Eastman Kodak’s slide into bankruptcy was no doubt lamented by many whose childhood is recorded in blotchy shades of faded yellow and sepia. But investors should overcome any sadness and consider the demise of the US company that was founded in 1880 as creative destruction – or what can be thought of as evolution for capitalists.
Creative destruction as an economic concept stretches to the mid-19th century and Marxist economic theory. It refers to the process of wealth creation and destruction that is characteristic of the capitalist model. Today, its results are recognisable as the economic cycle of boom and bust. The theory suggests that wealth creation and destruction go hand-in-hand; that one cannot occur without the other.
It is easy enough to visualise one side of this equation because you cannot destroy something that has not yet been created. But of more interest to investors is the idea that wealth creation is dependent upon destruction. The 63 straight quarters of GDP growth that the UK economy enjoyed between 1992 and 2009 gave many people reason to believe we might have overcome boom and bust. But we have since learned the natural progression of the economic cycle goes on.
A theory that implies that periods of contraction and pain are an inevitable consequence of expansion and progress might seem like something to make growth investors queasy, but it is the creative side of the equation that we should focus on. Which brings us back to Kodak, a firm that once defined its industry but one that is now fighting for survival.
Kodak’s problem was not that technology overtook it; that it was stuck making films when everyone wanted digital cameras. Take a look at the company’s website and you will see digital cameras for sale. What tripped the company up were management errors. In the early days of digital cameras, for example, it was an innovator, producing hardware that was as good as any produced by its ultimately-more-successful competitors. But it was more concerned about its digital business cannibalising its film business than it was about establishing a strong position in the new technology.
Kodak failed to overcome that mistake and has suffered for it ever since. But its self destruction might be the catalyst for its rebirth. That is what happened with General Motors, which, after a similar near death experience in 2008-09, has re-emerged as a leaner and more confident company with a streamlined product line-up and ambitious plans.
Giraffe-like
More generally, creative destruction can be thought of as the process of company and market evolution. There will always be winners and losers in a competitive, unregulated marketplace and it is rare for a dominant company to remain at the top for a long time.
Research in Motion (RIM), the company that makes the BlackBerry, is struggling to maintain what seemed like an unassailable share of the smartphone market because it has failed to keep up with Samsung, Apple and Google when it comes to hardware and software. It retains an enviable share of the corporate market and thanks to its instant-messaging service, the BlackBerry is the cool-kids handset of choice. But unless its new management team can capture fresh sales and innovate with products, RIM could be vulnerable on both fronts.
It is in this context that Apple’s recent success should be judged. Fifteen years ago, the company was struggling against Microsoft, IBM and HP. It might have been destroyed by the process of creative destruction, but the firm now dominates several sectors. Its iPod all but obliterated Sony’s Walkman; the iPhone threatens Nokia and RIM; and the iPad might eventually make laptops redundant. You could argue Apple helped sink Kodak by fitting a high-quality camera to the iPhone.
In nature, natural selection is an unconscious process of minute improvements. The giraffe is not aware that over generations its neck is growing longer to reach the tastiest leaves on the highest branches. Corporate evolution differs in that it is conscious. It is a ruthlessly competitive process where the winners like Apple are innovative and make the right decisions, and the losers like Kodak fall short. A company is only as good as the next decision it makes; a thought that would serve investors equally well.
References to specific securities should not be taken as recommendations.
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