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High Technology Entrepreneurship and Strategy

Professor Ron Adner

May 2002

WAMBERG ThomasGOLDBLAT FernandGONTHIER RomainGREEN JasonZEIN WalidCARLYLE Gordon

The Photography Industry

Chemical To Digital

______________________________________________________________________Table of contents

Introduction P.1

Part I: The basis of competition in the chemical photography market P.1Part II: The shift of competition in the digital era P.2Part III: The reaction of industry players P.6Sources P.8_______________________________________________________________________

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Introduction

From consumers, as well as industry players, photography is undergoing profound change as aresult of the digital revolution. Starting with the basis of competition in the chemical photography

market, we then look at the way in which the consumers evaluation of performance, thus thebases of competition, is changing with digital photography, and conclude by considering thereaction of industry players and the induced change in the photography value chain.

Part I - The basis of competition in the chemical photography market

The picture-taking end-consumer has traditionally been served by three fairly distinct markets.

1. Durables: the market for cameras

The cameras market can be segmented into 4 broad product categories as listed below.In each of this category, end users evaluate 3 main attributes: Picture quality, features and

functionalities, and price. The three dimensions have been the ruling basis of competition in thiswell-established industry. The whole industry has been evolving toward more attractiveprice/performance ratios over time but the fundamentals of photography havent really changedsince its inception.

Instant Disposables 35mm Compact 35mm SLR

Typical user Recreational Recreational Habitual Professional/amateur

Value proposition Instant processing No need to purchasea large durable

Ease of use;foolproof, rugged,inexpensive

Flexibility ofoperation; maximumscope for user input

Attributes Low quality

No features

No add ons

Low price

Improving quality

No features

No add ons

Low price

Good quality

Useful features

No add ons

Mid range price

High quality

Useful features

Add ons

High price

Illustrative

manufacturers

Polaroid Kodak, Fuji (filmmanufacturers)

Canon, Fuji, Olympus, Minolta, Nikon, Pentax

The introduction of the Advanced Photographic System standard, hailed as easier to use than35mm and as the new format for the mass market, came to a premature end, despite a heavy pushfrom the manufacturers of APS cameras and film, as consumers interest moved on to digital

cameras.

2. Consumables: film and photo paper

In the traditional market, film is the consumable. It is on the basis of repeat purchase ofconsumables that the large film manufacturers, Kodak and Fuji, have captured much of the valuein the industry, boosted in recent years by the introduction of disposable cameras, improved

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picture quality, enhanced choice and heavy marketing spend. As will be seen below, thisparadigm is being strongly challenged.

3. Services: developing & printing

The third business serving the end consumer is the plethora of walk-in photo D&P service

providers. In this business the basis of competition primarily results from 1/ brand equity andreputation of the film developers and 2/ proximity to the home.

Part II The Shift of Competition in the Digital Era

1. Market Overview1

From 1.5 million units in 1996, worldwide annual sales of digital cameras have increased to 10.7million in 2001. The take up rate significantly increased in 1999/2000 when mass-marketconsumer adoption started in conjunction with the introduction of below 200$ digital cameramodels. The market is expected to grow substantially over the next years to reach annual sales of40 million units in 2004. Digital camera sales currently account for 21% of new camera sales

(versus 4% back in 1998) and are expected to represent 40% of new unit sales in 2004. Thisfeatures a clear trend toward substitution of the traditional film cameras within the mass-marketsegment. Today digital camera penetration represents 9% of the installed base of cameras and isanticipated to reach 19% in 2003. Average sales price has been decreasing at a constant rate of25% per year over the last 5 years and settled at 250$/unit in 2001.Four major players share about 60% of the market, with Sony in the leading position (20%market share), followed by Olympus (16%), Kodak and HP (11% respectively). The market isbecoming increasingly more fragmented with new entrants stepping in and more than 15 cameramanufacturers are now competing in this space.

2 Demand driven change in the basis of competition

2.1 The introduction of new functional performance attributes

Digital cameras offer two radical innovations compared to traditional film photography, whichcan be broken down as follows:

Immediacy: offers the opportunity to see the shot immediately after taking the picture on theviewfinder (LCD). This feature provides instant gratification, instant feedback about the qualityof the shot, and possibility of showing /sharing the shot with photographer(s).

Manipulability: This broad category encompasses all the multimedia-enabled attributes of thedigital camera capabilities such as:

Transferability: Ability to transfer pictures from the camera to other computing devices

(PCs, PDAs, cellphones) Editability: Ability to stitch, retouch, modify pictures with editing softwares Storability: Ability to store images on a digital support such as a PC, floppy disks, or

network servers Sharability: Ability to share pictures with other people through email communications,

online posting, web site posting

1 All sources are listed at the end of the document.

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Printability: Ability to print digital pictures at will, either on home color printers, orthrough online photo-processing services or retail photo kiosks

Film photography may also offer some degree of manipulability when jointly used with ascanner. However, it was not a major adoption driver as scanning techniques entered commercialmarkets well after photography became pervasive. These new performance attributes represent

radical innovations and not just an incremental change, as they completely redefine the photoexperience and customers expectations. However, they are not intrinsic to the digital camera itself(except immediacy), but are enabled in conjunction with the use of complements.

2.2 The emergence of new complements

Whereas traditional film cameras depend only on two (critical) complements: film and filmprocessing, digital cameras require a vast array of new complements. The availability,affordability and installed based of these complements potentially represent major adoptiondrivers or inhibitors. They can limit or expand the performance attributes we described above.

COMPLEMENTS REQUIREMENTS

Transferability and sharability Storability Installed base of PCs, PDAs Connectivity between digital cameras and

computing devices Standard picture compression software

(JPEG) Internet connectivity and penetration Availability of bandwidth

Memory capacity in the camera Storage capacity on the computing platform Online storage capacity on servers

Editability Printability Availability of photo-editing software Compatibility with OS (Windows)

Installed base of home color printers Online processing services

2.3 The Persistence of Adoption Inhibitors

In addition to the ancillary requirements described above as complements, three other key factorshave played against the swift adoption of digital cameras. Complexity: The learning curve for new users is relatively steep as digital photography not

only involves interactions with a camera device, but also with PCs, emails, printers, Internet,memory cards that need to be simplified before reaching mass market adoption.

Quality: Whereas quality (image resolution) was one of the key performance attributes offilm cameras, it is only secondary for digital cameras as the pre-eminent performanceattributes are immediacy and manipulability. However, a minimum quality threshold must bereached before mass adoption. Improvements in quality expected by consumers would tendto delay their purchasing decisions to benefit from higher quality standards later on.

Pricing: The Average Selling Price of digital cameras in the early days (1996) was around

U$750, i.e well above the up front ASP paid for a traditional film camera. This represented amajor inhibitor for mass-market adoption as price-to-price comparison was made in spite ofdifferent performance packages offered by the two (traditional vs digital) devices. However,ASP sharply decreased (av. 30% p.a) and potential users started considering not only theupfront price, but also the total cost of ownership (durable and consumables) that makesdigital cameras a more attractive proposition.

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2.4 Adoption Lifecycle

1994-1997

Carving out a Niche

1998-1999

Crossing the chasm

2000-beyond

Going Mainstream

Players Apple (Quicktake 100) Kodak (DC 40) Casio (QV 11) Sony (Cybershot)

Sony: Mavica with floppydisk drive as storage unit

Casio: QV10 with floppydisk drive

Erosion of dominantpositions (Sony, Olympus)new entrants, e.g Nikon,Canon.

Adoption

Drivers

Non standard functionalattributes: immediacy &manipulability

Novelty

Affordability ofcomplements

Emphasis on simplicity /ease of use with floppy disk

Network effects Affordable Price Increased standardization Ubiquity of complements

Adoption

Inhibitors

Scarcity of complements Low performance (quality

below minimal level) High price > $1000

High price Lack of standards Quality can be improved

Overwhelming choice forconsumer

The transition from niche to mass market positioning took place when simplicity and ease of usewere placed at the core of the development efforts of Sony and Casio rather than qualityimprovements (image resolution) pursued by all other digital players. Quality improvementsmatched performance expectations from early techie adopters, whereas mass consumersprimarily needed to overcome the complexity of the device and its connectivity challenges withthe PC world. Most of the camera manufacturers kept on considering digital cameras as standalone products much as film cameras. In reality, it is just a piece of the multimedia value systemand it acts as an input device for the rest of the chain, therefore connectivity and storage are keyfor its adoption. In parallel, the widespread availability of complements at that time unlocked thepotential for all the digital transferability features.

2.5 Potential for disruptive competition

So far, we have looked at the adoption patterns of the new technology on the demand side. Wenow look at the competitive dynamics between the incumbent and the new technology.Market data indicate that the early years (1994-1997) of the digital camera were characterized bya coexistence of the two technologies in the installed base. In other words, digital cameras wereaddressing a specific segment (early adopters) with a specific need (technophiles, computeroriented). Performance attributes, notably in terms of image resolution quality, were so differentthat early adopters continued using their existing camera for traditional purposes. Cameras andFilm revenue continued to grow.

1994 -97 98 -99 2000 Time

Incremental

adoption(MM of units)

Innovators

Early

adoptersEarly

majority

Late

ma jority Laggards

1.5

3.0

6.7

2004E

25.0

Cr

oss in

gth

ech

as

m

1994 -97 98 -99 2000 Time

Incremental

adoption(MM of units)

Innovators

Early

adoptersEarly

majority

Late

ma jority Laggards

1.5

3.0

6.7

2004E

25.0

Cr

oss in

gth

ech

as

m

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The second phase (1998-1999) is characterized by a cannibalizationof new sales shipments bythe digital cameras and of the film business. Digital camera sales already capture 21% ofworldwide camera sales market in 2001 (InfoTrends, Lehman Brothers) and took away 1.5 pointsof growth from film in 2001 (Lehman Brothers). Film sales started declining in 2002 in the US.According to Infotrend, most household today use their digital cameras as their primary means ofphotography and 19% have stopped using film cameras altogether.

The third phase in the coming years heads toward substitution of the film cameras in the mass-market segment, as digital cameras are increasingly penetrating the installed base of cameras (9%in 2000, 14% in 2001 according to Lehman Brothers) and will ultimately replace film camerasand strangle the film business in OECD countries. How did consumer demand determine thissubstitution dynamics?

2.5.1 Performance provided and performance demanded

A possible explanation is the shift in the performance attributes expected by the mass-market. Ashift in expected performance attributes occurred in the mass market jointly with the introductionof non-standard capabilities. Expectations shifted from quality to multimedia capabilities, thuslowering the traditional quality standard expected by mass users. Mass users were willing to

adopt a new technology, even at higher price, because of the new performance package offered.Film camera makers continued on their quality performance oversupply track without observingthe shift in the preferences of customers. This left the market open for new digital cameramanufacturers. This dynamics is represented in a stylised form in the following graphics.

2.5.2 Preference overlap, asymmetries and price competitiveness

An alternative view is to look at consumer indifference curves for the attributes offered by digitalcameras and film cameras. (see below for a stylized version).

There is substantial degree ofpreference overlap between the two (mass market) users segmentsas the satisfaction of the mass market D.C users (conversely F.C users) with manipulability(conversely FCs quality)is indicative of the satisfaction of F.C users with the progressaccomplished along the manipulability attribute. In other terms, improvement in manipulability(valued by the DC segment) is also valued by the FC segment.Moreover, there is an asymmetry in this preference overlap. Film camera users extract moreutility from an improvement in D.Cs manipulability than digital camera users do from furtherimprovement in quality standard of F.Cs. In other terms, as D.Cs improve in quality (resolution),more film camera users will switch to digital, preparing the ground for competitive disruption.

Time

Quality ( Resolution)

Performance

Perform

ancetr

ajectory

offilm

came

ras(F

.C)

Perfo

rman

cetrajec

toryofD

igita

lCam

eras(D

.C)

19981960s 1980s

Performanceexpe

ctedbyF.Cmas

smarket

Performanceexp

ectedbyD.Cma

ssmarket

Intersect point: New performance attributes meeting new

performance expectations at a lower quality requirement

threshold.

Time

Quality ( Resolution)

Performance

Perform

ancetr

ajectory

offilm

came

ras(F

.C)

Perfo

rman

cetrajec

toryofD

igita

lCam

eras(D

.C)

19981960s 1980s

Performanceexpe

ctedbyF.Cmas

smarket

Performanceexp

ectedbyD.Cma

ssmarket

Intersect point: New performance attributes meeting new

performance expectations at a lower quality requirement

threshold.

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2. Consumables: the new paradigm

The new consumables: opportunities for the digital printer ink and paper suppliers

For printer manufacturers, digital cameras are perceived as the key to unlocking the value ofconsumables sales: ink cartridges and paper. If we can get people to print one extra colour pagea week, we can double the size of our paper and ink business (Srinivas Sukumar, Head, HP

Internet Imaging). It is why HP is moving upstream into digital camera supply. Lacking the corecompetency, it has licensed technology from Konica. Like Canon, HP aims to sell end consumerscameras and printers that can be connected directly, without a PC.

Impending loss of an end market: the plight and response of the traditional film manufacturers

The more we made nice cameras, the more we helped Fuji and Kodak. With digital cameras, theconsumables are in our hands. We can sell the printer with the camera (F. Mitarai, Pdt, Canon).

Fujis response has been to move early and aggressively into both digital camera componenttechnology R&D and sale, and digital camera manufacture for the end market. As well ascapturing a sizeable share of the digital camera market in Japan and building its position inEurope, it has sold chips to rivals, including Sony. That said, its main challenge is to achieve a

significant share of the US digital camera market.

Kodaks response has been to try to leverage its brand and place itself alongside the consumer atevery step of the digital experience. Thus, it has subcontracted Chinon to manufacture Kodak-branded digital cameras as well as begun manufacturing its own; partnered with retailers such asRitz Camera; collaborated with software writers and added printers to its product line to enableconsumers to manipulate, store, print and transmit images; and allied with AOL to enabletraditional photographers developed and printed pictures to be scanned and e-mailed to them.The challenge for Kodak is to capture value: as so much of what it has embarked upon liesoutside its traditional competencies, it is heavily reliant on strategic alliances and commercialagreements just to be present, let alone profitable. So, whilst it has achieved a significant share ofthe digital camera market, how much of the associated value actually flows to its suppliers?

3. Services

New entrants: multi media players

The revolution in photography results partly from the larger digital revolution, specifically thenetwork effect of the Internet economics. As a result, newcomers to the photo industry, namelyMicrosoft, ISP and online services such as AOL and Yahoo!, have benefited.Furthermore, whereas roles in the traditional industry camera manufacture, film supply anddevelopment & printing services were fairly distinct with limited interdependence, the digitalcamera and system suppliers are heavily dependent on such new actors.

Consequences for development and printing service providers

The future of development & printing service providers is ambiguous, dependent both on thelongevity of the installed base of traditional cameras among consumers, and on the serviceproviders capacity to provide digital services to those who have adopted and choose not to printtheir images at home.

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Business Week, November 1999: Fuji Beyond Film

Business Week, July 1997: HP Pictures The Future

Cnet: 2001. Digital Camera makers change focus. http://news.com/2100-1040-256837.html

Credit Suisse First Boston Equity Research, Apr. 1999. Pixels and Profits, Q1 Digital Cameraresults and Revised 1999 Forecasts. Technology / Imaging.

PMA Industry Trends Reports, 1997-98 and 1998-99: Digital Imaging News In Review

Eastman Kodak. 2002. Infoimaging A $225 billion Industry created by the convergence ofImage Science and Information technology. http://www.kodak.com

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Euromonitor research, 1993: Photography

Forbes, July 2001: Canon On The loose

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Forrester 2001. Device Review: Digital Cameras needs PC Integration. The Forrester Brief.

Imerge Consulting Group, 2002. The Worldwide Consumer Digital Camera Forecast and Market

Overview, 2001-2006.

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Journal of Business Strategy, July/August 2001: Kodak Embraces Disruptive Technology

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Olavsrud T. 2001. Digital Photography starting to reflect traditional market.http://www.internetnews.com/ec-news/article/0,,4_757331,00.html

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