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Kodak's Moment Of Truth


Antonio M. Perez left the consumer inkjet printer business seven years ago after he lost out to Carly Fiorina for the top slot at Hewlett-Packard (HPQ). But it has never been far from his mind. That's why, a few weeks after he joined a struggling Eastman Kodak Co. (EK) as president on Apr. 2, 2003, he was peering into a microscope in a lab on Kodak's sprawling Rochester (N.Y.) campus. Perez was amazed at what he saw: droplets of a new ink Kodak scientists had produced promised to yield photo prints with vivid colors lasting a lifetime. "It was the Holy Grail of inkjet printing, and they had it here," he recalls.

Ever since then, Perez and Kodak have been working on a top-secret plan, code-named Goya, to make a big entrance into the consumer inkjet printer business. For the past year a Kodak development team has been putting the finishing touches on printer technologies in a nondescript building across the street from HP's inkjet printer lab in suburban San Diego. On Feb. 6 it became clear what they were up to when Perez, now Kodak's chief executive, rented out the Saturday Night Live studio in New York to unveil a line of multipurpose machines that not only handle photographs and documents but also make copies and send faxes.

The Kodak printers are designed, first and foremost, to print high-quality photos: The ink is formulated so prints will stay vibrant for 100 years rather than 15. Most impressive of all, replacement ink cartridges will cost half of what consumers are used to paying. The new printers will arrive in stores in March, priced at $149 to $299. Black ink cartridges will cost $9.99, color $14.99. If consumers buy Kodak's economical Photo Value Pack, which combines paper and ink, the cost per print is about 10 cents, vs. 24 cents for HP's comparable package. "It's really a revolution of thought in how to bring the price of printing down and encourage people to print more," says David Morrish, senior vice-president of merchandising for Best Buy Co. (BBY), which has an exclusive on the product for three months.

UPENDING THE MODEL

If Kodak pulls this off--and that's a big if, considering the forces it's up against--it could pose a huge challenge to the $50 billion printer industry. Those companies now rely on a razor-and-blades strategy, often discounting machines and making most of their profits on replacement cartridges. "We're very proud that we're coming to market 20 years late," Perez says with a grin. "We think it will give us an opportunity to disrupt the industry's business model and address consumers' key dissatisfaction: the high cost of ink."

In particular, Kodak's strategy is an assault on the profit engine of industry leader HP. Printing supplied 60% of HP's $6.56 billion in operating earnings last year. Yet Perez claims he has no malice toward his former employer. "I spent my life there. I respect them," he says. "I'm doing this for Kodak."

Perez predicts the inkjet printers will become a multibillion-dollar product line. He'd better be right. Kodak has struggled for years to find a replacement for its rapidly declining photo-film business. In the fourth quarter the company posted its first profit in two years, a reflection of cost cuts, not rising sales. If he doesn't show growth soon, investors could bail out.

SCANNING OPTION

His last, best hope is to create a multifaceted printer-and-imaging business, a smaller version of the one that generated $26.8 billion in revenues for HP last year. Consumer printers are just the latest piece of that strategy: Perez already has a fast-growing but low-margin lineup of digital cameras, docking-station printers for cameras, an online site for managing and printing pictures, and a commercial inkjet business. Perez is cooking up such services as one that lets people run shoeboxes of old prints through a store scanner, quickly organizing and enhancing the images. And all the while he's been accumulating cash by shucking such major businesses as his medical imaging unit, whose sale to Onex Healthcare Holdings Inc. for $2.5 billion was announced in January.

What's been missing so far is anything that replaces the once-huge profits Kodak made on film. Perez insists that even while charging lower ink prices, he can extract double-digit operating margins from consumer inkjet printing within three years. He says Kodak cut costs by putting its print heads in the machine rather than in the replacement cartridges, which saves on materials and manufacturing. Plus, Kodak is using a lot of off-the-shelf parts.

But Kodak is up against a juggernaut. HP enjoys a huge advantage in shelf space at stores ranging from office supply chains to supermarkets and has done a masterful job of sharing some of its printer profits with retailers. All told, HP spends about $1 billion a year on printer research and development alone, which helps it continually find ways to improve printing speed and quality. Industry analysts expect HP to sit back and wait to see if Kodak's new machines get traction. If they do, HP could respond with selective discounting. Already, there are signs that hp is ready to defend its turf with tough tactics. "[Perez] is going into a gunfight with a knife," says Nils Madden, marketing director for HP inkjets.

The Feb. 6 unveiling of Kodak's printers signals the end of a remarkable 3 1/2-year forced march to get a potentially revolutionary product out the door. Perez built his team by matching a slew of former HP colleagues with Kodak chemists and nanotechnology experts. Perhaps never before has a challenge to a major company been launched by a rival that knew it so well.

Seeds of the project were planted in the late 1990s, when HP briefly considered acquiring Kodak. During a 15-day due-diligence process, Perez looked over Kodak's patent portfolio. Although HP's board nixed the merger, Perez' prowling later resulted in a joint venture, established in 2000, to produce high-quality inkjet photo printers for retail outlets.

The project, Phogenix Imaging, was ultimately a bust, a victim of conflicts between its owners. On May 14, 2003, with the first machines ready for shipment on the loading dock and only a month after Perez had joined Kodak, the two sides announced they would part company.

But Phogenix wasn't all for naught. Perez had hired two former top HP printer executives, Bill Lloyd and Philip S. Faraci, to help him evaluate the consumer inkjet business for Kodak. In 1979, Lloyd had led the HP team that came up with the key advance in inkjet printing that created the industry. As soon as the Phogenix news came down, Lloyd and Faraci were on the phone with about 40 key employees, many of them former HPers. They couldn't talk about Perez' ambitions yet, but "we called them up and asked them not to take other jobs," recalls Lloyd, who is now Kodak's chief technology officer.

The crucial go/no-go meeting came on June 25, 2003, in Perez' conference room on the 19th floor of Kodak headquarters. Lloyd and Faraci laid out the arguments, pro and con. The risks were enormous. Kodak would be entering a mature business already dominated by a handful of leaders. And with Kodak's turnaround in question, Perez couldn't afford an expensive failure. But the rewards were huge, too.

Perez decided to sleep on it. He tossed fitfully all night at his home in the posh Pittsford neighborhood of Rochester. By morning he had his decision. "The industry had been doing things the same way for 20 years, and it was time for a change," he says. "I called up Bill Lloyd and said: 'Go ahead. Let's launch a full program.'"

A few days later a dozen former Phogenix employees were invited to lunch at the suburban San Diego home of David Clark, who had been the Phogenix R&D chief. They sat by Clark's backyard pool with a view of the rugged Poway Hills in the distance, munched on chicken salad, and listened raptly while Clark laid out Perez' audacious plan. "At first we thought it was a far stretch. We know how capable HP is and how much technology it has and how much money they spend," recalls Susan H. Tousi, a 10-year HP veteran who now runs R&D for Kodak's inkjet business. Still, within a few days, all but one of those who had sat by Clark's pool decided to sign on. Tousi did so because she liked the startup mentality and wanted to keep working with people who had become close friends.

Perez wanted to get to market quickly, with a target of three years, so the InkJet Products Group leaders made choices designed to speed up the development process. They worked with technology partners, such as chip-design specialist SigmaTel Inc. (SGTL), rather than trying to design everything from scratch. And once they established their market goals, in late 2003, they never swerved from them. The result: a process that took years less than it might have and required just a $300 million investment.

One of the key decisions was choosing pigment as the basis for Kodak's ink rather than the usual dye. Pigment-based inks hold their colors longer, but typically the colors aren't as vivid. So Kodak engineers had to come up with innovations in ink chemistry, nozzle technology, and paper to produce vivid colors that also last. Software in the printer evaluates each image and determines what's in it (faces, trees, sky), optimizing the process based on that analysis.

FORMULA CHANGE

Ink is boiled and sprayed through 3,840 nozzles at a rate of 24,000 drops per second. The tiny pigment particles are designed to sit on the surface of porous paper while the liquid they're suspended in is absorbed. Drying takes just 15 milliseconds, so there are no worries about smearing the prints, which take 28 seconds to produce.

With any new technology, there are invariably glitches. The team faced a near-disaster a year ago when they discovered that the pigment particles in their inks were settling at the bottom of the storage containers, like sediment in a wine bottle. Unless the situation was remedied, image quality would suffer. The problem came fairly late in the development process; the team had already "frozen" the ink formula so they could design other components of the printer to go with it.

The temptation was to try to fix things without changing the ink recipe. The scientists considered putting a small mechanical mixer in the storage tank. But in the end they decided it was too risky to do anything but reformulate the ink. That led to a day-and-night work marathon. A month later the team had its answer: milling the pigment particles much smaller, so they would stay suspended in liquid. The formula was set, and Tousi came up with a new motto: "Don't dink with the ink."

Throughout the whole process Tousi was the stickler for quality. Dubbed "Queen of the Geeks" by her employees, Tousi carries a loupe for magnifying photographs practically everywhere she goes. She even takes prints into the parking lot to study them under harsh sunlight. Time and again, Tousi sent engineers back to the drawing board because their results weren't up to her standards.

Last June it was Tousi who had to tell Perez that they weren't going to be able to begin marketing the printers for last year's holiday shopping season. She thought more tests were necessary to assure the highest print quality. In an effort to boost the team's morale, Perez flew to San Diego to meet with the entire engineering staff. He stood on a table so he could see over their cubicle partitions. He recalls telling them: "Slipping by a quarter doesn't matter that much, but you have to promise me that these printers will work perfectly. We have only one chance to do this right. If our first introduction fails, we fail."

Analysts who have seen Kodak's printers have come away impressed. "The print quality is really good. They're at least as good as everybody else," says Larry Jamieson, director of industry-watcher Lyra Research Inc.

But Perez and Kodak are challenging a giant competitor that has a 33% worldwide market share and a sterling reputation among PC and digital-camera users. HP not only gets prime merchandising spots for its printers and ink in stores, but also gets to display its printers in the computer sections, because it bundles printers with its PCs. "HP has a lot of customer loyalty. They build a great product. The printers don't break," says analyst Alyson Frasco of market researcher Interactive Data Corp. (IDC).

It's up to Perez and Kodak to show they have a truly game-changing product. Perez seems immune to negative thoughts. He tells a story that shows just how confident he is of success. "J. Paul Getty said you have to do just three things to be successful: get up early, work hard, and strike oil," says Perez. "I didn't strike oil in my career, but I did strike ink."

By Steve Hamm, with Louise Lee in San Mateo and Spencer E. Ante in New York


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