Monday, January 30, 2012

Learning From Kodak's Demise

Learning From Kodak's Demise:

The human brain is capable of memorizing 67,890 digits of pi,
composing side two of Exile on Main Street, and inventing
a dog-to-human translation device called the Bowlingual. Yet, we
often-brilliant, always-innovating bipeds find it impossible to
imagine changing the trajectory of the world we think we live in by
more than a few degrees at any given moment. Whatever dominates
today we assume will dominate tomorrow. This is true for our
private lives, this is true for commerce, and this is especially
true for politics.


Tectonic shifts in the course of human events are almost never
predicted ahead of time, even by the very people who stomp on the
cracks. When asked in August 1989, only a few months after the
electrifying demonstrations in Tiananmen Square, whether the
communist East Bloc would ever be democratic and free in his
lifetime, Czech economist VĂ clav Klaus said no. Less than
five months later, he was the first finance minister of a free
Czechoslovakia. Morgan Stanley trader Howie Hubler lost $9 billion
on a single stock market bet in 2007, not because he didn’t think
the bubble of mortgage-backed derivative securities would pop, but
because he couldn’t conceive of the price reduction exceeding 8
percent. For all but the last 10 days of 2007, the famed Iowa
Electronic Markets (IEM) trading system for predicting major-party
presidential nominees established as its clear Republican favorite
the famous ex-mayor of New York, Rudy Giuliani. Yet, when it came
time for people to actually vote in the primaries and caucuses,
Giuliani lost in more than 40 states to Ron Paul, an obscure
obstetrician/congressman whose name never even showed up on IEM’s
2008 election trading board despite his ending up with the
fourth-highest number of delegates. Massive, fast-paced change,
whether liberational, destructive, or just plain weird, is always
and everywhere underpriced.


You may have heard of confirmation bias,
whereby people choose to notice and believe whatever rumors, news
stories, and quasi-academic studies confirm their basic worldview.
Well, get your mind around existence bias, where the mere
fact of a person’s, business’s, political party’s, or country’s
existence is taken as unspoken and unchallenged proof that the same
entity will exist in largely the same form tomorrow, the next day,
the next month, the next decade, forever and ever, amen. This
despite the fact that the Western world, and the United States in
particular, stands out in the history of Homo sapiens as the most
vigorous producer of constant, dynamic change.


Dig up the time capsules for every decade preceding us, and
you’ll find retrospectively laughable anxieties about seemingly
intractable threats that no longer exist. At the dawn of the new
millennium, for example, the overwhelming majority of media
observers agonized over how mere mortals could cope with the advent
of the new Big Brother–style corporate behemoth called AOL Time
Warner. As it turned out, the company set new records for financial
losses before disbanding altogether. A decade before that, the
question wasn’t whether the Japanese would own and operate the U.S.
economy but whether the American workplace would be free of
insidious group calisthenics led by Toshiro Mifune types. The
graduating class of 1980 could not imagine a world without high
inflation and the growing communist threat, and its 1970
counterpart forecasted constant Southeast Asian war fed by an
endless military draft.



In 2012, it’s tempting to give in to
the pessimism and existence bias of the moment. Unemployment and
underemployment have remained at levels not seen since the
1978–1982 recession, and unlike in that era of Federal Reserve
Bank–imposed austerity via heightened interest rates, the economy
has not been dosed with any medicine that hints at a better
tomorrow. Indeed, debt and deficits are reaching levels not seen
since World War II, when, as you might recall, we were fighting a
world war. Against Hitler. And as bad as the current fiscal picture
looks, there is rare unanimity across the discipline of
economics—as well as inside the administration, from President
Barack Obama on down—about one singularly unhappy fact: As the
first wave of the baby boomers born between 1946 and 1964 starts to
retire and goes on the public dole, things will only get much, much
worse.


Yet there is a glowing ember of real hope in this gloomy
picture, and it lies, paradoxically, right alongside our inability
to detect it. The same revolutionary forces that have already
upended much of American commerce and society over the past 40
years, delivering us not just from yesterday’s bogeymen but into a
futuretastic world of nearly infinite individual choice,
specialization, and autonomy, are at long last beginning to buckle
the cement under the most ossified chunk of American life: politics
and government. A close if idiosyncratic reading of recent U.S.
history gives us a blueprint for how to speed up that process of
creative destruction in the realm of public policy. Because it’s
not true that nobody predicted such history-altering innovations as
the Internet, nonviolent resistance to totalitarianism, and the
home-brewing renaissance, among a thousand other happy developments
in the modern world.


If we listen carefully to the theoreticians and practitioners
who helped midwife these giant leaps toward the decentralization of
power and the democratization of mankind, they have some
surprisingly consistent things to say about changing or working
around restrictive regimes, and—above all— altering the mindset
that tolerates and perpetuates them. As any revolutionary will
testify, there are structural impediments galore to our personal
and global pursuit of happiness. Before we can sweep those
roadblocks away, we have to declare our independence from the
forces that conspire to keep us less than free and recognize that
the status quo has no inalienable right to keep on keeping on.


Nothing in 21st-century life seems as archaic, ubiquitous, and
immovable as the Republican and Democratic parties, two
19th-century political groupings that divide up the spoils of a
combined $6.4 trillion annually in forcibly extracted taxpayer
money at the federal, state, county, and municipal levels. While
rhetorically and theoretically at odds with one another at any
micro-moment in time, the two parties manage to create a mostly
unbroken set of policies and governance structures that benefit
well-connected groups at the expense of the individual. Americans
have watched, with a growing sense of alarm and alienation, as
first a Republican then a Democratic administration flouted public
opinion by bailing out banks, nationalizing the auto industry,
expanding war in Central Asia, throwing yet more good money after
bad to keep housing prices artificially high, and prosecuting a
drug war no one outside the federal government pretends is
comprehensible, let alone winnable. It is easy to look upon this
well-worn rut of political affairs and despair.


But what if that's the existence bias talking? What if the same
elements that extend the incumbents’ advantage threaten to hasten
their demise? Luckily, economists have a particular fondness for
studying what Democrats and Republicans have become: the
longest-lived duopoly in American history. But while researchers
have done interesting work explaining how duopolies collude with
one another to carve up captive markets, they generally fail to
address the most interesting moment of all: how customer-unfriendly
collusion and customer-empowering technology combine to produce an
inevitable consumer revolt, sweeping one or more of the dominant
players into the dustbin of history.


In a widely circulated 2009 paper surveying the vast economic
literature on the topic, the late Larry F. Darby presented a list
of classic duopolies for discussion. Tellingly, several no longer
existed, including MCI and AT&T (MCI, then known as WorldCom,
became history’s largest bankruptcy in 2003) and Macy’s and Gimbels
(Gimbels was the country’s—and the world’s—dominant department
store chain in the 1930s; it ceased to exist in 1987). As such
examples illustrate, there is nothing inherently stable about two
organizations dominating a particular market in the hurly-burly of
modern American life. In fact, there is plenty of reason to suspect
that such arrangements are, if anything,
unstable—particularly when technology allows captive
consumers to flee.


It’s worth taking a closer look at a single such case, one of
the duopolies on Darby’s list: Kodak and Fujifilm. Like the
Democratic Party with the House of Representatives, Kodak was for
much of the 20th century synonymous with color photography.
Memories captured on film were “Kodak moments.” Eastman Kodak was a
bedrock member of the Dow Jones Industrial Average for more than
seven decades. At one point the company enjoyed an amazing 96
percent share of the U.S. market for photographic film. Such was
its dominance that the federal government sued Kodak for antitrust
violations not once but twice, producing out-of-court settlements
in 1921 and 1954. As recently as 1994, long after Japan’s Fujifilm
had entered the scene, the Justice Department argued that the
antitrust settlements should remain in force, since Kodak had “long
dominated” the industry, still enjoyed a U.S. market share of
around 75 percent, and could “greatly outsell its rivals despite
charging a higher price.” (Careful observers of and participants in
capitalism may notice in that latter claim a wonderful market
opportunity.)


Fujifilm began competing with Kodak globally in the 1970s and
seriously in the United States after the 1984 Olympics. Though
always the junior partner on Kodak’s home turf, the conglomerate
held its own enough that the duopoly soon attracted academic
studies such as “Entry, Its Deterrence, and Its Accommodation,”
“Vertical Restraints and Market Access,” and “Advertising Collusion
in Retail Markets.” The underlying assumption was that you could
assume the duopoly’s equilibrium for the foreseeable future. Even
those who noticed Kodak faltering in the late 1990s at the dawn of
the digital age were still apt to say, as Fortune magazine
did, “The Kodak brand remains solid gold, and its quality is not in
dispute.” No one could conceive of a photography world without
Kodak playing its customary leading role.


This, stunningly, is no longer true. Eastman Kodak share prices
tumbled from $60 in 2000 to $40 in 2001, to $10 in 2008, and under
the $1 threshold by the end of 2011. The Dow Jones kicked the stock
off its bedrock industrial average in 2004, and the New York Stock
Exchange threatened the company with de-listing. Kodachrome—subject
not just of a hit Paul Simon song but of the 1954 antitrust
settlement that the federal government was trying to maintain four
decades later—vanished from stores in 2009, and developers stopped
processing the stuff for good on New Year’s Day 2010. The company
closed scores of plants, laid off more than 10,000 employees, and

has now filed for Chapter 11 bankruptcy.


What happened? Technological advances gave consumers choices
that Kodak’s fat bureaucracy was unwilling to provide. Writing in
the Wall Street Journal in November 2006, William M.
Bulkeley explained how the implications of this insight ranged far
afield from the world of processing photographs:



Photography and publishing companies shouldn’t be surprised when
digital technology upends their industries. After all, their
business success relied on forcing customers to buy things they
didn’t want. Photo companies made customers pay for 24 shots in a
roll of film to get a handful of good pictures. Music publishers
made customers buy full CDs to get a single hit song. Encyclopedia
publishers made parents spend thousands of dollars on multiple
volumes when all they wanted was to help their kid do one homework
paper. The business models required customers to pay for detritus
to get the good stuff. . . . Eastman Kodak and Fuji Photo Film had
a highly profitable duopoly for 20 years before digital cameras
came along. They never dreamed customers would quickly abandon film
and prints.



When given real choice, especially the choice to go elsewhere,
consumers will drop even the most beloved of brands for options
that enhance their experience and increase their autonomy. We have
all witnessed and participated in this revolutionary transfer of
loyalty away from those who tell us what we should buy or think and
toward those who give us tools to think and act for ourselves. No
corner of the economy, of cultural life, or even of our personal
lives hasn’t felt the gale-force winds of this change. Except
government.


Think of any customer experience that has made you wince or kick
the cat. What jumps to mind? Waiting in multiple lines at the
Department of Motor Vehicles. Observing the bureaucratic sloth and
lowest-common-denominator performance of public schools, especially
in big cities. Getting ritually humiliated going through airport
security. Trying desperately to understand your doctor bills.
Navigating the permitting process at your local city hall. Wasting
a day at home while the gas man fails to show up. Whatever you come
up with, chances are good that the culprit is either a direct
government monopoly (as in the providers of K–12 education) or a
heavily regulated industry or utility where the government is the
largest player (as in health care).


Unlike government and its sub-entities, Kodak couldn’t count on
a guaranteed revenue stream: Consumers abandoned its products, and
now the company is basically done. The history of private-sector
duopolies and even monopolies is filled with such seemingly sudden
disappearing acts: The A&P supermarket chain—if you’re under 40
years old, or from the West Coast, you probably haven’t even heard
of it—enjoyed a U.S. market share of 75 percent as recently as the
1950s. Big-box music retailers and bookstores were supposed to
bestride the land like colossi at the turn of our new century, but
Virgin megastores have all but disappeared, and Borders has been
liquidated. Dominant newspapers in one-paper towns were able to
book some of the economy’s highest profit margins for four
decades—more than 20 percent a year, on average, positively
dwarfing such hated industrial icons as Walmart—yet with the
explosion of Web-based competition, these onetime mints are now
among the least attractive companies in the economy.


There is a positive correlation between an organization’s former
dominance and its present inability to cope with 21st-century
change. As technology business consultant Nilofer Merchant has
aptly put it, “The Web turns old industries on their head.
Industries that have had monopolies or highly profitable duopolies
are the ones most likely to be completely gutted when a more
powerful, more efficient system comes along.” We need to hasten the
inevitable arrival of that more efficient system on the doorstep of
America’s most stubborn, foot-dragging, reactionary
sector—government at the local, state, and especially federal
levels, and its officially authorized customer-hating agents, the
Democrats and Republicans.


The most important long-term trend in American politics is the
half-century leak in market share by the country’s political
duopoly. This January, Gallup released its latest study on the
question of political self-identification, finding that
"the proportion of independents in 2011 was the largest in at least
60 years
"--a stunning 40 percent. Democrats were at a desultory
31 percent, and Republicans proved utterly unable to capitalize on
a bad, Democrat-led economy, trending downward to 27 percent.



Voters free from the affiliation of
party membership are more inclined to view political claims with
the skepticism they so richly deserve, to hear the dog whistle of
tribal political calls as deliberate attacks on the senses rather
than rousing calls to productive action. By refusing to confer
legitimacy on the two accepted forms of political organization and
discourse, they also hint strongly that another form is gathering
to take their place.


When duopolies bleed share of a captive market, something
potentially revolutionary is afoot. The Bush-Obama era of bailout
economics and perennially deferred pain has produced a political
backlash that has been evident most every time voters have had an
opportunity to vent. When blue-state California was allowed in May
2009 to pass judgment on its political class, via a five-part
budget-fix referendum (including “onetime” infusions of income tax
and lottery proceeds) supported by a nearly unanimous cross-section
of major politicians, newspapers, and interest groups, the slate
lost by an average of 30 percentage points, despite opponents being
outspent by an average of seven to one. Eight months later, unknown
Republican Scott Brown won Teddy Kennedy’s old Senate seat in a
three-to-one Democrat Massachusetts. Congressmen mostly canceled
their traditional August town hall meetings in 2010 after getting
too many earfuls in 2009, GOP establishment candidates for Senate
were upended by Tea Party insurgents from Delaware to Kentucky to
Nevada, and limited-government Republican insurgent Ron Paul has
more than doubled his vote over 2008 so far in this presidential
primary season.


For the first time in recent memory, participants in the
political process, many of them newly engaged, are openly imagining
and pushing for a world other than the one they currently live in.
A certain spell is on the verge of breaking, with impacts we can
only guess at.


Matt Welch
(matt.welch@reason.com) is editor in chief of

reason and Nick Gillespie
(gillespie@reason.com) is editor in chief of

reason.com and
reason.tv. They are the co-authors of
The
Declaration of Independents: How Libertarian Politics Can Fix
What's Wrong With America
(PublicAffairs), from which this
essay was adapted.