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."

Housenbold thinks customers will pay more for quality, and Shutterfly's high-end photo culture is on display at its two-story headquarters at the edge of San Francisco Bay. Big photos taken by employees dominate the lobby. Upstairs, on the walls, nearly everyone has giant photos of travel, the spouse and kids. Doug Galen, senior VP for business development, tears up showing off a copy of a photo book written by a 12-year-old cancer patient, who died soon after finishing it. Not all staffers are parents or star photographers, but as chief marketing officer Kathryn Olson says, potential hires had better be "passionate about telling a story." (The company's slogan is "Tell Your Story.")

The CEO certainly is. Housenbold graduated from Harvard Business School and cut his teeth in e-commerce as an executive at Web companies such as Raging Bull and AltaVista, and, finally, eBay, where he supervised mergers-and-acquisitions, and later was in charge of finding and keeping new customers. He sees Web commerce as just a new way to fulfill old human needs. That un-awed attitude once led him to tell CEO Meg Whitman that eBay wasn't "doing anything new"; he went on to quickly explain that e-commerce was a better form of the village marketplace. Whitman, he says, got his point, but urged him "not to tell the technology guys." (An eBay spokesman says Whitman doesn't recall the conversation.)

Once the yearbook photographer at Cedar Ridge High in Old Bridge, N.J., Housenbold now has 106,000 of his own photos on Shutterfly's Web site. His wife, Ruth, makes about 10 photo books a year, and stands as "a great proxy" for key customers—educated women with disposable income who serve as their families' "chief memory officer." With a Wharton degree and three boys, she has plenty of ideas, like adding a spell-checker to the text-writing functions for photo books.

To broaden online sharing, Shutterfly is trying to move into the burgeoning field of social networks. As Facebook and MySpace grew in recent years, niche photo players like Flickr and Photobucket morphed into giant sites for loading low-resolution shots to blogs, MySpace pages and elsewhere. Those sites aren't direct competition in the print or book business. "We are focused on driving traffic and monetizing through advertising," says Alex Welch, president of Photo-bucket, bought for a reported $250 million last year by News Corp., which also owns MySpace. Housenbold knows that while many Shutterfly customers don't want the whole world looking at photos of their kids, they may want to post a few photos on a networking site. Housenbold says that's fine. "Just like the Internet increased the consumption of news, the social networks are breaking down people's barriers to creating and sharing their own content."

The company is also working on products that allow users to tell their stories without leaving Shutterfly. Earlier this year it launched Shutterfly Gallery, a public Web forum where proud creators of photo books have posted more than 10,000 books since February. The point isn't just to encourage creativity, although "letting customers help each other is a natural extension of our brand," says Housenbold. It's meant to stimulate sales by allowing a customer to press a MAKE ONE LIKE THIS button to copy a cool template. Another initiative is Share, a free secure Web site based on technology from a $10 million acquisition of Nexo Systems earlier this year. Within a few minutes the HTML-challenged can create a Web site with news, weather, videos, member polls and other features, and invite as many—or as few—people to share it as they like. "Our customers want to share, but they want security and control, too," says Erik Weitzman, senior director of product strategy.

Social networking was a long way from the company's founding vision. Started in 1999 by legendary Silicon Valley entrepreneur Jim Clark—creator of Silicon Graphics, Netscape and Healtheon—the idea was to use the Web merely to facilitate digital-photo printing. The company had its own quaint nativity tale—it was birthed in a cramped office over a Jenny Craig center. The payroll swelled to 300 employees, and for a time the hallway optimists wondered when the company might be buying up Kodak. When the bust came, the company shrank to 70 employees, but survived in part due to Clark's continued funding. By late 2004 Shutterfly had been profitable for two years, so Clark and the board sought a new CEO to take the company public.

Housenbold came onboard in early 2005. He persuaded the board to call off the IPO. The company had the right idea, he said, but the culture was broken. The "nuclear winter" of the lean years had produced "a culture of survivorship," Housenbold says. "It was all about 'get as profitable as you can because some day you don't know if you're going to make payroll'."

What Housenbold offered instead was "a vision of what the company could be beyond photo-finishing." The first step: solidify its position as the high-end player. He broadened the product line (the catalog included only a few books and calendars) and forced the company to think broadly about photos as memories, stories and social connections. He also changed the culture to encourage risk-taking again. "Don't shoot people if they fail," he says. (The company finally went public in September 2006. Clark remains the largest shareholder, with 21 percent.)

Thanks in part to his eBay years, Housenbold boosted spending on user experience. He favors Web sites that involve what he calls "progressive discovery"—easy for a newbie but layered with features for old hands. For the CEO of an online company that successfully reinvented itself after just a few years in existence, that combination of new and old sounds about right. Even picture perfect.