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Kodak declared bankruptcy last week. For years, this company was visibly a dinosaur. It had no visionary leadership. The senior managers had the wrong vision. The company had lots and lots of debt, which indicates how blind its creditors were. This brief report was published by the New York Times in 2003.
Moody’s Investors Service cut the rating on the $3 billion of debt of the Eastman Kodak Company to the lowest investment grade as a drop in film sales drained cash. The company’s long-term senior unsecured rating was lowered to Baa3 from Baa2, Moody’s said. Moody’s and Standard & Poor’s had cut their ratings earlier this year on concern that Kodak’s acquisitions and weak cash flow from film sales would hinder debt repayment.
Baa3 is just above junk bond status.
The bankruptcy killed $1 billion in debt. Citigroup has announced that it will loan another $950 million as a debtor in possession. Why didn’t Citigroup bail out in 2003? Or 2005? It was all downhill after 2003.
As it watched digital dissolve its high-margin film business, Kodak has shed 47,000 employees since 2003, closing 13 factories that produced film, paper and chemicals, along with 130 photo laboratories. The restructuring has already cost $3.4 billion, because it was done “in a socially responsible” way, said a spokesman, Christopher Veronda.
Then there were its stock investors. This company was doomed because it sold film. Film as a technology was clearly doomed a decade ago. Nevertheless, there were blind investors who paid $40 a share in 2003. It fell. It rebounded to $35 in 2005. It fell. It rebounded to $30 in 2008. Then it went over the cliff. It was at 31 cents when it filed for bankruptcy. You can see the 10-year chart here.
Hope springs eternal. So do losses.
In an article on the British operations of Kodak, the author interviewed a Kodak executive who quit in 2010. The poor guy had hung on faithfully for a decade longer than he should have. But, finally, he abandoned the capsized ship. He said this:
He also told of a baffling conversation with a member of Kodak’s management, revealing: “Just last week a Kodak executive came to me and said ‘I think film will make a comeback’, and I’m thinking ‘who are you kidding?’ That’s the mentality that’s stuck in that company and you’ve got to break that and they’ve never been able to.”
Kodak split the company in 1994. It spun off Eastman Chemical Company. That firm has had to compete internationally. A decade ago, you could have bought it at $22. Today, you would pay $46.
Kodak is a classic story of a fat and sassy firm with a near monopoly in its field that did not bother to adjust to changing customer demand. Its executives had no perception of the fact that the new technologies would kill it if it refused to alter course. They thought they were immune because their industry was immune internally. But it was not immune externally.
Kodak’s executives refused to develop digital cameras because they feared that the new cameras would destroy their business. They feared cannibalizing their own company. But as Steve Jobs famously said, “If you don’t cannibalize yourself, someone else will.”
IBM refused to promote the PC in 1981. They consigned it to a remote location, Boca Raton, Florida, far away from Armonk, New York. They let the people in Florida do whatever they wanted, but without much money. Not having software development capital, the people at Boca Raton went to Bill Gates to buy his software. Gates didn’t own any software to sell them. He told them no. He and Paul Allen immediately put up $50,000 to buy Q-Dos. (It’s nice to start out well off.) Then he called back. Yes, he had the software, but he would sell it only if he could retain the rights to it. The IBM guys said OK. They were in the hardware business in Boca Raton, not software. Why not?
The PC sold well. IBM could have made the next breakthrough in 1986: implement the new Intel 386 chip. But they were afraid that the PC would cannibalize the entry-level mini-computer market which IBM dominated. IBM skipped the opportunity. Compaq used the chip in a new computer. It took away the PC market from IBM. IBM finally sold its PC line to China in 2005: Lenovo.
WHAT’S OUR LINE?
Kodak’s executives made a fundamental mistake in 1975. This mistake is almost universal. It did not understand what business it was in. If you had asked a Kodak executive what business the company was in, he would have said “the film business.” Kodak was famous for its film. But it was not in the film business. It was in the photography business. Kodak film buyers bought the film in order to get pictures.
Film was a means for a customer to get a picture. For as long as the customer could get his pictures only by means of film, he remained loyal to Kodak. Only Fujifilm gave Kodak a run for the money. It was never a serious contender in the USA. The only reason Fuji had any market share is because Kodak deliberately did not compete head-on. Kodak feared antitrust action from the U.S. government if it crushed Fuji, which it could have done easily. It had been hit with antitrust injunctions in 1921 and 1954.
In 1995, Kodak charged Fuji with trade violations in Japan. Kodak complained to the U.S. government under section 301 of the U.S. Trade Representative’s rules. The government in 1996 prudently turned the case over to the World Trade Organization, which had opened for anti-business in 1995. This was the first case where the WTO decided on an antitrust issue, took Fuji before the World Trade Organization. It lost the case in late 1997. From the beginning, Kodak had a hard time proving its case. Japan had eliminated all tariffs on imported film in 1994. It had been slowly reducing tariffs on film for years, yet Kodak could not increase its market share in Japan. Fuji blamed Kodak’s lack of competition.
Here is the irony of Kodak’s case. In 1994, Kodak had brought a lawsuit against the U.S. government asking that the antitrust limits placed on the firm in 1921 and again in 1954 be removed. Kodak had a dominant share of the U.S. market, the government claimed. “Only because we offer better products,” Kodak replied. Kodak won the case. The limits were removed. Then Kodak asked the government to go after Fuji in Japan.
The hypocrisy of Kodak is obvious to anyone who understands economics. The company believed in domestic dominance apart from antitrust, but it also believed in antitrust intervention in Japan. It was focused on government, not customers.
Kodak was worrying about Fuji. It should have been worried about digital photography, a technology it invented – and immediately dropped – in 1975.
At about the same time as these antitrust cases, the World Wide Web was beginning as a result of the introduction of a graphical web browser, Netscape. Lew Rockwell got the Mises Institute online in 1995, the year after Netscape was released. I got GaryNorth.com online in 1996. A couple of guys in the boondocks could see what was coming. Kodak executives didn’t. They were too busy worrying about film sales in Japan. They were hypnotized by film. They were not focused on pictures. If anyone wants an epitaph for Kodak, I suggest this: “out of focus.”
A company that is run by people who do not see the future clearly is in big trouble. Senior managers must decide what is coming next, and in what order, and how soon. Then they must allocate the firm’s resources to meet expected future conditions.
This is why great success in the past can blind decision-makers. This was Kodak’s problem.
“They were a company stuck in time,” said Robert Burley, an associate professor at Toronto’s Ryerson University who has photographed shuttered Kodak facilities in the U.S., Canada and France since 2005. “Their history was so important to them, this rich century-old history when they made a lot of amazing things and a lot of money along the way. Now their history has become a liability.”
Those investors and creditors who thought that Kodak was a viable company did not recognize the truth after 2003. Kodak was a company with a great future behind it.
PROFITS AND THE FUTURE
Profits come from one source: accurate forecasting. People buy low and sell high. They see what is coming when the competition doesn’t. They can therefore buy low. If everyone saw it, they couldn’t buy low.
The free market allows people to invest their capital in terms of their vision of the future. Most people will guess wrong. A few will guess right. The customers are benefitted by this system of rewards and penalties. They are served by forward-looking decision-makers who see in advance what customers will want to buy and at what price.
The institutional problem is this: decision-makers find it difficult to keep seeing the future accurately. They are committed to one way of doing things. It is expensive to change. They don’t want to change. They want high salaries, stock options, and leisure. But customers are a fickle bunch. They keep asking this: “What have you done for me lately?”
Companies with brand loyalty are set . . . for a while. Their customers don’t change brands very often. But there is always a generational problem. Their customers die off. A new generation of not-yet-customers buy new products that produce the same results in a new, better way. Then the newcomers brag to the old-timers.
Digital photographers bragged to oldsters: “Digits are better than film.” The old-timers slowly saw that this is true. The price of the new technology falls. Then the old-timers finally shift.
I became a serious photographer in 1957. I spent a lot of money for a teenager on gear. I bought a Konica 35-millimeter camera with a 1.8 lens in 1958. I bought an electronic flash unit when hardly anyone had one. These were expensive. I paid with my own money that I earned selling records. (Remember records?) I upgraded in 1971. I had a friend buy me am Asahi Pentax 35-millimeter camera in August of 1971. He was in Japan. I knew the yen would soon be revalued. He got the camera just before Nixon’s closing of the gold window caused the revaluation. I used that camera for 30 years until it gave out. I bought nothing for a decade. I played around with cheap digital snapshot cameras. I have just bought a Sony A65. I’ll use it until I die, I suppose. It will still take great photos in 30 years.
The employees at Kodak did not believe that this would happen to Kodak. They hung on to their jobs. They could have left. They could have had new careers in another company or another industry. But they held on for dear life, just like the owners of Kodak stock. Just like the bond experts at Citigroup.
Customers change their buying habits. It is the role of the entrepreneur to see this coming in advance and sell his shares of doomed companies to other entrepreneurs who don’t see it.
ECONOMY OVER TECHNOLOGY
That which is technically superior may not be economically superior, as determined by the people whose opinions count: customers.
I still hear from lovers of vinyl records that records sound better than CDs. These are invariably old people. I always hated vinyl’s clicks and pops. I abandoned vinyl in 1983. CDs do not have clicks and pops. I have not listened to my vinyl albums in almost 30 years. Dead inventory. Maybe I’ll convert to MP3s someday. But my time is valuable. I keep postponing this.
Neil Young hates MP3s. The fabulously successful member of Crosby, Stills, Nash, and Young says that MP3s are terrible technically. They offer only 5% of what the master recordings contain.
I am an old, old Young fan. I have a Buffalo Springfield album from before CSN&Y. But I will probably make the switch to MP3. I am still in CD mode. Do I care about sound quality? No. Why not? Because I am such an old, old Young fan.
Take a look at the hearing loss graph for men. I included it in an article on the hi-fi gear I owned at age 17. (I overpaid.) These days, I can’t hear the difference between an MP3 and a CD. Sorry, Neil, but we’re old. And the youngsters are not audio fanatics. They are music consumers who use cheap earbuds while multitasking. They are not concentrating on the music. They are not audio connoisseurs. They are the fast-food generation. Their audio sensitivity matches their culinary tastes.
Forty years ago, I had a friend who was a concert organist, a graduate of Julliard. Problem: he could not find enough paying concerts. Today, he makes his living putting together high-end hi-fi systems. He sells fabulously designed high-ticket turntables. These play vinyl records. The clicks and pops are reproduced with magnificent fidelity. You can also buy amplifiers that use vacuum tubes. The trouble is, the only people who can afford amplifiers with vacuum tubes are men who are chronologically close to being on tubes themselves.
The reality of the marketplace is this: if you stick with producing whatever is old, no matter how high its quality, your market will shrink, one funeral at a time.
Do you remember wristwatches? You could buy a Rolex for a small fortune. But then came quartz watches. Then came LED watches. Then came digital watches. Then came super-cheap swatches. They all kept better time than Rolex watches. These days, young people do not wear wristwatches, which they dismiss as mono-function devices. You can still wear a Rolex, but you do it as a fashion statement. You mark yourself as upper class, meaning “money is no object,” meaning you have limited good sense.
People bewail the loss of craftsmanship. Yet when it comes to precision, a third-generation machine can usually beat a human. John Henry won the contest, but the exertion killed him. He would not be the last.
Craftsmanship points the way to innovators. It has a narrow market. Rich people buy the output of craftsmen. Then comes mass production and price competition. The precision declines, but the market grows. Then comes high-tech precision. Prices keep falling, but precision increases. At some point, the mass produced item vastly exceeds the quality of the comparable aristocratic good of two generations ago. I wrote about this in 1974. The process of technological replacement has accelerated since then.
Kodak invented the digital camera in 1975. The camera was bulky and slow. Its images could not match the precision and grandeur of film. That was one generation ago.
Kodak as a company proved to be equally bulky and slow.
There are still photographers who say that film is better. There are still audiophiles who say that vinyl is better than CDs, and that vacuum tubes are better than digital circuits. There are still snobs who say that Rolex is better. They can exercise their tastes if they want to pay enough money. They are buying status, not performance.
Here was my rule for buying audiophile equipment. “Do an A/B test. When you can’t hear the difference, buy the cheaper product.” It’s a good rule for just about everything.
With my ears these days, $300 does just fine. Sadly.
January 25, 2012
Copyright © 2012 Gary North