Commentary: The Kodak Revolt Is Short-Sighted

Digital is the only way to go, but Carp must prove he can deliver -- fast

In late September, Kodak CEO Daniel A. Carp unveiled a bold plan to remake the film manufacturer for the digital age. Carp told investors Kodak intended to cut its dividend by 72% in order to plow $3 billion into promising digital businesses. Only that, he claimed, would finally reignite growth. His prediction: the move would boost sales from around $13 billion today to $16 billion by 2006, while lifting earnings some 40% above this year's expected results.

Problem is, after years of disappointments, investors have little faith in the ability of Carp and his management team to deliver. Indeed, Carp's big plan prompted a 14% drop in Kodak's ailing stock, sparking open revolt among some shareholders. On Oct. 22, major investors huddled to discuss radically different "strategies to maximize shareholder value." Many are value players miffed that Carp cut the dividend from $1.80 to 50 cents a share. As for his plans to sink another $3 billion into digital dreams, "investors have lost confidence that Kodak knows what to do with the money," says Jim Mackey, managing director of The Billion Dollar Growth Network, a Palo Alto (Calif.) corporate research firm.

THE DISSIDENTS' FRUSTRATION is understandable, but retreat from digital markets is a bad idea. Why? Because, at least in the developed world, the traditional film business is in its death throes. Kodak itself alluded to that bleak future on Oct. 22, when it announced that U.S. film sales plunged an alarming 23% in the third quarter. Although partly due to an inventory correction, Kodak now says film sales will drop at a 10% to 12% annual clip over the next three years in the U.S., and nearly twice as fast in Japan. Says Frank J. Romano, professor of digital printing at the Rochester Institute of Technology: "If they don't invest in digital, that's the end of Kodak."

The problem isn't that Carp has the wrong vision -- but that he waited until the sky was falling to embrace it. Moreover, Kodak has stumbled in its efforts to build a digital consumer business. It has taken a scattershot approach to digital photo processing, placing bets on everything from online kiosks to minilabs used by retailers to print photos. By contrast, arch-rival Fuji Photo Film Co. started sooner, has better camera technology, and focused more on minilabs, which are expected to dominate the processing market.

Still, the race is hardly over. Kodak's digital camera business was profitable for the first time in the third quarter, as sales jumped 117%. Moreover, Kodak's bets are paying off in health-imaging, where it's leveraging longstanding ties with doctors eager to replace X-rays with digital images. That business makes more money than photography, and operating profits climbed 14%, to $357 million, in the first nine months of 2003.

TO HIS CREDIT, CARP HAS HIRED digitally savvy people in an attempt to shake up Kodak's sclerotic culture. Aside from him, virtually every top executive now has a proven track record in developing hit products for companies including Hewlett-Packard (HPQ ), Lexmark (LXK ) and GE Medical Systems (GE ) says a former HP executive who has worked with Kodak: "They know more about the science of imaging, photographs and what people want to do with them than any company in the world. They have great technical capabilities, but they've lacked focus and application."

The question is whether this team will get focused enough to be trusted with spending $3 billion rebuilding their digital future. Kodak aims to buy companies in the health-imaging and commercial printing markets. A sound strategy, perhaps, but Kodak execs have made bad choices before. Consider the ill-fated alliance with the German digital minilab maker Gretag. It foundered when Gretag went bankrupt in 2002.

Kodak is running out of time. Even after stripping out restructuring charges , operating earnings plunged some 24% in the third quarter due largely to dismal film sales, figures Standard & Poor's. Kodak should go ahead with its plan. But if Carp can't deliver soon, the board should find a replacement who can.

By William C. Symonds

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