PNI Digital Media - Solutions for the Digital Lifestyle

- Reprinted with permission from C.E. BIZ Magazine -

RETAIL: THE REMAKE

How a little-known technology company is transforming retailers into on-demand manufacturers.

By Andrew MacIntyre

Pity the poor retailer. The big box revolution may have filled his parking lots with eager bargain-hunters, but it hasn’t done anything to alleviate retail’s oldest and costliest headache: Inventory.

Inventory is retail’s Scarlett O’Hara – expensive, high-maintenance and prone to storms. Inventory and its myriad costs – transport, storage, security, management, etc. – make retail a complex and inefficient sales model, no matter how big you make the box. Innovations like just-in-time inventory have improved throughput, but the problem still remains: how to get more growth out of a business perennially choked by the length of its own supply chain?

For most traditional consumer goods, like food, clothing and household items, the retailer’s inventory woes will probably never go away. But one department may hold the key to retail’s next big growth spurt: Entertainment.

It’s taken 20 years to accomplish, but the entertainment industries have finally retooled completely along digital lines. Today’s entertainment content, whether it comes in the form of movies, music, videogames, or even your family’s photo album, is an all-digital affair. But retailers have yet to fully embrace this change. They’re still employing the same inventory model they use to sell furniture and clothing in order to sell digital products that, in fact, require no shelf or warehouse space at all.

Now a fledgling technology company has come up with a way for retailers to sell digital entertainment content to its in-store customers without any traditional inventory costs whatsoever. Publicly traded PhotoChannel Networks Inc. (OTCBB: PHCHF; TSX-V: PNI ) has built a modest reputation over the past five years selling a suite of on-line photofinishing services to major retailers like Wal-Mart. Their experience has led them to an innovative – and surprisingly obvious – conclusion: the same system that enables retailers to sell digital photographs can be used to sell digital music, movies and games, too. For growth-starved retailers, the opportunity is in the billions, and if early indications pan out as expected, there’s reason to believe PhotoChannel could be the biggest thing to hit retail since the big box.

Canadian-based PhotoChannel has been toiling in relative obscurity for ten years. In that time the company has gone through several incarnations, first as a developer of multimedia software products, and later as an on-line photofinisher. Shaking off the after-effects of the dotcom meltdown in 2001, new management took over with a vengeance. The board was significantly upgraded with heavy hitters from the photography, motion picture and digital imaging industries. Peter Scarth, ex-VP of motion pictures for Kodak, was brought in, as was Doug Rowan, the man Bill Gates hired to run Corbis, owner of the world’s largest digital library. Chairman and CEO Peter Fitzgerald came over from Gretag, where he had been heading up one of the world’s leading manufacturers of imaging equipment. Prior to Gretag, he ran Kodak’s worldwide photo processing operations.

With top-of-the-line oversight and a sharper strategic focus, PhotoChannel amped up its digital photofinishing business, invested heavily in research and development on a suite of web-based tools, and set up a new division called PNI Digital Media. Things looked dicey for a couple of years, as it was still unknown whether consumers would print their digital photos en masse. Then, in 2003, Wal-Mart Canada selected PhotoChannel as its supplier of on-line photofinishing systems, a key contract that was recently renewed for three more years. It had become evident that the largest customer demographic group, “soccer moms,” would print their pictures whether they were taken with film or digital cameras. With Wal-Mart on board, other retailers began to follow, including Eckerd Pharmacy and Brooks Pharmacy in the U.S., and all 7-Eleven stores in Canada. PhotoChannel is now booking triple-digit revenue growth on a quarterly basis. Revenues for the first six months of fiscal 2005 are up 153 percent over the same period a year ago.

Now that the company’s photofinishing model was being validated, and profitability loomed on the horizon, business development manager Kyle Hall, a former Corel software executive, wonder if the company could be doing more to push PhotoChannel finally into the black. “We realized that what we’d done with companies like Wal-Mart is basically turn them into on-demand manufacturers of digital photos,” Hall says. “That’s when we started asking ourselves, what else can our system do?”

Quite a lot, it turns out. PhotoChannel’s online photofinishing solution enables the customer to upload his digital photos to a retailer’s website, select his prints, and pick them up at the retail location of her choosing. The PhotoChannel system sends the retail location the photos all preformatted for the processing equipment at that location and the retailer prints them in as little as one hour. This is where it gets interesting: The machines used to print the photos come with industrial-strength CD and DVD burners, capable of burning about a hundred discs per hour. Up to now, the machines have been used only to burn copies of digital photographs for customers. But, of course, they can store almost anything in a digital format, such as music, movies and video games. Hall says the only reason they haven’t been used in this capacity up to now is that no one has come along with a turnkey solution for the retailer. That’s when PhotoChannel had its proverbial lightbulb moment:

“We realized that we had already solved the problem for the retailers,” Hall says. “We had developed a system that managed inbound content from the consumer – his digital photos – and married it up with a distribution system located at the retail level. All we had to do was convince the retailer that he could take any kind of inbound order for digital content, whether it be movies or music or games or even ringtones, and suddenly these industrial CD and DVD burners are working for you around the clock. The burner doesn’t care what it burns – pictures, music, movies, whatever. It’s basically all the same thing from a technological point of view.”

To manufacture all types of digital content on demand, a retailer would simply use PhotoChannel’s on-line system to take the customer’s order for whatever movies, music or games he wants, then acquire the content from the copyright owner (music label, movie studio, game developer, etc.) for distribution to the retail store. The files are then burned to CD or DVD, product packaging is printed, and the product is ready for pickup. Traditional inventory and warehousing costs are completely eliminated.

“The best part is that the engineering is already done,” Hall continues. “The R&D we’ve already put in on the photo side is scalable across the entire spectrum of digital content, and so are the machines the retailers have invested in. We’re just layering services onto an existing and well-proven platform.”

The only thing PhotoChannel needs now is for retailers to start seeing the light. A quick look at the numbers suggests they’d be foolish not to. It only took them a couple of years to become on-demand manufacturers of digital photos, now a $14 billion market, according to a recent report by a major computer manufacturer. How much more quickly will they want to do the same with music ($7.3 billion), video games ($10 billion) or movies ($18 billion)? With a system many of them are already using, retailers like Wal-Mart can cut out the shipping and warehousing costs associated with digital entertainment products and derive tens of billions annually in cost savings and increased profits.

PhotoChannel’s ideal revenue model calls for the company to receive a piece of every customer transaction. They’re cagey about exactly how much, but nobody balks at a “ballpark” figure of 10 percent. The potential growth multiple is dizzying, but to get the system rolled out to its fullest potential, the company knows it probably needs a much larger corporate partner to help leverage the technology. “It’s blue sky at the moment,” cautions Hall, “but from our point of view the ideal partner would be a media company or a company that understands media from a mass marketing point of view. InterActive Corp. or Microsoft come easily to mind, but I can imagine a host of others finding us attractive as well. We’re not restricting ourselves in any way.”

Meanwhile, PhotoChannel continues racking up new customers and inching towards profitability. In July, the company was selected by Bell Mobility, a division of Bell Canada, Canada’s largest telco, to provide on-line photofinishing for Bell’s cameraphones. As well, Costco and Ahold Group’s Stop and Shop/Giant Grocery store chain just signed on board. “The big names in the business now know they can trust us to deliver on our promises.” Hall says. “They’re starting to get the big picture. All digital media is becoming a much bigger part of our sales plans. I think they see they can take our photofinishing solution into music, movies and games. We can do it for them now. We’re ready. Now it’s just a matter of time before they realize they have to be there. When they do, our growth is going to be truly exponential.”

He admits that selling retailers on a comprehensive digital media platform has its challenges. Anything new generally does. But now that the company has completed a $1.5 million financing, Hall is confident they have the resources to finish what they’ve started. Besides, he adds, it took PhotoChannel a few years to finally get it right, so he can’t be too impatient with retailers. “Sometimes it takes a little while before you see that the answer to your problem is sitting right under your nose.”

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