Five Deadly Business Sins

Source :Bloomberg: Rick Wartzman:THE DRUCKER DIFFERENCE January 13, 2012, 

Two avoidable mistakes were enough to trip up Eastman Kodak, once one of America's mightiest companies

Just how lethal are Peter Drucker’s “five deadly business sins”? You might askEastman Kodak (EK), which has committed at least a couple of them and now finds itself on the verge of bankruptcy.

Word emerged last week that Kodak, founded in 1892 and for many decades widely celebrated as one of the world’s greatest companies, may soon file for Chapter 11 protection if it can’t raise enough cash by selling off pieces of its patent portfolio. The news was a sharp reminder of how incredibly challenging it is to sustain any organization, even the most iconic.

How did it come to this? In certain respects, Kodak has been on the defensive since it began facing heightened competition from its arch rival Fuji (8278:JP) some 30 years ago. But fundamentally the company has slipped because it fell prey to two of what Drucker identified in a 1993 essay as a quintet of “avoidable mistakes that will harm the mightiest business.”

The first is a preoccupation with high profit margins. The second: “slaughtering tomorrow’s opportunity on the altar of yesterday.” (The three other deadly business sins, according to Drucker, are “mispricing a new product by charging ‘what the market will bear’; “cost-driven pricing” in which you merely add up your expenses and then stick a profit margin on top—a subject I’ve explored previously; and “feeding problems” while “starving opportunities.”

PLUSH PROFITS CAME EASILY TO KODAK

Few things are as seductive to a business as fat profit margins, and cranking out little yellow boxes of film proved extremely lucrative to Kodak for a long time. For a company in this situation, “the economic returns from the alternatives are simply comparatively unattractive,” Ziggy Switkowski, a former top Kodak executive, explained last week to The Australian.

The problem is that an upstart with a new technology or a disruptive business model will invariably enter the market at the low end and eventually wind up bushwhacking the high-margin manufacturer. Clay Christensen describes this process in his book The Innovator’s Dilemma. Drucker, in his piece, highlighted a similar vulnerability.

The troubles long endured by the U.S. automobile industry were “in large measure … the result of the fixation on profit margin,” Drucker wrote. “By 1970, the Volkswagen Beetle had taken almost 10% of the American market, showing there was U.S. demand for a small and fuel-efficient car. A few years later, after the first ‘oil crisis,’ that market had become large and was growing fast. Yet the U.S. automakers were quite content for many years to leave it to the Japanese, as small-car profit margins appeared to be so much lower than those for big cars. This soon turned out to be a delusion—it usually is.”

Drucker believed that rather than focus on profit margins, a company is better off paying attention to total profit, which is profit margin multiplied by sales volume. It is this figure, he maintained, that helps ensure “optimum market standing.”

Kodak’s other sin—hanging on to the past so vigorously that it ignored the future—has bedeviled many others, as well. Drucker pointed, for instance, to the time that IBM (IBM) fought back against Apple (AAPL) to gain leadership in the then-fledgling personal computer market. But before long, Drucker recalled, IBM “subordinated this new and growing business to the old cash cow, the mainframe computer.” It was soon left behind.

EXTINCTION WASN’T FORESEEN

With Kodak, the “biggest failing was not identifying that the future of the high-margin chemical-imaging business was going to end,” said Switkowski, who worked at the company from 1978 to 1996 and once ran its Australian unit. Kodak’s “strategy was to optimize returns ultimately for a business that would become extinct.”

About 10 years ago, Kodak did try to move more forcefully into digital cameras. It couldn’t figure out how to make money on them, even as it became the leader in U.S. sales. Kodak’s frustrated chief executive officer, Antonio Perez, wound up calling it a “crappy business,” and the longtime Hewlett-Packard (HPQ) veteran has since been searching for some other product to turn the company around. For several years, Kodak has pushed high-tech printers. Nothing, though, has really clicked.

In some ways, it’s hard not to sympathize with Kodak’s struggles to reap a decent profit with its digital offerings. Film, after all, constantly needs to be replaced, just like razor blades. Digital photography, by contrast, provides no such recurring income stream.

Yet in the end, this radical shift only underscores that Kodak should have moved far more boldly—and much more quickly—into the digital universe. Doing so might have given Kodak sufficient time and space to totally overhaul its operations and better position the company for success in the 21st century.

The saddest part, perhaps, is that Kodak had a chance. In the mid-1980s, a consulting firm called the Index Group predicted in a report to Kodak’s marketing division that digital technology would take over film by 2000. “They rejected our work and told us it would not happen until after 2020,” says Adam Crescenzi, who helped prepare the Index analysis. “They laughed it off.”

The lessons from Kodak are clear: 

The future always arrives faster than you think it will.

 The temptations of sin, meanwhile, are awfully tough to resist.

Rick Wartzman is the executive director of the Drucker Institute at Claremont Graduate University.