Kodak, Disruptive Innovation And The Stock Market

Kodak, Disruptive Innovation and the Stock Market

The graph above suggests that Kodak’s stock hasn’t done very well since the

rise of digital imaging.

From 1999 to 2009, it went down from 88 USD to around

3 USD.

Film was a high margin

business that Kodak

used to dominate.

Digital imaging removed the need for film and

thus, Kodak’s profits faded away.

Therefore Kodak had to both use

existing capabilities

and develop

new ones in order to survive.

It’s been a tough journey for Kodak and as stated before, the stock has reached new

bottoms every year.

Standard & Poor’s Equity Research Analyst Erik Kolb commented on the results:

“They were late to the game in their shift to digital and they have

been playing catch-up since.”

Kolb also said in 2009 about Kodak that “They were late in their transition to digital business, namely

digital cameras and accessories.”

In fact, Kodak wasn’t late, Kodak entered at an early point.

Wouldn’t it be interesting to see the comments that analysts like Kolb have made

before the technological shift, before everyone suddenly ’knew’ that this would

happen and started to say that all companies which suffered did so because they were late?

Mary Benner at Wharton has done some great research regarding how securities analysts had looked at Kodak and its business from

the early 1990s and on.

The results are very interesting and will be summarized briefly on the coming slides.

Benner basically shows that analysts did not care about and scarcely commented Kodak’s investments in digital imaging that were made

during the early 1990s.

On the other hand, the analysts praised film-based and hybrid products, which would later

on collapse in revenues.

The ignorance cannot be

explained by industry

secrecy or that no one knew about

digital imaging…

… Photo Magazines and

industry publications

wrote extensively about digital

imaging in the early 1990s.

But the analysts did not give any

attention to digital imaging in its infancy.

Benner also showed that analysts were significantly more positive regarding film-based initiatives than those which were based upon digital technology.

Kodak introduced 13 digital cameras in 1990-96 and two ’hybrid products’ – the Photo CD and Advantix.

The Photo CD was mentioned 38 times in the

analysts’ reports and Advantix 144 times.

Kodak’s first filmless camera, the DCS 100

wasn’t mentioned at all!

In total, there are only ten mentions of Kodak’s digital cameras in the 196 securities

analysts’ reports.

Given that those reports total 2653 pages it’s obvious that they ignored the initiatives that were

essential for the long-term survival of the company.

The photo community seemed to be more interested in Kodak’s efforts:

“[Kodak]…appears to have found a way to reconcile the respective places of conventional and digital imaging in its strategy… If Kodak is going to lose film customers to digital imaging, it would rather lose them to Kodak…Kodak’s digital camera product line is now as extensive as it is impressive…”

// Future Image, Volume 2, Issue 6, October, 1994

Initiatives that sustained the film business were widely regarded as positive.

“There are excellent opportunities for Kodak and other film manufacturers to develop hybrid systems that combine the best characteristics of chemical and electronic imaging. The Photo CD is a good example of a hybrid system that we believe will extend the life of 35mm film substantially.”

// Smith Barney, August 14, 1991

“The Advanced Photo System…will

be the most important

development in the photography industry in 20

years.” // Smith Barney,

January 1996

Here’s my favorite:

“….Shareholders will revolt once the meager (and distant) potential returns from electronic imaging become clear…we are eager to see shareholders’

reactions when they realize how much of their money is squandered on ‘digital nonsense’”.

// Prudential, April 1994

History tells us that if you

should survive a technological shift you have to start at an early point…

… You have to explore it, develop prototypes, recruit

people with different knowledge and

remain committed to something that will

not boost the bottom line in many years…

… Kodak did the right thing and at

best, analysts ignored these

activities, at worst – they were ridiculed

and critized.

(By the way, both the

Photo CD and Advantix

were discontinued shortly after

their introduction.)

During the period 1997-2001 it became increasingly clear that digital imaging had a future after all and wasn’t only ‘nonsense’.

Kodak’s early work on digital imaging

now started to pay off.

In these years, Kodak launched 32 digital camera products and 3 hybrid cameras.

Many of them were very competitive, they received several awards and Kodak obtained

significant market shares.

3 products get 70 times more attention

than 32 products!

Bear in mind that the ignored products all had in common that

they had a future while the other ones were going to die soon.

Frightening.

Over time, the analysts became

increasingly positive to digital imaging.

The next mistake was to underestimate the dynamics associated with a technological shift.

“In our opinion, Kodak has the potential to dominate digital photography in the same way it has

dominated traditional photography.” // CSFB, December 8, 1999

A Smith Barney analyst said in March, 1997: “…we believe the penetration by digital

cameras of the installed base will be moderate for the next 10 years.”

0

5

10

15

20

25

30

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Number of film and digital cameras sold in the United States (guess which one is digital!)

Wrong.

0

5

10

15

20

25

30

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Somewhere around 1999-2000, many analyst’s started to become aware of the revolution.

“Despite our more positive stance, we still hold that longer-term fundamentals are shaky. Digital imaging

is and will continue to cannibalize Kodak’s highly profitable film business…we do not believe that profitability will match Kodak’s film business”

// Morgan Stanley, April 1999

"For Eastman Kodak to become a stronger investment, it has to make a seamless transition from its analog photography to digital photography business…"

"I haven't seen it make a smooth transition yet, but we have to take individual projects like these today and group them into their whole strategy before changing the forecast for the company.”

Gary Schneider, analyst at Bear Stearns.

Schneider is right, but I guess the problem is that technological shifts do not tend to be very smooth.

The analysts’ role becomes even more questionable when they later on explain Kodak’s decline by stating that the firm

overslept the technological shift.

“They were late to the game in their shift to digital and they have

been playing catch-up since.”

They ignored all efforts related to digital imaging up until the avalanche came into

motion, and when it happened some analyst’s started to make comments like the one above.

… Who had actually overslept the shift?!

If Kodak had followed the analysts’ way of reasoning, the company would have been

bankrupt around 2001 like Polaroid.

Hence, if you would have given attention

to the opposite of what they looked at

you would have been much closer to a good analysis (there are of course exceptions).

Why?

We can’t exclude that analysts are biased and have their own

agenda (the good old pump-and-dump

strategy).

Another possible explanation is the ’sheep behaviour’ among people doing the same job.

But those explanations

are not sufficient.

I think this spectacular ignorance is related to the way many financial analyst’s look at companies.

They discount cash flows, look at market shares, profitability on different products and use

sophisticated data analysis…

… without reflecting about the fundamental business that they are actually trying to understand.

If you juggle with numbers without thinking about what the numbers represent you end up like the

analysts did in the Kodak case.

For stable and predictable businesses such a static analysis usually works reasonably well.

But under turbulent conditions you’d end up like this:

Film=

Huge profits and

market dominance

Digital Imaging

=Uncertain, low profits,

low volumes at the given

time

=> Keep investing in the film business and

wait with digital imaging, would have

been the obvious conclusion from this.

And financially speaking, all digital imaging initiatives up until the 2000s only generated

insignificant revenues compared to film.

In the short term, it’s just a cost.In the long term, it’s absolutely essential.

It wouldn’t be an overstatement to say that financial analysts need to study and understand economic

history and the dynamics of capitalism.

Image attributions

Sources:

Benner, M.J. (2007). Securities analysts and incumbent response to radical

technological change: The case of digital technology in photography.

CNET News

Christian Sandström is a PhD student at Chalmers

University of Technology in Gothenburg, Sweden. He writes and speaks about disruptive innovation and

technological change.

[email protected]