a. Costs Hit Kodak Net, and Stock Falls 10% --- Disappointment over Halt in Curbing Outlays Stirs Doubts on Turnaround. Wall Street Journal, 1999 Jan 15: 1-A3, Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 560 Johannes, L. 1998a. Kodak Reports Loss of $744 Million Including Big Restructuring Charge. Wall Street Journal, 1998 Jan 16: 1-A4, Kerber, R. 1997. Kodak Boosts Layoff Plan, Restructuring Charge. Wall Street Journal, 1997 Dec 19: 1-A, 3:1, Nelson, E. 1997e. Kodak Plans Big Job Cut, Takes Charge. Wall Street

Beginning of 1983 End of 1999

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192 Back to Core Business did not include the number of employees related to businesses divested a year earlier, such as the 1996 sale of the office imaging unit, with 10,400 employees.

The layoff plan substantially burdened the company’s 1997 results [see Figure 73]. A $1.5 billion charge was taken that mostly covered the separation plan, but also included asset impairments.561 Kodak closed the year with net earnings of a marginal $5 million. The whole program was planned to be completed by the end of 1998 and aimed to trim the company’s annual costs by $1 billion.562 By the end of 1998, Kodak had improved operating margins and achieved nearly 75 percent of the projected figure.563 Nevertheless, strong price competition forced the company to incur another round of restructuring. Kodak decided to shed 2,000 to 2,500 jobs within the next two years. Before handing over his position to his second in command, Dan Carp, Fisher increased the number of layoffs to 3,400.564 By the end of 1999, Kodak was trimmed to 80,650 employees, from its all-time high of 145,300 in 1988. Between 1984, when Kodak started to diversify its business portfolio, and 1999, after returning to its core business and consolidating the balance sheet, about half of Kodak’s employees in the photographic segment had been laid off and partially replaced by digital employees [see Figure 74].

Layoffs also affected 200, or one fifth, of Kodak’s 1,000 high-level managers.565

Fisher admitted that it was time to become more aggressive and to change middle and senior managers in the company’s core business. New managers were brought in from Silicon Valley, while long-established ones retired. For instance, he named Willy Shih as president of Kodak’s Digital & Advanced Imaging group. Shih succeeded Bob

Journal, 1997 Jan 17: 0-B2, Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07), Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 561 1997a. Eastman Kodak Company Annual Report. Rochester, NY. 562 Maremont, M., & William, M. B. 1997b. Kodak to Slash 10,000 Jobs, Take Charge --- Moves Aim to Cut Costs by at Least $1 Billion; Shares Still Fall Sharply. Wall Street Journal, 1997 Nov 12: 1-A3. 563 1998. Eastman Kodak Company Annual Report. Rochester, NY. 564 Johannes, L. 1998a. Kodak Reports Loss of $744 Million Including Big Restructuring Charge. Wall Street Journal, 1998 Jan 16: 1-A4, Klein, A. 1999b. Eastman Kodak Net Income Falls a Bit, but Operating Earnings Rise by 9%. Wall Street Journal, 1999 Jul 22: 1-A4, Klein, A. 1999c. Kodak's Results Exceed Expectations on Global Film Sales and Cost Savings. Wall Street Journal, 1999 Oct 19: 0-A8. 565 Pereira, J., & Maremont, M. 1997. Kodak Warns It Plans to Fire 200 Managers. Wall Street Journal, 1997 Sep 26: 0-A, 3:4.

CASE 193

Unterberger, who resigned to follow other opportunities.566 Previously the new president had been in charge of commercializing high-end computer workstations at Silicon Graphics and enjoyed good connections to many technology companies, which made him predestinated for developing strategic alliances.567

The director of Kodak’s professional photography unit, however, retired at the age of 54.568

Kodak also divested the remaining few non-core-imaging businesses and outsourced where it was economically worthwhile. Shortly after his appointment as chief executive, Fisher had considered the strategic alternative of repositioning Kodak’s Office Imaging businesses, which comprised copiers, document management systems, and publishing systems, in order to improve its poor performance.569 At that time, he even seriously considered shedding the copier business altogether; the division had suffered from high R&D costs, stiff competition from market leader Xerox, and its products had underperformed.570 The 20 percent market share of Kodak’s copier business was too small to compete successfully; Xerox’s share was twice that.571 Hence, in the face of severe price pressure in the company’s core film business, Kodak finally decided to divest the struggling unit, which generated annual revenues of $1.8 billion but poor earnings.572 In late 1996, Kodak sold its copier service business to Danka Business Systems PLC for $688 million.573 While sales and marketing moved to Danka, the manufacturing and development of copiers remained at Kodak. Approximately 10,400 Kodak employees supporting the unit worldwide were offered employment by Danka.574 After continued price pressure, in 1999 Kodak sold the manufacturing part of its copier operations to Heidelberg Druckmaschinen AG, a

566 Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14. 567 Grant, L. 1997b. Missed Moments Critics Say Kodak's Fisher Made Three Big Mistakes. Fortune October 27, Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14. 568 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1. 569 1995b. Eastman Kodak Company Annual Report. Rochester, NY. 570 Bounds, W. 1996g. Kodak Planning to Sell Copier Division; Poor Earnings, Stiff Competition Cited. Wall Street Journal, 1996 Jan 16. 571 Nelson, E., & Wendy, B. 1996. Kodak Is in Talks with Britain's Danka to Sell at Least Part of Copier Business. Wall Street Journal, 1996 Sep 06: 0-A2. 572 Bounds, W. 1996g. Kodak Planning to Sell Copier Division; Poor Earnings, Stiff Competition Cited. Wall Street Journal, 1996 Jan 16, ibid., Nelson, E., & Wendy, B. 1996. Kodak Is in Talks with Britain's Danka to Sell at Least Part of Copier Business. Wall Street Journal, 1996 Sep 06: 0-A2. 573 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 574 ibid., 1996c. Kodak Sells Office Imaging Business to Danka. International Contact, 15(3) May June.

194 Back to Core Business German manufacturer of offset printers.575 Kodak and Heidelberg had collaborated since 1994 in the manufacturing of digital printing machines.576 Close to the end of the year, the deal was signed for $200 million and 1,500 Kodak employees were transferred to the German manufacturer.577

Other businesses that Kodak sold or shut down in the course of its massive cost-cutting program were, among others, the manufacturing of disc film; the digital motion imaging business, which developed hardware and software for films but was never profitable; the manufacturing of compact discs; and, last but not least, Kodak’s gelatin plant, which it had acquired in 1930 to secure the quality of an essential component in the making of film.578 The divesture of Kodak’s Image Bank – a collection of photos – was the company’s last divesture during Fisher’s leadership. It sold the electronic collection to Getty Images for $183 million.579

Finally, the company considered possibilities to outsource operations or to engage in collaborative agreements to reduce expenses. For Kodak, it did not make sense either to manufacture in-house compact discs or to compete in the digital camera hardware business with the rest of the world, particularly with Asian competitors.580 For instance, a new Taiwanese manufacturer started to produce compact discs at one fourth of Kodak’s price. Kodak’s $100 million profitable compact disc business, which was selling blank CD-R discs for non-PhotoCD users, suddenly turned into a $100 million loss operation.581 Likewise, Kodak was seeking to engage in collaboration or to merge with companies with capabilities the company was lacking in its effort to conquer the digital world, but could not afford to build by itself due to price pressure. Kodak approached Hewlett Packard, IBM, Xerox, and Canon, among

575 Klein, A. 1999g. Kodak Plans to Sell Copier Unit to Heidelberger. Wall Street Journal, 1999 Mar 17: 1-A3. 576 Ibid. 577 1999d. Heidelberger Agrees to Buy Copier Unit from Eastman Kodak. Wall Street Journal, 1999 Mar 18: 1-B19. 578 1997d. Kodak May Spin Off or Sell a Unit as Part of Cost-Cutting Plan. Wall Street Journal, 1997 Oct 21: 1-C30, 1997e. Kodak to End Disc Film. Wall Street Journal, 1997 Jan 27: 0-B, 10:13, Klein, A. 1999i. Who Knew Kodak Would Keep So Many Skeletons in Its Closet? --- Company Grinds Cow Remains but Has to Keep Its Costs Close to the Bone to Survive. Wall Street Journal, 1999 Jan 18: 0-A1, Maremont, M., & William, M. B. 1997a. Kodak's 10,000 Job Cuts May Really Amount to Just 8,000 at End of the Day. Wall Street Journal, 1997 Nov 13: 1-A4. 579 1999b. Business Brief -- Getty Images Inc.: Kodak Photo-Archive Sale to Be Set at $183 Million. Wall Street Journal, 1999 Sep 22: 1. 580 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 581 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11.

CASE 195

others, but none of these negotiations were successful.582 Terry Faulkner, then Kodak’s corporate strategist, identified the company’s obligations to hundreds of thousands of retired employees, as well as environmental issues, as the cause for breaking off negotiations.583 In the mid-1990s, a lot of publicity was given to the contamination of the land at Kodak Park, where chemicals had been dumped over the years.584 An acquisition or merger with Kodak would certainly be associated with unpredictable cleanup costs.

In conclusion, George Fisher’s strategy to re-focus on Kodak’s core photography business and to outgrow the company’s cost problems by promoting growth did not take off. It was thwarted by a fierce price competition in its domestic markets, stagnation of the photography industry in general, and the slow development of emerging markets. Moreover, the digital imaging business remained a loss maker throughout the 1990s. Kodak’s balance sheet was in trouble, and in order to consolidate the company’s core business and to secure the continuation of a viable cash stream for digital ventures, the CEO was forced to overcome his opposition to huge workforce reductions and to massively cut costs. In fact, he was required to continue a course of action previous executives had heavily relied on.

But unlike his predecessors he achieved a financial performance such as neither Colby Chandler nor Kay Whitmore had managed to accomplish between 1983 and 1993, – albeit his achievements in giving the company a clear vision to challenge a nascent disruptive technology and to face an unprecedented fierce competition. In particular, Fisher greatly improved return on equity, achieving a financial ratio the company had witnessed for the last time during the 1970s [see Figure 76].

582 Faulkner, T. 2009. Draft for a Talk That I Gave at Oak Hill to Retired Ek Managers. 583 Faulkner, T. 2013a. Personal Interview. November 04. With M. Shamiyeh, Faulkner, T. 2013b. Personal Interview (Follow-up). November 26. With M. Shamiyeh. 584 1989b. Environmental Group Says Kodak Is Major Emitter of Chemical. Wall Street Journal, 1989 Jun 20: 1, 1992g. Whatever Its Merits, Photography Can Be Incredibly Wasteful --- Film Spools and Packages Are Very Difficult to Recycle; Kodak Signs a Contract. Wall Street Journal, 1992 Feb 11: 0-PAGE B2, Bounds, W., & Noah, T. 1994. Kodak Will Settle Government Claims on Environment. Wall Street Journal, 1994 Oct 07: 0.


(1) Shareholders’ equity adjusted for the favorable gains Kodak generated through sales and the deletion of debts.

Figure 75

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Figure 76 Average Return on Equity and

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On average, he returned 23 percent of shareholders’ equity, more than double what Chandler had realized – not to speak of Whitmore’s performance during the early 1990s. One might wonder how he was able to do this. At a first glance, the increase of stock buybacks during his leadership suggests that he used the income of the many divestures to reduce equity and to improve the return on equity ratio, which would be completely detrimental to shareholders’ interests. A detailed analysis of Kodak’s cash flows and financial position shows, however, that the opposite was true. In fact, Fisher slightly increased shareholders’ equity during his tenure, freed the company of its high long-term borrowings, and substantially improved efficiency.

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CASE 197

(1) Shareholders’ equity

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Figure 77 Shareholders’ Equity, Retained Earnings, and Treasury at Stock

Changes on Average in CEO Period. Dollar amounts in millions. Sources all Figures: Data adapted from Eastman Kodak Annual Reports

In 1982, shareholders’ equity reached an all-time high of $7.5 billion [see Figure 75]. In the following decade, equity remained relatively constant. Chandler’s business development neither increased nor decreased equity significantly. Additions to retained earnings on average compensated expenses for the few share buybacks, offsetting the favorable effectof a lower equity in regard to financial ratios such as return on equity. Figure 77 synthesizes the matter. The diagram to the far left shows the relative increase or decrease of shareholders’ equity during Chandler’s leadership (black bars), the amount of share buybacks, which decrease equity (middle bars), and the increase or decrease of retained earnings (on the far right).

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198 Back to Core Business In 1993, the situation changed tremendously when the company’s equity suddenly was almost cut to half. This drop occurred because Kodak spun off its chemical unit. As a consequence, about twenty percent of the company’s equity left with Eastman Chemical, which equaled the unit’s share of earnings in the company’s overall income. Hence, the spin-off had no favorable effect on the return on equity ratio, because the reduction of shareholders’ equity mirrored the reduction of income. The other thirty percent, however, severely altered the level of equity (and thus financial ratios). During the late 1980s and early 1990s, Kodak’s overwhelming cost structure burdened the company’s balance sheet, to the extent that it was not able to retain earnings (and thus increase its shareholders’ equity); rather the opposite happened. Kodak started to extensively consume its retained earnings, shrinking the company’s equity. Kodak’s expensive retirement plan accounted for a good deal of the reduction. As a consequence, Kay Whitmore realized a negative return on equity on average [see Figure 76 and Figure 77].

During George Fisher’s era, the level of equity at first went up, but then fell continuously in consecutive years; changes in retained earnings almost mirrored changes in the company’s treasury stock, suggesting that Kodak used its discretionary cash flow to repurchase outstanding shares [see Figure 75]. Indeed, the company invested heavily in its own stock, but on average equity remained stable, even growing by 3 percent [see Figure 76]. The company basically leveraged additions to equity it had achieved earlier due to high income. And the cash-for-stock buybacks did not come from proceeds the company generated in the course of divestures, but from improved efficiency.

A cash flow analysis of Kodak between 1994 and 1999 reveals that Fisher’s divesture of the company’s non-imaging businesses generated proceeds as high as $7.8 billion, of which he used $7.1 billion to extinguish long-term debts for the most part associated with Chandler’s diversification efforts and the acquisition of Sterling Drug Inc., among other businesses. The vast bulk of cash from sales was earned in 1994, in Fisher’s first year as chief executive. Even if one adjusts shareholders’ equity for the favorable gains Kodak generated through sales and the deletion of debts, the return on equity was still about 21 percent (see Figure 76 and Figure 77 note (1)].

CASE 199

Kodak’s buyback of outstanding shares started in 1996, which indicates improvements in efficiency. During Fisher’s tenure, the company doubled the ratio of net earnings per employee compared to the performance Kodak was used to in the 1970s and 1980s [see Figure 60]. Moreover, it is important to note that until the 1990s, Kodak basically maintained a monopoly. Competition in the US was marginal. Fisher was the first Kodak executive to be challenged by the impact of fierce global price competition under unequal conditions. From this point of view, George Fisher’s achievements had been fruitful.

6 ANALYSIS

This chapter refers to the elaborated process model of resource allocation discussed in the theory section to categorize and interpret observations from the Kodak study. Underlying intention of developing an expanded model of the resource allocation process, to recap, is to explain Kodak’s intra-organizational investment pattern in response to the emergence of electronic/ digital photography. The new imaging technology disrupted and redefined the product performance demanded by customers in the company’s traditional chemical-based film markets.

Kodak, previously one of the top Fortune 500 companies, pursued multiple businesses. Numerous entrepreneurial initiatives competed for funding within the company’s intra-organizational ecology. This situation renders a close examination complex, if not problematic. The following elaboration, therefore, puts the prime focus on Kodak’s photography business. That is to say, it illuminates aspects that are important to understand the company’s strategic decisions related to investments in (or disinvestments of) businesses, but provides detailed information only of incidents that are directly connected with the photography business. Hence, the consequences of strategic investments for non-photographic businesses are not covered in detail.

Based on the argument outlined in the theory section, four variables influence an intra-organizational resource-allocation process – the structural and strategic context, powerful customers and capital providers, cognitive frames, and an organization’s current resources and capabilities.

In the following section, findings are structured according to these four variables. The discussion is organized in three separate eras: Electronic photography (Colby Chandler, 1983-1989), Film-based Digital Imaging (Kay Whitmore, 1990-1992), Fully Digital World (George Fisher, 1993-1999):

202 Period 1983-1989: Electronic Photography (Colby Chandler) 6.1 Period 1983-1989: Electronic Photography (Colby Chandler)

“On a product basis, they [Kodak’s senior management] paid attention to film; other products could be handled by lower levels of management.”585

Bob Shanebrook, Worldwide Product Manager Kodak Film

Sony’s worldwide presentation of its prototype for a “revolutionary” new electronic still video camera in 1981 annoyed Kodak – not so much because of the camera, but because of Sony’s public announcement of the beginning of the filmless era. Sony’s MAVICA (MAgnetic VIdeo CAmera) clearly marked the advent of an emerging disruptive technology, although industry leaders shared the belief that it would take decades to replace traditional silver-halide film. Kodak was therefore reluctant to bring its own developments in electronic photography to market. However, in the face of Sony’s move, the industry leader accepted the challenge willy-nilly.

In response to Sony, Kodak announced that it was moving into consumer electronics late in 1983. In the course of a large restructuring process, the company created the autonomous and independent Consumer Electronics Division (CED). The plan appeared to be coming to fruition. A year later, Kodak launched the world’s first 8-mm camcorder system, the Kodavision 2000 Series, among other products. The movie camera was developed in cooperation with Matsushita and built in Japan. Unique manufacturing know-how and low costs for manufacturing compared to those in the US rendered the cooperation feasible. Two years later, however, Kodak decided to leave the consumer electronic business.586 The lack of manufacturing resources, coupled with the promise of low profit margins compared to traditional film, motivated the company to exit the business altogether, preferring to strengthen its traditional photography business and to continue to deploy electronics solely in commercial applications.

585 Shanebrook, R. L. 2013a. Email Conversation. November 10. With M. Shamiyeh. 586 Some people close to the case suggest that one key reason Kodak created a “Consumer Electronics Division” was to sell videotape, which was had high margins at the time. In electronics, following their view, Kodak initially thought that selling the electronic recording media was the key to making these businesses profitable. In fact, aim of selling 8 mm camcorders was to generate a buzz as a high-tech company, so that it would be better positioned to sell videotape, which the company continued to do so for many years, well after stopping sales of 8 mm camcorders. Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh.

ANALYSIS 203

Early 1980s: (1) Kodak frames electronic photography as an opportunity (2) Kodak creates independent business units to drive innovation (3) Kodak makes low commitment to electronic ventures

Mid-1980s:

(4) Kodak trades investments in electronics against film (5) Kodak exits consumer electronics

Figure 78

Process Model of Eastman Kodak’s Resource Allocation

Figure 79 Silver-halide Photography

Technology and Digital Imaging

6.1.1 Cognitive Framing: Electronic Photography = Business Opportunity Kodak had already started to explore the potential of electronic-imaging sensors in the early 1970s, even before the Japanese got in. In 1980, for instance, Kodak built an electronic industrial camera deploying a black-and-white image sensor with 240 lines and 192 pixels per line, which is less than 50 thousand pixels, which cost between $11,500 and $18,000.587 However, Sony’s presentation of its prototype for a filmless camera in 1981 “shocked” the company – an event that three out of four interviewees recalled:

587 Ansberry, C. 1987d. Makers of 'Still-Video' Cameras Refocus Marketing Efforts on Commercial Users. Wall Street Journal, 1987 Jun 24: 1.

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204 Period 1983-1989: Electronic Photography (Colby Chandler) Bob Laperle, for instance, who then was Kodak’s senior marketing planning specialist, remembered the announcement of the Sony MAVICA as “one of the best things that ever happened to the company, because it sent a shockwave through the company, because even though it was based on a floppy disc, and even though all you could do is look at it on a TV, it was filmless; we all felt that shockwave, that was a healthy shockwave to feel.”588 Peter Palermo, Kodak’s senior vice president of imaging at the time, described the announcement as a “disaster, because it caused senior management to panic.”589

Figure 80

Eastman Kodak’s Framing of Emerging Technology (Early 1980s) Diagram adapted from Gilbert (2006)

Nevertheless, Kodak did not regard electronic photography as an immediate threat. According to Kodak and other individuals close to the industry, it was still in its infancy and not competitive with chemical-based photography in terms of quality, cost, and performance. Most available image sensors produced photos with some 300,000 picture elements or pixels to be viewed on a TV set whose standard resolution was a fraction of that of regular 35-mm film, which equaled some 18 million pixels; the costs of conventional cameras was low compared to electronic still video cameras, which were sold for several thousand dollars; and finally, some considered the contrast 588 LaPerle, B. 2013. Personal Interview. November 21. With M. Shamiyeh. 589 Palermo, P. 2013. Personal Interview. November 22. With M. Shamiyeh.

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ANALYSIS 205

range of TV sets to be limited and the television image too far away to allow close scrutiny.

Just a few days after Sony's announcement in New York of its MAVICA system, Kodak’s president Colby Chandler said that an all-electronic camera may have appeal for some consumers, but

“it remains to be seen whether such a camera could be offered at mass-market prices, and whether the filmless camera could – or would – offer benefits comparable to those available from traditional products. Silver-halide-based photography continues to be far and away the technology of choice for the creation of color photographs under the wide range of shooting and lighting conditions encountered by the typical amateur.”590

To illustrate his point with respect to the differences in performance between the two technologies, Chandler presented the following case:

“If you were to calculate the storage capacity of today's Kodacolor II film in terms of ‘bits of information,’ you would find that one 35-mm frame of film can store more than the maximum internal memory capacities of 100 home computers. If this image were displayed on television, you would need less than one-quarter of a 110-size film frame – or one-twentieth of a frame of 35-mm film – to get a full-color, acceptable image by today's TV standards.”591

Chandler concluded that “it was unclear whether consumers would be satisfied with a picture generated from a million-element sensor,” and that they “would continue to demand the high picture quality of current products.”

It is important to note that Chandler’s announcement received extensive support from Kodak’s technical staff; that is to say, rather than trying to downplay the impact of a new disruptive technology, management’s statement seemed to reflect a widely shared conviction. Larry Matteson, for instance, then vice president of Kodak Apparatus Division, explained in response to Sony’s MAVICA that

“images fly by so fast on a TV screen that no one notices that by the standards of still photography, each individual image is pretty poor. The still-photography challenge is to produce a camera with enough electronic ‘brainpower’ to record the

590 Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f. 591 Ibid.

206 Period 1983-1989: Electronic Photography (Colby Chandler) same amount of detail that can now be captured on a piece of conventional film –and to build it cheaply enough to appeal to an average consumer.”592

Kodak’s perception of electronic photography as being no threat to traditional silver-halide photography was echoed widely in the industry. There was a general belief that electronic imaging wouldn’t hit consumer markets before 1990.593 To demonstrate the industry’s skepticism about the new technology, two leading authorities are quoted:

Six years after the announcement of the MAVICA, in 1987, the professional journal Popular Photography noted that

“these filmless cameras, which use video floppy disks as the recording medium, present no immediate threat to traditional silver halide-based photography, but the new crop now hitting the market shows that there is some fire behind all the smoke.”594

The 1987 Industry Report by the American Photographic Association supported this view, even expressing concerns about ever newer technologies. It said:

“From Sony’s 1981 introduction of the MAVICA electronic still camera, and subsequent prolonged gestation period, to Samsung's ‘dance of the veils’ flirtation with a 4mm DAT camcorder, the video industry continues to show a propensity to dazzle the trade while confounding the consumer. This consumer confusion is aided and abetted by business, trade and consumer press giving extensive coverage to the newest technological breakthroughs and product developments. The downside is the potential for lost sales as a result of the ‘wait till you see what’s coming next’ syndrome.”595

6.1.2 Structural and Strategic Context: Integrated and Film-Centric Kodak shared the “wait-and-see” attitude. The company’s towering presence in the consumer marketplace, together with its carefully cultivated reputation for high quality, largely blunted Sony’s attack. Rather than perceiving electronic imaging as a threat, the US photography giant arrived at the conclusion that the new technology represents an opportunity that would eventually contribute to consumer’s desire to

592 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91. 593 Beam, A. 1985. The Filmless Camera Is Here, but Will It Sell? Business Week(April 15) 151f. 594 Goldberg, N. 1987. Electronic Imaging Today: Fast-Breaking Developments Have Sti Rred New Interest in Video and in Electronic Still Photography. Here's the Latest from Our Reporters in the Field. . Popular Photography(September) 68-71. 595 Lewis, B., Washburn, P., & Harrand, B. 1988. The 1987 Pma Industry Trends Report - a Performance and Trend Analysis of the Worldwide Photo/ Video Market. In P. M. A. International (Ed.): 146. Jackson, Michigan.

ANALYSIS 207

have the “convenience of electronic viewing.”596 In 1981 Chandler noted, for Kodak “the best approach for the future was toward ‘synergistic combinations of the two technologies – chemical imaging and electronics – uniquely joined to make picture-taking easier and more enjoyable.”597 As a consequence, at Kodak electronic imaging was explored within the boundaries of its bedrock business, traditional photography, which accounted for some 80 percent of Kodak’s sales.598 Ken Parulski, for instance, recalled that two days after the Sony announcement, the CEO came to the labs and asked, “What are you going to do to respond to Sony's MAVICA, what are we going to do with Disc [camera]?”599 Back then Ken Parulski was a research scientist at the Image Science Laboratory of Kodak Research and could not remember exactly who came up with the idea of bringing images from the disc film-negatives to video, but they were told, “Hey, drop what you’re doing; that’s what you’re going to work on for the next year.”600 Management’s note in the annual report mirrored that course of action; it said: “As we continued to promote and to maintain our foundation in traditional photography on a worldwide basis, we also strengthened our position in newer technologies.”601 The Disc film to video player, which was later presented at Photokina in 1992, introduced the “hybrid” strategy that later gave rise to PhotoCD.

6.1.3 Realized Strategy: Flexible Plan, Low Commitment In 1984, Kodak decided to restructure Kodak’s photographic division into 17 independent and autonomous business units, to direct thrust at the marketplace and not at functional disciplines, as had been the case in the past. Since then, line managers were responsible for all aspects of their own products. Major intention of this restructuring program was to increase reaction time to market changes, motivate innovation, and to define clear financial targets. To nurture ideas which did not fall neatly into existing lines of business, the company established a Venture Board and the Offices of Innovation, where new ideas were collected and screened for new opportunities.

596 Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f. 597 Ibid. 598 1983a. Eastman Kodak Company Annual Report. Rochester, NY. 599 Parulski, K. 2013b. Personal Interview (Follow-up). November 20. With M. Shamiyeh. 600 Ibid. 601 1983a. Eastman Kodak Company Annual Report. Rochester, NY.

208 Period 1983-1989: Electronic Photography (Colby Chandler) The Consumer Electronics Division was created within the company’s Photographic Products Division. Its mission included electronic imaging. Wilbur J. Prezzano, general manager of photo products, insisted that the new division “won't be distracted by our [Kodak’s] traditional interest in photography.”602

Figure 81

Eastman Kodak Office of Innovation’s Idea Connection Process Source: see Footnote 603

Within a year, Kodak’s strategic focus had changed. In its 1984 annual report, the company presents its newest efforts to integrate “optics and electronics to supplement

602 Beam, A. 1985. The Filmless Camera Is Here, but Will It Sell? Business Week(April 15) 151f. 603 Chandler, C. H. 1986. Eastman Kodak Opens Windows of Opportunity. Journal of Business Strategy, 7(1) 5-8.

ANALYSIS 209

its chemical-based products.”604 Kodak’s management publicly acknowledged that “there are excellent growth opportunities for our current products, as well as for those future offerings that combine the benefits of photographic and electronic imaging;”605 and Edwin Przybylowicz, Kodak’s director of Research, outlined the cornerstones of the company’s growth: “concentrating on imaging sciences and leading to innovative products based on silver halide, electrophotography, and electronics.”606 Kodak had clearly committed itself to electronic imaging and was pushing the development of multiple electronic imaging applications, building upon the “hybrid” approach. Among others there was: Kodak Information Management System (KIMS) to electronically manipulate images and texts stored on microfilm or magnetic tape; the Color Video

Imager, which could make instant prints from a video signal; and the Eikonix

Designmaster, which allowed the editing of scanned images for printing. In consumer electronics, Kodak launched the world’s first 8-mm camcorder, the Kodavision 2000

Series.

Nevertheless, Kodak’s commitment particularly to consumer electronics was low. In the mid-1980s, Kodak employed some 130,000 employees worldwide and 80,000 in the US. The Apparatus Division, the equipment-manufacturing organization for Kodak, counted some 20,000 employees at the same time;607 and, Kodak’s research lab was staffed with some 2,000 employees in 1978.608 Between 1978 and 1985, R&D budgets tripled, which suggests that the number of researcher increased too during this period. At the Consumer Electronic Division, however, at its peak there were about 300 people.609 Given that this division addressed the needs of customers (or potential customers) of Kodak’s most important market, the company’s commitment was low. The division was also small compared to Japanese engineering divisions. Sony, Matsushita, and other large Japanese manufacturers of video equipment were already years ahead in electronic still photography.610 Kodak entered the market late and with low commitment. Moreover, Kodak tried to push a single product type – a camcorder

604 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 605 1985b. Eastman Kodak Company Annual Report. Rochester, NY. 606 Ibid. 607 Matteson, L. 2013. Personal Interview. November 20. With M. Shamiyeh. 608 1978. You and Kodak in Perspective: Careers in Engineering, Science, Administration and Marketing. Rochester, NY: Eastman Kodak Company. 609 Paxton, K. B. 2013b. Personal Interview (Follow-up). November 19. With M. Shamiyeh. 610 Snyder Hayes, L. 1981. What's Kodak Developing Now? Fortune(March 23) March 23: 78-91.

210 Period 1983-1989: Electronic Photography (Colby Chandler) plus videotape – through a channel it had never been part of and where competing companies like Sony, Panasonic (Kodak’s supplier), and RCA were already well positioned with a broad range of products.611

Kodak’s commitment to electronic photography was also low in terms of funding. Many new product initiatives never made it to the market or were stopped shortly after their introduction, as happened with the Kodavison camcorder, the Modular Video

System, the Color Video Imager, and the Still Video System. There was a congruent observation among engineers, product managers, and the president of the division that they never got the resources required to really become successful.612 Don Pophal, for instance, described the situation as follows: “They never got the resources they needed to bring it out the door. It was always a battle for funding, for resources, for R&D dollars, to get the resources that you needed to get the job done.”613 He led several teams of people to commercialize a product from concept to manufacturing.

Management’s lack of confidence in the new technology was regarded as one important reason for the shortcomings. Statements such as, “This will never fly,” “We have this thing called film – why would anybody want digital?” or, “Sorry, why would anyone want this video-imaging technology when they had film?” are just representative of the many accounts team members heard from management.614 The uncertainty about the success of new electronic photography products rendered initiatives risky, compared to consumer products in film where investments had a proven track record and fast payback, with little risk. Electronic photography simply did not reveal this strength. For people involved in electronic photography, in particular consumer electronics, it was difficult to put forth an effective plan, with the players, management, products, strategy, target markets, tactics, and organization all in constant flux.615 Bob Shanebrook, a worldwide product manager for Kodak film who had earning responsibility for each product-line, including R&D for product development and commercialization, summed up the situations as follows:

611 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 612 Paxton, K. B. 2013a. Personal Interview. April 08. With M. Shamiyeh, Paxton, K. B. 2013b. Personal Interview (Follow-up). November 19. With M. Shamiyeh, Pophal, D. 2013. Personal Interview. November 4. With M. Shamiyeh, Wolcott, D. 2013. Personal Interview. April 10. With M. Shamiyeh. 613 Pophal, D. 2013. Personal Interview. November 4. With M. Shamiyeh. 614 Wolcott, D. 2013. Personal Interview. April 10. With M. Shamiyeh. 615 Shanebrook, R. L. 2013a. Email Conversation. November 10. With M. Shamiyeh.

ANALYSIS 211

“I had to compete for R&D funding with emerging technologies. For the twenty years I was the product manager for professional films, we met every development product goal for features, cost, sales, and schedule. The success of the professional film community allowed us to obtain funding for our projects. We were funded because the risk to the corporation was low and the payback high. This success made it difficult for emerging technologies to obtain sustained funding. In a sense, the success of the film business provided barriers to emerging technologies.”616

Management’s short-term thinking, coupled with the prospect of low profit margins in a hardware business (as opposed to Kodak’s consumable film business), rendered the “fight for funds” even more difficult for all those engaged in electronic imaging. Both, employees from Kodak’s traditional photography film business and those from electronic imaging, reported similar observations: First, the company’s strategic process, the Strategic Quantification Process, motivated short-term thinking. Management was looking forward a year or two, not beyond that, which had a negative effect on all business plans on consumer electronics that could not rely on a proven track record.617 Second, only initiatives with prospective profit margins close to film received attention from senior management.618 Film proposals made access easy; others need not apply.

It is important to note that at Kodak, management’s response to new initiatives was not clear in the first instance. Indeed, initiatives related to electronic imaging received “personal” attention from management, but resources were not made available as required if project did not meet expectations. Employees from several organizational levels support this finding. Brad Paxton, for instance, who was running the Electronic Photography Division, was well connected to senior management and could make a case for the Still Video System; however, resources were never made available to bring it to market.619 According to Don Pophal, a common procedure was to be asked to take ten or twenty percent out of next year’s budget. This did not lead immediately to a shutdown of the project; but many projects eventually got shut down because of this.

616 Ibid. 617 Shanebrook, R. L. 2013b. Personal Interview. April 09. With M. Shamiyeh. 618 Pophal, D. 2013. Personal Interview. November 4. With M. Shamiyeh, Shanebrook, R. L. 2013a. Email Conversation. November 10. With M. Shamiyeh. 619 Wolcott, D. 2013. Personal Interview. April 10. With M. Shamiyeh.

212 Period 1983-1989: Electronic Photography (Colby Chandler) 6.1.4 Resources and Capabilities: Low Discretionary Cash Flow, Film-Centric Kodak’s Consumer Electronic Division faced several problems in developing and launching the Kodavision camcorder: First, Japanese companies were years ahead in consumer electronics. The last movie camera Kodak made serious attempts at developing was in 1976. As a consequence, the company decided to design and manufacture the new camcorder in partnership with Matsushita in Japan, which resulted in poor profit margins for Kodak.

Second, hardware for electronic photography was sold through different distribution channels than film companies used to sell their equipment and consumables. Most notably, consumers bought the counterparts to standard photographic cameras and film, including video cameras/camcorders, blank videotapes, video camera accessories, etc., at mass merchandisers that specialized in electronics.620 This generated a severe problem for Kodak. Japanese firms such as Panasonic or Sony were already selling TVs and VCRs and all the other equipment. For Kodak, which entered consumer electronics late and with only an 8-mm camcorder, it was very hard to get shelf space. Moreover, people had already become accustomed to the VCR, whose unit sales nationwide grew by some 50 percent a year in the mid-1980s.621 Hence, Kodak required a large sales staff (and thus money) to get into the market. One employee close to the commercialization process of the Kodavision described the situation as follows:

“When we [Kodak] were starting up, any time you start up, you just cannot afford to spend a lot of cash without sales. And we were spending a lot of cash on putting salespeople out into the marketplace to buy shelf space so we could sell the product [Kodavision]. But we were spending so much money on those people that we were never going to make it back, no matter how much of the products we sold. Because the products in the hardware business are not profitable, and certainly not like film. And so, the business case just didn’t fly at that time for Kodak.”622

Thirdly, which is closely related to the other two issues, the hardware business did not return high profits. In the case of Kodavision, it was even worse, because volumes 620 International, M. R. D. o. P. M. A. 1987. Guide to the Photo Market for Mass Merchandisers. In P. M. A. International (Ed.): 140. Jackson, Michigan. 621 Lewis, B., Washburn, P., & Harrand, B. 1988. The 1987 Pma Industry Trends Report - a Performance and Trend Analysis of the Worldwide Photo/ Video Market. In P. M. A. International (Ed.): 146. Jackson, Michigan. 622 Wolcott, D. 2013. Personal Interview. April 10. With M. Shamiyeh.

ANALYSIS 213

were relatively low and the prices Kodak was being charged by Matsushita fairly high. Thus, the alternative to enhance profitability by building internal manufacturing capabilities for the cost of some $1 billion was weighted against investments in film.

Figure 82 Eastman Kodak Consumer Business Portfolio Matrix (Mid-1980s)

In the mid-1980s, Kodak’s traditional photography business was in trouble too. Return on assets had fallen from some 25 percent in the late 1970s to 5 percent [see Chronology Figure 8]; Fuji had aggressively captured market share in the US and forced Kodak to cut its profit margins; and, finally, the imaging giant was still suffering from the disappointing product launches and the discontinuance of instant photography following its loss in the Polaroid patent-infringement suit. As a consequence, in 1985 and 1986, Kodak was forced to fall back on long-term borrowing to pay dividends and provide funds for capital additions. Kodak was not able to cover expenses with earnings from operation, let alone with reserves in cash or cash equivalents such as marketable securities. Thus, in the mid-1980s, Kodak was confronted with the choice between (at least) two competing businesses in the consumer market: to extensively fund (with long-term borrowings) either consumer

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214 Period 1983-1989: Electronic Photography (Colby Chandler) electronics with a prospect of low profit margins and the challenge of competing against Japanese rivals in order to achieve a leading market position, or, to strengthen the leading market position of its traditional photography business by investing heavily in efficiency improvements and advertising.

6.1.5 Realized Strategy: No Commitment At the time electronic-imaging technologies were brought to market, technologies that were not based on the traditional silver-halide-based film that had long maintained Kodak’s cash cow, the US imaging giant decided to exit consumer electronics. As people both inside and outside Kodak observed, there was no new product that approached the proprietary position and the high profit margin of Kodak's blockbuster color film. Kodak was fully aware of this situation when Leo J. Thomas, then director of Kodak Research, noted that “it's very hard to find anything [with profit margins] like color photography that is legal.”623 And CEO Colby Chandler added, “It was clear to us that it would take more than a new Kodacolor film or a new disc camera. It would take a whole new area – like life sciences – or it would take massive expansions into areas we hadn't participated in very much before.”624

In other words, Kodak was less certain about its leap into consumer electronics and therefore exited the business altogether, after two years of struggling to define the company’s role in that volatile market.625 After that, Kodak decided to apply electronics to a limited array of non-consumer products. Besides the reasons elaborated above, Kodak was certainly cautious about marketing products that would take business away from its highly profitable photographic segment. Electronic-imaging equipment such as still video cameras and optical discs promised to compete with traditional photography for consumer dollars in the near future.

Significantly, employees from both the traditional and electronic photography divisions observed an obvious lack of management interest in alternatives to film, By comparison, the other businesses were poor performers; staying with a business that was never going to have the return of film was considered a poor choice and not worth the effort. 623 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 624 Ibid. 625 Ibid.

ANALYSIS 215

Figure 83

Eastman Kodak’s Framing of Emerging Technology (Mid-1980s) Diagram adapted from Gilbert (2006)

“This also goes back to ‘looking for the big idea,’ commented a person close to decision-making; “we kept looking for a business that was as good as the film business. When it became apparent that a new venture wasn't going to come close to the standard set by film, interest was lost and yet another new venture was explored.”626

The behavior was partly explained by the typical career path of managers. Kodak managers usually advanced from Kodak Park, which is where the company manufactured film, to a leadership position. They were very much embedded in the silver-halide world, employees noticed, so that they were by and large reluctant to do anything that might hurt their asset called Kodak Park. The omnipresent phrase, “It’s not Ektachrome,” weighted all developments against film.627

626 Shanebrook, R. L. 2013a. Email Conversation. November 10. With M. Shamiyeh. 627 Paxton, K. B. 2013b. Personal Interview (Follow-up). November 19. With M. Shamiyeh.





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6.2 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore)

“Don't expect huge announcements. The changes will be incremental.”628 Kay Whitmore

In the late 1980s, Kodak again saw itself faced with the question whether it should enter consumer electronics. Japanese companies began to market their versions of analog-electronic cameras to consumers, and industry insiders more and more accepted the belief that in the 1990s, the rapid development of electronic imaging would change the traditional silver-based photography business in many areas: consumer products, photo (image) processing, printing, publishing, and communication.

Kodak’s threat-induced response to the upcoming industry change was a half-hearted attempt to control existing resources, rather than searching for new solutions: Constrained by its former strategic choices (and thus resource commitments) to silver-halide developments and by increased pressure by shareholders to rely on business with prospects of high profit margins, the company decided to “enhance and sustain the life of traditional photography” by betting on hybrid technologies, that is, by using both traditional silver-halide and electronic imagining for the benefit of customers.629 The PhotoCD system was the embodiment of Kodak’s new film-based digital imaging strategy. It aimed at establishing a new standard of electronic image quality for television display, transmission, and printing. Images captured on film and transferred to PhotoCD provided quality superior to even the most advanced electronic still photography systems, while giving both consumers and professionals the convenience of digital storage, display, and manipulation. However, the PhotoCD flopped in Kodak’s most important consumer mass market.

628 Hymowitz, C., & Alecia, S. 1989. Kodak Chooses Whitmore for Top Job; Samper Quits. Wall Street Journal, 1989 Dec 11: 1. 629 Burgess, J. 1991. Kodak Focuses on the Future - Company Responds to Japanese Electronic Challenge by Developing Cd Technology. The Washington Post, September 15(h.01).

ANALYSIS 217

(1) Kodak frames electronic/digital imaging as a threat (2) Kodak decides to be best in traditional and electronic imaging (3) Kodak sustains film business by betting on hybrid systems (4) Kodak trades investments in electronics against film (5) Capital providers and customers urge Kodak to focus on film (6) Kodak divests non-imaging units to increase cash flow

Figure 84

Process Model of Eastman Kodak’s Resource Allocation (Early 1990s)

(1) Photography industry (and Kodak) frames electronic/digital imaging as a threat. Recognition that it will take a decade before electronic imaging matches silver halide in quality and cost.

Figure 85 Silver-halide (Film) and Electronic

Photography (Early 1990s)

6.2.1 Cognitive Framing: Threat and Opportunity In the late 1980s, Kodak framed electronic imaging in a more nuanced way. It perceived electronic imaging partly as a threat and partly as an opportunity: Viewed from the perspective of image capture and storage, the company considered the technological process in electronics as a short-term enhancement to conventional photography, but as a long-term threat to replace silver halide in the mass market, which was Kodak’s most important market. Seen from the other end of the imaging chain, from the photofinishing perspective, Kodak framed advancements in electronics as an opportunity to extend its promised new sources of entrepreneurial growth. The company’s framing of electronic imaging was tempered by another threat Kodak perceived to its traditional silver-halide film and paper businesses: Fierce competition in its home market was eroding the incumbent’s market share.

Sales of products based on electronic photography posed no threat to companies engaged in the silver-halide film business in the early 1980s, because the base of the

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218 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) newer technology was relatively small. But as the household penetration of video cameras and camcorders increased, electronic imaging began to consume more of the disposable dollars consumers allocated to lifestyle activities in general, and imaging specifically. In 1987, for instance, camcorder sales in the US equaled sales of 35-mm SLR cameras, with a total of 1.6 million units sold; however, while sales of SLR cameras declined 15.8 percent, camcorder sales increased 37.2 percent from 1986 figures.630 In the same year, conventional 35-mm camera sales stabilized and film rolls and processing growth rates fell.631 Kodak clearly “missed the opportunity to participate in video.”632

It is important to note that electronic imaging did not match traditional photography in quality and cost; nevertheless, there were other benefits that showed signs of a threat to the traditional industry. Electronic imaging allowed easy and more flexible manipulation of images, quick turnaround of soft or hard copies of images, and speed of image transmission. These benefits were considered to draw down the base of silver halide well before quality and cost standards were met.633

While industry analysts were cautious in forecasting a particular point in time that electronic imaging would rival silver-halide photography, at the turn of the 1980s the shared belief was that it would take “a decade before electronic imaging matches silver halide in quality and cost.”634 A 1987 conference presentation stated the following:

“The improvements in conventional silver systems provide a constantly moving target. Far too much speculation is required to compare these two improvement rates: ·conventional photo systems and electronic imaging. I, therefore, find it extremely difficult to predict a definite time span . . . 5 years, 10 years, or 15 years, by which time electronic still picture taking will become our primary means of recording amateur events. However, I am certain that this evolution will certainly occur.”635

630 Lewis, B., Washburn, P., & Harrand, B. 1988. The 1987 Pma Industry Trends Report - a Performance and Trend Analysis of the Worldwide Photo/ Video Market. In P. M. A. International (Ed.): 146. Jackson, Michigan. 631 Ibid. 632 Chairman Kay Whitmore quoted in Rigdon, J. E. 1991e. Kodak Tries to Prepare for Filmless Era without Inviting Demise of Core Businesss. Wall Street Journal, 1991 Apr 18: 0-PAGE B1. 633 Omura, G. S. 1991. Imaging Technology Trends: Transition to a New Industry. In P. M. A. International (Ed.): 51. Jackson, Michigan. 634 Ibid. 635 Stein, H. 1987. Future of Imaging-Emerging Technologies. Paper presented at the GRETAG Photofinishing Symposium.

ANALYSIS 219

Figure 86 Industry Trend (1991)

Source: Omura, G. S., & Lewis, B. (1992). Photo/ Imaging in the Year 2000 - Report of the PMA 1991 Strategic Planning Conference. Jackson, Michigan.

“In the chart, two curves are shown. The dashed line represents one possible shape of traditional silver-based photography, with 1991 being the zenith of the bell-shaped curve. The solid line represents the possible shape of the photo imaging industry. The current leveling of industry sales may or may not signal an industry peak in 1991.”

Thus, film – following the general opinion – would remain as a prime medium for image capture until well into the next decade, while the technology for producing hard copy and transmission of images would face a rapid change. A report on the PMA 1991 Strategic Planning conference illuminates the state of affairs by depicting several assessments of industry leaders.

By and large, participants agreed that “the next decade will see very rapid movement towards the electronic imaging environment,” but that the traditional photography market will continue “maintaining its reliance on silver-halide technology.”636 “Electronic imaging will certainly play a major role in the years ahead,” some speculated, “although it will not take over any segment of our industry 100 percent”; “consumer mass market usage – in any significant volume – of electronic imaging technology is 10 years away.”637 The immediate advent and

636 Omura, G. S., & Lewis, B. 1992. Photo/ Imaging in the Year 2000 - Report of the Pma 1991 Strategic Planing Conference. In P. M. A. International (Ed.): 70. Jackson, Michigan. 637 Ibid.

220 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) application of all-electronic cameras was anticipated for a large part in photo journalism and catalogue photography, which “had absolutely no need for silver-anything anymore!”638

While assessments by industry leaders seemed to reflect a general reluctance in acknowledging electronic imaging, companies engaged in traditional silver-halide film and paper business, such as wholesalers and wholesale finishers, clearly framed the progress of electronic imaging as a threat. Some even went so far as to express the need “to continue promoting quality silver-based imaging at least through the end of the century.”639

The prospect of filmless cameras scared Kodak too; however, their framing of the technological progress in electronics was subtly nuanced. It regarded electronic imaging as a long-term threat to its core business related to color film, but not to the photographic paper business. Its first reaction to new all-electronic consumer cameras was, “Holy cow, let's circle the wagons,” William Fowble, vice president and general manager for consumer imaging products, recalled.640 He tried to get employees thinking about the possibility of a filmless world by running around telling people, “Look, we cannot stem the pace of technology, [but] if the lunch is on the table and it's going to be eaten, your choice is do you eat it or does somebody else eat it?”641

Kodak’s officials made efforts to calm the situation by publicly announcing that filmless cameras wouldn’t be a serious threat for at least a couple of decades. “Our forecast well beyond 2000 is for traditional photography to continue growing, although electronic imaging may grow faster,” CEO Kay Whitmore conceded. “We don’t think traditional photography will shrink and die. That’s one thing I don’t worry about.”642 Internal forecasts by Kodak predicted that by 2010, the costs of electronic imaging would have fallen to a point where amateurs would use it; one third of all images would be captured electronically by then.643 The company’s belief in traditional chemical photography was partly fueled by the massive stock of existing film cameras

638 Ibid. 639 Ibid. 640 Rigdon, J. E. 1991e. Kodak Tries to Prepare for Filmless Era without Inviting Demise of Core Businesss. Wall Street Journal, 1991 Apr 18: 0-PAGE B1. 641 Ibid. 642 Martin, T. J. 1991. The New Look of Photography. Fortune July 1. 643 Hirsch, J. S. 1990. Kodak Hopes Electronic Imaging Clicks, as Company Faces Fuzzy Photo Future. Wall Street Journal, 1990 Jul 16: 0-PAGE B5.

ANALYSIS 221

in the consumer market and the potential growth opportunities in developing countries.644 Another aspect that triggered Kodak’s faith in traditional film was their misleading comparison of the different technologies in terms of performance. Kodak argued that an Ektachrome color print film can capture about 18 million pixels of visual information, while their latest $20,000 digital camera captured only 1.4 million pixels.645

The company's internal actions, however, rendered a different picture. Indeed, they showed that Kodak had concluded that electronics would play a big role in photography's future. By 1988, Kodak had focused its research on PhotoCD. The digital imaging system was based on the use of film. At least for the moment it aimed to preserve Kodak’s core product line. “We clearly set a hurdle for electronic cameras,” said Mr. Fowble. 646

In contrast to Kodak’s threat framing of devices that capture electronically images, the company regarded newly emerging opportunities on the side of photofinishing positively. They believed that the excitement generated by electronics would trigger a growth in the photographic print market.647 So far, every new camera technology had created voracious surges in film demand, Kodak’s strategists contended. Their argument was:

“In 1970, when simple, inexpensive 35-mm cameras began to roll into the market, Americans took five billion photographs a year. In 1980 they took ten billion, and last year 17 billion. As anybody who works in an office knows, computers have not done away with paper. Sales of bonded paper, used for printouts and other things, have increased over 50 percent since 1980.”648

644 Burgess, J. 1991. Kodak Focuses on the Future - Company Responds to Japanese Electronic Challenge by Developing Cd Technology. The Washington Post, September 15(h.01). 645 See, e.g., Drukker, L. 1982. How Two Giants View Electronic Photography's Future. Popular Photography(January) 75f, Verity, J. W. 1993. Does Film Have a Future? Business Week November 14. 646 Rigdon, J. E. 1991e. Kodak Tries to Prepare for Filmless Era without Inviting Demise of Core Businesss. Wall Street Journal, 1991 Apr 18: 0-PAGE B1. 647 Burgess, J. 1991. Kodak Focuses on the Future - Company Responds to Japanese Electronic Challenge by Developing Cd Technology. The Washington Post, September 15(h.01). 648 Martin, T. J. 1991. The New Look of Photography. Fortune July 1.


Figure 87

Eastman Kodak’s Framing of Electronic/Digital Imaging (Early 1990s) Diagram adapted from Gilbert (2006)

Besides, at Kodak there was the strong conviction that Americans would always demand high-quality prints. “You ask people in a burning house, what are you going to take out?” said Peter M. Palermo, Kodak’s general manager of consumer imaging. “After the kids and the dog, the answer is the family photo album.”649 Electronic imaging, therefore, “won’t eliminate demand for prints, any more than computers ended the need for paper,” Leo J. Thomas, Kodak’s president of Imaging, concluded. “The number of hardcopy pictures that people have and hold is not going down.”650

Kodak’s nuanced framing of electronic imaging as a threat on the one hand and an opportunity on the other was tempered by the perception of another threat: Competition in Kodak’s traditional silver-halide film and photographic paper business had become extremely fierce. The world’s largest manufacturer of film, which ever since the 1970s had set the standards and the prices at will on everything related to photography, had been forfeiting sales increases to stave off Fuji and others. In the early 1980s, Fuji had a small foothold in the US market. At the turn to the 1990s, however, Fuji aggressively captured market share in photography film and paper. Within less than five years, Kodak’s US market share in color film dropped from 85 649 Burgess, J. 1991. Kodak Focuses on the Future - Company Responds to Japanese Electronic Challenge by Developing Cd Technology. The Washington Post, September 15(h.01). 650 Press, A. 1991. Kodak Bets on Film-Digital Format : Photography: 'Photo Cd' Is Seen as a Bridge from Imaging to Electronics. Los Angeles Times, October 14.





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percent to 80 percent.651 In the same period, Kodak had to cut margins and to protect its leading market position from rivals who sold their own branded goods at a discount.652 For instance, 3M, which sold its ScotchColor 100 under the brand name of various retailers such as Target and Kmart, priced a roll of film at $4.40, which is about two thirds of the price at which Kodak sold its Gold 100 Plus film. 653

Fuji and Agfa slashed prices likewise.654

What Kodak (and its shareholders) were threatened by was the combination of sluggish sales growth, loss of market share, and pressure on prices that reduced profits, while the company sucked cash from this business for other endeavors such as the sluggish information operations. The company could not rely on high growth rates in its traditional film business to offset stagnation or losses in other segments, such as information. In 1989, Kodak’s earnings could not keep pace with a viable growth rate of 9 percent by volume.655 Four years later, Kodak reduced its expectations regarding annual growth rate from its core film and photographic paper business to 3 percent.656

The acquisition of the Sterling Drug Inc. was meant to ease the pain. However, Kodak soon recognized that the pharmaceutical company wouldn’t make any meaningful contributions to the company’s income until the mid-1990s.657 Likewise, ongoing restructuring efforts in the organization to lower the costs of Kodak’s traditional business failed to deliver substantial improvements. In summary, Kodak felt its most important consumer market threatened on two fronts: by electronic imaging and fierce competition. Negatively associated prospects of electronic image capture and the fear of loss in its core businesses outweighed the virtues seen in electronics as a means to make photofinishing easier.

651 Martin, T. J. 1991. The New Look of Photography. Fortune July 1. 652 Dickson, M. 1993. Focusing on Grander Horizons. Financial Times, Novemeber 1(11), Martin, T. J. 1991. The New Look of Photography. Fortune July 1. 653 Taylor, A. I. 1993. Eastman Kodak Higher Rewards in Lowered Goals, Fortune. 654 1993d. Kodak Alleges Fuji Photo Is Dumping Color Photographic Paper in the U.S. Wall Street Journal, 1993 Sep 01: 0-PAGE B6. 655 Hammonds, K. H. 1989. Kodak May Wish It Never Went to the Drugstore - Coughing up $5 Billion for Sickly Sterling Drug Hasn't Paid Off Yet. Business Week December 4. 656 Taylor, A. I. 1993. Eastman Kodak Higher Rewards in Lowered Goals, Fortune. 657 Hammonds, K. H. 1989. Kodak May Wish It Never Went to the Drugstore - Coughing up $5 Billion for Sickly Sterling Drug Hasn't Paid Off Yet. Business Week December 4.

224 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) 6.2.2 Structural and Strategic Context: Integrated and Film-Centric In the years following Kodak’s exit from consumer electronics in 1986, the company focused on strengthening its core photography and high-profit businesses: “We must continue to maximize the value of our product line-up,” the 1986 annual reports declared, “nourishing the growth of those products which enjoy superior rates of return.”658 Film clearly remained at the core of the company’s strategy and the company spent record sums to “extend the lively future of silver halide photography,” in capital projects that drove for greater efficiency in manufacture and in products that perform better than ever.659 All photography-related acquisitions that Kodak made in the aftermath of its consumer electronic business strengthened its traditional silver-halide business. There was no sign that the company would seriously look for opportunities in electronic photography. For instance, in 1986 Kodak acquired Nagase & Co. to extend its photographic distributorship, and Fox Photo, a large photofinisher which operates wholesale photo labs and mini labs in 23 states.660 In 1987, Kodak acquired American Photographic Group, a privately held wholesale photofinishing company operating in 17 states; and, in 1988, the company’s US photo finishing operations were combined with those of Fuqua Industries Inc., operating since then under the brand Qualex Inc.661 Still, in 1989, when electronic cameras such as video camcorders revealed tremendous growth rates compared to the stagnating 35-mm SLRs and the decline of Disc cameras, Kodak decided to stick to its core businesses in film and photographic chemicals. The 1989 annual report synthesized Kodak’s thinking:

“Traditional photography has tremendous growth ahead – in its largest markets, such as North America, Japan and Europe, and in newer world markets which represent enormous potential. Is traditional photography a mature business? Far from it – it is a business still rich in opportunity. We will continue to aggressively exploit those opportunities.”662

658 1986. Eastman Kodak Company Annual Report. Rochester, NY. 659 Ibid. 660 Ibid. 661 1987. Eastman Kodak Company Annual Report. Rochester, NY, 1988b. Eastman Kodak Company Annual Report. Rochester, NY. 662 1989a. Eastman Kodak Company Annual Report. Rochester, NY.

ANALYSIS 225

6.2.3 Realized Strategy: Rigid Plan, High Commitment Kodak’s response to the perceived threat of electronic imaging and fierce competition in traditional photography triggered a sudden turn in the company’s strategic orientation and structural organization. The company, which had focused on traditional film photography for more than a century, suddenly announced that its impetus for growth must be electronic imaging. Kay Whitmore, shortly after his appointment as chief executive officer as of June 1989, decided that the company should aim to be “the world's best in both electronic and (traditional) imaging.”663 In a statement to shareholders and employees, he explained that “We [at Kodak] are exploring and defining the best ways to manage the convergence of conventional imaging science with electronics.”664 For years, Kodak managers had recognized the impact this new technology could have on the silver-halide company, but previous management had never dared to take a definite stand on it. Mr. Whitmore, who took over the reins from Colby Chandler, was the first to do so.

In practical terms, Kodak’s strategic turn meant to sustain and strengthen existing resources by pursuing the development of hybrid systems, rather than searching for new alternatives. Kodak’s competitors by and large focused on the development of electronic/digital image capture devices that rendered traditional silver-halide film obsolete as a storage medium and allowed direct transmission to photofinishing services or other means for output and manipulation, such as printers, television displays, computer terminals, and storage devices [see Figure 88 (middle)]. For instance, in 1988 Canon marketed its RC-250 Xapshot to consumers in Japan and the US. The $499 camera used a 200K pixel CCD, and the extra $999 kit allowed users to send a video signal to a TV-set or video cassette recorder, to store images on a floppy disc, or to manipulate images by connecting the camera via interface card and software to a Macintosh computer.665

Kodak, in contrast, decided to focus on developments that put traditional silver-halide film at the core of any consumer product. The core intention was to preserve and extend the life of silver-halide film [see Figure 88 (bottom)]. Kodak’s Create-A-Print 663 ibid., Hirsch, J. S. 1990. Kodak Hopes Electronic Imaging Clicks, as Company Faces Fuzzy Photo Future. Wall Street Journal, 1990 Jul 16: 0-PAGE B5. 664 1989a. Eastman Kodak Company Annual Report. Rochester, NY. 665 CANON RC-250 XAPSHOT explained in Popular Photography. December 1991. p 108. See also http://www.digicamhistory.com/1988.html.

226 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) station and the PhotoCD in particular were examples that represent merely the tip of the iceberg of the company’s (hybrid) film-based digital imaging strategy.

The Kodak Create-A-Print allowed consumers to manipulate their own pictures, for instance, to make enlargements in a few minutes. The machine scanned the negatives of a 35-mm film, showed the positive on a screen, and made prints.666 The development of the PhotoCD system was Kodak’s biggest response to the threat of electronic imaging. It was hoped that this would be widely accepted in the consumer market.

Kodak expected to reach 100 million or 15 percent of all US households.667 The system aimed at establishing a new standard of electronic image quality for television display, transmission, and printing. Images captured on a 35-mm film and transferred to PhotoCD provided quality superior to even the most advanced electronic still photography systems, while giving both consumers and professionals the convenience of digital storage, display, and manipulation [see Figure 89 and Figure 90]. The logic behind the project was clear: “We believe the film business is going to survive much longer than we did before PhotoCD,” explained Stephen Stepnes, who was in charge of Electronic Imaging Systems at Kodak.668 The company’s credo was then:

“Kodak will continuously improve its photographic films, papers and allied products while adding to their appeal the flexibility offered by electronics. As this company did with black-and white photography and with color, we intend to set the standards and lead the way in film-based digital imaging.”669

Accordingly, major investments in the photography film and paper business were driven by Kodak’s (unavoidable) belief in the long life of photographic film, which, management believed, would continue to offer unsurpassed quality and remain the premier image-capture medium.670 Certainly the company was facing a conundrum: Any electronic imaging product would succeed at the expense of the lucrative film and paper business. At the turn of the 1980s, Kodak had 80 percent of the US photography market; hence, the incentive to change was very small.

666 Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. 667 Press, A. 1991. Kodak Bets on Film-Digital Format : Photography: 'Photo Cd' Is Seen as a Bridge from Imaging to Electronics. Los Angeles Times, October 14. 668 Ibid. 669 1991a. Eastman Kodak Company Annual Report. Rochester, NY. 670 1990a. Eastman Kodak Company Annual Report. Rochester, NY.

ANALYSIS 227

Figure 88 Analog (Chemical) and Digital Imaging Chains

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Figure 89 Kodak PhotoCD System

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ANALYSIS 229

Figure 90 Hybrid PhotoCD System

Source: Eastman Kodak Company

230 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) Kodak’s internal investment pattern and structural changes mirrored the new strategic focus. Research budgets for the development of products such an all-electronic camera for consumers were cut, and the Electronic Photography Division – where the exploration of the new technology had taking place originally – was transferred from the company’s most important Photographic Products Segment to the commercial Information sector.671 Within the Federal Systems Division, the research into electronic imaging systems was continued, but on a marginal scale.

Figure 91 Eastman Kodak Consumer Photography Portfolio Matrix (Early 1990s)

Schematic Depiction of Circumstance

Gary Connors, who served as program manager on several major contract projects for the US government and ran the Federal Systems Division, remembered the fateful day when his budget was cut to almost nothing. He recalled the events as follows: 671 1989a. Eastman Kodak Company Annual Report. Rochester, NY, Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh, Rigdon, J. E. 1991a. Eastman Kodak Puts the Focus on Leo Thomas. Wall Street Journal, 1991 Aug 14: 0-PAGE B1.

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“So we may have had wonderful ideas about where we were going in the electronic systems and the electronic imaging systems and all of that. But we weren’t going anywhere because there was not going to be any more money for us to invest except for what I had in my little purse in the government business. And that was I must say a day that I will always remember as part of my Kodak experience. People slammed the door and walked out. And that was pretty much the end.”672

Paradoxically, research on electronic imaging was continued in the form of skunkworks, and thereby became the basis for the first Kodak commercial electronic cameras.673 The division used some of its Independent Research and Development (IRD) budget to develop electronic imaging products. Every year the division received several million dollars it could use any way it wanted.674 Later, Connors regretted that the project was kept secret:

“As I look back on it, it was something we were able to do without telling anybody because we had the money and we could spend it however we wanted. So that was a good thing. The bad thing was probably we should have told, we should have tried to sell it more throughout the company. I guess I feel that I never did that as much as I should have. I kind of kept quiet about it and we did our thing and didn’t get into that kind of discussion.”675

Others at Kodak supported Mr. Connors’ reluctance to discuss the issue of electronic cameras within a silver-halide based company. Right around the same time, Don Pophal, a project manager on many early digital projects at Kodak, recalled a meeting with his senior manager in which he expressed his intention to become a project leader for a digital camera project. The manager slammed his fist on the table, according to Pophal, and said, “There will never be a digital camera at Kodak as long as I’m here.”676

6.2.4 Resources and Capabilities Kodak’s strategic investment into film-based digital technologies cannot be fully explained on the grounds of cognitive framing. Indeed Kodak’s amount of cash or cash equivalents and deployable resources moderated the company’s resource allocation process in the early 1990s too as did the pressure from shareholders.

672 Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh. 673 Ibid., McGarvey, J. 2013. Personal Interview. April 10. With M. Shamiyeh. 674 Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh. 675 Ibid. 676 Pophal, D. 2013. Personal Interview. November 4. With M. Shamiyeh.

232 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) Since the early 1980s, Kodak’s preference to strategically invest in its most important business – the color film and photographic paper business – to protect and gain market share had not changed in favor of other businesses; rather the opposite. Due to a fierce competitive environment, the multi-business corporation was forced to defend its market share by strategically investing even more in its core business. “For every year that film could be conserved and for every percentage point and market share that we could gain,” Kodak’s business analysts concluded, “it was worth hundreds of millions of dollars and so in net present value; quantity was established, and that formed the basis for a new direction for the company.”677 There was simply no incentive to fund a business with inferior profit margins and market share, such as all-electronic consumer cameras.

Moreover, Kodak’s competences related to hardware-manufacturing had not changed since its exit from consumer electronics in the mid-1980s, which explains another aspect of the company’s reluctance to commercialize its world-class expertise in electronics. During its hundred years of existence, Kodak had built an extraordinary stock of technologies, which made photography ever easier and protected the company’s leading market position. Kodak was granted about 1,000 patents per year in the US alone, which was second among US companies, and fourth worldwide in the early 1990s.678 Besides its unbeaten competence in silver-halide photography, Kodak managed to build up world-class competences in electronics. For instance, Kodak was the world’s first developer of the 1.4 and 4.2 megapixel sensors. In 1990, the company received its 18th R&D 100 award from Research and Development magazine for this latter innovation.679

The bulk of Kodak’s electronic competences, however, remained trapped in the labs. Several managers in charge of running operations directed attention to lack of manufacturing competences. Dennis DeLeo, for instance, who managed Kodak’s development of businesses for CCD electronic image sensors, image capture, and transmission products between 1990 and 1992, explained that Kodak was never an efficient volume manufacturer, except when it generated a new film in camera system,

677 Melnychuck, P. 2013. Personal Interview. November 20. With M. Shamiyeh. 678 1993b. Eastman Kodak Company Annual Report. Rochester, NY. 679 1990a. Eastman Kodak Company Annual Report. Rochester, NY.

ANALYSIS 233

for instance the film size 126 or 110.680 But the company was never, he clarified, a volume manufacturer in the same way as the Japanese were when they introduced manufacturing process improvement programs back in the 1960s and 1970s.681 Others confirmed Kodak’s lack of hardware-manufacturing competence.682 Kodak’s decision to exit 35-mm SLR camera production in the early 1970s, was seen as another case in point.683 Kodak lacked the manufacturing competence to produce electronic products and always had to rely on third parties. The company’s reluctance to enter and fund hardware businesses was certainly fuelled by the lack of high profit margins and distribution channels, as discussed earlier. The PhotoCD, which was built by Philips, was a special case, as Kodak intended to garner royalty income by licensing its proprietary system.

In this circumstance of aggressive competition in the consumer market and Kodak’s lack of electronic hardware-manufacturing expertise, the company’s photographic business did not yield the massive cash flow needed to fund new project development, let alone new ventures in electronics. Throughout the late 1980s and early 1980s, the company did not manage to increase its cash and cash equivalents substantially – gains never exceeded about $250 million a year, and by and large the company could not fund its capital additions and pay dividends to its shareholders without diminishing its cash and cash equivalents or resorting to long-term debt. Therefore, in the late 1980s, year after year, management cut the workforce to increase cash flow. In 1993, for instance, CEO Kay Whitmore announced another major cut in workforce – the fifth within less than ten years – to increase cash flow. The layoff of 10,000 employees, or about 8 percent of the company’s global workforce, was expected to help Kodak to achieve $700 million in cash flow in 1993, $1 billion for the year after, and $1.1 billion in 1995.684

680 Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh. 681 Ibid. 682 Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh, LaPerle, B. 2013. Personal Interview. November 21. With M. Shamiyeh. 683 Deleo, D. 2013. Personal Interview. November 18. With M. Shamiyeh, Lieser, E. 2014. Personal Interview (by Telephone). April 4. With M. Shamiyeh. 684 Rigdon, J. E. 1993d. Kodak to Cut 8% of Work Force, or 10,000 Jobs --- Move Viewed as First Step as Whitmore Leaves; Spending Cuts Planned. Wall Street Journal, 1993 Aug 19: 0-PAGE A3.

234 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) Besides, Kodak’s photography business had to make up for the loss generated in the information businesses, which focused on commercial products such as copiers, printers, and publishing systems. This segment continued to report negative figures.

Thus, the incentive to invest in new technologies and products such as all-electronic cameras, which included the prospect of cannibalizing the company’s most important consumer business, was certainly not very high, especially given low levels of uncommitted resources and high high capabilities predominantly deployable in the silver-halide business.685

6.2.5 Capital Providers and Customers: Film-Demanding By the end of the 1980s, shareholders were concerned about Kodak’s weak cash flow and considerably high level of long-term debt.686 In 1989, the company’s balance sheet already showed $8.7 billion of long-term borrowings, despite some $1.7 billion in deferred income taxes. Total liabilities had grown to a sum nearly two-and-a-half times as great as shareholders’ equity. Yet Kodak continued to base its resource commitments on growth predictions higher than 7 percent a year, while the result remained several points below that.687 Hence, staff plans and funding for administration, selling, and general overhead as well as R&D, which had been the highest in the industry, grew apace. Since the early 1980s, net earnings had been cut in half, from a peak of $7.12 per share in 1982 to $3.53 in 1992.

Kodak’s consecutive but ineffective efforts to cut workforce and to become more efficient showed that it was difficult to undo or even reverse retained resource commitments quickly. Kay Whitmore always deferred severe cost-cutting programs, in the belief that the company's most important photography business would recover from stagnation and return to high growth rates.688 But competitors and retailers of generic brands continued to capture market share and to vaporize Kodak’s margins. Efforts to bring about change with the help of outsiders failed due to frictions with the corporate culture. Kodak’s newly appointed chief financial officer, Mr. Christopher J.

685 Rigdon, J. E., Hill, G. C., & Naik, G. 1993. New Focus: Hiring Fisher, Kodak Gambles on a Future in Multimedia World --- a Builder, Not a Bloodletter, He Conjures Bold Course on the `Digital Highway' --- the Board's Priorities Shift. Wall Street Journal, 1993 Oct 29: 0-PAGE A1. 686 Jaffe, T. 1990. Still out of Focus. Forbes, 146(2) 388-389. 687 Richman, L. S., & Skookdeo, R. 1993. When Will the Layoffs End? Not Soon, Maybe Never. For Many Large Companies in the Nineties, the Big Shrink Has Become Not a Onetime Event but a Way of Life., Fortune. 688 Maremont, M., & McWilliams, G. 1993. Kodak: Shoot the Works. Business Week November 14.

ANALYSIS 235

Steffen, who enjoyed an outstanding reputation as an excellent cost cutter, quickly left the company after conflicts with Kay Whitmore.689

No wonder that in the early 1990s, shareholders aggressively criticized Kodak for its bad performance, demanding extensive cuts in administration and R&D spending. A particular frustration of many large investors stemmed from their perception that the company had been allocating too much money for new electronic technologies that delivered small returns on investment.690 This concern was even shared by people who were familiar with Kodak’s unique organizational culture. Scott Brownstein, a former Kodak executive in charge of the PhotoCD system, noticed that “Kodak has thrown too much money and management too haphazardly at high-tech products at the expense of its $5 billion film franchise. Lots of us are excited about electronics; the question is how do you make money at it.”691 Therefore, in the opinion of many shareholders, Kodak should rather become an “aggressive follower by capitalizing on rivals’ inventions instead of mostly developing its own.”692

In response to shareholder pressure, Kay Whitmore announced a strategic change in 1991: “Our view of the future suggests,” he conceded, “that we should concentrate our energies and resources in three areas of imaging activity: silver-based products, hybrid imaging systems, and imaging systems that offer photo-quality pictures. Electronic imaging,” Mr. Whitmore continued, “doesn’t yet offer photo-quality pictures.”693

People close to the industry cheered the move. The Wall Street Journal applauded Kodak’s focus on traditional photography with the following comments: “This is a big

689 Loomis, C. J. 1993. The Battle to Shape up Kodak the Board Is Backing Kay Whitmore -- Coolly and for Now. Will He Be the Next Bigtime Ceo to Fall?, Fortune. 690 Dickson, M. 1993. Focusing on Grander Horizons. Financial Times, Novemeber 1(11), Rigdon, J. E. 1991d. Kodak Shuffles Executives, Operations, Announces Plans to Cut 3,000 Workers. Wall Street Journal, 1991 Aug 13: 0-PAGE A3. For a detailed discussion on how security analysts reacted to Kodak’s undertakings in regard to the development of radical technological change one might refer to the work of Mary J. Benner from the Wharton School, Philadelphia, Pennsylvania: Benner, M. J. 2010. Securities Analysts and Incumbent Response to Radical Technological Change: Evidence from Digital Photography and Internet Telephony. Organization Science, 21(1) 42-62. 691 Rigdon, J. E., Hill, G. C., & Naik, G. 1993. New Focus: Hiring Fisher, Kodak Gambles on a Future in Multimedia World --- a Builder, Not a Bloodletter, He Conjures Bold Course on the `Digital Highway' --- the Board's Priorities Shift. Wall Street Journal, 1993 Oct 29: 0-PAGE A1. 692 Rigdon, J. E., & Lublin, J. S. 1993. Kodak Seeks Outsider to Be Chairman, Ceo --- Search for Savvy Marketer, Cost Cutter Follows Dismissal of Whitmore. Wall Street Journal, 1993 Aug 09: 0-PAGE A3. 693 Rigdon, J. E. 1991d. Kodak Shuffles Executives, Operations, Announces Plans to Cut 3,000 Workers. Wall Street Journal, 1991 Aug 13: 0-PAGE A3.

236 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) positive,” and “It's excellent. It dramatically de-emphasizes research and development spending in electronic imaging.”694

But it was not only shareholders’ concern that affected Kodak’s strategic investments from outside the company. Customers’ reluctance to embrace new electronic imaging products such as the PhotoCD led to an even bigger effort to sustain the company’s traditional silver-halide business.

Kodak’s move to hybrid systems, in response to the threat of electronic photography, never aimed at searching for radical new alternatives. Rather, it was a rigid reaction, as Kodak intended to sustain the company’s traditional photography business precisely because silver-halide film was still the basis for every new Kodak electronic product.

The PhotoCD system, which was Kodak’s embodiment of their new film-based digital imaging strategy, failed in the consumer market. Conceived as a blockbuster item to be sold to millions of US households, consumers simply did not take to the idea of looking at their images on a television screen using a $400 player and paying $20 to have their film roll transferred to a compact disc.695

The other customers, whom Kodak considered of secondary importance, such as developers of desktop computer applications, were also reluctant to embrace the new technology. Kodak plans to commercialize the PhotoCD system relied on two different markets. The company would develop the system for its home consumer market itself and would generate royalty income from all others that wanted to incorporate the system in their applications. Software developers, manufacturers of players, or system integrators such as Apple or Adobe were considered part of the latter group. They could make use of the system by licensing particular patent portfolios.696 Nevertheless, these customers were also reluctant to purchase licenses or to invest in developments to incorporate the new technology in their applications, because of the uncertainty of demand. Thus, the product failed in the consumer market and Kodak had to turn to businesses and professional photographers. 697

694 Ibid. 695 Taylor, A. I. 1993. Eastman Kodak Higher Rewards in Lowered Goals, Fortune. 696 Smith, G. V., & Parr, R. L. 2004. Intellectual Property: Licensing and Joint Venture Profit Strategies: Wiley. 697 Rigdon, J. E. 1992c. Kodak Is Aiming Photo Cd Concept at Business Firms. Wall Street Journal, 1992 Aug 25: 0-PAGE B7.

ANALYSIS 237

6.2.6 Realized Strategy: Exit Consumer Market, Spin-off Eastman Chemicals Kodak’s foray into film-based digital imaging systems did not take off in the company’s most important consumer market, while its traditional silver-halide photography suffered from fierce competition. To sustain and strengthen its core business, cash flow was needed, which the company lacked. Retained resource commitments in administration and R&D could not be undone quickly, and shareholders put more and more pressure on management to focus on cutting costs and on the traditional photography business.

Figure 92 Eastman Kodak’s Framing of Emerging Technology (1993)

Diagram adapted from Gilbert (2006) As a consequence, Kodak decided to concentrate on its core businesses and to shed a variety of profitable non-imaging units, to generate cash flow. Among those sold were the Verbatim CD manufacturing unit, the Ultralife lithium battery production unit, and several other businesses related to its troubled information division [see Figure 91].698

Gary Connors, who led the Federal Systems Division, remembered the days early in 1992, when Kodak was aggressively searching for profitable businesses to be sold. He

698 1990b. Verbatim Unit to Be Sold to Mitsubishi Kasei Corp. Wall Street Journal, 1990 Mar 22: 0, 1992e. Kodak to Sell 10 Non-Imaging Units, Expand Its Alliance with Canon U.S.A. Wall Street Journal, 1992 Jul 10: 0-PAGE B6, Ansberry, C. 1990. Eastman Kodak Is Pulling Plug on Its Ultralife. Wall Street Journal, 1990 Apr 10: 0-PAGE B1, Pae, P. 1989a. Eastman Kodak Plans to Eliminate Minilab Division. Wall Street Journal, 1989 Dec 05: 1.

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238 Period 1990-1993: Film-Based Digital Imaging (Kay Whitmore) too was asked to find someone to acquire that business. The person to whom he was asked to report, Bob Hamilton, said:

“We don’t want to be in the business that you are in anymore. Kodak doesn’t want to be in that government business. We need cash. We know that your business is profitable; sell it as quickly as you can to anyone, anyone who will buy it; sell it.”699

At the turn of the 1980s, Kodak had three pillars of income. Imaging accounted for about 60 percent of the company’s earnings, Health, together with the newly acquired Sterling Drug Inc., and Eastman Chemical each accounted for 20 percent [see Figure 61]. The Information segment did not generate returns for years. In mid-1993, Kay Whitmore decided to shed Eastman Chemical in response to shareholders’ pressure to “shed a major asset and focus on its core imaging business.”700 Kodak’s chemical operation was one of the company’s oldest pillars of income. After that, Kodak still had two viable businesses: traditional photography and health.

699 Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh. 700 Rigdon, J. E. 1993e. Kodak to Shed Chemical Unit in Restructuring --- Spinoff Is Expected at End of Year, and Chairman Hints at Joint Ventures. Wall Street Journal, 1993 Jun 16: 0-PAGE A3.

ANALYSIS 239

Figure 93 Eastman Kodak’s First Major Divesture in Response to Threat

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240 Period 1994-1999: Fully Digital World (George M. C. Fisher) 6.3 Period 1994-1999: Fully Digital World (George M. C. Fisher)

“And if that [digital imaging] eats up some of the film business, so be it.”701 George Fisher, Chairman and CEO, Kodak, 1994

“Imaging offers Kodak tremendous opportunities for long-term success and growth. To achieve maximum success, we have concluded that we must commit our entire

resource base to imaging opportunities and divest noncore businesses.” 702 George Fisher, Chairman and CEO, Kodak, 1994

“Our projections are that the square footage of film coming out of our factories will carry on growing for the next 10 years. Beyond that we stop guessing.”703

George Fisher, Chairman and CEO, Kodak, 1995

George Fisher, Kodak’s newly appointed chairman and chief executive, reversed several assumptions the company was used to. First, he regarded digital imaging as an opportunity with great growth potential and the ability to enrich the company’s core business. Second, he felt that Kodak had committed resources to too many activities, passing up too many opportunities and generating an economically unviable cost structure. If the company retained its core business, he concluded, Kodak could change rapidly. As a consequence, Fisher reversed previous efforts towards diversification by divesting most of the company’s non-imaging businesses, used the proceeds from the sales to free the company of its long-term borrowings as well as to fund digital imaging ventures, and created an autonomous unit to promote the development of digital imaging products independently from the traditional silver-halide business. The core objective of his strategy was growth to overcome the company’s cost problem and to generate a viable source of cash for dividends to shareholders and the investments required to push digital. Three years after Fisher took over, it became clear that Kodak’s growth strategy was not paying off. Both environmental changes and internal failures thwarted the growth plan. As a result, retained resource commitments started to stress Kodak’s balance sheet and the company was forced to return to previous strategies of workforce reduction and asset divestiture.

701 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29. 702 Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 703 Jackson, T. 1995. Pictured from a New Angle. Financial Times, May 11(13).

ANALYSIS 241

1994:

(1) Kodak frames digital imaging as an opportunity (2) Kodak supports the development of too many diverse

businesses. Result: Just the photography business maintains a strategic position. Furthermore, Kodak suffers from liquid resources to promote digital imaging.

(3) Kodak focuses on core competence – pictures – and creates autonomous business unit to promote independent development of digital imaging. Strategic objective: growth in traditional business to generate cash flows required to promote digital imaging.

(4) Kodak divests non-imaging businesses and makes high commitments to both digital and traditional silver-halide ventures

1997:

(5) Kodak suffers from its overbearing cost structure due to declining sales in its photographic film and paper business. (The company loses money because of fierce price competition and general stagnation in consumer demand.)

(6) Investors exert pressure to provide high returns on investments.

(7) Kodak recognizes an industry change. Computer manufacturers enter the photography industry by getting people to print photos at home.

(8) Kodak upholds its strategy to combine the high quality of film with digital imaging and forces people to make their prints at professional photofinishing facilities.

(9) Kodak trims the company by cutting costs and reducing workforce – in both digital and silver-halide business.

Figure 94

Process Model of Eastman Kodak’s Resource Allocation (1990s)

1994-1999: (3) Electronic (digital) photography does

not yet consume a significant share of the market for traditional silver-halide photography; however, there are signs in the industry that digital image capture devices will catch on rapidly, gaining substantial appeal to consumers in the early 2000s. Experts disagree on whether paper prints will survive digital imaging. A continued growth in photofinishing services suggests that digital imaging promotes the making of paper prints, rather than extinguishing the photofinishing market altogether.

Figure 95

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242 Period 1994-1999: Fully Digital World (George M. C. Fisher) 6.3.1 Cognitive Framing: Digital Imaging = Opportunity In 1994 there was no doubt that digital cameras were catching up. A leading international photography characterized the industry change as follows:

“The escalating importance of digital technology, which could only be surmised two years ago in the shape of various electronic imaging processing systems, has this year become very tangible indeed. The digital chain of image processing has now been expanded to include the field of image capture. When our editing team set about drawing up a market survey of digital camera systems, they were astonished to find that, whereas camera systems of this kind with their limited performance for specific fields of application could be counted on one hand two years ago, there were this year no fewer than 21 different models in differing price and quality categories. This does not even include systems introduced just before or even at photokina '94, like the Kodak DCS 460 and the joint development between Fuji and Nikon.”704

People who were immediately engaged in the business reported similar observations. For instance, in the same year, Bob Banasik, then president and CEO at Best Photo Lab, Inc., said, “Digital cameras seem to be making real progress. I don’t know whether or not that is ‘interesting – good’ or ‘interesting - like a train is heading at me.’ Labs may find opportunities here, but we had better do so quickly.” 705

Kodak’s own research and development efforts certainly hinted at similar findings. Almost a decade before George Fisher was appointed chairman and chief executive, the company invented the world’s first 1.4 megapixel imaging sensor.706 Engineers enhanced the technology to the extent that the resolution doubled almost every four years, besides the improvement of other performance attributes such as color, shutter speed, etc. Kodak also developed professional image capture devices in close collaboration with leading camera manufacturers such as Nikon and Canon, not to mention the digital projects it pursued in the era of professional graphics, such as pre-press approval proofing systems.707

704 Blömer, H. J. 1994a. The Photo Sector Puts on a New Face in Cologne. A Digital Photokina? International Contact, 13(5) September/ October: 3. 705 O'Neill, J. 1995b. Pma 1995: "A Clearer Picture of the Industry's Direction". International Contact, 14(2) March/ April. 706 1989c. Journey: 75 Years of Kodak Research. Rochester, NY: Eastman Kodak Company. 707 Connors, G. 2013. Personal Interview. November 18. With M. Shamiyeh, Gustavson, T., & McGarvey, J. 2013. The First Digital Single-Lens Reflex Cameras. IMAGE(Winter 2012/2013) 5, McGarvey, J. 2004. The Dcs Story: 17 Years of Kodak Professional Digital Camera Systems. 1987-2004, McGarvey, J. 2013. Personal Interview. April 10. With M. Shamiyeh, McGee, J. 2013. Personal Interview. April 11. With M. Shamiyeh, Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh.

ANALYSIS 243

l/mm b [mm] h [mm] Equivalent Pixels

Film (135) 150 36 24 The image quality of a typical consumer 36 x 24 mm, ISO 100-speed film was considered to be equivalent to the resolution of a digital image containing roughly 20 million pixels. The diagram above shows that this image resolution could have been achieved in about 2003. At the same time, costs per megapixel became affordable for consumers, which supported forecasts from the early 1990s that by 2003, half of all cameras sold in the US market would be digital.

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Figure 96

Enhancement of Kodak’s Digital Camera Technology Source: Data adapted from source in footnote 708

In the early 1990s, Kodak also joined with Apple to launch the Apple QuickTake camera, which aimed at the consumer segment.709 Progress in Kodak’s own technology clearly suggested that digital image capture devices would become available for the mass market sometime in the early 2000s [see Figure 96].

708 McGarvey, J. 2004. The Dcs Story: 17 Years of Kodak Professional Digital Camera Systems. 1987-2004. 709 1994d. Eastman Kodak Company Annual Report. Rochester, NY, Parulski, K. 2013a. Personal Interview. April 10. With M. Shamiyeh.

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244 Period 1994-1999: Fully Digital World (George M. C. Fisher) An internal forecast supported this view too. Terry Faulkner, who then was director of Strategic Initiatives and reported directly to Fisher, recalled that a key event was the 1994 technology substitution forecast that he and some members of the Technical Intelligence Group developed under his direction. They predicted that “digital cameras would replace film cameras more rapidly than 35mm NSLRs replaced box cameras but less rapidly than video cameras substituted for Super 8 movie cameras.”710 But more important, the forecast predicted that “in 2004 50% of all re-useable cameras sold in the US market would be digital; film sales would collapse with a lag of three years but parallel to the collapse in camera sales” – conclusions, according to Faulkner, that “George Fisher and Harry Kavetas did accept (although not publicly) and they responded to them.”711

Significantly, the 1994 forecast was not shared by all of Kodak’s senior managers. Faulkner remembered a meeting during the mid-1990s with about 20 of Kodak’s top managers to discuss various issues.712 The meeting happened within the scope of a senior management initiative called “strategic frame-working,” which took place a couple of times a year. In one meeting he submitted a questionnaire, asking senior managers when they thought that 50 percent of all reusable cameras sold in the US market would be digital.713 Answers to that question ranged from 2002 to 2025, but the majority was close to 2008-2010. The only person who was really early, according to Faulkner, was Willy Shih, who then directed the Digital & Applied Imaging unit; he suggested 2002.714 The truth turned out to be 2003 [see Figure 22 and following].

Many senior managers at Kodak – as well as external industry observers – had difficulty believing in Faulkner’s forecast for several reasons.715 On the one hand, there was a large installed base of film cameras that rendered quick substitution implausible. In the mid-1990s, analysts estimated that there were about 630 million

710 Faulkner, T. 2009. Draft for a Talk That I Gave at Oak Hill to Retired Ek Managers. 711 Ibid. Annotation according to original document. 712 Faulkner, T. 2013b. Personal Interview (Follow-up). November 26. With M. Shamiyeh. 713 Ibid. 714 Ibid. Given that Willy Shih participated in the survey, the meeting must have taken place between 1997 and 1998, the year Faulkner retired. 715 Burgess, J. 1995. Digital: Back into the Picture; for Now, Digital Products Are Focused on Special Markets. The Washington Post, November 13(F. 15), Faulkner, T. 2009. Draft for a Talk That I Gave at Oak Hill to Retired Ek Managers, Faulkner, T. 2013a. Personal Interview. November 04. With M. Shamiyeh, Faulkner, T. 2013b. Personal Interview (Follow-up). November 26. With M. Shamiyeh.

ANALYSIS 245

cameras in use worldwide and a demand for 2.8 billion rolls of film every year, not to mention the opportunities for film in emerging countries.716

On the other hand, not long before, the industry had witnessed the advent and immediate flop of electronic photography. The still video cameras convinced customers and camera manufacturers alike that electronic imaging-capture devices did not change the world of silver-halide photography. As a consequence, the system disappeared from the shelves. People close to the industry remembered that this first attempt to knock silver-halide photography out of the saddle with electronic technology was a miserable failure. The second generation of electronic cameras came along with similar flaws, despite significant improvements in pixel resolution, up to several megapixels, and exposure times that ranged from a few thousandths of a second all the way to several minutes. But they were substantially more expensive than a regular 35mm SLR or APS camera, from about $1,000 to almost $25,000. Thus, these cameras aimed at commercial applications, signaling the provisional retreat of electronic imaging technology from the consumer segment – Kodak’s most important target group. In contrast, only about 1 to 2 percent of the camera base was used commercially.717 The largest user group in photography was the snap-shooters who, by purchasing compact cameras, demonstrated that they wanted mementos that are pleasing to the eye and easy to obtain at low cost. No wonder the cheap, single-use cameras – “a film with a lens” – maintained its position as the fastest growing segment in the photography market, with growth rates of 40 percent a year and a market share of one fifth of the total camera base.718

Journals of this transitional period reflected the widely shared observation that the second generation of filmless cameras did not address the demands of the consumer market and therefore was not considered a threat. For instance, a leading photography journal argued that

“the printed quality of the inexpensive cameras designed for amateur enthusiasts is still unsatisfactory and the prints are also usually more expensive than normal photographic prints. No consumer is likely to want to take a digital camera on

716 Hujer, F. 1995. Will Photo Go Digital? International Contact, 14(4) July/ August: 40-42. 717 Ibid. 718 ibid., Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83.

246 Period 1994-1999: Fully Digital World (George M. C. Fisher) vacation with him to capture his holiday memories. Digital cameras should therefore not be offered as a substitute for the normal photo cameras – 35mm or Advanced Photo System.”719

Others claimed that “old-fashioned film is still the best way of storing and recording images” and that “the conversion from film to electronics may take 30 years or ten years or (watch out!) five years.”720 Hence there were considerable reasons for the belief that silver-halide technology would remain the major technology for consumers in picture-taking.

Figure 97 Eastman Kodak’s Framing of Emerging Technology (1990s)

Diagram adapted from Gilbert (2006)

George Fisher too believed in a slow and gradual transition of film in the face of digital imaging; however, in opposition to the view of many people close to the industry, he regarded digital imaging as a valuable opportunity. “Film is cheaper than electronic imaging, and will stay that way for a while,” he quite pragmatically explained. “That will change, but slowly.”721 He acknowledged that digital cameras will “grow over the next decade,” but did not hesitate to make clear that “most of the pictures they take will merely add to the pictures taken by conventional cameras.”722 Hence, for Fisher, then in charge of Kodak’s new strategy, digital imaging clearly

719 Blömer, H. J. 1996d. The Photo Trade Must Not Miss the Boat When It Comes to New Technologies - We Need Advanced Retailing Channels! International Contact, 15(3) May June. 720 Jackson, T. 1995. Pictured from a New Angle. Financial Times, May 11(13), Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83. 721 Jackson, T. 1995. Pictured from a New Angle. Financial Times, May 11(13). 722 Ibid.



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remained a valuable opportunity that would enhance traditional photography, rather than threatening or cannibalizing it. “Imaging offers Kodak tremendous opportunities for long-term success and growth,” he declared publicly, and speculated that the market for digital imaging would be about $15 billion, growing about 35 percent every year.723 The traditional photography market was about $9.5 billion at the time.724

Since the mid-1980s, Kodak had been developing a tremendous array of digital products, but by the time Fisher became the company’s new chief executive, little had been brought to market. By and large, senior executives – mostly those with a film background – had been fearful of launching digital products they thought would cannibalize the company’s high-margin silver-halide photography business.725 Memos in the archives showed Fisher that previous executives had even prohibited resource allocations to digital projects.726 “There’s been too much fear that the new technology would kill the old business,” Fisher concluded.727 “It’s a supplement to our traditional business and a major element of future growth.”728

Thus, by framing digital imaging as a business that could live in a fruitful symbiosis with traditional silver-halide business, Fisher replaced Kodak’s long-lasting fear with a passion for digital technology [see Figure 97].

6.3.2 Resources and Capabilities: Low Uncommitted Resources, Diversification Soon after Fisher took over, he faced a severe dilemma: Kodak was spreading available resources over too many activities while underfunding each activity, leaving each business in an unfavorable competitive position [see Figure 98]. To invest in the potentially lucrative digital imaging business, however, he was required to take resources from available businesses, first and foremost from Kodak’s most important and profitable core photography business. But it appeared that that business too was becoming increasingly commoditized and thus relatively unprofitable.

723 Blömer, H. J. 1995b. Kodak Bares Its Soul to Wall Street. International Contact, 14(3) May/ June: 8, Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 724 Port, O. 1996. The Digital Camera Finds Its Photo Op. BusinessWeek April 14. 725 Partalon III, W. 1994. Betting on Future of Digital Imaging. Democrat Chronicle: 1f, Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 726 Bounds, W. 1995b. George Fisher Pushes Kodak into Digital Era. Wall Street Journal, 1995 Jun 09: 0. 727 1994c. Eastman Kodak Co.: Computer Industry Partners Sought for Digital Imaging. Wall Street Journal, 1994 Mar 16: 0-PAGE A4. 728 Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114.

248 Period 1994-1999: Fully Digital World (George M. C. Fisher)

Figure 98 Eastman Kodak Business Portfolio Matrix (1994)

Schematic Depiction of Competitive Setting Between 1983 and 1993, Kodak’s years of diversification, the company spent $12.7 billion on research and development, but net earnings remained stable at an average of $550 million or about $3.10 a share. Even worse, in the early 1990s Kodak’s market share per unit felt from about 80 percent to 70 percent [see Figure 66].729 Both Fuji’s cross-subsidization of film and paper products by means of a profit sanctuary in Japan, and private labels’ offering of discount products at 20 to 30 percent below Kodak’s price, extensively eroded the company’s market share. Yet the US imaging giant still maintained probably the highest overhead costs in the industry, being thereby

729 Nully, P., & Rao, R. 1995. Digital Imaging Had Better Boom before Kodak Film Busts. Fortune, 131(8) 80-83, Nulty, P. 1994. Kodak Grabs for Growth Again. Fortune May 16.

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Kodak’s investment program before George Fisher took over: The company spread available resources over too many businesses, each trying to gain market share and to build a competitive advantage, while underfunding each activity. Each business was put in an unfavorable competitive position, except Kodak’s traditional core business. Fisher’s dilemma: How to fund the move into digital future.

ANALYSIS 249

constrained in its ability to undercut competitors’ prices. Hence, rather than being able to suck money from Kodak’s core business to fund development of the nascent digital imaging business, Fisher needed to stem the erosion of its declining business in the US by extensively allocating resources to it.

There were no other businesses Fisher could look to for cash. In particular, Eastman Chemical, Kodak’s former chemical unit, was spun off when he arrived at Kodak. It remained one of the company’s four strategic areas of operations and consistently accounted for 20 percent of Kodak’s annual income. The information unit, with its copier or other commercial businesses that Kodak tried to start, or acquired, during this period, actually lost money throughout the 1980s and 1990s [see Table 5]. Kodak’s copier business, for instance, lost significant market share to Xerox during the 1980s. Kodak maintained about half of Xerox’s 40 percent market share for high-end copiers.730 In order to stem that competition, Kodak would have to invest heavily. Finally, Kodak’s Sterling Winthrop drug unit, with its over-the-counter pharmaceutical business, had continued to perform weakly since its acquisition in 1988.731 While burdening the company with a huge debt, the unit failed to pay back the investment. The unit announced that it had a number of potentially lucrative products in the pipeline, but admitted that it would take several years to launch them in the market.732 The alliance with Sanofi promised to enhance Kodak’s access to a global market and research; however, an ongoing industry consolidation rendered their collaborative efforts marginal compared to the big players. While the Sterling-Sanofi collaboration was considered to be one of the world’s top 20 operations in the pharmaceutical industry, it was far from being number one or two, as Kodak was in the photography industry.733 Kodak’s Sterling was simply too small to prosper, given its current resource commitment.734 Thus, based on the dilemma that Kodak’s retained resource commitments posed for its strategic positioning, Fisher’s new strategy was to be multilayered but straightforward.

730 Nelson, E., & Wendy, B. 1996. Kodak Is in Talks with Britain's Danka to Sell at Least Part of Copier Business. Wall Street Journal, 1996 Sep 06: 0-A2. 731 Pulliam, S., & Bounds, W. 1994. Heard on the Street: Investors Are Betting That Kodak Will Shed Drug Line. Wall Street Journal, 1994 May 03: 0-PAGE C1. 732 1992f. Technology Brief -- Eastman Kodak Co.: Sterling Winthrop Discloses Some Products in Pipeline. Wall Street Journal, 1992 Dec 18: 0-PAGE B3. 733 1991d. Technology Brief -- Eastman Kodak Co.: Sterling Drug Unit, Sanofi Initiate Joint Operations. Wall Street Journal, 1991 Aug 06: 0-NO PAGE CITATION. 734 Jackson, T. 1995. Pictured from a New Angle. Financial Times, May 11(13).

250 Period 1994-1999: Fully Digital World (George M. C. Fisher) 6.3.3 Structural and Strategic Context: The Move Towards Separation Largely reversing Kodak’s earlier diversification efforts, Fisher abandoned most of the company’s non-imaging units, including Sterling Winthrop Inc., which made pharmaceuticals and over-the-counter drugs; L&F Products, which made Lysol and other home and personal-care products; and the Clinical Diagnostics division, which produced medical testing devices. He used the proceeds from sales to free the company of its long-term borrowings, and directed the company’s focus entirely to its core competence – pictures, in the broadest sense of the word and without differentiating between silver-halide and digital technology. The goal was to exploit the five key elements of the full spectrum of imaging, comprising “image capture, processing, storage, output, and delivery of images for people and machines anywhere in Kodak’s worldwide market.”735 Growth strategies by means of geographical expansion and product differentiation aimed at strengthening Kodak’s market share to gain a competitive advantage and to fuel new ventures in the digital world.

To secure autonomous and independent development of digital ventures, Fisher separated digital operations from silver-halide ones, forming the Digital and Applied Imaging Division. “We need to separate the two [digital and silver-halide operations],” he said. “There’s been too much fear that the new technology would kill the old business.” 736

Key managers to direct the division were hired from outside, while Kodak kept one person to which both sides were asked to report.

6.3.4 Realized Strategy: Flexible Approach, Heavy Investment “The company was trying to do too many things at once and wasn’t able to afford to do any of them well enough,” Fisher asserted.737 Moreover, Kodak’s efforts to diversify its businesses consumed cash the company required to push the digital imaging business. “Imaging offers Kodak tremendous opportunities for long-term success and growth,” but “to achieve maximum success, we have concluded that we must commit our entire resource base to imaging opportunities and divest noncore businesses.”738 As a consequence, Fisher divested most of the company’s non-imaging

735 1994d. Eastman Kodak Company Annual Report. Rochester, NY, Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04. 736 1994c. Eastman Kodak Co.: Computer Industry Partners Sought for Digital Imaging. Wall Street Journal, 1994 Mar 16: 0-PAGE A4. 737 Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114. 738 Holusha, J. 1994b. New Kodak Strategy: Just Pictures. The New York Times, May 04.

ANALYSIS 251

businesses, used most of the proceeds of the sales to redeem the company’s long-term borrowings, and pushed Kodak straight back to its roots.

Figure 99 Eastman Kodak’s New Strategy (1994)

Schematic Depiction

After Kodak’s debt-to-capital was down from 70 percent, when Fisher took over, to 12 percent, he started to heavily invest in the core film business, with the aim to “send a clear signal to everyone in the film business.”739 For instance, Kodak acquired the

739 Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114.

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borrowings with proceeds from sales, and support of core business with remaining cash

(2) Growth in core business by means of geographical expansion and product differentiation (to overcome the company’s cost problem and to generate funds for the development of digital ventures)

(3) Investment in digital business with profit from core business until business achieves payback, which was expected to happen in 1997

252 Period 1994-1999: Fully Digital World (George M. C. Fisher) other half of Qualex Inc., the largest US wholesale photofinisher, for $150 million.740 A year later, it acquired the majority of Fox Photo for about $52 million.

741 Outside the

US the company bought Nagase, a distributor of chemical goods as well as of Kodak products, and concluded a long-term cooperation agreement with Belgian Spector Photo Finishing Group, one of Europe’s leading retailing and photofinishing concerns.742 Smaller competitors in the imaging business got the message: DuPont and 3M planned to sell or spin off their film operations.743

Fisher also redirected a lot of resources to the development of emerging markets and product differentiation. For example, the company “set aside a lot of money in 1995 and beyond for China” and gave manufacturing of photographic film and paper there “a high priority.” 744

Likewise Kodak spent huge budgets on the new Advanced Photo System (APS). Fisher remembered that

we spent a lot of money on it and I remember sitting in meetings where people had to make the final decision, were we going to go ahead with it? And I agreed with going ahead with it, given all we had invested in it and given the fact that nobody really knew how fast digital was going to come on, that maybe this would satisfy a lot of the needs that digital satisfied.

Elsewhere he became more explicit on the virtues of the new product, saying that “I think this system promises to be one of the greatest growth drivers for film this company has seen in decades.”745 His strong belief in the system was reflected in Kodak’s resource allocation. In 1995 alone, the company invested $300 million in new manufacturing facilities at its Kodak Park complex in Rochester, and budgeted about $100 million for an advertising campaign, after spending an estimated $1 billion to develop the system.746 In Europe, the company invested $167 million in new plant to

740 Bounds, W., & Frank, R. 1994. Kodak Is to Buy Actava Group's Half of Photofinisher Qualex for $150 Million. Wall Street Journal, 1994 Aug 08: 0, O'Neill, J. 1994. U.S. Industry News. International Contact, 13(5) September/ October: 42-43. 741 1996a. Eastman Kodak Company Annual Report. Rochester, NY. 742 Blömer, H. J. 1996b. Earthquake in Europe. The Alliance between Spector and Kodak Alters the Map of the Imaging Market. International Contact, 15(5 [photokina '96 issue]) September/ October: 5, O'Neill, J. 1996. U.S. Industry News. International Contact, 15(3) May/June: 12. 743 Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114. 744 Maremont, M. 1995. Kodak's New Focus. BusinessWeek January 29, Nelson, E. 1997d. Kodak Is in Talks to Make Film, Paper in China. Wall Street Journal, 1997 Apr 08: 0-A, 10:13. 745 O'Neill, J. 1995d. U.S. Industry News. International Contact, 14(4) July/ August. 746 Bounds, W. 1996i. Marketing: Camera System Is Developed but Not Delivered. Wall Street Journal, 1996 Aug 07: 4, Johannes, L. 1998c. Photography: For New Film, a Brighter Picture. Wall Street Journal, 1998 May 05: 0-B1, Maremont, M. 1996. Will a New Film Click? BusinessWeek February 02.

ANALYSIS 253

manufacture APS film cartridges.747 Investments in the APS system were widely regarded as “record amounts” in the industry.748

Fisher’s resource allocation to developments related to digital technology caused great tumult at Kodak.749 For years, the company had dabbled with this technology, conscious that it was the wave of the future, but threatened by the prospect it would render its core business obsolete. Fisher bundled various efforts that had been scattered through the company, allocated them to a separate unit, and pumped nearly half of the company’s annual budget for research and development – about $500 million – into the digital future, expecting the division to be profitable by 1997 [see Figure 67].750

6.3.5 Resources and Capabilities: Low Uncommitted Resources, Imaging In 1997, it became evident that Kodak’s retained (and even enhanced) resource commitment to its silver-halide photography business had become a burden, tremendously stressing the company’s balance sheet at times of industry stagnation and fierce competition. While George Fisher was cautious about substantially cutting resources in view of his forthcoming growth program, three years later, in the absence of growth, the overbearing costs of overhead started to eat up the company’s profit. Kodak reported declines in sales in every division, rendering the company’s resource commitment blatantly out of proportion to returns on investments. In particular, total 1997 sales decreased by 9 percent compared to the previous year. Kodak explained the decline on the ground of the sale of the Office Imaging operations and the negative effects of currency exchange; however, a close examination of Kodak’s performance in the consumer segment reveals a similar situation. According to Kodak, sales in the Consumer Imaging segment were basically flat for the year. The growth in unit volumes Kodak managed to generate for film and paper products, likewise, were basically compensated by the negative effects of the dollar exchange rate and low retail price for film. Certainly, the poor performance of the photography business was also affected by the flop of the new Advanced Photography System (APS). 747 O'Neill, J. 1997. U.S. Industry News. International Contact, 16(1) January/ February: 20. 748 Bounds, W. 1996b. Don't Blink: Photo Industry Launches Global Blitz to Tout New Cameras, Film. Wall Street Journal, 1996 Feb 01. 749 Bounds, W. 1995b. George Fisher Pushes Kodak into Digital Era. Wall Street Journal, 1995 Jun 09: 0. 750 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114, Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109.


Figure 100

Eastman Kodak’s Revision of Its 1994 Strategy (1997) Schematic Depiction

With respect to digital imaging, Kodak was facing a similar situation, although the source of the problem was different. Indeed, heavy investments increased sales of digital products such as cameras and scanners, but the unit continued to lose money. The huge drop in prices for CD-R media due to Taiwanese companies entering the market largely increased the poor performance. Thus, contrary to early expectations, efforts in digital imaging did not reach the breakeven point to start paying back investment. Rather, in 1997 it became clear that the unit would continue to rely on external funds.

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ANALYSIS 255

Kodak’s resource base burdened the company’s performance also from another perspective. For more than a century, the company had been building a worldwide network of distribution channels and customer relations, mainly serving the company’s photographic film and paper business. Kodak’s push for digital imaging posed the problem of how to get digital products, such as filmless cameras, into the market without cannibalizing the profitable silver-halide empire. In practical terms, it raised the question of whether Kodak should go for one or multiple sales forces, as well as whether a different market (and thus distribution channel) would be necessary. Accounts from several marketing managers confirmed that a lot of the company’s problems while moving into digital imaging were caused by this challenge.

For instance, Paul Melnychuck, then in charge of marketing digital products in Hollywood and Los Angeles, summed up the challenge as following:

“In the early days of Kodak’s efforts to sell electronic imaging products, the company was struggling with the problem of whether to use its established skilled sales force for both silver-halide and electronic products or to add a new one. While the use of its film sales force promised the benefit of well-established relationships with retailers, a separate sales force for electronic products would be more related to the fast-paced industry.

You have people with a sales quota based on the traditional portfolio of products. They owned those relationships by and large maintained control of the customer. And then there is a new breed of people, like myself, who were new to sales. Now I come in wanting to sell to the same customer the new products, which are PhotoCD, cameras, and printers.

What I discovered was friction.

I didn’t own the customer relationship; I didn’t have that relationship, so I had to rely on the cooperation of the sales organizations that had those relationships. And what would you do if your paycheck is based on selling the products that you have in your portfolio and someone is asking for help to basically take away your sales and replace it with new products? It’s ill conceived. It doesn’t invite cooperation.

So the problem was not here in the research labs, it was not here in terms of developing it. It was outside of Rochester. It was in the selling and in the marketing of it, because you have a conflict between two very different paradigms.”751

751 Melnychuck, P. 2013. Personal Interview. November 20. With M. Shamiyeh.

256 Period 1994-1999: Fully Digital World (George M. C. Fisher) Jerry Magee, marketing manager for Kodak’s professional digital cameras in the 1990s, remembered similar challenges, despite the fact that he was developing new distribution channels in his efforts to introduce digital technology to professionals as an alternative to film. In 1994, Kodak launched the NewsCamera 2000, a fully digital camera developed for and distributed exclusively by the Associated Press. Magee set up the collaborative effort, which was discontinued due to an internal competition a year later:

“The Professional Photography unit controlled us because we were part of them. They didn’t like that we had given exclusivity to the Associated Press and therefore killed our digital-only customer to make their film customers happy. They weren’t as concerned about losing photographic film, because they didn’t see that right in front of them. It was their relationship with their dealers that they were concerned about. And they were probably being played at that time, because Fuji was making big inroads with better films, so they had to keep that customer happy. So that’s where the tension was. So in 1995, it wasn’t a film displacement story. It was a customer-dealer relationship issue.

I just remember we were forced into going into New York, telling the Associated Press that the exclusivity was over. And almost from that day on, we sold so few [digital] cameras.”752

A similar experience but on a different matter was related by Nicoletta Zongrone, general manager for ink-jet media at Kodak and later vice president of the company. She remembered that even the naming of digital products became problematic in the face of the two competing imaging businesses – a circumstance that in the end put the company in an unfavorable competitive position in the marketplace, which was flooded by companies from industries that had no background in the photography industry (and thus no valuable resources to defend):

We developed ink-jet papers for home printing. What was great about that was we were able to re-purpose film and paper machines, coating machines, coating ink-jet photo papers. And we achieved Number One Market Share over HP. We didn’t have our own printer and we got to Number One Market Share photo printing.

I still remember this meeting I had down at Kodak office. The CMO [Chief Marketing Officer] Carl E. Gustin and Dan Carp was in the room as the CEO and we had the head of the Consumer Imaging Business Film and they wanted to see my packaging

752 McGee, J. 2013. Personal Interview. April 11. With M. Shamiyeh.

ANALYSIS 257

because we were putting photos on the package and we wanted to call it Kodak Photo Paper. I was told it was not a photo; I could not call it photo paper.

And then we had, on the highest end one, you know we wanted to call it professional. Oh my gosh, I could never call it professional. This is not professional paper and one of the pictures was of a bride, no way could you put a bride on there. You can’t put weddings; we can’t be printing wedding pictures at home. This is not photos; we can’t teach people that these are photos.

We were up against HP in the category. We’re up against Canon; we’re up against all these other printer manufacturers. They’re calling it photo paper and we are Kodak and we couldn’t call it photo paper.”753

These three reports on personal experiences in bringing digital products to market clearly document the dilemma the company was facing: Kodak’s resource base – its predominantly film-centric nature – rendered a transition to new frontiers more difficult, particularly because film-related products were the sole source of income. Coupled with the problem of an evident decline of this sole source of income, the company was required to revise its 1994 strategy. Customers and powerful capital providers too maintained a decisive force in the revision of the strategy.

6.3.6 Customers and Powerful Investors Investors had long criticized Kodak for not reducing its workforce, which many considered as bloated compared to rivals. In the course of recurring poor quarterly results, they had been asking again and again for substantial layoffs.754 People close to Wall Street paid attention to investors’ clamoring for massive layoffs. For instance, Alex Henderson, a Prudential Securities analyst, noted the following in regard to a press release Kodak sent out to inform the public about its plans to fire 200 managers: “It doesn’t sound like Kodak is going to do enough to satisfy Wall Street. We’ll have to wait and see how this plays out. There's a lot of pressure on management to do something quickly.”755

While Kodak had been quite reluctant in terms of providing numbers of layoffs in the early days of 1997, investors were precise in pressing Fisher to cut the workforce by as

753 Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh. 754 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 755 Pereira, J., & Maremont, M. 1997. Kodak Warns It Plans to Fire 200 Managers. Wall Street Journal, 1997 Sep 26: 0-A, 3:4.

258 Period 1994-1999: Fully Digital World (George M. C. Fisher) many 20,000 employees to save $1 billion in cash from its annual costs.756 In January, Kodak announced that “job cuts will be mainly in European photofinishing operations, Latin American retail stores and administrative and support personnel at the copier business,” but did not specify how many employees would have to leave; in fact, it was announced that Kodak's employment level of about 90,000 worldwide won’t change because the company is adding personnel in other areas, such as digital imaging.757

In the course of the year, Kodak successively increased its projections for an impending layoff. Late in January 1997, it announced the layoff of about 3,900 employees; in September the figure was raised to 10,000, to finally come close to the amount requested by investors. “We’ve learned that [the] wishful thinking that we’ve been guilty of in the past won’t change the facts,” said Fisher. “I think we’re out of denial. We’re dedicated to getting back on track.”758 Shortly afterward, he declared that he would substantially cut the company by 19,900 employees by the end of 1999 and save at least $1 billion in costs to “boost investors’ confidence.”759

6.3.7 Cognitive Framing: Digital Imaging = (Still) Opportunity Despite recurring negative headlines in the press about Kodak’s poor performance in traditional photography and continued losses in digital imaging, Fisher kept holding on to Kodak’s strategy. “I don’t have the slightest hesitation that we’re on the right track,” he said, specifying elsewhere that “the company’s basic strategy remains on course.”760 Given the industry change, this stand was remarkable, but understandable:

In the mid-1990s, two observations – coupled with a pragmatic view of the company’s resources – apparently affected Kodak’s mindset and thus its subsequent strategic

756 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 757 Nelson, E. 1997e. Kodak Plans Big Job Cut, Takes Charge. Wall Street Journal, 1997 Jan 17: 0-B2. 758 Maremont, M., & William, M. B. 1997b. Kodak to Slash 10,000 Jobs, Take Charge --- Moves Aim to Cut Costs by at Least $1 Billion; Shares Still Fall Sharply. Wall Street Journal, 1997 Nov 12: 1-A3. 759 Kerber, R. 1997. Kodak Boosts Layoff Plan, Restructuring Charge. Wall Street Journal, 1997 Dec 19: 1-A, 3:1, Maremont, M., & William, M. B. 1997a. Kodak's 10,000 Job Cuts May Really Amount to Just 8,000 at End of the Day. Wall Street Journal, 1997 Nov 13: 1-A4, ibid., Maremont, M., & William, M. B. 1997b. Kodak to Slash 10,000 Jobs, Take Charge --- Moves Aim to Cut Costs by at Least $1 Billion; Shares Still Fall Sharply. Wall Street Journal, 1997 Nov 12: 1-A3, Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07). 760 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4, Smith, G., Wolverton, B., & Palmer, A. T. 1997b. A Dark Kodak Moment. BusinessWeek(3538) 30-31.

ANALYSIS 259

behavior: the perception that digital cameras actually increase rather than decrease picture-taking and the debut of low-cost home printers, designed exclusively for printing photos at home. Whereas the former strengthened Kodak’s framing of digital imaging as an opportunity that complements traditional photography instead of killing it, the latter motivated an inconsistent framing. The production of photo-paper for home printers certainly remained a lucrative opportunity, because for Kodak it promised a consumable business on the basis of its coating capabilities. The lack of competences in manufacturing consumer printers, plus the prospect of consumers printing their photos at home (and thus not at Kodak’s photofinishers), however, undoubtedly posed a threat.

Fisher never tired of repeating that digital imaging tended to create additional images rather than to replace conventional photographic ones. “Despite fears that digital will cannibalize film, we haven’t seen it,” he said, though admitting that the graphic arts industry today uses less film and more digital technology.761 Although experts disagreed about how long it would take for digital imaging to substantially shrink traditional photography, Kodak for itself concluded that it would take 40 to 50 years to become a purely digital business.762 “We know film will remain a preferred format for consumers for decades,” the company announced, simply because “it’s easy to use, people like it, and it's economical. Yet digital imaging and digitization offer definite advantages, enabling people to do more with their pictures.”763

Kodak’s projection was surely exaggerated to ease investors’ scruples, but the company had come to realize that digital imaging would not replace photographic film and paper immediately. Subsequent estimates specified Kodak’s expectations two years later. In 1999 the company assumed that by 2005, silver-halide film and paper would add $3-7 billion in annual revenues, with emerging markets having a significantly larger share; digital products, by contrast, would add approximately $3.5-

761 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, O'Neill, J. 1996. U.S. Industry News. International Contact, 15(3) May/June: 12. 762 Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1, Smith, G. 1999. Film Vs. Digital: Can Kodak Build a Bridge? BusinessWeek(3640) 66-69. 763 1998. Eastman Kodak Company Annual Report. Rochester, NY.

260 Period 1994-1999: Fully Digital World (George M. C. Fisher) 4 billion.764 Only about 20 percent of all US households were expected to own digital cameras by 2005.765 Hence, Kodak’s way of seeing digital technology as a means to generate more pictures (and thus prints), even though it would take a long time to replace traditional capturing devices, seemed to justified further investments in the chemical-based photography business – at least on the output side of the imaging chain, paper production.

In contrast to varying estimates about the speed at which digital image-capturing-devices might diffuse into the market, Kodak was certain that its business would have to move from the capture side of the imaging chain – mainly cameras and film – to the output side. “We did believe for a long while that at the end of the day, the money was going to transition from color film to output and processing and that’s proving to be true today,” said Fisher.766 The debut of low-cost photo printers made by computer manufacturers, therefore, suggested the need for a substantial change in Kodak’s strategic behavior; however, the company decided to stay on course, for understandable reasons.

In 1996, it became apparent that printing technology had improved so rapidly in recent years that manufacturers were ready to conquer a new marketplace: photography, with about 70 billion pictures taken annually.767 Several leading computer manufacturers, for instance Hewlett-Packard, Epson, and Canon, launched their first low-cost photo printers, which could produce color prints that were close in quality to those from professional film developers.768 Moreover, these companies also started to offer accessories to turn the home computer into a home photo studio.769 Hence, there were

764 Klein, A. 1999e. Kodak Executives Say They Forecast 8%-12% Annual Revenue Rise by 2004. Wall Street Journal, 1999 Apr 28: 1-B13. 765 1999c. Eastman Kodak Company Annual Report. Rochester, NY. 766 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 767 Franz, D. 2014. Cameras + Film Rolls, 1984-2012. In P. News (Ed.). Bonita Springs, FL, Gomes, L. 1996. New Pc Printers Take on Market for Home Photos. Wall Street Journal, 1996 Aug 13: 4, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1. 768 Franz, D. 1997. Wolf Camera on the Internet. Tomorrow's Images for Everybody. International Contact, 16(1) Jannuary/ February: 14-16, Franz, D. 2014. Cameras + Film Rolls, 1984-2012. In P. News (Ed.). Bonita Springs, FL, Gomes, L. 1996. New Pc Printers Take on Market for Home Photos. Wall Street Journal, 1996 Aug 13: 4. 769 Franz, D. 1997. Wolf Camera on the Internet. Tomorrow's Images for Everybody. International Contact, 16(1) Jannuary/ February: 14-16, Franz, D. 2014. Cameras + Film Rolls, 1984-2012. In P. News (Ed.). Bonita Springs, FL, Gomes, L. 1996. New Pc Printers Take on Market for Home Photos. Wall Street Journal, 1996 Aug 13: 4.

ANALYSIS 261

clear signs of a new technology that brought along with it the prospect of replacing the other end of the already staggering traditional imaging chain, replacing traditional photofinishing services with the home printer.

However, there was less certainty about how fast the technology would progress or how soon consumers would switch to it. For instance, some analysts argued that “it will be years before home photo printing becomes as easy, inexpensive, and high-quality as traditional photo processing [because] manipulating photos on a computer may be convenient, but it’s also time-consuming.”770 This evaluation was widely shared by people close to the industry, as well as by consumers, during the 1990s.771 Others were confident that digital images would render photofinishing obsolete (and thus a several billion-dollar business).772

Kodak for itself apparently acknowledged the emergence of home photo printers, but remained seesawing for plausible reasons. The company saw the potential of being able to leverage its coating competences to commercialize special paper for use in home photo printers, but by the same token it was aware that it owned no capabilities for manufacturing a low-cost consumer printer.773

According to Steve Sasson, then in charge of developing photographic quality thermal printing systems at Kodak, the company tried to get to a consumer level for printers. However, most of its printers were commercial, deploying an expensive thermal printing technology.774 “We didn’t make that many consumer products,” recalled Sasson, “certainly not in the US.”775

Nicoletta Zongrone confirmed senior management’s quest for a consumer printer back then, in order to compete against manufacturers of low-cost home photo printers:

“We had this constant technology assessment about ink-jet printing, thermal printing, silver-halide printing, electro-photographic printing and there was tons of work done

770 Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109. 771 Sandberg, J. 1998. Digital Cameras Are Better, but Still Waste a Lot of Time, Money. Wall Street Journal, 1998 Jan 15: 0-B1. 772 Alsop, S. 1997. Digital Photography Is the Next Big Thing. Fortune August 04. 773 Gomes, L. 1996. New Pc Printers Take on Market for Home Photos. Wall Street Journal, 1996 Aug 13: 4, Sasson, S., & Zongrone, N. A. 2013. Personal Interview (Steve Sasson and Nicoletta Zongrone in Conversation with Michael Shamiyeh). November 18. With M. Shamiyeh. 774 Sasson, S., & Zongrone, N. A. 2013. Personal Interview (Steve Sasson and Nicoletta Zongrone in Conversation with Michael Shamiyeh). November 18. With M. Shamiyeh. 775 Ibid.

262 Period 1994-1999: Fully Digital World (George M. C. Fisher) around comparing all those technologies, comparing their cost per print, comparing total cost to ownership, trying to really understand the technologies and figure out what kind of consumer printing should we as Kodak get into.

We always knew ink-jet was the lowest cost. But we didn’t have the technology. Electrophotography was even lower-cost, but it never met the quality standard in those days. And then thermal dye-sub was always going to have this barrier, because there were multiple layers, multiple pieces of material, two pieces of material, you are never going to get to one consumable. And the printing technology was precise enough and controlled enough that it also – with print head cost and everything – you are never going to get down below a certain barrier. We were trying to get down to $200, but were sure that it was never going to get down there; it was more like $400 or $500 cost I am talking about. So, you are never going to get to a home printer with a thermal printer that was as low-cost as an ink-jet home printer. And so that is another reason why paper was continued to be invested in.”776

It is important to note that Kodak once owned competence in ink-jet technology, but had sold it just four month before Fisher took over.777 Dayton Operations, or Diconix as it was called previously, manufactured ink-jet printers and received international recognition by launching the world’s first portable ink-jet printer.778 The company was acquired by Kodak in 1983 and sold in an effort to return to profitability after diversification efforts.779

6.3.8 Structural and Strategic Context: Efforts to Enhance Autonomy In the mid-1990s, the excess of retained resources started to burden the company’s financial and operative performance in every domain; as a result, powerful capital providers put Kodak under pressure to lay off about 20 percent of its workforce; and, above all, the entry of computer manufacturers into the photography industry suggested the need for altering long-established business models. Despite all these challenges, Fisher’s 1994 strategy basically remained unchanged, with just some nuanced modifications in certain eras, particularly in regard to the photofinishing part of the imaging chain. In its annual report, Kodak reveals its slightly adjusted plan:

776 Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh. 777 1993a. Eastman Kodak Co. Wall Street Journal, 1993 Jun 08: 0, 1993f. Scitex Corp. Wall Street Journal, 1993 Jul 08: 0. 778 Paxton, K. B. 2013c. Pictures, Pop Botttles and Pills. Kodak Electronics Technology That Made a Better World but Didn't Save the Day. Rochester, New York: Fossil Press. 779 1983a. Eastman Kodak Company Annual Report. Rochester, NY.

ANALYSIS 263

“Our strategy is to enable people to keep using film, while helping them obtain and appreciate the benefits of digital imaging. Best of all, our strategy embraces both internet solutions and photo retailing. Simply put, we see more growth in digitization by including everyone – and not excluding anyone.”780

The recurring theme that digital technology sits alongside film, and may even assist it, found its practical expression in a new Kodak product, the digital print station. These print stations were essentially kiosks that allowed consumers to upload their pictures locally, edit them on a touch screen, and make prints without being obliged to wait an hour for the copy. Kodak expected to have a kiosk on every street corner, reaching a distribution network as dense as that of ATM machines.781

Kodak based its expectation on the assumptions that by the turn of the century consumers would take about 75 billion pictures annually, while continuing to use mostly traditional film, which was cheap and provided high quality. Kiosks held the advantage, in the company’s view, so that for consumers there was no need to connect to their personal computer to get high-quality prints, to upload an image on the web, or to send pictures electronically to friends.782 Consumers should “be able to store and index images on a worldwide server and to send pictures to a friend halfway around the globe or even to interact with photofinishers to preview images over phone lines and select sizing and editing of the pictures they want.” 783

The view that home printers could replace Kodak’s long-established and recently extensively enlarged resource base of photofinishing facilities was not considered by senior management – at least not according to their public comments. “Nonsense,” commented Fisher, on the launch of HP’s $500 PhotoSmart printer, adding that “HP is probably caught up in the hype of the industry.”784 Kodak believed that consumers would prefer the easy way to have their pictures scanned or printed, at a local retailer or a digital-imaging kiosk.785

780 1998. Eastman Kodak Company Annual Report. Rochester, NY. 781 Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh. 782 Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109. 783 O'Neill, J. 1996. U.S. Industry News. International Contact, 15(3) May/June: 12. 784 Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109. 785 Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07).


Figure 101 Transitions in the Customer Relationship in Photography

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Hence, in viewing two distinct markets – the digital darkroom at home on a PC and kiosk-based digital imaging at retailers – Fisher apparently decided to go for the alternative that leveraged the company’s core resources in silver-halide photofinishing and strengthened the relationship between consumers and Kodak in the face of an upcoming transition in photography towards a do-everything-yourself mentality [see Figure 101]. While Hewlett Packard, among other computer manufacturers, put its focus on home printing and thus allowed consumers to take charge of the entire imaging chain, Kodak tried hard to keep control of the last remaining part of the imaging chain – the editing, viewing, sending, and printing of images:

“Some of the hard decisions we’ve got to make over the next few years in the digital world will be: ‘What parts of that chain do we participate in, which parts do we partner, which parts do we just source?’ In the end, the answers will be different by product, by business, so there’s not just one answer for the whole company,” declared George Fisher. 786

Likewise, while Hewlett Packard felt certain that its technology was going to capture substantial shares of the photofinishing market of traditional photographic film and paper manufacturers, Kodak was convinced that its own model would boost sales.787 “In a good number of venues, like with digital print stations,” Fisher explained, “we see digital supplementing traditional imaging and providing us with new profit streams for media.”788 Kodak expected kiosks to spur profits by at least 10 percent.789 By 1997, it had installed some 10,000 kiosks and planned to triple the number within a year.790

Opting for only one market while sidestepping the potentially larger market in the future certainly contributed to Fisher’s decision to focus the company’s efforts first on its money-losing Digital Imaging unit. Kodak had no ink-jet technology, which was required to compete successfully in the low-cost home printing market, and the unit was far away from turning digital projects such as PhotoCD or digital cameras into profit-makers. On several occasions, Kodak’s senior executives announced that they would not approach the consumer printer market until digital photography became a hit at home; meanwhile, they hoped for a “windfall” from their installed base of kiosk 786 Ibid. 787 Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109. 788 O'Neill, J. 1996. U.S. Industry News. International Contact, 15(3) May/June: 12. 789 Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109. 790 1998. Eastman Kodak Company Annual Report. Rochester, NY, Smith, G. 1997. What Kodak Is Developing in Digital Photography. BusinessWeek(3534) 108-109.

266 Period 1994-1999: Fully Digital World (George M. C. Fisher) and photofinishing retailers.791 Robert Unterberger, then head of the Digital Unit, specified that Kodak wanted to wait until ink-jet technology was on the market with high picture quality, and Fisher considered reselling printers made by another manufacturer, which was more closely related to a lack of resources than to allegedly weak consumer interest.792

Fisher’s commentary also directs attention to another issue in Kodak’s response to the ongoing computerization of the photography business. Despite the fact that Kodak had no brand for computer peripherals – “the Kodak brand meant the yellow box to most people” – its low resource commitment to computer-related businesses relative to competitors from the semiconductor industry prevented the photography company from competing successfully.793 Fisher illuminated Kodak’s thinking at the time by explaining particular conditions in the semiconductor industry:

“The semiconductor industry has found it too expensive for the most part to build these big $4 billion facilities. And even before that, when the memory card had split off from Micron Technology to the Koreans, most of the semiconductor companies got out of the DRAM [Dynamic Random-Access Memory] business and later out of the SRAM [Static Random-Access Memory] business, because it was so fiercely competitive and it needed scale.

For Kodak to think that we could compete in that space would’ve been just ridiculous, even though we had people who understood the technology.

And on the [image] sensor side, we had to make a decision. We talked to IBM on their CMOS [Complementary Metal Oxide Silicon] technology extensively and it was very good; it was world class. But we had to make the decision, do we go into it – because we had the capability and prototype labs to build devices – or do we let somebody else do that. And for the most part, those decisions always ended up on, let somebody who has more scale do it rather than build up our costs.”794

Kodak’s strategic choice was to solidify the separation of its digital unit as an autonomously operating organizational entity. Fisher wanted to take decisive actions to turn the digital imaging business finally into the profit zone. The business was

791 Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07), Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 792 Smith, G., Symonds, W. C., Burrows, P., Neuborne, E., & Judge, P. C. 1997a. Can George Fisher Fix Kodak? (Cover Story). BusinessWeek(3549) 116-128. 793 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 794 Ibid.

ANALYSIS 267

expected to reach breakeven by the end of 1997, but continued losses rendered that goal unlikely.

Ever since Kodak restructured its activities related to photography into several business units back in 1984, the operating philosophy was that they were “independent and autonomous.”795 Each business unit was to develop its own strategy to achieve the financial goals that it was given. As a result, separate business unit strategies continued to exist even during the company’s renewal under Fisher’s direction. According to Terry Faulkner, then director of Strategic Initiatives, this circumstance generated a serious problem at a time when the coming replacement of silver halide by digital technologies had become obvious, because senior corporate management accepted the structural context of independent and autonomous entities and made no attempt to dictate any changes in business unit strategy.796 Instead of demanding concrete solutions to the problem of a prospective digital substitution, they continued to assign financial performance goals:

The business unit strategies were what mattered. When he [Dan Carp] talked to business unit presidents, it was never about anything but financial performance. I never ever heard him try to suggest that they should be doing something different. He urged them in respect to financial results. “You’ve got to improve your financial performance; here’s the goal I’m setting for you; you’ve got to achieve this financial performance. I want to be assured you’re going to get it, and you’re not doing as well as you should, etc., etc.”

I never heard him say to a business unit manager, “You need to have a strategy that’s more focused on coping with digital.” The subject just didn’t come up.797

Certainly, business units could achieve their performance goals just with their own product lines, which were based on silver-halide technologies for the most part. Fisher addressed this shortcoming by establishing a structurally separate entity focusing exclusively on digital imaging technologies, where a loss associated with the start-up period was accepted. According to Terry Faulkner, Kodak’s corporate strategist back then, the 1994 founded unit “didn’t accomplish much of anything until 1997.”798 Initially, it was managed by Richard Bourns, who had a strong background in

795 1984a. Eastman Kodak Company Annual Report. Rochester, NY. 796 Faulkner, T. 2013b. Personal Interview (Follow-up). November 26. With M. Shamiyeh. 797 Faulkner, T. 2013a. Personal Interview. November 04. With M. Shamiyeh. 798 Ibid.

268 Period 1994-1999: Fully Digital World (George M. C. Fisher) traditional photography manufacturing; he was succeeded by Carl Gustin, who was promoted to chief marketing officer shortly after. In subsequent months, Robert Unterberger, a 57-year-old IBM executive, managed the unit, but he was not very effective.799 But of course, one has to keep in mind is that D&AI was not given responsibility for consumer digital imaging until 1997. Until then, the consumer photography division, which sold film, and was responsible for kiosks, also had responsibility for consumer digital cameras, and initially developed the Kodak DC25 camera as a response to the Casio QV-10 camera.800

In the course of a layoff of more than 200 top and middle-level managers, Fisher brought Willy Shih, a 45-year-old computer veteran, to take over the Digital and Applied Imaging unit.801 Shih had earned a good reputation in commercializing high-end graphic workstations. At Kodak he successfully reinforced the autonomy of the digital imaging unit and managed to foster a Silicon Valley culture, foreign to the philosophy the film and paper company was accustomed to.

Team members of the unit recalled that Kodak and its digital imaging unit were “like two companies; [at] the digital group were really different kind of people.”802 Others recalled that “Willy Shih was doing some really novel stuff, not just from the technology point of view, but from a marketing point of view and from a channel point of view. He was penetrating channels and managing to do this with cameras and paper without getting the traditional CI [Consumer Imaging] channels.”803

“We [at the Digital Imaging Unit] went and built the consumer electronic channels for Kodak, because there was no Best Buy or Circuit City. We built it with cameras; we also went into office product super-stores like Staples and Office Max and Office Depot with the ink-jet paper. The ink-jet paper was profitable, very profitable; cameras weren’t so, but both were a good pair. We used to call it the power of two. You have to sell both, because you have to sell something that is profitable as well as cameras. And then we went into Wal-Mart and into CVS and other places and we had to make sure that our meeting was separate from the consumer imaging people. The sales people knew what we were doing. But we had our own sales people and we 799 Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14. 800 Parulski, K. 2014b. Written Feedback on Research Per Email. September 20. With M. Shamiyeh. 801 Johannes, L. 1997b. Kodak Names Shih as New President of Its Digital Unit. Wall Street Journal, 1997 Aug 08: 0-B14. 802 Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh. 803 Sasson, S., & Zongrone, N. A. 2013. Personal Interview (Steve Sasson and Nicoletta Zongrone in Conversation with Michael Shamiyeh). November 18. With M. Shamiyeh.

ANALYSIS 269

talked to different people, and we didn’t place our digital products necessarily always in the photo section; we had it in stationery or in electronics. We weren’t talking to the same buyers as the film guys.”804

6.3.9 Realized Strategy: Flexible Plan, High Commitment The reason for selling most of Kodak’s non-core-imaging businesses, including Sterling Winthrop operations, in 1994, was to free up capital to finance the new move into digital imaging. But neither the company’s traditional silver-halide photography business nor digital imaging provided the growth Kodak required. Even worse, expectations that digital imaging, which was endowed with an annual budget of $500 million a year for research and development, would start to return investments had been elusive. The unit continued to lose money and Fisher needed additional capital, he thought, to compensate with profits from Kodak’s core business. However, there an increasingly commoditized industry, coupled with fierce price competition, reduced cash flow when needed the most. Excessive overhead of retained (and even enlarged) resource commitments in Kodak’s traditional business started to depress the results. The dilemma: “We couldn’t kill the goose that laid the golden egg, namely color film, even if some of us believed that ultimately, maybe quicker than we had hoped, digital would take over.”805

No wonder that in 1997, the company had to increase its efforts to cut costs and improve efficiency, put more energy into growth by means of geographical expansion and product differentiation, and spur the search for potential alliances for joint development of new products, particularly in the domain of digital imaging. In 1997, Kodak had taken $1.5 billion – or one year’s net earnings – in restructuring and other pretax charges to cut costs of operations (which totaled $13 billion excluding the restructuring charge) by $1 billion.806 The layoff of some 20,000 employees, a workforce reduction the company had never made before, significantly improved Kodak’s operating margins, despite strong price competition.807 In one year, the company achieved nearly 75 percent of the $l billion in net cost savings it had pledged

804 Zongrone, N. A. 2013. Personal Interview. November 18. With M. Shamiyeh. 805 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 806 Kerber, R. 1997. Kodak Boosts Layoff Plan, Restructuring Charge. Wall Street Journal, 1997 Dec 19: 1-A, 3:1. 807 Johannes, L. 1998a. Kodak Reports Loss of $744 Million Including Big Restructuring Charge. Wall Street Journal, 1998 Jan 16: 1-A4.

270 Period 1994-1999: Fully Digital World (George M. C. Fisher) to make over a two-year period.808 In addition, the company started to reduce its resource commitments to research and development. Before Fisher took over, the company was spending up to 9 percent of its total revenues on R&D. In the course of the company’s 1997 cost savings program, the budget was lowered by 1 percent every year. This reduction made the search for partners necessary. Kodak also continued to divest its last remaining non-core imaging operations, such as the office imaging business and digital motion-imaging business, which was losing money and eating up valuable resources.809

Cuts in costs enabled Kodak to grow, to expand geographically, and to introduce new products. The company started to aggressively invest in China’s fast-growing photographic film and paper market, of which it had a 40 percent share. In 1997, it spent $375 million on manufacturing in China, to bypass China’s duty on imported film.810 A year later, Kodak spent $380 million in China to rescue three state-owned film manufacturers from bankruptcy, in return for more operating freedom and improved distribution channels.811 Part of the budget was also used to improve existing facilities. In 1999, Kodak even spent $1 billion in China to improve its own strategic position, counting on big growth.812 Indeed China showed significant growth rates of up to 30 percent between 1997 and 1999; however, total sales outside the US had fallen to 3.8 billion from 4.2 billion in the same period.813 Growth in China could not stem the decline in other regions. “The big question,” Fisher said, “is when it will begin to make money overall.”814 The other question he raised, which was also of concern to his successor, Dan Carp, was “how do we win in the digital space in China, because it was likely to move very fast, as it did for us [while I was CEO at Motorola] in the cellular telephone area, where we leapfrogged.”815

Fisher invested heavily in product differentiation. Kodak poured an all-time high budget into advertisement to smooth away the flawed product launch of the new 808 1998. Eastman Kodak Company Annual Report. Rochester, NY. 809 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4. 810 Roberts, D., & Barnathan, J. 1997. Will Kodak Get Lucky in China? BusinessWeek(3537) 48-48. 811 Bulkeley, W. M., & Craig, S. S. 1998. Business Brief: Kodak to Invest in China in a Bid to Improve Its Strategic Position. Wall Street Journal, 1998 Mar 24: 1-B4. 812 Ibid. 813 1999c. Eastman Kodak Company Annual Report. Rochester, NY. 814 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4. 815 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh.

ANALYSIS 271

Advanced Photographic System and to launch a marketing campaign that aimed at the vast children’s market.816 In 1997, the company spent $100 million to introduce the new camera system; a year later it spent another $100 million on the system.817

Nevertheless, the big marketing budget could not compensate for the circumstance that one third of consumers didn’t want to buy a camera that was more expensive than a regular 35mm camera.

On the side of digital imaging, Kodak came to the conclusion that it had made the mistake of trying to do it all alone. “I think we’re finding is that the opportunities are just too many, too diverse, that we can’t afford it,” concluded Fisher, and he started to engage in alliances to jointly develop products.818 Kodak joined with Intel to re-launch its PhotoCD, then called Picture CD; with AOL on its internet services, featuring pictures of 22 million consumers online; and with Lexmark to launch a home ink-jet printer in 1999.819 Such collaboration saved R&D costs and allowed Kodak to focus and reallocate resources to the expansion of its global retail network of Picture Maker kiosks and digital cameras. By the end of 1999, Kodak’s number of global placements of Picture Maker kiosks was over 23,000.820 And in the US, Kodak was the number two supplier of digital cameras, accounting for 20 percent of all shipments, compared to Sony with 35 percent.821

816 Maremont, M. 1997. Kodak Chief's Picture of Growth Is Slow to Develop --- Decision to Seek New Markets over Cost Cuts Proves Expensive. Wall Street Journal, 1997 Sep 17: 0-B4, Nelson, E. 1997c. Kodak Focuses on Putting Kids Behind a Camera. Wall Street Journal, 1997 May 06: 0-B, 8:3, Nelson, E., & White, J. B. 1997. Blurred Image: Kodak Moment Came Early for Ceo Fisher, Who Takes a Stumble --- Bet on Digital Photography Has Been a Money Loser; Fuji Is Gaining Ground --- Dennis Rodman's Film Flop. Wall Street Journal, 1997 Jul 25: 0-A1. 817 Grant, L. 1998. Why Kodak Still Isn't Fixed America's Other Famous Troubled Giants--Ibm, Gm, Sears--Got Turned Around. Not This One. Can Ceo George Fisher's Big New Shakeup Do the Job? Fortune May 11. 818 Patalon III, W. 1997. Kodak Chief Outlines Photo Giant's Challenges. Denver Post, November 9(J-07). 819 Johannes, L. 1998b. Kodak, Intel Join to Make Slimmer, Cheaper Cameras. Wall Street Journal, 1998 May 01: 1-B6, Johannes, L., & Alec, K. 1998. Eastman Kodak and Intel Join Forces to Offer Photographs on Compact Disk. Wall Street Journal, 1998 Sep 28: 1-B8, Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P. 820 1999c. Eastman Kodak Company Annual Report. Rochester, NY, 2000. Eastman Kodak Company Annual Report. Rochester, NY. 821 Kunii, I. M., Smith, G., & Gross, N. 1999. Fuji: Beyond Film: 132-138: Bloomberg, L.P.

Part III Discussion and Conclusion

7 DISCUSSION

7.1 Summary and Theoretical Contribution This research started with an elaboration on discontinuous change, directing attention to particular characteristics that distinguish this type of change from mere incremental or evolutionary change. I showed that unlike evolutionary change, where an organization adjusts its competences to small alterations in the environment, discontinuous change requires organizations to develop an additional competence configuration in parallel to the existing one, to address requirements in the new environment while keeping a tight fit of operations with the traditional environment. I made this argument building on two important premises: First, that the discontinuity of a prevailing technology is foreseen; and, second, that organizations can use a time period between perception of a potentially threatening new technology and complete replacement of the old one to reconfigure their competences. I have generally referred to technologies rather than products or processes to emphasize that it is the particular technique or methodology that changes or is discontinuous, and not the other way round.

I further suggested assessing the level of additional resources and capabilities required to effectively respond to discontinuous change, on the basis of relatedness between a current set of competences and a required one. Instead of building on more simplified frameworks of technological change and their impact on an organization’s competences – frameworks, which usually fluctuate between two extreme poles of competence destruction or enhancement, radical or incremental – I offered a more fine-grained contingency model to assess demands for resource development. I adapted the proposed model from a theoretical extension of the current Resource-Based View. Depending on the level of new competences required to develop and commercialize a new technology, I argued, different implications evolve for organizations with respect to the provision of liquid (uncommitted) resources or the leverage of currently deployed (committed) resources. While the effort to develop competences unrelated to a current set indicates that an organization needs high levels of uncommitted resources to acquire additional competences, to leverage closely

276 Summary and Theoretical Contribution

related and thus existing competences indicates a low demand for uncommitted resources, because the organization can exploit economies of scale.

In addition, I linked discontinuous change with organizational decline to demonstrate that the process of technological replacement may be accompanied by erosion of an organization’s resource base (and thus valuable sources of income that could fund resource development in an effort to respond to discontinuous change). I showed that as soon as a new technology gets a foothold in the market of a prevailing technology, it potentially eats away the stock of resources of those organizations that deploy the traditional technology. This confronts these organizations with a dilemma: they are required to allocate resources to the quick development and commercialization of the new technology, while simultaneously sustaining (and thus investing in) their traditional business, to stem its decline and to generate the funds required in the new domain. Organizations have to make choices regarding resource allocations to competing businesses.

I addressed this issue in the final section of the theory chapter by integrating the stocks of resources and their deployment in current models of the Resource Allocation Process, with the aim to explore their moderating effect. Current research has proposed multiple factors that shape an organization’s resource allocation process. In particular, scholars have directed attention to the moderating effect of resource dependency (Pfeffer & Salancik, 1978), the blindsidedness towards new technologies due to too close a focus on current customers and businesses (Christensen & Bower, 1996), and the mismanagement of multiple cognitive frames in responding to discontinuous change (Gilbert, 2006). The moderating effect of stocks of resources and their deployment in multi-business organizations (which is symptomatically characteristic of organizations responding to discontinuous change) has received less attention. I therefore built upon and expanded current research.

Findings in the Kodak case yield a series of insights enriching current research on the Resource Allocation Process model. To start with the minor discovery, findings suggest that a more fine-grained perspective of organizational inertia may be adequate, because Kodak was not late in its response; rather, search activities and new venture development, particularly related to digital endeavors, did not result in valuable sources of income to sustain the company’s growth. As a consequence, the strong

DISCUSSION 277

strategic and financial value of core assets fueled tendencies to retain and reinforce once selected internal capital investment decisions. Observations indicate a limitation of current models on the resource allocation process: resource scarcity seems to offset positive effects of structural differentiation in an organization’s effort to manage competing cognitive frames in their response to discontinuous change.

The important insight derived from the analysis of the Kodak case is that adaptation to the disruptive technology is only wise under certain (favorable) conditions. The relatedness of the current business to a targeted one and the requirements for resource development derived from that, as well as the time frame available for developing and sizing the new business to volume, to gain a competitive market share, primarily define these conditions. Findings clearly suggest that in certain cases an organization are better off by searching for business opportunities that allow leveraging of current resources, rather than adapting to the disruptive business at all costs. That is to say, I propose that adaptation as a response to discontinuous change is not in every case useful. The particular conditions are discussed in detail.

The research brings forward other implications of a strategic character: It shows that a bottom-up strategy process, which is essential in dynamic environmental change, can stall in reverse in the face of resource scarcity. Proposals for reversing a once selected and retained resource allocation process, for instance to exit a business or to reduce operating budgets, do not emerge from the bottom up. This finding directs attention to the role of top management and their capability to actively intervene in an organization’s variation-selection-retention process. It challenges common assumption in Resource Allocation Process research, that middle managers’ capabilities are determinants of an organization’s performance. The research shows that top management’s distinctive managerial skill spectrum maintains a significant role in moderating an organization’s response to change.

In the following these findings will be discussed in detail.

Figure 102 and Figure 103 Overview: Kodak’s Response to Discontinuous Change

See next two pages

278 Summary and Theoretical Contribution

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280 Prioritizing Strategic Resource Allocations

7.2 Prioritizing Strategic Resource Allocations Literature on population ecology suggests that structural inertia prevents organizations from engaging quickly enough in a strategic behavior conducive to adaptive change to environmental shifts (Carroll, 1988; Hannan & Freeman, 1984). Once an organization selects and retains a trajectory of evolution, the permanence of this selection makes it hard to introduce a change (Campbell, 1965; Hannan & Freeman, 1989). Observations in this research suggest that a more fine-grained perspective on inertia may be more suitable to explain Kodak’s response to discontinuous change. The organization’s response to the disruptive force of digital imaging cannot be described simply as being delayed. The company responded early by promoting and investing in multiple search activities, even beyond opportunities that leveraged existing core competences; however, the delay was partly limited by the reluctance to engage in business opportunities strategically and financially inferior to traditional silver-halide photography film and paper business.

The literature on the Resource-Based View has extensively outlined the relationship between resources and competitive advantage (Barney, 1991; Peteraf, 1993). Central to their work was the question of what makes some resource bundles superior to others and what are the criteria that render these resource bundles, or “strategic assets” (Amit & Schoemaker, 1993), difficult to easily acquire, copy, or imitate. Kodak’s foremost strategic asset was chemical engineering. It drove the company’s growth and maintained a strong barrier for rivals wishing to enter the market, and prevented others from easily imitating these assets. For decades the company enjoyed a market share almost equivalent to a monopoly. Moreover, the silver-halide photography film and paper business generated high profit margins with which no other conceivable business could possibly compete. Continued capital investments strengthened the company’s strategic assets, but equally reinforced resource commitments which were difficult to change. Hence every business unit, in particular those that suggested opportunities for replacing the traditional photography business – for instance, digital imaging – had to meet the test of comparative strategic analysis, by offering competitive prospects in terms of strategic advantage and earnings. Obviously, the commodity business of digital imaging, which competed with a low profit margin similar to other electronic hardware businesses, had a hard time competing against a consumable business that, as in the case of Kodak, revealed an extraordinary high

DISCUSSION 281

profit margin and extensive market share. “It's very hard to find anything (with profit margins) like color photography that is legal,” a Kodak senior executive once noticed.822 Kodak’s film and paper business absorbed the majority of the overhead, the fixed costs of the company, such as manufacturing and research and development. Every potentially new business intending to replace the film business, therefore, had to meet the test of competitive strategic analysis. (The other facet of Kodak’s delay, which was limited to the difficulty of removing resources from ongoing operation without exiting the business altogether, will be discussed later.)

A quote from a senior executive may illuminate the corporate perspective of the resource allocation process, in contrast to a senior manager’s view:

Senior Executive: “We had a bar chart for earnings and a bar chart for revenue and the revenue obviously was strongly positive, everything was north of the zero access.… You had a lot of very tall bars, very high earnings and then you had probably half of our strategic product groups, which were negative in earnings. That’s where all the digitals lived.”823

Senior Manager: “We kept looking for a business that was as good as the film business. When it became apparent that a new venture wasn’t going to come close to the standard set by film, interest was lost and yet another new venture was explored.… The digital guys were competing for investment dollars. I don’t think the film programs took investment dollars from the digital guys, but we certainly got everything we asked for. Film investment could offer a proven track record and fast payback with little risk. Digital did not have this strength.”824

Thermal printing is an interesting case in point, because it was a digital business that didn’t lose money. Digital printing of photos was largely a bottom-up initiative in the 1990s and was largely successfully implemented over the next 10 years. The development manager for the thermal printers of that time noticed the following:

“I can tell you that although there were very good margins on the media sales and a good synergy with the existing chemical coating expertise on paper and donor of the company , we were still threatened almost yearly with extinction, because the growth and margins could not keep up with the promises made by our middle

822 Elaine, J. 1985. Kodak Facing Big Challenges in Bid to Change --- Slowing of Photo Business Forces Firm to Look Elsewhere. Wall Street Journal, 1985 May 22: 1. 823 Brenner, B. S. 2013. Personal Interview. November 20. With M. Shamiyeh. 824 Shanebrook, R. L. 2013a. Email Conversation. November 10. With M. Shamiyeh.


management. This was a successful digital business and still you often felt like a loser, because you failed to meet the AgX [silver-halide] dream model.”825

The data on Kodak clearly reveal that the strategic/structural context triggered the bottom-up development of multiple new venture initiatives, initiatives that even challenged the existing strategic context; however, activities that did not leverage the company’s critical resources or capabilities or did not have financial viability comparable to film in the portfolio of all businesses were typically abandoned at the point of high-volume commercialization. “Our strategy is to come back and concentrate on those markets where we are presently very strong,” a senior executive said; “if we can’t establish substantial margins in these [electronic camera] businesses, we will get out of them.”826

This behavior was made further problematic by Kodak’s ingrained culture (another kind of retained resource), defined by its high quality standards. Kodak valued some aspects of the imaging chain, specifically image quality captured and the value of a print (versus electronic display) more than its new competitors did in the emerging digital business. This constrained a number of initiatives within Kodak until George Fisher’s arrival. If the promise of a “photographic quality” result was not going to be met, no resources were allocated.

Kodak well understood the disruptive nature of digital imaging and that a groundbreaking transition needed bold investment decisions. “You need big portfolio moves to get through this kind of transition … and we made lots of big bets,” said Kodak’s corporate strategist.827 Kodak was not reluctant to invest heavily in new opportunities in its effort to respond to discontinuous change. For instance, it invested considerable funds in the copier business and paid $5.1 billion (about half its annual sales) for the acquisition of the pharmaceutical firm Sterling Drugs. A move into the pharmaceutical industry promised high profit margins and the opportunity to leverage some of Kodak’s core competences related to chemicals. But in both cases, post-launch investments to size the business to volume, to get market share and build a competitive advantage, were not available to the extent required. Therefore, both businesses maintained a minuscule competitive position. As a consequence, here too 825 Sasson, S. 2013b. Personal Interview (Follow-up). November 22. With M. Shamiyeh. 826 Rigdon, J. E. 1991a. Eastman Kodak Puts the Focus on Leo Thomas. Wall Street Journal, 1991 Aug 14: 0-PAGE B1. 827 Brenner, B. S. 2013. Personal Interview. November 20. With M. Shamiyeh.

DISCUSSION 283

the company decided to promote the businesses that showed prospective returns, and thus sold the non-core imaging businesses. “While I [George Fisher] was there, the eye had to be on not investing in too many things, but in being more careful about how you invested.”828 “The company was trying to do too many things at once and wasn’t able to afford to do all of them well enough”829

The observation that the stock of resources and its deployment in a multi-business organization is a moderating factor that shapes the resource allocation process challenges recent findings on managing competing cognitive frames, which is worth detailed discussion:

In his research on discontinuous change, Gilbert (2005, 2006) identified contradictory findings in inertia research, which he explained on the grounds of a poor differentiation between two phenomena: the failure to change the retained process of resource allocation and the failure to change the process of implementing these resources. Building on theories of organizational behavior (Dutton & Jackson, 1987; 1988; Staw et al., 1981), Gilbert argued that framing an external stimulus as a threat motivates an increased resource commitment, while at the same time causing deep organizational rigidity; that is to say, rather than being willing to invest in new ventures and to search for new business opportunities, threat framing usually limits organizations to focus on developing current resources. For this reason, organizations are required to structurally differentiate between operations to stem decline in the traditional context and new venture operations in the emerging context, because managers cannot start out to frame an external stimulus as a threat and at the same time switch to an opportunity frame in the course of implementation. Based on an in-depth study of newspapers challenged by Internet news, Gilbert (2005) identified structural differentiation, external personnel, and different cognitive framing in various contexts as moderating variables positively affecting response to discontinuous change.

The Kodak case suggests that an organization’s particular stock of resources and strategic deployment offset the positive effects that Gilbert (2005) identified. In the mid-1990s, Kodak was fully aware of the need to separate development of digital

828 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh. 829 Rotenier, N. 1996. Back in Focus. Forbes, 157(1) 114-114.


endeavors from its core business and to bring in people from the outside to embrace opportunity framing. People in charge of the company’s traditional photography business felt too threatened by digital technologies to positively engage in this business. Therefore, the autonomously operating Digital and Applied Imaging unit was founded and people almost exclusively from the electronic world were hired.

In line with Gilbert’s (2005, 2006) findings, the perception of a threat triggered a substantial change in investment patterns. Kodak had redirected half of its research and development budget to its digital imaging unit. Moreover, structural differentiation and hiring people from outside aimed to promote exploration of new possibilities in the digital world. And indeed, people started to explore digital technologies in the form of cameras, scanners, printers, data compression algorithms, web technologies, etc. Hence up to this point, the case fully supports Gilbert’s propositions. However, the Kodak case shows that conditions of resource scarcity motivate a return to efforts to control existing strategic assets, instead of promoting new ones, despite positive effects of structural and personnel differentiation. Kodak’s response to ink-jet home printing is an example.

In 1997, Hewlett-Packard, Epson, and Canon, among others, launched their first models of home photo printers. All these companies made use of the technological progress in ink-jet technology. Due to their low price, industry observers predicted the end of chemical-based photofinishing, which forces consumers to send digital pictures (either physically on a CD or electronically) to wholesale photofinishers. The advent of the ink-jet home printers caught Kodak at a bad moment. It was suffering from significant losses in its traditional photography business due to a fierce price war, an overhead too expansive relative to the industry standard, and continued losses in its digital division. Moreover, it had sold its ink-jet business five years earlier, assuming that the advent of digital cameras would not affect conventional photofinishing. In the end, Kodak decided not to go for ink-jet technology (which was a viable path at the time), but to conceive a product that makes use of both worlds: The print stations, which used Kodak’s traditional (and reliable) thermal printing technology and were aligned with computer terminals, allowed consumers to get their prints within seconds at drugstores or supermarkets.

DISCUSSION 285

This observation suggests an extension of Gilbert’s finding, to the extent that his recommendations for how organizations should respond to discontinuous change are viable only under conditions of resource abundance. How do we explain the fact that the moderating effect of stocks of resources and their deployment offset the positive effects of Gilbert’s findings under conditions of resource scarcity? I attribute that to the fact that case studies used to support the argument of a successful response to discontinuous change typically reveal a situation in which the traditional and the new businesses remained viable in parallel for a long time. Hence organizations adapting to new technology experienced no significant decline of the traditional business (and thus did not face resource scarcity). For instance, scholars have shown how companies such as Xerox, Hilti, and IBM have launched services while revamping their core business (Christensen & Raynor, 2003; Johnson et al., 2008); how the newspaper firm Desert News managed to stay in print while going digital; or, how Barnes & Noble managed to sell books and e-book reading devices simultaneously (Gilbert et al., 2012; Gilbert, 2006). However, while all these cases reveal a success in managing the coexistence of competing cognitive frames within one firm, they all have in common that the substitution rate of the core business was (and partially still is) relatively low. Therefore, in all these cases the resource base of the organization maintained a viable level high enough to allow explorative activities in another environment. But what happens if an entire environment crashes fairly quickly? What happens if the overlapping time of traditional and new businesses is relatively short?

The imaging industry was witnessing a reduction of the worldwide demand for traditional silver-halide film by about two-thirds within less than five years, as of 2001 [see Figure 25]! Moreover, it is important to note that Kodak experienced another form of disruption starting to burden the company about a decade earlier: Fuji and private label discounters aggressively entered the US photography market Kodak previously owned almost alone. In short, changes in the industry caused Kodak a severe resource problem.

In the discussion above, I have shown how the stock of resources and its deployment in a multi-business organization such as Kodak shapes the resource allocation process and thus strategy. The assessment of the strategic and financial viability of each business commonly motivated the reinforcement of the company’s retained investment

286 Reversing Retained Resource Allocations

pattern, which prioritized the chemical-based photography film and paper business. Moreover, I have shown how priority-setting based on current resources and capabilities may offset the positive effects of structural and personnel differentiation, in an effort to manage competing frames in resource commitment and implementation. In the following, I discuss the major challenge Kodak was facing in its response to discontinuous change: the difficulty of sustaining its traditional business, to generate funds required for adaptation, while being compelled to downsize the business in face of a forthcoming decline. Implications will be drawn for theory of discontinuous change and managerial practice.

7.3 Reversing Retained Resource Allocations In the discussion above, I have drawn on evolutionary theory with its variation-selection-retention framework to direct attention to a particular force shaping the competition for resources within an organization. I have adopted the conceptual lens of evolutionary theory to show how a once selected and retained path of resource commitments – which is assumed to be difficult to change because of its permanence (Campbell, 1965; Hannan & Freeman, 1989) – ignites search activities that continue the path’s trajectory rather than redirecting it. Much of the research to date takes on a similar perspective; however, few research was done on the question of how an organization can reverse a once selected and retained path of resource commitment without exiting the business altogether. There is a difference between downscaling a business by reversing a retained investment pattern, and withdrawal from a business altogether by means of a strategic business exit, as discussed by Burgelman (1994) in his study on Intel, or the divestiture of a business as part of a diversified portfolio (Gilmore & Hirschhorn, 1983). Reversing a once selected and retained resource allocation process first and foremost means removing resources from an ongoing business, and not to divest it.

In the face of discontinuous change, organizations are challenged by a particular dilemma related to the reversal of retained resource allocations: Resources have to be removed from the current business in order to fund competence development in the new businesses (which may replace the current one), while additional resources are required to stem decline (in order to secure a viable source of income for the new business). Hence organizations aiming to respond to discontinuous change are

DISCUSSION 287

challenged by the trade-off between decline-stemming investments in their current business and start-up (or post-launch) investments in the new business. Because each business places a demand on available funds, choices have to be made based on the prospective rate of substitution and anticipated investments needed. It does not make sense for an organization to downscale its current (and potentially to be discontinued) business too early, because of the risk of losing a valuable source of income, nor does is it wise to promote the current business for too long, because of the risk of generating an overhang that burdens the company’s financials when that business drops off.

Two factors problematize decision making in the face of this trade-off: First, every exploration of a new venture is unpredictable and thus costly in its outcome, depending on the entrepreneurial actions taken (Alvarez & Barney, 2007). Therefore, it is difficult to estimate when the cash curve of a new business will reach breakeven and the business will become viable enough to entirely rely on the returns it generates. New ventures usually require start-up and post-launch investments to size the business to volume before generating a payback (Andrew & Sirkin, 2006; Christensen, Kaufman, & Shih, 2010). The difficulty in assessing the rate of substitution (which usually can be estimated accurately only in retrospect) contributes its share to the uncertainty. Second, initiatives for retrenchment – for instance, efforts to downscale a declining business by closing manufacturing facilities or cutting budgets – do not evolve from the bottom up, from individuals at the operative or middle management level.


Figure 104 2003 Projection of Worldwide

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DISCUSSION 289

Figure 107 2003 Projection of Worldwide Shipments of Imaging Devices And Actual Data

Figure 108 2003 Projection of Worldwide Total “Photo” Prints by Type and Actual Data

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Kodak’s struggle in its response to discontinuous change was marked by difficulty in managing the trade-off: The company always scaled up its chemical-based photographic film and paper operations worldwide, because of its strong strategic position in the overall business portfolio (see previous discussion) and the need to sustain its only viable source of income required to fund the company’s transition to digital imaging. Moreover, forecasts on digital imaging did not suggest an immediate exit from the chemical-based photographic film and paper business. Rather the opposite: Still in 2004, three years after the decline of global sales in traditional photography might have indicated the start of an ongoing substitution by digital technologies, Don Franz, a respected industry insider and consultant to Kodak, projected “worldwide combined amateur and professional film sales to fall from 3.5 billion rolls in 2000 to 2.9 billion in 2008, taking into account that, outside of the U.S.A. , Canada Western Europe and Japan, film usage is still growing in most other countries.”830 Certainly there was awareness that by around 2004, about half of film cameras would be replaced by digital cameras; however, by and large people close to the industry believed that film and paper would be around for a long time. It was assumed that the photofinishing side of the imaging chain in particular would last. As a consequence, Kodak generated an overhang of absorbed resources, mostly committed to the fast-declining chemical-based photography business. When the business unexpectedly dropped off in 2001, this overhang tremendously burdened the company’s balance sheet and subsequently its response to discontinuous change. For Kodak it then was very hard to go in the other direction and to scale down rapidly. First, because removing (committed) resources from a current business and developing new ones is costly – particularly when opportunities for leverage are limited; and, second, because organizations require (uncommitted) resources for the exploration of new and uncertain opportunities. In the following, both aspects are discussed in detail.

Adapting parts of an organization to a new business while maintaining a tight fit between the current business and the traditional environment is expensive. Kodak spent about one-third of its total earnings from operations for restructuring from 1989, when it decided to adapt to digital technologies, to bancruptcy [see Figure 103 and Figure 109]. From then until Kodak filed for Chapter 11 bankruptcy in 2012, charges

830 Franz, D. 2004. Will Digital Cameras Generate Prints for Retailers? International Contact, 23(1) February/ March.

DISCUSSION 291

for restructuring accounted for $10 billion and included the severance payments made to employees whose positions were eliminated, charged due for the write-down of several assets, and costs related to the execution of plans to redefine nonstrategic operations. To get a sense of the drastic measures Kodak had to take, a look at the change in workforce is illustrative: By 2000, that is, one year before Kodak experienced a performance gap due to digital substitution, half of the company’s workforce related to chemical-based businesses left (or had to leave) [see Figure 74]. For one out of three people leaving, a new person was hired from the field of electronics.

Figure 109

Decrease of Kodak’s Earnings from Operations by Restructuring Costs All Years up to Bankruptcy


With a reduced level of uncommitted resources of about two thirds of the company’s operating earnings, Kodak basically had to fund two businesses. On the one hand, it was required to provide start-up investments for ventures related to digital imaging, endeavors that were losing money well beyond 2000; and, on the other, the company needed to invest heavily in its traditional chemical-based photography business to sustain its primary source of income, but also to offset losses due to fierce competition with Fuji and private label discounters. In fact, initially Kodak could “afford” spending one third of its earnings for restructuring just because the film business continued to promise favorable earnings, in spite of the lower margins the company had had to

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accept since the early 1990s. Moreover, the company was basically debt free. George Fisher sold most of Kodak’s non-imaging businesses to generate cash to redeem long-term borrowings. Hence in the 1990s, restructuring the company to meet the demands in digital imaging was only possible on the premises of a profitable film and paper business and the divesture of valuable assets.

Kodak’s earlier effort to actually buy its way into a new business by taking out loans was an even more counterproductive response to discontinuous change. In the late 1980s, the company decided to acquire Sterling Drugs to gain access to the pharmaceutical industry. Kodak thought it could leverage its competences related to chemistry, which turned out to be a misjudgment; its base of about half a million chemical formulation did not result in new drug with a big commercial success and the company was required to heavily invest in product development (not to mention product commercialization). What it is of importance here is that charges for interest expenses related to the acquisition of the pharmaceutical company reduced Kodak’s earnings from operations by an additional one third. Hence Kodak had to spend one-third of its earnings from operations, on average, for restructuring charges necessary for the transition to the pharmaceutical industry (e.g., merging research and development divisions of the two companies), plus one-third to redeem long-term borrowings. As a result, little cash remained to promote the core photography business, which was under pressure from fierce competition, while funding initiatives in the pharmaceutical business. Kodak could not generate the investments necessary to quickly develop a “blockbuster” drug or to size its pharmaceutical division to volume to achieve a competitive market share, because its core business was losing market share and required excessive investments in product development and commercialization to defend its incumbent position. Fisher understood the dilemma and therefore divested all non-imaging businesses, including those related to health. “Kodak’s future calls for nothing less than total commitment to imaging,” he said. “We were passing up too many opportunities to make small investments because we were so strapped for cash. If we attempted to retain both health and imaging, we would have short-changed both.”831

831 Bounds, W., & Moore, S. D. 1994. Kodak to Sell Sterling Winthrop Drug and Two Other Units to Focus on Film. Wall Street Journal, 1994 May 04: 0-PAGE A3.

DISCUSSION 293

I want to emphasize here again, that spending one third of its operational earnings for restructuring was not a one-time charge, but continued to burden the company’s financial position until it filed for Chapter 11 bankruptcy. Based on this constraint, the company was required to invest its remaining available resources in both its core business, to stem decline, and the new business. Scholars have argued extensively that organizations require resources to explore new opportunities and to take risks (Bourgeois, 1981; Cyert & March, 1963; Singh, 1986). At Kodak, developing unrelated business was extremely expensive, compounded by the problem that such ventures lost money well beyond the 2000s, when Kodak’s core business was rapidly declining in the face of digital substitution.

Operations in Kodak’s Digital and Applied Imaging unit were expected to become positive three years after its inception in 1997 [see Figure 67]; however, the unit continued to lose money well beyond the 2000s. Rapid technological change and a growing number of competitors, as well as Kodak’s lack of competences to successfully compete, rendered it difficult for the business to turn a profit or even reach breakeven. Fisher recalled, that “if we made a mistake in those days, it was probably not so much the structure as it was that we didn’t really have the right people. We had brilliant people, but they had never run businesses before and that made the whole process a little awkward and ineffective.”832

Kodak’s cumulative investments in digital imaging business did not reach breakeven before the disruption of its traditional chemical-based business. Hence the decline in the core business fueled a demise in the digital imaging business: The drop in profits in Kodak’s core business due to high fixed costs relative to the rapidly falling sales figure led to a reduction of investments in digital and thus to a downturn spiral. Less earnings (or low uncommitted resources that the company would have required to adapt to digital imaging) motivated the divestiture of the last remaining imaging-related businesses such as the copier business, as well as further cuts in the workforce and budgets for research and development, which in turn once again triggered a downturn. The nascent digital imaging industry was still unexplored and required more from the budget rather than less.

832 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh.


By the end of the 1990s, Kodak realized that it could not afford to pursue all of its digital imaging endeavors alone. “We’ve learned very quickly,” Fisher acknowledged, “that in this digital world, the opportunities are just too massive for any one company to do it on its own.”833 Competences required for digital imaging were too unrelated to the company’s current ones in chemical-based engineering. From a value chain perspective, there was almost nothing allowing Kodak to leverage its current competences. Therefore, to form a relationship with another company that had the abilities it lacked was considered the only viable path forward. The main options considered were the sale of Kodak to or a merger with one of several companies that were approached. When these options proved impossible, the company continued to downsize to the point of bankruptcy. After 2003, the company reported operating losses every year.

The divesture of all non-imaging business opportunities in the early 1990s led to a troubling constellation in the face of discontinuous change: Kodak’s exclusive strategic focus on imaging limited the number of potentially viable sources of income to the one that might potentially be discontinued. In other words, in the belief that traditional photography would be around for a long time, Kodak enforced the trade-off between discontinued and new business by eliminating all other potentially viable sources of income that could have funded developing and sizing to volume the digital imaging business, as the traditional photography business declined. This led to a tremendous overhang and then destruction of valuable resources at times of disruption – in both businesses.

Hindsight is easier than foresight. Kodak’s decision to divest all non-imaging businesses is understandable on the background of its strategic considerations and resource requirements. The company required excessive sources of revenues to sustain growth in the core photography business and therefore could not maintain multiple businesses that all were trying to build a competitive position in the market, let alone develop emerging technologies that required extensive exploration.

833 Bounds, W., & Rigdon, J. E. 1995. Kodak, Seeking Inroad in Digital Arena, Opens up Proprietary Photo Cd System. Wall Street Journal, 1995 Mar 29: 0.

DISCUSSION 295

Figure 110 Kodak’s Challenge in the Face of Disruption

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The case of Kodak allows us to derive the following conclusions for managerial practice in general and for theory of discontinuous change in particular: The stock of resources and its deployment shape an organization’s resource allocation process and thus its strategy. The observations summarized here contribute to this finding by confirming a trade-off between reversing a retained resource allocation pattern and building or sustaining a new one. The relatedness of current competences to those required in a targeted domain, coupled with the time of threat response and rate of substitution that define the time available to develop a new business to the point of cash payback, moderate the level of required uncommitted resources [see Figure 111]. The more unrelated a targeted business is and/or the shorter the time period available for adaptation, the higher the demand for uncommitted resources. Depending on available sources of income (one or multiple businesses), a manager therefore may choose between adapting to the new technology or leaving the market altogether and looking for opportunity that embraces leverage.

In the case of Kodak, management only seriously questioned the value of its engineering capability related to coating film and paper when it was too late. For instance, Kodak’s efforts to commercialize, license, or partner in OLED technology, which started well before 2003, received sufficient funding after that.

In the introduction to this section, I briefly referred to two factors that plague the trade-off between decline-stemming investments in a current (and potentially to be discontinued) business and start-up (or post-launch) investments in a new business. I discussed the moderating effect of uncommitted resources. In the following, I discuss the other moderating factor: the lack of initiatives for retrenchment; for instance, efforts to downscale a declining business by closing manufacturing facilities or cutting budgets.

Contrary to Burgelman’s (1983b) description on an organization’s strategic renewal by means of autonomous and bottom-up behavior, initiatives for retrenchment do not evolve from the bottom up, from individuals at the operative or middle management level. Kodak’s evolution in the face of discontinuous change proves to be an informative case to illustrate this phenomenon. Initiatives to remove resources from an ongoing business do not evolve from the bottom up for a simple reason: Individuals at the operative level, who maintain the richest knowledge of an organization’s strategic

DISCUSSION 297

assets (for instance, particular research and development knowledge of projects), tend to propose investments that improve and sustain their fortunes or those of their divisions rather than to scale down or exit the business (hence risking their job security).

This finding is in line with Sull’s (1999) study on Firestone, in the face of substantial changes in tire design and production, which required severe changes or closures of manufacturing facilities. Burgelman’s (1994, 1996) reports on Intel’s change from fabricating memory chips to microprocessors, in contrast, show that an organizational context may alter this tendency; however, it is worth noting that Intel was neither faced with the problem of unavailable resources nor did the change destroy existing competences. Rather, seen from a Resource-Based View, Intel’s bottom-up strategic change leveraged and enhanced available strategic assets. Employees used an opportunity offered by a managerial change in the structural context to gradually shift away from the commodity fabrication of memory chips toward advanced microprocessor chips. In contrast, Kodak’s lack of alternative business opportunities that leveraged the company’s strategic assets rendered necessary the reversal of a retained investment pattern in the face of discontinuous change.

The Kodak study reveals another reason for the reluctance to reverse retention – the organization’s structural alignment. In 1984 Kodak went to a global business structure. It installed a number of “autonomous and independent” business units. Before that, the company for its entire life had been functionally organized. The company’s information architecture, however, was never fundamentally changed. Each business unit was assigned the job of developing its own strategy and achieving the financial goals that they were given by top management. There was actually no corporate strategy. Rather, there was a loose conglomerate of separate business unit strategies. In the 1990s, when the threat of digital replacement of silver-halide film had become obvious, top management tried hard to reverse this retained strategy process. General managers of business units had to promise the result that had clearly been communicated of what the financial expectations for the business were; and, at the same time they had to deliver on the other expectation of top management, which was to get a credible assessment of what could be accomplished immediately or in the long run against the substitutions that were taking place, changes in distribution channels,


competition, and so forth. It is in the nature of things that the definition of the problem space and knowledge applied in search of solutions to prevent substitution were by and large determined by the very technology (and associated paradigm) embraced by the particular business unit. In other words, requesting a business unit level manager to come up with solutions that would offset negative effects of substitution assumes that it is possible to fight substitution with the techniques employed by the substituted. Certainly this endeavor was doomed to failure. Fisher, the first outsider to head the company, recognized the shortcomings of this mode thinking and hired personnel from the digital world to run digital operations. Asked about the role of individuals downscaling the company’s chemical-based operations and the push in digital endeavors, Fisher replied: “I don’t think people were ill willed or trying to torpedo anything; it was just natural that they were champions of film. There weren’t any champions to speak of in digital imaging. There were handfuls of people around the digital labs. And you had to have somebody championing that on the business level and we didn’t have those people.”834

Scholars investigating the internal strategy process generally argued that managerial influence to shape the internal variation-selection process is limited to the manipulation of the structural context (Burgelman, 1991, 1994; Lovas & Ghoshal, 2000; Noda & Bower, 1996). More recent studies indeed argue that top management can more actively intervene (Eisenmann, 2002; Eisenmann & Bower, 2000; Lovas & Ghoshal, 2000); however, their findings rather depict a management that intervened in the process by reshaping the organizational context. The Kodak case study unearths a perspective of top-level managers who actively intervened in the organization’s internal resource allocation, and shows that such a reversal of the bottom-up process may be not just possible, but even necessary under certain conditions. When critical resources and capabilities are becoming obsolete, individuals at operative or lower levels of management simply have no incentive to propose initiatives that reverse retention (and thus put their job security at risk). At Kodak, the initiative to remove resources from an ongoing business was moved by top management and did not emerge bottom-up from individuals at the operative or middle management level. This phenomenon was observed also by Sull (1999) in his investigation of Firestone’s

834 Fisher, G. M. 2014. Personal Interview. Jan 3. With M. Shamiyeh.

DISCUSSION 299

challenge to adapt to new tire designs, as well as by Gilmore and Hirschhorn (1983) in their study of management challenges under conditions of decline and retrenchment.

The necessity for managerial intervention at times of retrenchment directs attention to the question of whether the locus and process of resource allocation (and hence strategy making) differs depending on the particular managerial skills. I will address this question in the following section. The Resource-Based View again will allow me to establish a linkage between managerial capabilities and an organization’s response to discontinuous change.

7.4 Reinforcing Retained Resource Allocations Findings in organizational ambidexterity and the resource allocation process seem to converge on a key capability essential for organizations in their attempt to adapt to discontinuous change (see, e.g., Gilbert, 2006; O’Reilly III & Tushman, 2008): “dynamic capabilities” “to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments” (Teece et al., 1997). Rather than abandoning traditional business altogether in response to discontinuous change, the challenge for organizations is to manage explorative and exploitative efforts in parallel: on the one hand, the adaptation of current business to the changing market conditions; and, on the other, the creation of a new business to develop sources of future growth (Gilbert et al., 2012). As is evident in the case of the advent of the digital imaging technology, it can takes years for an innovative initiative to become large enough to replace the revenue stream an organization has lost. Christensen’s (1997) early conclusion, that organizations confronted with discontinues change can resolve the “innovator’s dilemma” only in a separate, exploratory organizational entity, may hold some limitations.

Two mechanisms in organizational design have been found to support response to discontinuous change: first, the creation of a differential organizational alignment allowing enacting multiple behaviors simultaneously (though transforming from one business to another in a sequential manner is not an option in times of discontinuous change); and, second, senior-team frame integration to embrace a diversity of competing cognitive frames across sub-units (Gilbert et al., 2012; Gilbert, 2006; O’Reilly III & Tushman, 2008). Drawing on the findings in the fields of social

300 Reinforcing Retained Resource Allocations

psychology and organizational behavior, scholars have argued that the framing of external stimuli as a threat elicits resource commitments, but then typically invokes a behavior that aims to focus on existing resources instead of pursing new initiatives (Jackson & Dutton, 1988). Threat perception typically reinforces rigid behavior, motivating managers to enhance traditional routines and behavioral patterns (Staw et al., 1981). In contrast, opportunity framing relaxes the constraints produced by routine rigidities and initiates new search processes (Dutton, 1992); however, it usually does not create the same level of resource commitment necessary to effectively respond to change (Dutton & Jackson, 1987). Thus, an effective response to discontinues change requires the solicitation of threat and opportunity framing simultaneously. To invoke a change in resource investment patterns, therefore, managers need to frame external stimuli as threats to the organization’s vitality, and, to initiate then a change in the behavior of applying those resources, managers need to enhance opportunity framing (Gilbert, 2006). The separation of structural contexts coupled with an integration of senior-teams enable organizations to embrace this cognitive paradox by decoupling threat perception from threat response.

In 1994, Kodak developed independent contexts to embrace competing frames in response to the advent of disruptive digital technologies. The company separated its digital imaging operations from its core silver-halide film business to enable an independent development of new business. Managers from outside were hired to run the new Digital and Applied Imaging Division. Kodak’s move towards structural differentiation and opening for outside influence relaxed routine rigidity and opened the path for the new division to explore new business opportunities that would have been constrained in the context of the traditional business. The division successfully began to offer numerous products and services to multiple customer segments. In short, Kodak’s competence development to address discontinuous change confirms research findings in organizational ambidexterity and resource-allocation process.

However, the study of Kodak also enriches these scholarly works by showing that managerial capabilities can play an influential role in the interaction among differentiated sub-units. Depending on their distinctive experience and intimate knowledge of the core business, managers actively tightened or loosened the links among differentiated units and thereby changed the locus and process of strategy

DISCUSSION 301

making. This finding is in line with the earlier-discussed phenomenon that an active intervention in the resource allocation process by managers is possible and even optimal under certain conditions.

The Resource Allocation Process model directs strong attention to the capabilities of middle managers, arguing that these are direct determinants of an organization’s performance (Floyd & Lane, 2000; Wooldridge et al., 2008). The Resource-Based View, in contrast, focuses on managerial resources by directing attention to “the skills and abilities of managers” (Castanias & Helfat, 2001). This stream of research regards the qualities of top management as critical for attaining a competitive advantage over rivals, presuming that managerial qualities differ significantly across organizations (Adner & Helfat, 2003; Castanias & Helfat, 1991). Acknowledging the possibility and necessity for top managers to actively intervene directly into the strategy process, the findings of the Kodak study enrich existing Resource Allocation Process theory: The data show that top managers’ distinctive operating skills and cognitive structures can influence an organization’s response to change by shifting the locus and process of strategy making.

Managers (and other individuals) often rely on learned patterns in their response to problems that are structurally and cognitively reinforced as opposed to pursuing the search for new opportunities (March & Simon, 1958). Part of the explanation is that an organization’s effort to tightly align its operating processes to an environment becomes self-reinforcing (Miller & Friesen, 1980; Siggelkow, 2001). The underlying logic is then often manifested in the manager’s cognition (Prahalad & Bettis, 1986; Tripsas & Gavetti, 2000). Schein (1988) showed that this cognition can also become tacit, which then makes it even more challenging to decipher the sources that generate the problem within routines.

Castanias and Helfat (1991, 2001) introduced the concept of transferability of managerial skills to enrich the concept of routine rigidity by distinguishing between “generic” and “specific” skills. Generic skills comprise those top managerial capabilities that could be transferred to virtually any organization in any type of industrial setting. In contrast, firm-specific skills refer to a manager’s organizational and industry-specific skills that are not easily transferred (Castanias & Helfat, 2001). Top-level managers’ capabilities then vary in the degree to which they possess more


specific or generic capabilities with respect to the particular organization (Bailey & Helfat, 2003). Hence different types of experience and learning opportunities will lead to different managerial capabilities, as well as to different sets of beliefs or structures underlying perception through which subsequent interpretations of external stimuli are made (Schön & Rein, 1995).

The active intervention of basically two different types of Kodak managers – one hired from outside, who mainly revealed generic capabilities, and others who reached their position only after years of experience within the company, bringing with them a deep cumulative experience of chemical engineering – suggests a more nuanced conceptualization of the classic model on the Resource Allocation Process. Their significant operational or firm-specific experience enabled them to more or less successfully take an effective hand with shaping the resource-allocation process (and thus strategy) in the face of discontinuous change.

George Fisher was the first CEO appointed by Kodak to be hired from outside. Prior to Kodak, he had managed Motorola to become the world’s leading wireless carrier. By 1995, Fisher and his CFO clearly recognized the potential of digital technology to replace Kodak’s chemical-based photography business, accepting an internal forecast that by 2003 half of all cameras sold in the US market would be digital. In realizing the insurmountable differences between traditional silver-halide film and digital business (e.g., revenues, margins, customer channels), he separated digital imaging from the rest of the company, to enable its autonomous development and to prevent a negative impact across sub-units. Managers outside the film industry were hired to run the new Digital and Applied Imaging unit [See Figure 111].

Within a few years, Fisher’s decision enabled the development of coexisting competing cognitive frames and the embrace of appropriate behaviors: Opportunities in digital imaging were explored flexibly. Kodak started to offer numerous products and services to multiple customer segments. For instance, Fisher pushed the introduction of multiple print stations that had been sold to semiprofessionals and minilab owners, to allow customers to digitize and manipulate their images; new digital cameras; and thermal printers and papers to print images once they had been transferred to computers.

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Figure 111 Eastman Kodak Company’s Structure and Autonomy of New Ventures

Schematic Illustration

Fisher’s rigid separation of the sub-unit rested on the view that Kodak would not be able to change its existing business model, cost structure, and culture quickly enough to become successful in digital imaging. Forming a relationship with another company that had the abilities that Kodak lacked was believed to be the only viable path forward. The main options pursued were a sale of Kodak to or a merger with one of several companies including HP, Xerox, Canon, Gillette, P&G, and others, which, however, proved to be impossible after several years of effort, due to the company’s liabilities and obligations to employees.835

835 Faulkner, T. 2013a. Personal Interview. November 04. With M. Shamiyeh.

A A’

A

KODAK Digital imaging structurally and operatively separated from core business (autonomy)

A A A(b) A

A’ A’

B(b)

C n(b)

* The distinctive skills and abilities of managers related to Kodak’s traditional silver halide business ** In 2004 Kodak stops selling traditional film cameras; in 2009 it stops selling Kodachrome film

genericspecific specificspecific generic Managerial Capabilities*

Sustaining some level of interaction between subunits

Consolidating digital imaging businesses (exit in 2013 altogether)

Silver-halide film business (e.g., Consumer Imaging, Kodak Professional etc.) Electronic/ digital imaging ventures scatters over many divisions

Sale of core business (failed)

Kodak creates many divisions (e.g., Commercial and Government etc.)

Gradual exit**

Commercial Printing (new focus)

CEO

t 1983 1990 2000

George Fisher

1994 2006

Colby Chandler Dan Carp K.Whitmore Antonio Pérez


A retained investment in the chemical-based photography film and paper business meant the continual neglect of non-imaging business opportunities and thus value destruction in the wake of the progressing replacement of film with digital. Under these conditions, George Fisher’s successor, Dan Carp, loosened the linkage between digital sub-units and parent, sustaining strong interaction in order to use digital technology to improve the silver-halide film business, rather than to replace it.

Unlike Fisher, Carp had held a variety of positions at Kodak before becoming president in 1996 and CEO in 2000. In his thirty-year career at Kodak, Carp had gained an intimate knowledge of the company’s core business. He and other members of management did not share Fisher’s perspective. They believed that the installed base of film cameras, along with opportunities in developing countries, would ensure that film sales would only decline slowly. The profits from film over this long period would support a gradual shift from film to digital. This belief led to further investments in the silver-halide film business, aiming to extend its lifespan.

Kodak’s ventures in the digital domain, for instance the Internet platform Kodak Gallery or Picture Kiosk to allow customers to print digital images on paper, mirrored the price points and product specifications of the traditional business model, ignoring completely the fact that consumers’ behavior regarding photographs had changed dramatically. These commitments proved difficult to change. As a consequence, the business they built failed in both the traditional environment and the new one.

One product manager summarized the phenomenon in the following words: “Fisher intellectually understood the issue, but couldn’t move the organization via internal forces; Carp culturally understood the organization, but didn’t feel comfortable with the emerging new technology and marketplace; and Perez tried to make the organization into the HP inkjet organization he previously had success with. The top person’s biases and comfort zone were very important to the future of the organization in reacting to discontinuous change.”836

836 Sasson, S., & Zongrone, N. A. 2013. Personal Interview (Steve Sasson and Nicoletta Zongrone in Conversation with Michael Shamiyeh). November 18. With M. Shamiyeh.

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8 CONCLUSION

8.1 Recapitulation In this study I explored how the stock of resources and its deployment in ongoing business operations affects an organization’s capability to allocate resources to new businesses in response to discontinuous change. I did so in order to understand a problem managers are facing today more than ever: how to respond to a substituting technology that gains a foothold in the traditional market and thus begins to replace the traditional business.

Of course, the topic of discontinuous change has been an issue of ongoing inquiry in both scholarly research and managerial practice for years. However, in looking at Kodak, the former industry leader in traditional chemical-based photography, I realized that the company’s challenge to adapt to digital imaging could not be explained on the basis of theoretical findings available in current scholarly research; rather the opposite was true: Data gathered in my longitudinal case study suggested that Kodak presented a sort of anomaly, offering the opportunity to elaborate existing theories:

To start with the most important theory I am building upon, I found that the Resource Allocation Process Model as described by Bower-Burgelman and extended recently by many scholars provided a valuable source to explain organizational dynamics in the face of discontinuous change. In this stream of literature, scholars have addressed the question of how external dependencies such as capital markets, or internal factors such as an excessively narrow focus on profitable customers, or the cognitive framing of forces leading to discontinuous change, shape an organization’s investment pattern and thus its strategy to adapt to a new environment.

Data of this study suggests that, contrary to models that suggest that companies usually fail in the face of discontinuous change because they focus too closely on their most powerful customers and thus direct strategic investments exclusively to their core business, Kodak did not solely invest in traditional film (Christensen & Bower, 1996). Likewise the company did not always perceive digital imaging as a threat to its core business, which would have resulted in rigid efforts to control and increase existing

306 Recapitulation

resources in traditional film, rather than promoting autonomous initiatives in digital imaging, as suggested by other theoretical contributions on discontinuous change (Gilbert et al., 2012; Gilbert, 2005, 2006). Furthermore, at Kodak it was not the case that the internal bottom-up strategy process failed in the face of institutional barriers (Sull, 1999, 2005) or volatile investment decisions (Eisenmann, 2002).

Quite the contrary, the world’s largest imaging giant actually invented digital photography back in 1975. It also was not so arrogant as to ignore technological changes. It had promoted multiple electronic-digital imaging initiatives before anyone else in the industry had directed any attention to this issue. Its research labs were full of technological inventions that anticipated many features of today’s devices, such as Wi-Fi-equipped digital cameras or iPod-like designs for imaging devices. The company also was not blindsided by missed business opportunities in low-margin areas or small markets. Kodak was fully aware of the disruptive potential of the nascent digital technology, invested billions in its development, and set up autonomous structures to allow an independent and autonomous proliferation of the business.

In fact, the data of this longitudinal study suggests that Kodak wrestled with a completely different problem: how to develop a completely new competence configuration in an unrelated business environment while being forced to provide extensive support for the core businesses to prevent decline. Organizations attempting to respond to discontinuous change are usually faced with the dilemma that a new technology disrupts and erodes an organization’s resource base by getting a foothold in the market of the firm’s traditional business. For organizations, the objective is therefore to reconfigure and orchestrate multiple competences simultaneously. The traditional business must remain viable unless the new business achieves payback to fund its growth.

The case of Kodak clearly showed that building a new competence configuration for digital imaging, which is completely unrelated to its core competence of chemical engineering, and trying to gain a dominant market share for purposes of profitability, depend primarily on the availability of uncommitted resources. In such a situation, existing competences cannot be leveraged, but must (at least) be reconfigured and stretched, or replaced by newly acquired or developed competences. Kodak provided a

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compelling case in that stemming the extremely fast erosion of the traditional chemical-based photography business ate away valuable resources required to fund the development of competences necessary to adapt to the new environment. The company’s low level of uncommitted (or quickly available) resources, such as cash or cash equivalents, simply constrained Kodak in its effort to adapt to digital imaging.

In directing attention to an anomaly present in current literature on discontinuous change, I have also addressed the question of why the moderating effects of committed (or uncommitted) resources and a firm’s resource allocation process might have been overlooked in current research. I have argued that scholars concerned with understanding discontinuous change have usually referred to examples in which a profitable core business remained viable for a long time, in parallel to the advent of disrupting technologies. For instance, Gilbert and his colleagues (Gilbert et al. (2012); Gilbert (2005) discussed challenges to newspaper companies from online news, or to publishers and book retailers from e-books. Christensen and Raynor (2003) discussed the challenges traditional businesses faced from the emergence of mini steel mills, online banks, and online travel agencies.

Moreover, these studies presumed that sufficient funds to promote the development of new competences existed. The likely need to fall back on stocks of resources that might not be available due to the decline of the core business in face of substitution has by and large escaped notice.

To elaborate on the identified research gap, I followed the following methodology:

At the beginning I defined the relevant terms and constructs common in the relevant literature. Relying on this background, I then linked discontinuous change with organizational decline to show that there exists interdependence between stocks of available resources an organization can choose to be adaptive and the substantial material damage organizations may face in the course of ongoing substitution. In short, I suggested that stocks of resources and their deployment moderate an organization’s response to discontinuous change. For this very reason, I proposed to elaborate the current Resource Allocation Process model with findings of the Resource-Based View. In the course of the following discussion I was able to derive the following insights:

308 Recapitulation

First, Kodak shows that in multi-business organizations, the strategic and financial viability of resources deployed in each business relative to overall portfolio guides internal capital investment decisions; the company failed in its response to digital imaging not because it was late in response, but rather because its search activities and subsequent acquisitions did not result in appropriate business opportunities viable enough to sustain growth. I therefore suggested a more nuanced conceptualization in theories of organizational inertia.

Second, for organizations, discontinuous changes poses the problem of being required to reverse retained resource allocation to a business rather than exiting the business altogether. This presents organizations with the dilemma that they have to remove resources from current business to fund development of the new businesses (which may eventually replace the current one), while simultaneously adding resources to the current one to stem decline (and to secure a viable source of income needed for the new business). It is in this sense that I argued that under certain conditions, organizations might be better off to leverage current resources and capabilities in related but different markets, rather than trying to adapt to new and unrelated environments at all cost.

Kodak was primarily a chemical engineering company with great capabilities in coating film. To change from chemicals to electronic circuits meant extensive (financial) efforts which the company could not undertake, due to its declining core business. The lack of other profitable businesses that could have absorbed the initial loss in building up digital businesses rendered the situation even worse. Kodak’s early diversification efforts failed to produce value, but rather negatively affected the company’s balance sheet. Coupled with financial troubles in the 1980s and 1990s that were largely the result of two failed film format introductions (Disc in 1982 and APS in 1996), Kodak entered a new business environment without a solid and durable resource base. In contrast, Fuji entered digital imaging with a superior financial background (it managed to build, due to its profit sanctuary) and a profitable portfolio of business, because the company had diversified early on.

CONCLUSION 309

Other findings related to the implications for strategy research are: Proposals for reversing a retained resource allocation process do not emerge from the bottom up, a finding which challenges current understanding of the role of top management and their capability to actively intervene in an organization’s variation-selection-retention process. Finally, this research shows that top management’s distinctive managerial skill spectrum maintains a moderating role in shaping an organization’s response to discontinuous change. Implications for further research and managerial practice are addressed.

These findings suggest recommendations for future research and managerial practice, which I will address in the following, to conclude:

8.2 Limitations and Directions for Future Research The research presented here has several limitations that suggest pathways for further studies. The conclusions were derived from a single case. Future investigations should go beyond the presented research site. Particularly interesting could be the comparison of Kodak with its most important rivals, Fuji and Agfa, which all survived. Neither Kodak nor Fuji nor any other photography company could have prevented discontinuous change of chemical-based photography film business. The imaging businesses of both Kodak and Fuji reveal similar declines in sales. What distinguishes the two companies with respect to the issue discussed here, however, is their response to discontinuous change. Fuji entered the digital imaging era with a good economic background and leveraged its competences into other industries early on, for instance into cosmetics, and thus relied on multiple sources of income to fund digital imaging ventures and to stem decline in conventional photography. Kodak, in contrast, entered digital business with a troubled balance sheet and made some bold investment decisions in various areas in digital imaging that turned out to be wrong.

The benefit of looking at a single case, however, was that it made it possible to explore the general construct proposed, related to the moderating effects of an organization’s stock of resources and its deployment in the resource allocation process. Findings may invite the development of more measurable constructs, particularly concerning the issue of relatedness.

310 Limitations and Directions for Future Research

Also, the issue of partial or regional differences in discontinuous change received less attention in this work. Scholars investigating discontinuous change have elaborated theories of technology maturity (Sahal, 1981), determinants and directions of technological change (Dosi, 1982, 1988a), the S-curve and its limitations (Christensen, 1992a, b; Foster, 1986), the different complexity of innovations (Henderson & Clark, 1990), the impact of technological discontinuities on competence (Tushman & Anderson, 1986), and the distinction between sustaining and disruptive technological changes (Christensen & Bower, 1996). In the literature stream on discontinuous change, less attention has been directed to a more nuanced view of discontinuous change, which may be appropriate to understanding challenges faced by globally operating organizations in response to discontinuous change.

I briefly summarize my findings, which reveal the limitations of prevailing views of discontinuous change: First, Kodak’s chemical film business was based on a customer value proposition requiring activities in multiple areas of the traditional imaging chain, which, for the sake of parsimony, may be circumscribed here as image capture, storage, and finishing. While image capture required skills to engineer hardware devices for capturing light on photographic film, image storage and finishing required the skill to coat chemicals on media. Important, the advent of digital imaging did not replace the entire traditional imaging business; rather, the finishing part of the business has remained comparatively unaffected up to the present day, leaving core competences of Kodak intact, since customers continue to purchase prints made from digitally captured and stored images, although in lower units.

Second, the emergence of an eco-system required to process and manipulate digital images advanced differently in various geographical locations. For instance, at times when the impact of digital imaging for chemical-based photography business severely affected Kodak’s performance in the US and Europe, countries such as China or India still offered growth opportunities in the traditional film business. Also, while the photo kiosk business was met with extensive resistance in the US due to its inferior photo quality relative to photofinishing in labs and offense against professional photographers, the product was embraced in the Australian market. In fact, Australia’s persistence in promoting photo kiosks saved the emerging business from closure. In the end, one of the only “digital” businesses worth selling to get out of bankruptcy in

CONCLUSION 311

2013 was this kiosk business. Without taking advantage of this regional difference, Kodak probably would not have been nearly as successful in this business as they ended up being.

Finally, in response to an aggressive competition in sales of digital cameras that disrupted the traditional camera business, traditional photography companies moved upmarket with their product offerings, as observed in other industries by Christensen (2003); for instance, Fuji, Canon, and Nikon redirected their focus to digital single lens reflexive cameras to address the needs of professional photographers. Kodak, however, could not move upmarket for two reasons: On the one hand, it lacked the necessary competencies to produce professional cameras, because it stopped manufacturing these in the end-1960s, focusing since thereafter on comparatively simply engineered point-and-shoot consumer cameras; and, on the other, unlike its Japanese rivals, Kodak could not make use of a professional retailer network in its home market. Whereas Europe and Japan have dense networks of professional retailers, in the US the market is served by supermarket chains, which usually lack a professional sales advisory service.

Thus, regional differences can constrain alternatives in responding to discontinuous change. A discussion of these three aspects would enrich our current understanding of discontinuous change and help to explain challenges in adaptation.

8.3 Practical Implications In a fairly recent article in the Harvard Business Review, Gilbert and his colleagues (2012) argued that for organizations aiming to bring about the dual transformation needed in the face of discontinuous change, “each organization must operate as if the future of the company depended on it alone.…The idea is to exploit the disruption without being encumbered by the legacy margins, revenue requirements, or practices of the core business.” (p. 70). As a case in point, they refer to Barnes & Noble’s move into the e-book reader business and praise it as a success story. The traditional bookseller launched an initiative far from its New York City headquarters, in a former Palo Alto bread bakery, where a new team conceived the Nook e-book reader; the introduction of a color e-reader and the capturing of some 27 percent of the e-reader market in only two years surprised the book world. Two years later, in 2014, however,

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Barnes & Noble’s move into the digital world reveals a different picture. It is worthwhile to look again at this case in order to show the relevance of the conclusions drawn in the research presented here, and to continue with some general recommendations for managerial practice.

In the article mentioned above, the authors applaud Barnes & Noble’s strategy to launch the new business outside the core business, while capitalizing on shared resources (Gilbert et al., 2012). The new e-book business made extensive use of Barnes & Noble’s large network of brick-and-mortar bookstores. Before buying an e-book reader, potential customers could easily try out the device, which was something Amazon could not offer in its merely virtual presence on the web. It is mentioned only in passing that the development of the e-book business loses millions of dollars a quarter. In fact, the bulk of Barnes & Noble’s $7 billion in revenues came from its retail brick-and-mortar business (Gilbert et al., 2012). No information is given on how Barnes & Noble is going to fund start-up costs and the costs required to scale the e-book reader to a volume competitive against Amazon.

In fact, back in the 1990s, Barnes & Noble was known as a strong competitor with the power to aggressively expand its retail chain and to wipe out independent bookstores.837 However, already in early 2012, the traditional bookseller needed to acknowledge how costly it can be to reinvent itself by moving into the completely unrelated digital e-book reader business. The nation’s largest bookstore chain had to warn its shareholders that “it would lose twice as much money this fiscal year as it previously expected,” and that “it is weighing splitting off its growing Nook digital-book business from its aging bookstores.”838

Paradoxically, Barnes & Noble was one of the first to foresee the business opportunity associated with digital books. Already in 1998, about a decade earlier than Amazon started selling its Kindle, it invested in NuvoMedia Inc., a company that developed e-book readers. Even though Barnes & Noble exited the still nascent business in 2003 due to lack of any profitability, it managed to re-enter the business in 2009 and to capture a 27 percent share of the market.839 By the end of 2011, however, it became

837 Trachtenberg, J. A., & Peers, M. 2012. Barnes & Noble Seeks Next Chapter. Wall Street Journal, 2012 Jan 06. 838 Ibid. 839 Ibid.

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evident that heavy investments in the Nook development to achieve a competitive share of the market had tremendously weakened the company’s annual results. Competing with Apple and Amazon, the company confirmed, is now becoming difficult and might requires partners.840 Spending on advertising alone abruptly soared from about the $10 million the company spent to promote its traditional book businesses in 2008 to some $50 million in 2011, of which some $40 million was spent exclusively on the digital book business.841

In early 2014, Barnes & Noble decided to spin off its loss-making digital book business from its struggling retail-store business.842 The full separation is expected to be completed by March 2015. An ever-shrinking market for print books, fierce competition with Amazon, and heavy investments in the e-book reader business made it necessary to separate the business, to better highlight the value of the core business. Throughout the last two fiscal years, the loss of the e-book business was nearly equal to the profit of the brick-and-mortar bookstore business.843 Since 2012, Microsoft Corporation and other shareholders have been helping finance the Nook business. However, in mid-2014 Barnes & Noble had to take steps to reduce its spending on the Nook: It decided to buy Samsung co-branded tablets, to reduce staff by almost half, and to move out of its costly Palo Alto technology campus into cheaper space nearby.844 Since then, revenues from the Nook digital business have fallen 54 percent, indicating a tremendous decline in device and accessory sales.845 In December 2014, Barnes & Noble disclosed that it is even trying to attract a buyer for the whole enterprise.846 In the same month, Microsoft Corporation announced the end of its

840 Trachtenberg, J. A. 2014b. What's Barnes & Noble's Survival Plan? --- Former Ceo Cuts His Holding to 20%, but Says, 'the Story Isn't Written Yet'. Wall Street Journal, 2014 Apr 18. 841 Trachtenberg, J. A., & Peers, M. 2012. Barnes & Noble Seeks Next Chapter. Wall Street Journal, 2012 Jan 06. 842 Trachtenberg, J. A. 2014a. Corporate News: B&N to Carve Off Its Nook Business --- Retailer Is Splitting in Two, with Underperforming E-Book and E-Reader Unit as a New Company. Wall Street Journal, 2014 Jun 26. 843 Ibid. 844 Trachtenberg, J. A. 2014c. Wsj.D Technology: Samsung Will Supply Nooks --- Barnes & Noble Strikes Deal to Reduce Its Costs to Compete in Tablets. Wall Street Journal, 2014 Jun 06. 845 Alpert, L. I. 2014. Barnes & Noble's Loss Narrows on Cost Cuts Ahead of Split; Bookseller Says Plans to Split Retail, Nook Operations Are Progressing. Wall Street Journal (Online), 2014 Sep 09. 846 Gottfried, M. 2014. Barnes & Noble Poised to Close Chapter; Bookseller Is in a Better Position to Split Itself in Two or Attract a Buyer for Whole Company. Wall Street Journal (Online), 2014 Dec 03.


partnering with Barnes & Noble; it decided to accept a loss on its investment, but won’t have to make any further financial commitments.847

To sum up, despite its position as the leading national US bookseller, Barnes & Noble could not manage to scale the digital book business to volume, to achieve a leading market position and to make it profitable. Stagnating revenues or even losses in the core business rendered it impossible to sufficiently fund the loss generated in the Nook business. Significantly, Barnes & Noble managed to stem weakening performance in its core business by leveraging its resources to related businesses. Sales of games, calendars, and coffee, among other things, kept the company far from collapsing in the face of discontinuous change; indeed, Barnes & Noble managed to keep its overall performance stable in the face of declining revenues from print books.

What are then recommendations for managerial action to respond to discontinuous change? To be quite specific on this point, we may finally look at Apple’s announcement of a digital watch and possible strategies for the Swiss watch industry, with its world-leading competence in precision mechanics:

On September 9, 2014, Apple announced the launch of a digital watch allowing users not only to keep time, but also to collect data on their health and fitness, to be notified about new emails or short text messages, and even to get travel directions, among other features.848 This announcement triggered passionate debates in Switzerland, which has positioned itself as the world leader in precision mechanics.849 Of particular concern was whether people would like having access to personal data on their wrists or would still prefer to access and handle it on their smartphone. A look at technology forums and news agencies revealed that reactions were split.

Some recalled the drama of the 1970s, when the traditional Swiss watch industry was flat on its back, having missed the invention of more accurate and cheaper quartz or

847 Trachtenberg, J. A., & Dulaney, C. 2014. Barnes & Noble, Microsoft End Nook Pact; Bookstore Chain Buys out Tech Giant's Stake in E-Reader Division. Wall Street Journal (Online), 2014 Dec 04. 848 Inc., A., "Apple Unveils Apple Watch—Apple’s Most Personal Device Ever (Apple Press Info, Sept 09, 2014)," Apple Inc., http://www.apple.com/pr/library/2014/09/09Apple-Unveils-Apple-Watch-Apples-Most-Personal-Device-Ever.html, accessed on Sept 11, 2014, 849 Fischer, T. 2014. Gerangel Ums Handgelenk - Die Apple Watch Könnte Den Markt Intelligenter Uhren Beleben. Der Schweizer Uhrenindustrie Erwüchse Damit Konkurrenz Aus Der Computerbranche. Wie Stark, Ist Umstritten. Tagblatt, September 11.

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electronic watches.850 Thanks to the realignment of the luxury segment and the development of trendy Swatch watches, the industry got back on its feet. But now the question is whether the Apple iWatch means a repetition of the quartz watch tragedy for the Swiss watch-making industry. Jonathan Ive, Apple’s design chief, gleefully said, “Switzerland is in trouble.”851

Others, on the contrary, see in the new Apple watch an opportunity for the Swiss watch industry. For instance, Jean-Claude Biver, Chairman of Hublot, believes that the new “smart” watch will open up a new group of buyers who no longer wear watches today. Once the young generation gets used to wearing an information device on the wrist, Biver believes, sooner or later they will look for more durable watches. In contrast to mechanically built Swiss watches, the short life cycles of technological development will quickly overtake smart watches – an opinion that is shared by Ryan Rafaelli, a Harvard professor and expert on the Swiss watch industry.852

On the basis of the findings of the research presented here for organizations facing discontinuous change, the following actions might be advisable: First, it is important to recognize the likely threat of a new technology for one’s own business. The Swiss watch-manufacturing industry seems to have done so already, because they are not just trying to assess the possible impact of smart watches, but have also already expressed concern for the local industry.853 There seems to be a consensus that the smart watches compete in the low-end price segment of functional watches such as Swatch. For the Swiss market of high-priced luxury watches, the new technology is not considered to pose a threat.

Second, given that there is serious concern about disruption, organizations are advised to assess three important variables: (A) Organizations need to judge how related resources required to compete in the new business environment are, compared to existing core competences. That is to say, they have to question whether they can leverage existing competences in order to target the new business or whether they are required to reconfigure and stretch or even import new (and costly) resources. 850 Landes, D. S. 1984. Revolution in Time: Clocks and the Making of the Modern World. Cambridge, Mass.: Harvard University Press. 851 Bilton, N. 2014. Tech, Meet Fashion - Intel and Opening Ceremony Collaborate on Mica, a Stylish Tech Bracelet. New York Times: E2. 852 Husmann, N. 2014. Geschenk Für Die Schweizer Uhrenindustrie. Handelszeitung, September 10. 853 Ibid.


Organizations may also measure the relatedness in terms of strategic assets to ensure a sustained (or at least temporary) competitive advantage. (B) Based on the measure of relatedness, organizations are able to assess the level of uncommitted resources required to fund resource development. This variable directs attention to the pragmatic question of whether the organization can afford to compete in the new business environment or whether it should move up-market by offering a premium. Of course there is also the option to move to a related business environment and to exit the current business altogether. In fact, this variable helps to answer the question of whether there are enough resources to start the business and size it to volume in order to achieve a leading market position. (C) Finally, organizations are required to evaluate the rate of technological progress and substitution. Is there a need to immediately partner with someone competent in the new business environment, due to lack of time, or are the chances good to develop the required resources in time by oneself? In the case of the Swiss watch manufacturers, it is believed that there is no urgency, because there are neither “killer apps” on the market yet that render smart watches absolutely essential, nor are there convincing solutions to the problem of battery load.854 For instance, most smart watches have to be charged every day. In regard to resources required, there exists an understanding that the computer technology underlying the new watches is certainly distinct from mechanical precision engineering; however, several leading Swiss manufacturers are well positioned in the sense that they have launched businesses delivering various key components. For instance, Renata and EM Microelectronic, which are subsidiaries of the Swatch Group, produce batteries or energy-efficient processors and sensors that are used in several smart watches.

Finally, given that there is a need to respond to a new technology – as would make sense for Swatch – organizations are advised to establish a separate business unit with its own business model, dedicated staff, and organizational culture. This structural differentiation helps to launch a new business outside the threatened legacy business. In order to scale up the business to become a growth engine, however, the new business requires a structure that allows the old and the new business to share strategic assets. Only by sharing their strengths can superior performance be achieved. Aside from their competence in precision mechanics, the Swiss watchmakers certainly have 854 Martel, A., & Rütti, N. 2014. Mir Fehlt Die Killer Applikation. Neue Züricher Zeitung.

CONCLUSION 317

world-class competence in design, such as how to design watches to comfortably rest on the wrist, how to place setting wheels or buttons to allow pleasant operation, and how to make watches resistant to environmental influences such as water. That said, joining forces with partners on this basis would allow Swiss watch manufacturers to leverage existing resources while avoiding the risk of having to develop costly resources in unrelated domains, such as computer chips.

In conclusion, it can be stated that contrary to the current scholarly urge to figure out the best practices companies may deploy in order to successfully adapt to particularly those disruptive forces that may render their present businesses discontinuous in the future, findings of this research suggest that such a move is only wise under certain conditions. The stock and deployment of resources, as well as their relatedness to resources required in a targeted business, are decisive for a company’s success in adapting to a new environment, irrespective of the point in time of threat perception, threat response, and the disruptive force’s rate of development and substitution. In certain cases, companies are advised to reorient their operational objectives altogether and leverage their existing competences in other domains, instead of attempting to reconfigure or extend them at all cost to achieve a tight fit to the new and disrupting environment.

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About the Author

Michael Shamiyeh Born in May 4, 1969 Citizen of Austria Academic Experience (most important) 2000 - PROFESSOR AND HEAD OF DOM RESEARCH LAB LINZ The Design-Organization-Media (DOM) Research Lab is based at the

University of Arts and Design Linz, Austria Professional Experience (most important) 2000 - PRINCIPAL OF SHAMIYEH ASSOCIATES GMBH LINZ Architectural practice and consultancy 1998 - 2000 FREE-LANCE ARCHITECT AND PROJECT LEADER TRINIDAD Realization of hotels and resorts in the Caribbean Islands Education (most important) 2008 - 2014 UNIVERSITY OF ST. GALLEN, CH ST. GALLEN PhD in Management (Steven Floyd, Martin Hilb) 2006 - 2008 ARCHITECTURAL ASSOCIATION, UK LONDON MA in History and Critical Thinking (Mark Cousins) 2000 PUBLICLY AUTHORIZED AND SWORN EXPERT, A LINZ Certification by chamber of architects & chartered engineering consultants 1996 - 1998 HARVARD UNIVERSITY GSD, USA BOSTON MArch in Architecture II-postprofessional (Rem Koolhaas, Michael Hays) 1994 INTERNATIONAL SUMMER ACADEMY OF THE FINE ARTS, A SALZBURG Masterclass Architecture (Daniel Libeskind) 1988 - 1994 TECHNICAL UNIVERSITY OF VIENNA, A VIENNA Dipl-Ing. in Architecture (Anton Schweighofer) Selected Awards (most important) 2010 Gold medal for Invention Solar-Display: KIWIE 2010, Seoul, Korea Gold medal for Solar-Display: World Intellectual Property Organization

Nomination of Solar-Display for Energy Globe 2010 2009 Innovation Prize 2008 by Austrian Ministry for Science and Research

Discontinuous Change and Organizational Response ... · Discontinuous Change and Organizational...

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