Getting Kodak To Focus

By Unmesh Kher/Rochester

"I like change," says Eastman Kodak CEO Daniel Carp. "I'm one of those people that has to have change." Good thing, because Kodak has had plenty of it. Carp is now well into the monumental task of dragging the iconic American company that invented consumer photography more than a century ago into the fast-moving, low-margin world of the digital era. He has little choice. As digital cameras have grown in popularity, Kodak's profitable film business has gone into free fall. Not the first Kodak CEO to try to refocus the company on the digital future, Carp is clearly taking the biggest risks. He put his marker down 16 months ago when he announced that Kodak would cut dividends, slash investments in its film business--and milk its declining profits to fund $3 billion worth of acquisitions and investments crucial to the digital transformation. The market response was swift and brutal: Kodak's stock price plunged 18% that day to a 20-year low. Carp followed up with a plan to eliminate nearly a quarter of the company's 64,000-person work force by 2006. Still, Wall Street analysts doubted that Kodak, with its legacy culture and reputedly ossified management, could match the pace set by its lean digital competitors. How could it generate sufficient profit from digital sales and cut costs fast enough to offset the precipitous decline of its primary source of profit?

Today such skepticism on the Street, if far from gone, is tempered by pleasant surprise. A year after Carp launched the restructuring, Kodak has lined up a respectable portfolio of increasingly lucrative digital products and services. The company, based in Rochester, N.Y., lost $12 million in the last quarter of 2004, but that was largely because of restructuring costs. Meanwhile, its revenues actually climbed 3%, to $3.8 billion, in that period--the 16% decline in Kodak's traditional film business offset by a 40% surge from its digital sales and services. Yet there remain ample reasons for doubt. For one thing, Carp has promised a pretty picture: $16 billion in revenues by 2006, up from $13.5 billion last year, with more than half of that coming from its digital endeavors. He also says the company's profit margin will drop from roughly 40% to 30%--and no further--and serve up $3 in earnings per share, vs. last year's operational EPS of $2.62. To longtime Kodak watchers, this optimism smacks of old times: Kodak trumpeted its digital aspirations nine years ago--and failed to deliver, unable to wean itself from traditional film businesses and their 60% margins. Is this just another false start? "Everybody's been skeptical," says Carp, "except we've put the numbers on the board."

To be fair, Kodak has long invested in digital technologies, going back to a 1976 digital-camera prototype. More recently, in 2001 it introduced the first of a line in digital cameras named EasyShare that have grown in popularity and today command a leading share of the market, ahead of Sony, according to International Data Corp. Carp began preparing the ground for Kodak's transformation soon after he took over in 2000, placing people from digitally dominant companies like General Electric and Lexmark International into top management posts. After his first COO, Patricia Russo, left to head up Lucent, he replaced her in April 2003 with Antonio Perez, 59, a former Hewlett Packard exec who had nursed its printer division into a $10 billion dynamo. "I think people will have more confidence in this strategy if they know Antonio is actively involved," says Carp, laughing.

Perez sifted through Kodak's intellectual property to come up with a new plan. The picture was brighter than he expected. "People think our challenge in becoming digital is that we don't understand the technology," says Perez. "They're absolutely, terribly wrong. We have technology coming out of our ears." What the company didn't have was focus. Perez provided one, identifying three areas of concentration: consumer imaging, health imaging and commercial printing. To eliminate distractions, he sold Kodak's Remote Sensing Systems satellite business to ITT Industries for $725 million and began pulling Kodak out of a range of other partnerships.

Kodak had already been through several ugly reorganizations, but Perez still saw the ghosts of old, comfortable business habits. He exorcised them. "I guess, as a legacy from a very rich, very successful company, [Kodak's management] was sloppier than we wanted it to be," says Perez. "We were looking for accountability. We organized the company so it was very clear who was responsible for what." Perez also had to find the right people to--as Carp puts it--"teach" Kodak about the brave new world it was entering. Many have come from outside--including seven of the 10 most recently appointed senior managers--though Carp himself joined Kodak as a statistical analyst 34 years ago.

The company overhauled its manufacturing process as well. That task fell to an old-timer, Charles Brown, a lean, cerebral 31-year Kodak survivor who is today the chief administrative officer. A chemical engineer, Brown spent much of his career in manufacturing, ultimately developing a lean production system in 1997 that was based on Toyota's acclaimed continuous-improvement approach. He dubbed it the Kodak Operating System. KOS forces managers to look at everything that happens in a plant in terms of waste--waste of time, waste of space and so on. They then analyze every step in a process--down to the hand movements of assembly-line workers--to look for a better way. Everything goes that does not "create value for the customer," says Brown.

The progress has been measurable. In 1997, for instance, 100 days passed between the first step of making film to when the little yellow box reached the customer; today such cycle times are half as long. So far, says Brown, KOS has saved "tens of millions of dollars worth of capital and hundreds of millions in inventory" and has contributed "hundreds of millions in productivity." Impressed by such stats, Carp asked Brown in late 2003 to inject KOS into Kodak's entire corporate plumbing, from human-resources management to product development to the products themselves. "It's an entire management philosophy," says Brown.

KOS may be helping put some of the shine back on Kodak's prospects, but its hometown, Rochester, is hurting. It has borne the brunt of the company's downsizing, as Carp has sought cheaper manufacturing abroad. Most of the company's digital cameras are now made in China. In Rochester's northwest, the 2,200-acre Kodak Park, once the hub of Kodak's industrial operations, is full of vacant lots and demolished buildings. At its peak in 1982, the firm--once called the Great Yellow Father--employed more than 60,000 people in the city and had long been famous for its paternalistic employee policies. That figure is now 16,300 and trending down. Factories have also been closed in Europe, Australia and elsewhere in the U.S.

Carp says Kodak's workers understand the pressure the company is under. But that does not necessarily mitigate their misery. The tyranny of micromanaged productivity, says a veteran employee, hangs like a cloud over Kodak's rank and file: "You're accountable for everything you do, or don't do, all the time. You're worried that you may not have a job from one week to the next, and you don't know whether, if you come up with a good idea to save the company money, you could cost people their jobs."

It's a leaner and meaner company, no doubt. Yet Wall Street still isn't convinced that Kodak can compete in the digital marketplace. Its latest camera, EasyShare-One, available this summer for $600, features the largest display screen around, a memory capable of holding 1,500 high-resolution images and, for an extra $100, wireless communication. But competition is intense, especially in photo printing, which is still where the money is. In film, Kodak had only two major competitors, Fuji Photo Film in Asia and Agfa-Gevaert in Europe. Now, both its old foes are in the printing market, as is the giant HP. And Sony and Canon aside, there are at least a dozen firms making digital cameras.

Similar doubts dog Kodak's most promising digital adventure--medical imaging, a process that extends from the nonfilm capture of X-ray images to their dispersal through a hospital network and their digital manipulation to produce detailed images. Kodak sells digital radiology machines and software that manages the diagnostic and other information that accompanies each image. It even posts the bill. Not ready to go fully digital? No problem: Kodak will sell you bridging devices--like laser printers to transfer the picture to film. The company also provides consulting services, putting KOS into operation to make patient care more efficient. The ultimate goal: to set up information networks for hospitals and entire hospital systems. Kodak says the digital component of its health-care business grew 20% last year.

"One of the best things we hear about Kodak is the quality of their service," says Scott Grier, a director at First Consulting Group who specializes in medical information technology. But here, again, old rivals are already a threat, while other technological powerhouses--GE, Phillips, McKesson and Siemens--have competing products and services.

The company's third core business, commercial printing, seems promising, even though it's losing money right now. But here Kodak will have to battle a giant called Xerox. That does not mean the technology is anything like that of office photocopying. Kodak's machines can be 40 ft. long and cost from $11,000 to $5.5 million. Its pricey Versamark, for example, produces color prints in huge volume--at a rate of 1,000 ft. per minute. The magic: digital technology makes it possible to economically print custom copies of anything at almost any volume--books, flyers, bills. "It's a reasonable thing for Kodak to do," says Jack Kelly, an analyst with Goldman Sachs. "The competition isn't as vicious." Barbara Pellow, chief marketing officer of Kodak's Graphic Communications Group, points out that the customers Kodak will target--like direct marketers who want to customize their flyers or retail chains that need variable posters--represent a $30 billion market that's growing at a 12% clip. Once again, Kodak's recently acquired portfolio of products is arranged to bridge the gulf between traditional and digital printing.

Carp's clarity of purpose and Perez's management seem to have engendered some enthusiasm, but this is epic work. Very few companies of this size, faced with a seismic shift in technology, emerge intact. When his team gets weary, says Pierre Schaeffer, director of business strategy for Kodak's digital and film imaging business, he boosts their spirits with a reminder. "We're involved in a really exciting transition," he tells them. "Regardless of the outcome--and hopefully, we're playing it for the best--the moments we're going through now will be making the textbooks." In a sense, Carp has turned Kodak's quandary into strategic inspiration. As he puts it, "The strategy is to lead our customers through the transition from traditional products to digital products." And, presumably, to take Kodak with them in the bargain.