Shutterfly: It’s Picture Perfect

Jeana Scholl is a typically dedicated Shutterfly customer. That's why the young San Jose, Calif., mom has driven to the company's Silicon Valley headquarters 20 miles up the freeway to spend an hour as a guinea pig. While researcher Eugene Chen watches through a two-way mirror in the company's "Usability Lab," Scholl tries to figure out how to assemble a 20-page photo book using new online features. Sitting at a PC, Scholl navigates easily. Still, "she's having a hard time finding the ADD PAGES button," says Chen. In the end, Scholl gets through the sequence just fine—and seems to favor the new look of her photo book. "It's a bigger view, more in-your-face," says Scholl. "The more options, the better."

Obsessing over what customers want and constantly offering more options have helped transform Shutterfly from a mere survivor of the dotcom bust to a premium online photo-printing and merchandise site with revenues of $187 million last year. Led by CEO Jeff Housenbold, the nine-year-old company in Redwood City, Calif., has branched out from standard 4x6 photos into a range of related products: do-it-yourself photo books of various complexity, holiday cards and wedding announcements. Now styling itself a "social expression and personal publishing company," the onetime Web 1.0 upload-and-printing site is planting a cautious foot in the 2.0 world of social networking. The goal: to enable customers to find new ways to share photos and memories, as well as to allow Shutterfly to compete in an industry with two Goliaths. "We'd like to be a household name like Starbucks and Whole Foods," says Housenbold.

First, though, he's got to grapple with household names like Kodak and Hewlett-Packard. Those two giants control Shutterfly's two main competitors, Snapfish, bought by HP in 2005, and Kodak Gallery, a division of Kodak that began as the start-up Ofoto. Together, Shutterfly, Snapfish and Kodak Gallery control about 85 percent of the online photo and merchandise market, according to InfoTrends, which last year said Shutterfly eked ahead in revenue. (Snapfish and Kodak Gallery dispute that, but as divisions of larger companies, they don't provide revenue or earnings data.) All three companies seek to expand beyond photo-printing. Their battle is still mostly over women, who are about three quarters of the customers, most in the 25- to 44-year-old category, says Housenbold.

The 38-year-old Housenbold, who took over in January 2005, has succeeded by positioning the company as a premium brand. His strategy has been to leverage a high-quality printing operation into high-priced "adjacent markets" like photo books, calendars, mugs and greeting cards. It's not that 4x6 prints aren't profitable—the margins are roughly the same across product lines. But making a few dollars on a $10 photo order doesn't boost the bottom line, like, say, the profits on the sale of a 20-page, 12x12 book priced at $54. (Jimmy Carter's foundation and Beyoncé's record label are among the customers for photo books.) Shutterfly has now added stationery and baby announcements. The company has also teamed up with another firm to offer "digital scrapbooks" for customers; that market alone is worth $2.9 billion.

Despite the competition, Shutterfly has done well. Revenues jumped 51 percent in 2007, with 2.4 million customers. For the first time, books and merchandise revenues topped photo-printing. Margins ran to 55 percent, thanks to premium pricing and lower manufacturing costs because the company owns its production facilities (in Hayward, Calif., and Charlotte, N.C.). "We believe we are the only one that's profitable," says Housenbold. The stock, initially offered at $15 in 2006, jumped to $37 last year but sank back to about $13 earlier this month, in part because of concerns about a decline in consumer spending.

The big players all offer mugs and key chains, so Housenbold is determined to stay a step ahead on quality and ease of use. That's why Housenbold created a "war room"—a large windowless space with floor-to-ceiling white boards to hang side-by-side comparisons of marketing tools, Web pages and the products themselves. "We compare print quality every week," he says. Each company has advantages. Kodak Gallery aims to leverage its famous name in prints with new products like a digital picture frame that, for an extra $25, comes with a preloaded memory card of your photos. HP's Snapfish has deals with retailers that help to move printers and ink. And Snapfish is the volume player, churning out more than 1.5 billion photos last year. When Snapfish slashed the price of 4x6 color prints to nine cents at Christmas (it's 15 cents at Kodak and 19 at Shutterfly), its sales jumped. Shutterfly is a "niche player," says Kevin Frisch, Snapfish's VP of marketing and sales. "It's not a little bit more expensive. It's a lot more expensive."