Case Studies

Case Studies

Short-Selling Case Study: Kodak

Eastman Kodak (formerly: EK) was, for more than a century, one of America’s leading technology

enterprises. Kodak was notable for coining phrases such as a “Kodak moment,” having Neil Armstrong

use their film when he went to the moon in 1969, and even more or less building the entire city of

Rochester, New York.

And yet, within the past twenty years, Kodak went from being one of America’s largest stable blue-
chip companies to total insolvency. Making the failure more surprising, it’s clear that Kodak was long

aware of both the threat and opportunity from the digitization of photography, and yet it entirely failed

to prepare itself for the inevitable migration.

The story of Kodak offers a prime example of how businesses get stuck following a set formula

for success, and as such, become blinded to radical changes in their industries. The same sorts of

fundamental miscalculations used at Kodak also resurfaced at Blockbuster, Research In Motion,

and RadioShack, to name just a few other recent examples. And surely there will be numerous

additional opportunities in the future for short sellers identifying the next crop of stultified and geriatric

businesses that lie just one technological change away from extinction.

Kodak as Innovator: The Early Entrepreneurial Days

Eastman Kodak was originally founded in 1881 as the Eastman Dry Plate Company. The company’s

founder quickly realized that the dry plate method of photographic technology would eventually

be replaced by paper film. He abandoned his original business, moving entirely to film. This was a

bold move, as at the time, dry plates produced far higher quality of photos than film. His competitors

ignored him, thinking that the superior images produced by dry plates would more than compensate for

their higher costs. Dry plate maintained its market share with professional photographers for several

decades, but paper film captured the lion’s share of an emerging market: amateur photographers. This

same switch, a century later, would be Kodak’s downfall as this time they failed to make the early jump

to a new revolutionary technology.

By the early 1900s, Kodak had achieved 90% market share for paper film. At this point, a new threat

emerged: German scientists began working on new color film, that while of far inferior quality to

traditional black and white film, threatened to disturb the marketplace sooner or later. Kodak realized

the gravity of the threat and began researching and designing its own line of color film, which it began

producing in the 1920s.

So at this point, Kodak had foreseen a market shift from dry plates to film and conquered the

market by moving their first. It then foresaw color film on the horizion and successfully adapted

to that technological change. For roughly 50 years, all was calm, but then the specter of digital

photography began to appear on the horizon. Kodak, now an older entrenched firm, rather than a young

enterpreneurial one, would fail to handle this shift with its former agility.

Texas Instruments would patent a filmless electronic camera in the 1970s, and Sony introduced the first

electronic camera for the commercial market in 1981. Around this time, Kodak produced an in-house

research analysis which forecast that for the next 10 years, until the 1990s, digital imaging techonology

would be too expensive, cumbersome, and inferior in quality to make a broad threat to traditional film

photography.

And that was true, Kodak’s role at the center of the photographic universe still held firm in 1990, as

digital technology wasn’t quite ready to replace film yet. However, the contest didn’t end in 1990. And

Kodak’s management decided that since its role was secure for awhile, it didn’t need to worry about

any radical changes to its operations, and instead only made minor adjustments to its business plan

throughout the 1980s when they still could have prepared for the incoming digital storm.

Kodak’s in-house research team invented a digital camera in the 1970s, but was told by management to

keep it under wraps as it posed a threat to the company’s film monopoly. In 1986, Kodak produced a

prototype for a sensor that is now at the core of current digital cameras. Despite having the R&D know-
how to prepare for a digital transformation, the company instead went in a wildly different direction.

Seeing Negative: Kodak’s Cataracts Develop

Finally realizing by the late 1980s that digital might become an issue, Kodak decided to “diversify”

by buying Sterling Drug, which produced pharmaceutical drugs and chemical agents in a more than

$5 billion acquisition in 1988. The thinking was that since Kodak produced chemically-treated paper,

it could move further into the chemicals industry and thus reduce its direct exposure to the film

photography market. This was a classic management blunder, as Kodak didn’t have the expertise to run

a drug company, it didn’t understand the regulatory environment, nor did it know how to market drugs

for heart disease or hormonal agents.

Kodak was forced to jettison Sterling at a 50% loss just a few years later, and by now was far behind

the curve in adapting to changes in its core photographic film market. The company, petrified of losing

its stable high-margin film monopoly, then moved on to a truly ridiculous idea: the Advantix Preview

camera. This was a “hybrid” camera that used traditional film to store the images, however it also had

a digital core and display that would show users the photos and allow them to decide how many prints

of each photo they wanted. As such, the Advantix would force customers to buy an essentially digital

camera and pay for film – needless to say this was a gigantic flop. Consumers saw no benefit, and the

project produced a more than $500 million loss for Kodak.

Kodak would then try to set up imaging kiosks in stores, so that customers would still be reliant on the

company to print their digital photos. Additionally Kodak formed ventures with firms such as AOL

which offered an odd service: develop your traditional film in a store, and Kodak would (for a large

fee) send digital copies of the images to your AOL-using friends.

What Kodak didn’t realize – or at minimum wouldn’t acknowledge – was that photography was going

entirely digital, and customers didn’t need their hands held or need an intermediate product as they

adapted to digital. Most customers could buy a digital camera and use e-mail and printers on their own

without paying through the nose for Kodak’s “assistance”.

Mr. Market’s Digital Blindness: The Short-Selling Opportunity

By 1997, things, you’d think, were looking dim for Kodak. As early as 1995, Fortune magazine said

that Kodak’s business would be “ground zero” for digital competition and that half the company’s

revenues and 75% of its profits came from North American traditional photography – the most

threatened segment of the company’s business. And yet, bizarrely enough, Kodak’s market cap was still

rising. Kodak’s peak market cap would be just shy of $30 billion, which it hit in 1997, long after the

threat of digital had morphed into a clear and present hazard.

By 2002, digital camera sales passed traditional film, and film fell so fast that, hilariously enough,

Kodak’s camera that won a 2004 “camera of the year” award had its production discontinued before

Kodak could even collect the award.

Kodak began a spasm of moves to try to react to the now-daunting digital transformation, but it was too

little, too late. The company would try to buy online photo sites long after the first-mover advantage

was gone. The company finally started producing high-quality digital cameras but it was late to that

market and competition was so intense by the time it showed up that by 2002 it was losing money on

every digital camera it sold.

Kodak spoke of trying to lengthen the lifespan of traditional film by aggressively targeting poor

consumers in other countries who wouldn’t yet move to digital while at the same time continuing to try

to find a digital strategy for the developed world. This raises obvious parallels to Research In Motion,

whose bulls were notable for touting how well the company was doing selling to the “emerging

middle class” in Indonesia and other third-world markets as its core market collapsed thanks to Apple.

Needless to say, Kodak’s milk the poor strategy failed as cell phones added cameras giving even poor

third-world consumers access to basic digital photography, killing that last outpost of the company’s

strength.

What Went Wrong/How To Identify Future Kodaks To Short Sell

Kodak was a phenomenoal short-selling opportunity in 1997 and on into the next decade. Stunningly,

as late as 2005, the company was still worth more than $5 billion in market cap despite by then obvious

nature of the company’s abject operational failure.

Kodak saw the future as a derivation of the present, rather than a totally new marketplace. Blunders

such as the “hybrid” digital-film camera showed that the company would cling to its traditional film

market rather than make the moves necessary to survive in the next era of photography. And even when

the end game was clearly visible, the company continued to try to hold onto film by pushing misguided

growth with antiquated technology in third-world markets.

This came from a common business failure that one could term “paralysis by analysis”. Companies

that rely on meeting quarterly Wall Street business metrics are incentivized to avoid sweeping business

model changes. Traditional film had a much greater profit margin than digital photography, and as

such, it was much easier to tell Wall Street that the company would protect its profit margins by

“shoring up” film instead of cutting ties with the past and moving aggressively to tackle the new

evolving marketplace despite the short-term pain.

Kodak’s primary film competitor, Fuji, didn’t try to hold onto film, instead Fuji made an early and

aggressive push into digital cameras and in the process created technologies integral to flat-screen

monitors that has led its market value to rise in the ensuing years. Kodak itself, when on the verge

of bankruptcy, noted that its patents were its main asset, worth several billion dollars. Just imagine

what could of have been had Kodak utilized its patents to produce cutting-edge products rather than

squandering the fruits of its noted R&D laboratories.

As late as 2003, Kodak’s then-CEO said, “People are no longer saying film is dead. There are still

ways to expand the life of film and expand the category.” And with that shocking statement of total

cluelessness, it was clear to short sellers that the company’s life was nearing its end.

When you see a company that seems tied to maintaining an old business model in the wake of

overwhelming evidence that suggests an industry transformation is occuring, strongly consider short

selling the company. While it may be able to keep up appearances for awhile, an eroding business can

only be “shored up” for so long as the competitive tide continues to rise. In Kodak’s case, the company

remained solidly profitable from 1997, the company’s peak, until 2000. In 2001 the digital wave arrived

in force, profits plunged 95% in just one year from more than a billion annually to just $76 million.

From then on, the company’s inexorable decline to bankruptcy became increasingly certain, offering

short sellers bountiful rewards.

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