TESTIMONY OF TERRENCE W. FAULKNER, DIRECTOR STRATEGIC PLANNING, EASTMAN KODAK COMPANY
Before the Federal Trade Commission
October 19, 1995
I. Globalization
For 150 years, the photography industry has been based on the manufacture of sensitized silver halide materials. That technological base is now in the process of changing and I will address some of the implications of that technology substitution later in my remarks.
But, for clarity, we should first focus on the silver halide manufacturers. The photographic products that they manufacture include the familiar color negative films used by consumers, the color papers used for prints, X-ray films, motion picture films, graphic art films and a range of other related products. The current set of silver halide manufactures includes: Eastman Kodak Company, Fuji, Agfa, Konica, DuPont, 3M, Polaroid, International Paper (Ilford and Anitec), and Mitsubishi. The first four companies that I listed account for over 80% of industry revenues and all nine account for well over 95%. Every major participant in this industry must compete on a worldwide basis in order to succeed and all nine of the companies that I listed do sell their products in the United States. That global competition has intensified as the rate of growth in the silver halide business has begun to slow. Thus, it is not surprising that when Eastman Kodak Company sought to vacate consent decrees originally entered in 1921 and 1954, both the district court and the court of appeals found that the relevant geographic market for amateur color film includes the U.S., Western Europe and Japan. U.S. v. Eastman Kodak Company, 853 F. Supp. 1454 (1994), aff'd, 63 F. 3d 95 (1995).
II. Technology Intensive Competition
Kodak spent $850 million in 1994 on research and development, or 6.3% of revenues. We will spend even more on R&D in 1995. We have consistently ranked in the top ten companies in the United States in terms of the number of patents awarded. Our competitors also invest heavily in R&D. Fuji has been in the top ten companies receiving U.S. patents for six of the last seven years. There is a continuing strong competition to achieve the highest levels of product performance. But, silver halide technology is now more than 150 years old and product performance improvements are increasingly expensive to obtain. That innovation can generally be characterized as incremental in character. One consequence of this increasingly expensive R&D is that the new Advanced Photographic System (APS) that will be introduced next year was jointly developed by five companies. Kodak and Fuji were joined by three camera manufacturers. Another reason for this cooperation was the need to have a worldwide standard for the new format. Even with the sharing of development costs all of the manufacturers of APS products will need to compete on a global basis in order to achieve a reasonable return on their substantial investments. In past decades, Kodak could drive a new standard by itself, but that is no longer possible.
III. Competition From New Technology
Silver halide based photography has already been replaced by electronic imaging in some applications. Electronic News Gathering (ENG) replaced 16 mm film in the early 70's in the television market. Later, video cameras and magnetic tape replaced the Super 8 movie cameras and film used for home movies in the consumer market. This technology substitution will continue on an application-by-application basis. It is important to understand that there is not always a sharp boundary between silver halide and digital imaging -- hybrid products such as Kodak's Photo CD can exist. A Photo CD contains digital images scanned from traditional silver halide film, and this provides a bridge between silver halide and digital imaging. I should also note that several of the silver halide manufacturers have developed digital imaging products. Besides Kodak, these include Fuji, Agfa and Konica.
Like all technology substitutions, this substitution of digital for silver halide enables new entrants. Consumer electronics companies such as Sony, Matsushita and Sharp face very low entry barriers and the same is true of companies in the computer industry such as Apple and Microsoft. The new digital video cameras that have been introduced by Sony, JVC and Matsushita over the last two months all contain a Still Picture Function. A very small extension of their electronic products line enables them to offer consumers a color print much like the ones obtained from a traditional silver halide camera. In digital imaging, information and images are much the same thing. Digital technology is enabling the convergence of imaging, information and communications. In the vernacular of our times, "bits are bits." This is dissolving old industry boundaries and we must now accept the existence of an emerging imaging industry that is much larger than that defined by the nine silver halide manufacturers I mentioned earlier.
Kodak is probably better positioned than any other U.S. company to become a leader in digital imaging. We have invested more than $3 billion in electronic imaging R&D over the last 15 years... but, there is no guarantee that we will succeed. Large additional investments in the development of products, channels and markets will be required to build a successful, value-generating digital imaging business. The Japanese consumer electronics companies, in particular, have a strong position that can easily be extended into digital imaging. If Kodak fails, then it is likely that the new digital imaging industry will be centered overseas.
IV. Industry Consolidation
To fully appreciate the situation that Kodak and the other silver halide manufacturers face, we must also consider the industry consolidation that is underway. There are several forces that are driving consolidation in the silver halide industry. I have already described the substitution of digital for silver halide. That limits growth within silver halide and this, coupled with excess industry capacity, increases price based competition. The more marginal manufacturers then begin to drop out. Another force driving industry consolidation is increasing Customer Power. In the consumer market a few major customers like Wal-Mart account for an increasingly large percentage of all film sales. These large retailers demand the lowest possible price form the manufacturers (who are competing with one another for scarce shelf space) and then often use film as a loss leader to attract consumers into their stores. Smaller retailers then also press for lower prices. In the health care market, Group Purchasing Organizations come together to negotiate multi-year contracts for large volumes of X-ray films. Product performance does matter, but price is increasingly the determining factor in who gets the contract. This can lead to a "winner takes all" outcome where the winners are the companies with the best technologies and the lowest manufacturing cost. And, in silver halide manufacturing, cost is very much a function of scale. Increased scale is an important tool for reducing manufacturing costs and those reductions are essential since, in some categories, sensitized goods prices are declining at rates in excess of 5% per year. Industry consolidation is taking several forms among the silver halide manufacturers. Some small companies (Orwo, Oriental) have declared bankruptcy. Some large companies are divesting entire divisions (e.g., DuPont with Medical Imaging) or are exiting product lines (e.g., Agfa with motion picture negative film, DuPont with Industrial X-Ray film, etc.).
V. Policy Implications
As you consider potential changes to U.S. antitrust policy, the first point that I would make is that markets must be defined globally. That is certainly true in the photographic industry and I believe that it is increasingly true in many other industries as well.
A second point is that market definition needs to be more forward looking. The rate at which technology is driving change seems to continually increase. Technology substitution inevitably drives changes in industry boundaries. Kodak saw this emergence of electronic imaging coming more than 15 years ago and began to shift its R&D spending accordingly. Just as manufacturers do, government policy makers must also anticipate these kinds of changes when they define market boundaries. In the case of the photographic industry, we must recognize not only an existing global silver halide industry but also an emerging imaging industry that includes both silver halide and digital electronics companies. I am sure that similar trends are occurring in other industries.
A third point that I would make is that antitrust enforcers need to be more receptive to allowing U.S. companies to actively participate in an industry consolidation, in those cases where that process is occurring. U.S. companies must have the same freedom that foreign companies have to acquire a weak competitor, either in whole or in part (e.g., a product line, physical assets, other assets such as intellectual property or brands, etc.). This is especially critical in industries where there are large fixed costs and manufacturing scale is necessary for survival. Whatever the letter of Japanese antitrust regulation may be, I have no doubt that the Japanese government will not stand in the way of a Japanese photographic company when it wants to acquire a competitor. If a Japanese company can combine the advantage of manufacturing scale with the advantage of a protected home market, then the resultant lack of a level playing field will greatly disadvantage Kodak. And, if Kodak's core silver halide business becomes significantly less profitable -- then we will not have the sustained cash flows that we need to fund a successful transition to digital imaging.
This leads into a fourth point. Where foreign competition policy conflicts with U.S. policy in a way that hampers U.S. companies, the U.S. antitrust agencies need to be more active in pushing for open markets and enlightened competition policy.
Finally, I want to thank you for this opportunity to describe the current situation in the photographic industry and to suggest what some of the implications of that situation might be for the revision of antitrust policy.