One negative too many for Kodak

For the best part of two decades, Eastman Kodak has been a case study in whether a global pioneer in an earlier, analogue technology can successfully make the transition to the digital era.

The answer finally came shortly after midnight on Thursday morning in its home town of Rochester, in upstate New York: the company that local entrepreneur George Eastman founded 131 years ago after he was bitten by the photography bug would file for bankruptcy.

Kodak’s long fight to defy the tide of business history will send a chill through other companies that have struggled to adapt to the faster pace and lower cost structures of the digital world. And even though its roles as the dominant employer in Rochester has shrunk greatly from the days when it had more than 60,000 local workers, the setback will come as a blow to the city on the southern shore of Lake Ontario with which the company has long been almost synonymous.

The main question now is whether the action will result in the fire sale of its remaining operations and other businesses – a fate that recently befell Canadian telecoms equipment maker Nortel Networks – or whether a new, digitally enhanced Kodak will survive bankruptcy to emerge finally from the shell of its industrial past.

A filing under Chapter 11 of the US bankruptcy code, which protects a company from its creditors while it negotiates with them and seeks to reorganise its business, was the only way to clear old liabilities, raise immediate cash and set the stage for sales of assets that would let its remaining businesses survive, Kodak said on Thursday.

Escaping from the burden of its past is something that the company has struggled with for years. Revenues peaked some 20 years ago, at more than $16bn, while employee numbers reached some 130,000. Since then – and particularly after 2003, when it started to cut back in earnest – employee numbers have fallen to some 18,800. Yet the liabilities and higher costs from the past that still hangs over the company – including pension commitments – have continued to drag it down.

The digital rebirth dreamed of by a succession of Kodak chief executives has not been enough to make up for the collapse in its silver halide film business pioneered by George Eastman.

Revenue has fallen steadily as new digital businesses have failed to make up the loss of its cash cow, and is expected to dip below $5bn this year.

“They didn’t anticipate the pace of the technology change,” said Mark Zupan, head of the University of Rochester’s graduate school of business. A key mistake, he added, was to treat digital imaging as a separate business and keep it apart from the company’s main operations, rather than risk “cannibalising” sales of its most profitable products.

It was only earlier this month, with a reorganisation into divisions focusing on consumer and commercial customers, that Kodak finally broke down the internal barriers that had left it divided by technology, Mr Zupan said.

This long transition to digital may finally be coming to an end, Antonio Perez, chairman and chief executive, claimed as he announced the bankruptcy filing: some three-quarters of revenue now comes from Kodak’s digital businesses, he said. But that may not be enough to enable him to hold the remaining parts of the business together.

Kodak was early in trying to translate its core skills into digital products, being among the first to move into digital cameras. Ironically, while the company itself failed to build a successful business around digital imaging, the portfolio of patents it developed has now become one of its key assets and its best hope of raising the cash it needs to carry on in business.

Its main hopes of building a sustainable business now rest on a printer division that faces a difficult job in a standing up against stronger rivals such as Lexmark and Hewlett-Packard.

“The printer business is an intensely competitive market and the Chapter 11 decision will damage the brand in consumer markets,” said Crawford Del Prete, chief research officer at the IDC research firm. The fall-off in PC sales that HP suffered last year after announcing it might quit the PC business provides a warning, he added. “Consumers may take a step back with Kodak and ask if this company is viable.”

The printer market has always been a “razor and razor blades” business, with printers being sold cheaply and manufacturers making money on selling supplies for them. Kodak’s strategy has been to tell customers they will spend a little more on the hardware but will save money in the long run on cheaper toner and ink-jet cartridges. “That’s been a tough sell so far and it gets significantly harder as you go into bankruptcy protection,” said Mr Del Prete.

Whether Mr Perez and his fellow executives will get another shot at proving themselves as managers of Kodak’s digital businesses remains questionable, however.

Corporate history suggests that it will be hard for the company to make the case that cash raised from asset sales should be ploughed back into another shot at trying to build a sustainable company. And Kodak will need considerable investment if it is to sustain the R&D and marketing spending needed to stand up to companies such as HP, Lexmark and Canon, according to analysts such as Mr Del Prete.

“Is there any appetite among the creditors to allow management to reinvest the money in the business?” said Jim Bromley, the partner at law firm Cleary Gottlieb who oversaw the Nortel bankruptcy process. “They will have to make a very compelling case. It’s an uphill battle – there is not a lot of precedent.” The past failure of the current management group will also loom large, he added.

With the series of assets sales that followed the Nortel bankruptcy, creditors came away with some $10bn. About three-quarters of Nortel’s employees, who numbered more than 25,000, were transferred with the businesses that were sold, according to Mr Bromley.

But Nortel itself was consigned to the corporate graveyard. The same fate could now hang over Kodak.

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