Question;Kodak: Mistakes Made on the Road to InnovationLed by CEO Antonio M. Perez, Kodak is struggling to reinvent its business model. It's notaloneBy Steve Hamm and William C. SymondsWhen Eastman Kodak (EK) vowed in 2000 to become a leader in digital cameras, the ideaseemed ludicrous. The old-line Rochester (N.Y.) company had film and print all through itsDNA. Yet by 2005, Kodak ranked No. 1 in the U.S. in digital camera sales. Its digital salessurged 40%, to $5.7 billion, even as its film-based businesses fell 18%. The key: productinnovation, something Kodak knew how to do oh-so-well. The company designed one awardwinning breakthrough after another to make digital photography nearly as simple as pointing andclicking.So why does Kodak Chief Executive Antonio M. Perez now dump on digital cameras, callingthem a "crappy business"? Simple: While blazing growth of camera sales has helped blunt theeffects of Kodak's fast-fading film revenues, it hasn't replaced the rich profits of the filmbusiness. Even the best mass-market cameras yield slim profit margins. So, although Kodak'sdigital camera business was a roaring sales success, it turned out to be a crushing profitdisappointment. Perez, who arrived at Kodak in 2003 and became chief executive last year, hadchampioned a dramatic change only to find it wasn't the right model for turning the companyaround.Now he's crafting yet another strategy for Kodak, its third in less than a decade. Building on themistakes made and lessons learned in recent years, Perez is attempting innovation of another sort-- reinventing the company's core business model. He aims to make Kodak do for photos whatApple does for music: help people to organize and manage their personal libraries of images.He's developing a slew of new digital photo services for consumers that he expects to yieldhigher returns. They include everything from online photo sharing to a rapid-fire scanningsystem, called Scan the World, that takes shoe boxes full of yellowed snapshots and convertsthem into crisp digital images organized by the date originally printed. But the shift from hardproduct to digital services is a huge challenge. It's "a very hard transformation," says Perez."History says very few companies have made it."In an era when innovation is all the rage, many CEOS, like Perez, are discovering that productinnovation alone isn't enough to save sick companies or turbocharge healthy ones. For many,their core businesses are being disrupted by globalization, technology shifts, and newcompetitors. They must reinvent the company. Even at healthy companies, business modelinnovations are essential to retaining their competitive positions. Microsoft (MSFT)ChiefExecutive Steve Ballmer says he no longer thinks of his competition as individual companies.Instead, "it's alternative business models that we'll have to compete with or embrace," he says.His two biggest threats are the open-source phenomenon and advertising-supported software.There's no better example than Kodak of the importance of coming up with new ways of doingbusiness -- and the difficulties of succeeding. At its peak, Kodak was an icon of Americantechnology innovation. Now it's fighting to recover from a tech revolution that is strangling itscore business. Kodak was late to recognize the problem, slow to react, and then went down thewrong innovation path. It faces many of the problems and is making many of the mistakes thatany company can make when so threatened. Because of these delays and missteps, it's still farfrom clear how Kodak's story will play out. Yet it provides a vivid case study for businessesfacing similar challenges. A March survey commissioned by IBM (IBM) showed that 65% of theworld's top CEOs plan on radically changing their companies in the next two years.Over time, all innovation gets commoditized. In this regard, business models are not differentthan products and services. So business model innovation must be a perpetual quest for renewal.Look at how Dell, (DELL) long the PC industry's heavyweight champ, has suddenly becomewobbly in the knees. It revolutionized the PC business by assembling computers to order forcustomers while eliminating the middleman. Now competitors have caught up with Dell'sefficiencies and are even undercutting its prices. So Dell is emphasizing designing a bettercustomer experience and selling through retailers.This reinvention stuff can be a tough slog. "Business model innovation is harder than productinnovation. It's harder to visualize, and the scope is larger and much more complex. It includeseverything the company does. Everything has to be changed," says Jay Desai, chief executive ofmanagement consultancy Institute of Global Competitiveness.Apple Computer (AAPL) shows how it's done. Here's a company that was trapped in an everdwindling niche of the PC business. Then came the iPod, a must-have device for music fans, andiTunes, an online music shop that turned music downloading into a profit-making business. Bymaking iPod and iTunes work with Windows PCs, Apple broke out of selling only to its niche ofloyal fans. But its transformation is even more profound than that: In essence, it switched frombeing a great designer of computer products into a great designer of consumer experiencesdelivered via devices and services. Now music represents 44% of Apple's revenues, and an evenlarger share of profits.Kodak's Perez dreams of replicating Apple's success. "In two to three years, this will be seen asone of the most successful transformations in the history of our country," he predicts. Maybe.Wall Street doesn't share his optimism. Kodak's stock is trading at about 26 per share, down froma high of 95 in 1997. Kodak has been in the red for eight consecutive quarters, losing a total of$2 billion. It hopes its new strategy will get it into the black by yearend 2007.Many of Kodak's problems can be traced to the successes of its past. Wherever Perez turns inRochester, N.Y., he is haunted by the specter of George Eastman, one of America's greatestinnovators. In spite of the fact that Eastman died in 1932, his mark is still huge on the companyhe founded in 1880. Decades after his death, it remains difficult to change Kodak's longestablished ways. One of them is a hierarchical culture that believes in the omnipotence ofleadership. It's so powerful a habit that when Perez came to Kodak from HP in 2003 as chiefoperating officer, he couldn't get people to openly disagree with him. "If I said it was raining,nobody would argue with me, even if it was sunny outside," he laments.WATCH FOR TREACHEROUS SHIFTSBefore Perez arrived on the scene, Kodak was in denial. The company had supposedly been on adecade-long journey to digital technology, yet very little had actually been done. The pressure torethink the business didn't seem that great. There was no crisis. It wasn't until 2001 that filmsales dropped, and even then insiders attributed the financial shocks to the September 11 attacks.The hope was that Kodak might be able to slow the shift to digital through aggressive marketing.The company hedged its bets and launched an all-out blitz on the digital camera market. Itsfamily of digital cameras, called EasyShare, was widely praised. The company spent atremendous amount of time and energy studying customer behavior. It found that women inparticular loved taking digital photos but were frustrated in moving them to their computers. Itwas just too hard. Kodak's researchers had found a key unmet consumer need -- a hugeopportunity.Once Kodak got its product development machine humming, it cranked out model after modeloffering consumers top-quality cameras at reasonable prices that made it easy to share photoswith friends and family members via their PCs. One of the coolest innovations: a printer dock.Consumers could insert their cameras into this compact device, press a button, and watch theirphotos roll out.But there was a fatal flaw in Kodak's strategy. Its executives didn't anticipate how fast thesedigital cameras would become commodities, with low profit margins, as every competitor racedinto the market. Then film really began to tank. Perez had counted on rising demand fortraditional photography in China to slow the fall. But China went digital as fast as everybodyelse.Perez began investing heavily in digital technologies, shutting down film factories andeliminating 27,000 jobs. He spread the word that Kodak would have to come up with newservices and new ways of capitalizing on its technology innovation to boost profit margins.When he was promoted to CEO in May, 2005, he summoned his top seven executives to thePresident's Room, a spacious, wood-paneled conference space on the second floor of the Kodaktower. The most dramatic change in Kodak's strategy in over a century was under way, and therewould be no turning back. "You have to burn the boats," the Spanish-born Perez told them,quoting conquistador Hern?n Cort?z.For the new service-oriented business model to work, Kodak had to throw out some of its mostcherished notions. No longer would it fool itself that product innovation would be sufficient for itto be successful. And no longer would it try to do everything itself, from manufacturing toselling finished products.GET YOUR BEST PEOPLE BEHIND THE PROGRAMPerez found he had to replace a lot of executives to get the company on a new track. The film-eralifers just didn't get it. Of the company's 21 executive officers in 2003, the year Perez arrived,only three remain. Most of their replacements came from outside Kodak, and most had digitalexperience.Perez believes that in any organization, one-third of the staff will readily support a change, onethird can be convinced, and one-third will be unwilling to make the shift. He calls it The Rule ofthe Thirds. To help him win over a clear majority, he assembled a group of people who wereskeptical by nature and assigned them to a committee he called the R Group. ("R" stood forrebels.) He asked them to make suggestions on how the company could be improved. Thosediscussions contributed to the strategy of coming up with new digital services and new ways ofcommercializing existing technology. Also, once these people felt like they were part of theconversation for change, they spread the word throughout the organization that Perez was a goodleader. And, because they had credibility, their opinions influenced many others.Other companies haven't been as fortunate. Take Siebel Systems. When the idea of deliveringsoftware as a service emerged as an alternative to selling packages of software, Siebel SystemsCEO Thomas Siebel threw his weight behind it. Yet even his influence wasn't enough. Awatershed moment came when Siebel competed against upstart Salesforce.com for the businessof tech giant Cisco Systems (CSCO). Even though Cisco was tilting toward Salesforce.com,(CRM) Seibel's sales people pushed traditional product software because they'd get richercommissions that way. Siebel lost the deal, and its business was forced to sell out to Oracle(ORCL). "There were groups of disbelievers in the organization, which is a recipe for disaster,"says Bruce Cleveland, who ran the software-as-a-service initiative.GIVE YOUR NEW INITIATIVES ROOM TO BREATHEA company's core business and its new initiatives are typically at odds with one another. Forcethem together, and the old business may well smother the new one. Kodak tried it both ways. Fortwo years it placed the digital camera group within its film business so they could shareresources and digital could grow more quickly. But last year it split them off again. "One reallycouldn't piggyback on the other," says Pierre Schaeffer, chief marketing officer for the digitalbusiness.Other companies have scored big by managing their new businesses separately from the start.When Dow Corning conceived of its e-commerce business, Xiameter, the idea was to run itindependently. The company didn't want to devalue the Dow Corning brand, which is equatedwith premium service. Xiameter was about selling large quantities of silicone at low prices withno services attached. Since its 2002 launch, Xiameter has grown to about 15% of Dow Corning'stotal sales.MAKE PAINFUL BREAKS WITH THE PASTSwitching business models requires a thorough rethinking of everything a company does, fromplanning to manufacturing to marketing. For 120 years, Kodak had done everything for itself. Atone time, it even raised its own cattle and used the bones for making photographic gelatin. Whenit tried to collaborate with others, the results could be messy. For instance, it sought outsideexpertise from Adobe Systems (ADBE) in 1999 when it was developing a product fortransferring consumers' photo prints to compact disks so they could be viewed on PCs. Yet thealliance was fraught with bickering. When Adobe people came up with suggestions, the kneejerk reaction from Kodakers was "This will never work," recalls Brian Marks, a 19-year Kodakveteran.Today, Kodak has had a complete change of heart. In early January, Perez and Motorola (MOT)CEO Edward Zander stood together at the International Consumer Electronics Show in LasVegas and announced a 10-year partnership in which Kodak would provide chips to operatehigh-quality cameras in Motorola's cell phones. It was a startling break with Kodak's past. Anorganization that had always built its own products would now provide technology for somebodyelse. Kodak will also help consumers transfer images to PCs or online galleries (75% of allphotos never leave cell phones).Perez is gambling that the match will be well worth all the contortions Kodak is going through.He expects much of the growth in digital photography to happen in mobile phones, and hebelieves profit margins for sensor chips will be twice those of the digital camera business.In spite of the changes Perez has made, he admits he still has a lot to do. Old habits die hard. AtKodak, it's standard procedure to test a new product or service -- and then test and test again tomake it perfect, even if that stretches out the journey to the marketplace. Case in point: Kodakhas been talking up its Scan the World consumer service for a year, but it's still not sure when orhow it will be introduced broadly. The company hopes to sell or lease scanners to photo shops,plus get a piece of the fees charged to customers for the service. Among other things, it'swrestling with the $50,000 cost of the scanner. Will Kodak be able to adjust quickly enough tomeet the demands of new and untried markets? Not clear.DON'T CONFUSE WHAT YOUR COMPANY DOES WITH HOW IT DOES ITIt is taking time for Kodak to understand that it is an image company, not a film or cameracompany. Perhaps it should take lessons from Western Union. (WU) Founded in 1851, thecompany has managed to ride each successive wave of change in its history rather than gettingswamped. (A bankruptcy protection filing in the early 1990s was caused by managementmistakes rather than external threats.) After handling the first transcontinental telegram in 1861,it spotted the opportunity to transfer money by wire 10 years later. Then, a series of firsts: a cityto-city facsimile service, a microwave communications system, a commercial satellite network,and online money transfer.Why has Western Union been able to adapt to severe disruptions and survive over so manyyears? It never confused the business it was in with the way it conducted its business. At its core,Western Union was about facilitating person-to-person communications and money transfers -whether via telegraph, wireless networks, phone, or the Internet. "We always saw ourselves as acommunications company," says president Christina Gold. Contrast that with Kodak. Bydefining itself too narrowly as a product company all those years, it was headed for a fall.Kodak teeters on the precipice and with it stand some of the other once-great businesses of the20th century, from autos to newspapers. They were immensely successful and proud, but theirvery success made it difficult to adjust. "The more successfully you use a way of working, thestronger your culture is, which is a great strength right up to the time when you need to change,"says Clayton Christensen, a professor at Harvard Business School. All innovation is hard.Reinventing your entire business is the hardest innovation of all.
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