Kodak Ready to Bridge Film and Digital?

For the past few years, the rising tide of digital photography has
seemingly threatened to turn the traditional photography world upside down,
marginalizing venerable giants like Eastman Kodak in favor
of device manufacturers, software vendors and printer OEMs as digital
technology cannibalizes the film base.

Analysts and investors have spent the past year turning away from Kodak due
to assumptions about digital cannibalization and price pressure from film
rival Fuji.

But with the 2003 International Consumer
Electronics Show
(CES) approaching next week, Deutsche Bank Securities
analyst Peter Ausnit called those assumptions into question, noting that
new technology from Kodak is finally lining up to allow the company to link
film and digital strategies with powerful synergies.

The technology has nothing to do with digital cameras, which Ausnit
considers a losing proposition for the company. Instead, he said the great
hope for the company is its new Perfect Touch (PT) processing software,
which can correct common problems like weak flash, opaque shadows, washed
out highlights and inaccurate film tones by scanning film negatives and
then digitally correcting and laser printing on traditional photo paper.

This process, according to Ausnit, “has the effect of vastly increasing the
dynamic range of the film and paper, allowing images hidden in deep shadows
that typically appear black in photographs to print as they appear in life.
Other benefits include greater detail and greater range using flashes.
Pictures that are extremely difficult to print using conventional
processes, such as faces backlit by a sunset, now can be printed. With PT,
the number of photos that are useless and discarded because of poor
exposure should be sharply reduced. This may increase satisfaction with
photography and burnish Kodak’s brand, not only for film and paper, but
also for advanced technologies.”

PT can similarly improve photos taken with a digital camera.

“Previously, we had little faith in Kodak’s digital camera-centric strategy
for digital photo customer acquisition,” Ausnit said. “Kodak has tried to
attach software to loss making digital cameras to drive output to Kodak
online services. This is very difficult as Kodak needs to win market share
in digital cameras, drive higher software attach rates, and then induce
consumers to upload large photo files over slow modems. This process seems
unlikely. Now it appears that Kodak is developing other options.”

“We believe that Perfect Touch processing may provide a link bringing
digital services to traditional photographers,” Ausnit continued. “By tying
PT processing to Kodak’s online ofoto service, Kodak can automate the
creation of digital photographs by scanning traditional film negatives.
Further those digital photos are then in Kodak’s possession, potentially on
ofoto, where they can be edited, shared, stored and reprinted.”

Such a move means consumers can enjoy many of the benefits of digital
photography without a digital camera. This is an important point, Ausnit
said, because while the number of consumers switching to digital continues
to accelerate, Deutsche Bank believes the digital cut of the 2002 U.S.
consumer film market was about 4.5 percent, with Kodak holding 65 percent
share over the entire market.

“If cannibalization increases 50 percent next year to 7 percent, then we
would expect an EPS hit of about 11 cents, and an incremental hit of just 4
cents,” Ausnit said. “This suggests that the headwinds from digital
cannibalization are increasing, but at a moderate and manageable pace.”

Meanwhile, Kodak — which already dominates conventional photo channels —
can play PT as a trump card, using it drive share on the conventional
front, take a strong position in the digital file processing market, and
drive business to its online services.

The pieces are there, but Ausnit said Kodak has not yet played them to its
greatest advantage, due largely to the company’s seeming reluctance to
bundle ofoto with PT processing.

“Instead it is encouraging customers to order a Picture CD, which does not
store the photos at Kodak,” he said. “This foregoes the opportunity for
Kodak to hold consumers’ photos and act as the de facto scrapbook to the

Photo files tend to be large, and are difficult to move over the
narrow-band connections which dominate currently, meaning that by
encouraging customers to build digital scrap books at ofoto, the company
will create incentives to return to Kodak and generate long term loyalty to
the brand.

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