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How Covidien Reinvented Itself and Thrived

For Richard Meelia, then president of billion-dollar medical devices and services maker Tyco Healthcare, 2002 turned into a long nightmare. That year, Dennis Kozlowski, CEO of parent company Tyco International (TYC) resigned amid a scandal involving lavish spending of corporate money. Kozlowski ended up in jail, the company's stock dropped dramatically, its credit rating was downgraded, and the Tyco name became tainted—creating significant obstacles to its strategy of growth through acquisition.

But as it turns out, the scandal proved to be a golden opportunity for Meelia. "I realized that if we didn't change the way that we managed and rewarded employees, which was based on earnings and cash flow, and if we didn't commit resources to innovation, we were going to be a 1%-to-2% grower and would lag the pack," he says. So he started agitating for a spin-off.

The Securities & Exchange Commission investigation and its fallout delayed it, but in June 2007, Tyco Healthcare became Covidien (COV), an independent publicly traded company headquartered in Dublin. (By that time, Tyco had regained its footing, if not its stock price, thanks to new management.) Meelia, named Covidien CEO, officially began the work of transforming an efficiency-driven company into one focused on innovation and growth.

Besting Blue-Chip RivalsToday, Covidien is a $10 billion company with 41,000 employees worldwide and a full innovation pipeline. Scott Flora, president of Covidien's surgical devices division, estimates that 80% of the company's sales growth last year came from new products. And the company was recently recognized by the Patent Board, a Chicago intellectual property research and consulting firm, with a No. 1 ranking on its Medical Products & Services Scorecard, an assessment of the top companies in the industry based on the strength of their recent innovations. That put Covidien ahead of Medtronic, Johnson & Johnson, and more than 100 other competitors around the world.

Meelia's first step in steering the newly independent company was to increase research and development funding to $260 million from $248 million in 2006. An increase of $12 million might not seem like much, but given that Meelia—a first-time CEO of a newly public company—faced an earnings drop for 2007, Wall Street would have been looking for cuts. Instead, he warned the earnings-hungry analysts to expect a loss. Ultimately, the company would report a net loss of $342 million for the year. Despite the red ink, Meelia again increased the budget—to $341 million—in 2008, and predicts: "We'll be at $600 million in two to three years."

But a generous R&D budget won't produce innovation if a company doesn't have the structure in place to manage innovation and the increased risk inherent in developing innovative products. To that end, Covidien had to make changes to everything from its product development process to its employee evaluation and compensation program.

To encourage more creative thinking on the front end of the product development process, says Paul Hermes, vice-president for global research and development, Covidien shifted the teams responsible for early product research at each of the company's three business units out of those units' product-development groups. Half of that new group's project budget is spent on many early-stage ideas, the other half on the few that prove most promising after initial development. All of these researchers are able to work without the get-to-market pressure common in a product development group.

Customer-CenteredAnother key change in the product development process was to consolidate the customer research that had previously been done within multiple departments. Now marketing handles a more robust process up-front. That, says Flora, has helped bring the "voice of the customer" into the innovation process.

For instance, one innovative product, developed in-house, is a surgical stapler preloaded with a reinforcing absorbable plastic. Customer research had shown that surgeons were putting tape-like strips on top of the staples to reinforce the closure in gastric bypass surgeries, an extra step that added 20 minutes of surgery. "One day I went to visit the guys in R&D, and they mentioned that they had a material they could put right onto our staples," says Flora. "I said: 'Why isn't this a product?'"

Ultimately named Duet TRS Reload, the reinforced stapler was one of 60 Covidien products launched in 2008-09. That compares with fewer than 20 launched in 2005-06. "When I joined [in 2006], we hadn't launched a product in six years," says Flora of output within the surgical division.

Booming SalesMeelia also made innovation one of the criteria used to measure performance and determine pay, with employees rewarded based on the sales and health impact of products they've worked on. And Covidien established an annual Innovation Awards program that gives cash awards to those behind successful projects. The most lucrative—the Chairman's Award—grants funding for a project of the winner's choice.

The financial results suggest Meelia's turnaround efforts are working. In 2008, one year after Covidien spun out, it reported $10 billion in sales, with $1.4 billion in net income. More telling, the company estimates net sales for 2010 to increase from 4% to 7%, despite the downturn.

"[Covidien] has returned to prominence in the medical device arena," wrote Morningstar analyst Alex Morozov in a report. "Over the past few years, as the company gained full control over its capital-allocation decisions, it was able to right its ship."
Scanlon is a Bloomberg Businessweek contributor.

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