Survival of Traditional Chemical Photo Producers in the Digital Age

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Abstract

Shares in Eastman Kodak plunged by a quarter on September 6, after the worlds largest photographic company warned of an unexpected shortfall in earnings. At first glance it would seem reasonable to assume that the rapidly expanding market for digital photography was the culprit, but closer examination reveals that digital photography has had only a small effect. Furthermore, both Kodak and Fuji, who together control 70% of the conventional photo-finishing, will be able to both survive and thrive in the coming digital onslaught.

Introduction

When a new technology is introduced, it generally comes at a premium price. The market for this new technology is usually early adopters , a segment where price is not the object but having the latest technology is most important. Even thought this technology may be superior, the initial costs make it unattractive to the majority of the market. Since the marginal cost of the technology is so high, the demand is very low. The volumes needed to lower the price to a point where the mass market will adapt the technology are often difficult to reach. This concept is illustrated in Fig. 1.

Fig. 1

Price vs. Demand

Since the startup of the new technology is slow, this will often make the providers of the older technology slow to react, since the threat is growing slow. Often by the time the traditional providers realize that the threat is real, they cannot react in time to participate in the new market.

It would appear to the casual observer that the above scenario is presently being played out in the photography market, as digital photography gains ground and the market value of Kodak declines. It would also appear that Kodak is finished as a long term player in the photography market, that the need for the consumables presently provided by the firm will disappear. Several market analysts have rated Kodak a short sell . However, in reality this giant has been instrumental in creating the digital photography market and will continue to redefine the technology. I will show through market analysis and economic reasoning that Kodak will survive and thrive, and that the present loss in capitalization value is a function of the economic downturn.

Discussion

In order to understand the potential acceptance of digital photography as a replacement of traditional film, one must have an exposure to demand theory and an individuals demand for a commodity. This demand is a function of several parameters price of the commodity, the individual's income, price of substitute commodities, and the consumers taste. This can be expressed mathematically as

Eq 1

Where Quantity demanded per unit time

Price of Commodity x

Individuals Income

Price of substitute commodity

Consumers taste

The "early adopters" of digital photography had to deal with a very high and a very low , and therefore accepted a low and had a very high Since the quality of early digital cameras was very poor relative to film and the startup costs were very high, was small.

The first digital camera was introduced in 15 by Kodak, a 6MPixel $1,000 professional SLR type, aimed at product photography . The high expense limited it to a few specialized applications where instant results were an absolute necessity and cost no object. The start of the consumer market was in 16 with the introduction of 4 cameras of 0.MPixels at an average cost of $500 . In 17 there were 8 cameras introduced with an average density of 0.5MPixels at an average cost of $68 . These early devices had very poor image quality as compared to even $10 disposable cameras and required an expensive computer and printer to create hardcopy. The resulting was very small and no manufacture made any profit. As a result, there was no perceived threat to the traditional photo processing markets, although Kodak was experiencing stiff competition from Fuji. The following graphs shows, Kodak's sales revenues and income from this period to present .

Fig.

Kodak Sales Revenue 14 - 000

Fig.

Kodak Income

In 17 Kodak experienced a loss in the commercial divisions as a result of several one time restructuring charges. They also shed nearly 0,000 workers and shifted to higher profit products . As a result, by 18 Kodak was much leaner and increased profits in light of slightly reduced revenue. Clearly at a time when digital photography was growing and it was facing competition from Fuji, Kodak was able to keep sales relatively constant while increasing profits. This is because digital only represents 1% of all cameras in use in the US , with disposable one time use cameras over 0% of the market. Fig. 4 shows how the market has grown in the US over the last 6 years.

The present demand equation for digital will not remain unattractive for the mass market forever. As prices decrease ( ) and quality increases ( ), and the cost of conventional photography ( ) remains constant, digital will eventually dominate the market. It is this long term shift in the demand function which represents the greatest threat. Kodak presently has about 10% of the market for digital cameras; however the potential loss of the consumables used by conventional photography poses the greatest risk to long term growth. The question for Kodak is how to grow its market share of digital bodies and retain the consumable market. There are several directions that Kodak can follow to do both.

FIG. 4

Analysis

There are several problems with digital photography at this point in time, and they all present an opportunity for the conventional producers. The first is the issue of output. Nearly all pictures taken today eventually become prints, and the present infrastructure allows for both very fast turnaround and very low cost. The omnipresent mini lab produces very high quality, usually in 1 hour, at about 5 cents a print. The disposable camera, at usually less then $10, provides higher quality pictures then all but the most expensive digital cameras, without any capital expense. It is this very high degree of convenience provided at very low cost that has allowed film based photography to continue to grow, even as digital grows. Digital provides the promise of instant gratification and easy editing, but at very high startup costs. Although the latest generation of low cost ink printers generates prints very close to analog prints, the cost of the paper and ink is much greater then analog prints. There is also a significant amount of time required by the user to download, "edit" and print the results.

The printing of digital photos onto conventional chemical paper will be a major market in the future and presents a great opportunity for Kodak to maintain a consumable market. The consumer could upload the digital photos to a web based photo processing lab, which would then return the pictures by mail. The consumer would save the cost of the film and maintain the print quality of traditional film photography. The present mini lab network would convert to handle digital formats and provide chemical prints from digital formats. In addition, Kodak has pioneered the Photo Kiosks, labeled as Picture Centers, the small self contained digital printer stands appearing nearly everywhere. They now have new features aimed specifically at digital cameras users who want immediate prints. Kodak manufactures the printers, paper and ribbons consumed by these devices.

Fig. 5

Historical and Calculated Cost per MP

Another area would be in the area of disposable digital cameras. Consider how prices of most digital electronics have followed "Moore's Law", where the performance doubles every 18 months for a given price point . The Fig. 4 describes how the cost per mega pixel has dropped since 15 and may continue to drop over time. The calculated cost in Fig. 5 used the equation

Eq

Where next years price

Present price

Equation 4 was derived by modifying Moores Law to fit the historical data from 15 to 001 for cost per pixel. Although not an exact fit for the data, it should provide a basic understanding of how the cost per MPixel will decline in the future. This assumes that there is no major breakthrough in technology, something that is entirely likely given the intense research presently being applied.

The CCD image sensors ( and increasingly CMOS ) used in digital cameras will not follow Moores Law exactly, since embedded into Moores Law is the fact that geometrys of digital ICs keep getting smaller, resulting in continually increasing yields. Digital image sensors cannot get increasingly smaller since they are limited to how small the optics can be made and still have reasonable resolution.

CMOS based sensors hold the promise of very low cost digital cameras since the imager, processing electronics and memory can be integrated onto one monolithic device. Just as calculators have dropped to the point where they are so cheap that they can be given away, so it will be with low end digital cameras. In the early days of electronic calculators, they were several hundred dollars even for very simple versions. They are now less then $1, do to very high degrees of integration and tooling. A properly designed electronic imaging and processing chip, along with a housing, battery and flash would be no more expensive then present throw away cameras. If such a device had a pixel density of MP, then for normal sized prints there would be little loss in quality as compared to present disposable film technology.

Using regression analysis of the historical market data of the US market, we can generate a demand function for low end digital cameras. This will serve as an indication of what the market for a low cost disposable digital camera would be.

Year DigCams Avg Pixel Avg Cost Cost/ Pixel Units sold

In Market ( MP ) ( Millions )

15 1 6 $ 1,000.00 $,000.00 0.005

16 4 0. $ 500.00 $1,666.67 0.1

17 8 0.5 $ 68.00 $1,66.00 0.5

18 4 1 $ 550.00 $550.00 0.

1 50 1.7 $ 74.00 $41.40 1.8

000 6 . $ 61.00 $7.7 6.7

001 .66 $ 40.00 $161.65 8.6

Fig. 6

History of US Digital Camera Market

In Fig. 6 we see what the history of the US Digital Camera market from 15 to present . By any measure it has experienced very fast growth, but this has recently slowed, in part due to a slowing economy. The following is a demand function based upon the regression of the average number of pixels, average cost and units sold.

Eq

Where quantity of digital cameras sold per year

Number of mega pixels

Average cost disposable digital camera

The regression is

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.58858

R Square 0.140065

Adjusted R Square 0.86566775

Standard Error 16556.61

Observations 6

ANOVA

df SS MS F Significance F

Regression 6.007E+1 .01104E+1 17.11057 0.088175

Residual 5.76E+1 1.7575E+1

Total 5 6.55E+1

Coefficients Standard Error t Stat P-value Lower 5% Upper 5% Lower 5.0% Upper 5.0%

Intercept 57776.8 5001.477 0.881405 0.44007 -770471.18 16104.84 -770471.18 16104.84

X Variable 1 7.550685 0.61607 5.08107 0.010406 1.48587 5.667808 1.48587 5.667808

X Variable -77500.77715 5165.874 -1.5008074 0.0441 -410.0756 868.588 -410.0756 868.588

Fig. 6

Regression Analysis

Since a disposable digital camera must have about MP to approach the quality of a disposable film camera for 4X6 prints and must match the price of about $10, plugging both into Eq. yields a demand of 16.78M cameras per year. Combine this volume of cameras with the paper and chemicals needed to produce the prints and this would be a market of about $00M / year. Over time as film is phased out, the demand for the digital disposable will only increase. When this is combined with the growing market for online processing of digital images and the developing market for digital processing by mini labs, one can see that there is significant opportunity for Kodak in the digital age. Furthermore, the penetration of digital photography is only about 10%, which means that conventional photography is far from finished. Although digital is the "hot" gadget, the high startup costs, considerable time requirements for printing and generally poorer quality will limit acceptability for some time to come.

Counter-Arguments

Although digital photography has several drawbacks at this time, it is where all the major camera, consumer electronic and film manufacturers are spending the bulk of the research and development money. The recent advances in quality and reduction in the cost per Mega Pixel have been remarkable. Equally as impressive has been the advances in the quality of low cost ink jet printers, which have been optimized to easily "talk" to digital cameras without the need to first download to a computer, and can now generate output which rivals chemical analog prints. The newer inkjet technology can accept roll paper allowing the user to print continuous series of X5 or 5X7 prints, a major convenience. Although these inkjet prints are presently more expensive, that will change over time.

The argument that there is a market for a disposable digital camera has several problems. The graph in Fig. 4 shows that digital technology will not reach the $10 price point until the year 007, too long from now to carry Kodak through. Furthermore, a semiconductor fab to produce such a camera would cost at least $1B, plus development costs. After all of this capital expense, all that has been accomplished is to replace one technology with another without adding any significant improvement. Such a disposable would not have a LCD display with which to view stored pictures and thus not provide one of the major advantages of digital, to determine if the picture just taken is acceptable. It would be very risky to attempt replacing present disposable technology with a digital version and Kodak would not be wise to expect this to be a long term solution to the changing technology.

The idea that on-line photo-finishing for digital images will ever be more then a niche market and provide a robust outlet for consumables is a long shot. First, since quality digital images are several Mbytes in size, unless the consumer has broad band internet connection, uploads to the photo-finisher will take longer then consumers will tolerate. Second, the consumer will have to wait several days before receiving the prints through the mail. A major aspect of digital, instant gratification is therefor lost. Third, it adds an expense to a process that has as a major feature no additional costs.

Kodak cannot expect the mini-lab to remain the dominate user of consumables in the future, since it requires a trip and additional expense. Over time, as film is phased out, the mini-lab will become obsolete and disappear.

Summary

Kodak is in a unique position in that it was a major player in creating the market that poses the greatest single risk to its future. In time, digital will displace film based photography just as the CD displaced the LP. Kodak is uniquely positioned to participate in this emerging market as both a provider of digital cameras and the photographic consumables. The market for medical imaging products and other industrial photographic products will remain strong, and although they provide a smaller profit margin then the consumer products, they will provide a steady cash flow for the foreseeable future.

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Managerial Economics by Salvatore; Harcourt College Publishers, Forth Edition; Copyright 001

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