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THERE MAY NOT BE MUCH CONFETTI AT MILAN PANIC'S HOMECOMING
ICN Pharmaceuticals has been doing just fine without its founder
When more than 300 General Electric Co. appliance division suppliers assembled in a cavernous ballroom at the Hurstbourne Hotel outside Louisville, Ky., last November, most were apprehensive. But they were hardly expecting the jolt that GE had prepared for them. Executives at the meeting announced "Target 10," a draconian initiative aimed at slashing the appliance unit's supplier costs by 10% annually, starting in 1993. Suppliers would get help from GE in finding savings, but those that didn't go along would probably lose GE's business. And with appliance margins slim and price-cutting fierce, declared appliance unit President J. Richard Stonesifer somberly: "We see no relief in sight."
Today, GE's new cost-saving intiative is in full swing, and many of its contractors are struggling to find ways to cope. A few have resisted. But they're bucking a trend that's quickly gaining momentum. Across America, in industries big and small, companies are giving their suppliers a blunt message: Cut, cut, and cut some more.
General Motors Corp.'s cost-slashing messiah, J. Ignacio Lopez de Arriortua, brought the issue to the fore when he very publicly demanded double-digit price cuts from GM suppliers last year. Now, a legion of big-name U.S. concerns, including AlliedSignal, IBM, Dow Chemical, and DuPont are playing variations on the cost-slashing theme. While the companies all say they are seeking "cooperation" with suppliers, a few are clearly taking the get-tough, Lopez approach. United Airlines Inc. has demanded that suppliers come up with cost cuts of 10% or more. And at GE, Chairman John F. Welch Jr. is leading a companywide drive to slash supplier costs. The Hurstbourne meeting, as recorded in a videotape made by GE and obtained from a supplier by BUSINESS WEEK, shows that GE's demands are hardly mild.
BOOMERANG. For Corporate America's suppliers, there's often no alternative but to go along. The cost of purchased materials accounts for more than 50% of most manufacturers' expenses (chart), so suppliers know it's the main place big companies must cut. Despite the steady recovery in the U.S. economy, vicious price competition and customer demands are forcing the companies to browbeat, cajole, and beg contractors to cut costs. And they're never satisfied. The message, says Alexander A.C. Wilson, director of U.S. manufacturing at IBM's personal-computer company: "20%, 20%, 20%--continual price reductions."
The trend, moreover, is already going global. In Germany, auto maker Mercedes Benz recently announced an overhaul of its supplier relations. And rival Volkswagen in early March asked some suppliers for price cuts of at least 5%. Now, ailing VW also may be courting Lopez for a top spot. Lopez has said that he's happy at GM, though he hasn't shut the door on a move. VW won't comment, though it says it will consider personnel changes at a Mar. 16 board meeting.In any case, Volkswagen is already showing just why Lopez would feel at home there. At one recent meeting with suppliers, new Chairman Ferdinand Pi ech was confronted by a supplier who insisted he couldn't afford a 5% price cut. Attendees at the meeting say Pi ech, an engineer by training, turned to one of his engineers and asked if the supplier improved VW's mileage. Told no, Pi ech replied: "O.K., let's do without them."
Few companies, however, are so closely following the GM formula. Though GM denies it, suppliers say Lopez alienated many of them by rebidding long-term contracts, offering greater volumes but sometimes ditching old partners for low-ball bidders. While acknowledging that GM needs big changes, Robert Cizik, chief executive of Cooper Industries Inc., a big Houston parts supplier, calls that a "caveman" approach.
The cutting at GM may be having a punishing boomerang effect. Several suppliers claim, for instance, that they're now pulling back on research for future GM parts. They also claim they will turn over new ideas to Chrysler Corp. or Ford Motor Co., which take the more cordial approach of forging tight cooperative relationships with their suppliers. GM says it isn't aware of a problem. But a spokeswoman adds that suppliers who cut needed research and development, "won't be doing business with GM much longer."
That could be a big advantage for rivals. Thomas T. Stallkamp, Chrysler's vice-president for procurement and supply, says his company is mainly interested in attacking "system costs" by working with suppliers so vehicles can be made more cheaply. And the approach is working: One castings supplier went so far as to recommend that the intake manifolds he made could be replaced by plastic, saving Chrysler $3 a car. That cost him the business, since he didn't make plastic parts. But he was rewarded with new orders for suspension components.
Such "partnering" has been a buzzword for some time. Companies such as Xerox, Motorola, Ford, and DuPont in the 1980s built ties that involved suppliers in product design and troubleshooting. But, says James P. Kuhn, a vice-president at A.T. Kearney Inc., there was a "relaxation, almost imperceptible, of demands by customers for price competitiveness."
Now, companies such as DuPont Co., which forged close ties with many of its contractors, are asking vendors for more. In January, DuPont told suppliers it needed 5% in cost cuts this year, through lower prices or savings through process changes. DuPont isn't scrapping its partnerships, but Philip J. Keller, a company procurement-process manager, wants to keep the pressure on. "We don't want to get fat, dumb, and happy," he says. The goal, he adds: "to keep us both from getting flabby."
NO BEATING. Other large corporations are also trying to build on the relationships they forged during the 1980s. Crown Equipment Corp., a maker of forklift trucks, sent out a letter in late February, asking its top suppliers to ferret out savings and offer price cuts, though it specified no exact percentage. Crown isn't trying to "beat suppliers over the head," says its purchasing manager, Mark Gagle.
And the partnering trend isn't going to let up any time soon. AlliedSignal Inc. says it plans to drop 80% or more of its 10,000 suppliers over the next three years as a prelude to building closer ties with those that remain.
Of course, all these painful changes do have a bright side. Consumers benefit, for one thing. Georgia State University economist Donald Ratajczak says reduced supplier costs are one big reason inflation will remain low, because the cuts are usually passed along to consumers in lower prices.
But the penchant of some companies for hammering very hard on suppliers worries some pioneers of partnership. "I think it's a little early to judge," says former Motorola Inc. purchasing chief Ken Stork. "But I'd share a concern that things are headed in a negative direction." Many suppliers also have that worry. As one auto-supplier executive moans: "I'm preparing for the worst year of my life." And it's only March.
Somebody had better check the North American Free Trade Agreement's pulse.
When George Bush left office, the pact looked healthy. It was expected to glide through Congress, adorned with a few side accords to meet critics' concerns. Supporters hoped the agreement would trigger a trade boom and spawn similar market-opening pacts throughout the hemisphere.
But as U.S., Mexican, and Canadian negotiators plan for a Mar. 17 meeting in Washington to hash out the final details, the agreement is on life support. Some of the Clinton Administration's core constituencies want to kill it. Conflicts within the Administration may hamper a unified strategy for curing some of the agreement's ills. What's more, investor jitters about Mexico's prospects without the deal and upcoming elections in Canada pose further threats to the Yukon-to-Yucatan accord. "NAFTA is in trouble," says Robert L. McNeill, executive vice-chairman of the Emergency Committee for American Trade, a supporter of the agreement.
One reason is a shift in American public sentiment. Last year, polls showed approval of the pact running more than 2 to 1 among the small number of people who knew about it. But as familiarity has grown, so has opposition. With slightly more than half of American voters now saying they are aware of NAFTA, opponents outnumber supporters, according to recent polls. That reflects fears that American jobs will be lost to low-cost labor in Mexican plants.
Rising opposition is galvanizing a lobbying effort on Capitol Hill. Key Clinton supporters such as unions, environmentalists, and minorities are griping. And lawmakers are listening. "What our big businesses want to do is make products down there with cheap labor and sell them on the open market," complains House Small Business Committee Chairman John J. LaFalce (D-N.Y.). "Who benefits from that?"
STRAY PACT. To win passage, the Administration will have to become far more aggressive than it has been up to now. Although Clinton has endorsed NAFTA, there are lingering doubts about how committed he is to George Bush's deal. "This Administration didn't negotiate NAFTA," says U.S. Trade Representative Mickey Kantor. "Our challenge is to strengthen this agreement and make it acceptable to the public."
To assuage opponents, the Administration plans to negotiate a series of supplemental treaties governing worker rights, environmental safeguards, and protection against import surges. But internal splits could hurt these efforts. The Commerce, State, and Treasury Departments want a toothless trinational panel to monitor abuses and publicize them. But more hawkish Labor, Interior, and the Environmental Protection Agency want arbitration panels in each area that could impose stiff penalties and even confiscate goods if companies fail to adhere to standards.
The Administration faces a delicate task. If the supplemental accords are too strict, they could embarrass the ruling Mexican Institutional Revolutionary Party (PRI), which is counting on NAFTA to give the Mexican economy a boost. "We've got a big problem here," says one senior U.S. official. "It's hard to follow through without being horribly intrusive or allowing countries to harrass each other."
The uncertainty over NAFTA, which is supposed to take effect Jan. 1, 1994, already is making investors nervous. Outsiders are waiting for ratification before making the additional investments in Mexico desperately needed by the government of President Carlos Salinas de Gortari. "We need a bit of good news to cure these jitters," worries Mexican economist Luis Pazos. "People in Washington appear to be listening mainly to lobbies and ignoring the medium- and long-term benefits for the American consumer."
LONG ROAD. Even if NAFTA is approved on Capitol Hill by the end of the year, its ultimate prospects are murky. While Canadian Prime Minister Brian Mulroney's Conservative government has reaffirmed its intent to push NAFTA through Parliament by June, it must call national elections this fall. And the Conservatives are currently running 28 points behind the opposition Liberals, who vow to push for reopening the highly unpopular agreement if they win. Their beef: They want a precise definition of subsidies in the agreement to stop the endless U.S.-Canadian skirmishes over Canadian exports. "The longer-term success of free trade depends on the ability to define what a subsidy is," says Liberal Member of Parliament Roy MacLaren, the party's chief trade critic.
Despite the dangers of the Clinton Administration's high-wire act, few experts believe NAFTA will collapse. "That would seriously disrupt the whole Mexican economic game plan," says Bernard W. Aronson, outgoing Assistant Secretary of State for Inter-American Affairs. He notes that in anticipation of NAFTA, much of the rest of Latin America has been moving toward free-trade pacts that could eventually link the entire Western hemisphere.
That has always been the dream. But achieving a North American free-trade pact still will require delicate surgery in the side deals. And even then, Canada's allergic reaction makes it far from certain that NAFTA will survive for long. Somebody get a respirator--quick.
As a rookie diplomat, Milan Panic was a bust. Just six months after taking a sabbatical from ICN Pharmaceuticals Inc., the Costa Mesa (Calif.) drug company that he founded in 1960, Panic was ousted as Prime Minister of Yugoslavia. Civil war continues to rage in his native country, undeterred by his efforts to galvanize the Serbian opposition and move the country to a market economy.
Panic returns to ICN this month, but this homecoming may not be any more fruitful. Despite a sales decline of 9% in the third quarter, ICN's stock price has soared 83% since January, to $11. Prospects are good--so good, in fact, that some investors would just as soon see the 63-year-old Panic (pronounced PAHN-ish) stay in Yugoslavia.
A BRAWL? Indeed, shareholders are leaving open the possibility of a proxy fight for control of ICN's board. "Most professional investors would like to see a change in management, and we'd support anyone who would propose a more independent slate" of directors, says John Kaweske, a portfolio manager at Invesco Trust Co., whose funds own an estimated 6% of ICN. Adds Seth Glickenhaus, a New York money manager and ICN investor: "There's been a welling disaffection with Panic, and I would guess that there's going to be some sort of struggle over his return."
Panic's tenure at ICN has been long on controversy. Over the years, the drugmaker has had numerous spats with shareholders, the Securities & Exchange Commission, and the Food & Drug Administration. Two years ago, it paid a $600,000 fine to the FDA and signed its second SEC consent decree--both without admitting fault--over the promotion of its flagship drug, the antiviral Virazole, an AIDS treatment.
These days, investors are upset that Panic would abandon the company for a fling in international politics, however well-intentioned. They're also upset that ICN's board continued to pay his $620,000 annual salary while he was on leave. That perk reawakened feelings among investors that Panic has long run ICN and its subsidiaries as a private fiefdom. Panic, traveling in Europe, was not available to be interviewed.
"Institutions are fed up that the board continually replenishes Panic's pocket with options year after year," says Steven B. Reid, health-care analyst at H.J. Meyers & Co. The Beverly Hills brokerage in February managed a stock offering that netted $9 million for Viratek Inc., ICN's 78%-owned research subsidiary. "And they're very unhappy that he continually sells stock on the open market to support his lavish lifestyle," he adds. Most recently, Panic in January cashed in $2.9 million worth of ICN options, then sold the shares.
But investors are bullish on ICN. One big reason: the company's push into Eastern Europe. "ICN is leading the charge of Western companies by providing quasi-commodity pharmaceuticals" to the region, says veteran drug analyst Samuel D. Isaly of New York's Mehta & Isaly.
In May, 1991, SPI Pharmaceuticals Inc., ICN's half-owned drugmaking and marketing subsidiary, bought 75% of Yugoslavia's biggest drug company, Galenika--and rewarded Panic with $5.4 million in SPI stock. Galenika soared in its first year under SPI, then lost 56% of its sales to the war and the onset of U.N. sanctions. Now, SPI is within weeks of formalizing a similar deal in Russia. It has signed a letter of intent with a Polish drug concern and has had discussions with Hungarian companies.
ALLURING VOWS. Investors are betting even more on renewed interest in ICN's proprietary ribavirin. One of the few broad-spectrum antiviral agents, ribavirin--ICN's Virazole--seems well on the way to FDA approval for the treatment of hepatitis C. Analysts say that ICN could apply for FDA approval as early as yearend. Approval could add $500 million to ICN's annual sales.
Wall Street, of course, has heard such alluring promises before. The difference? This time, they're coming from scientific meetings and professional journals, instead of from the hastily called press conferences often favored by Panic. Suddenly, Virazole's prospects looks a whole lot more promising. Indeed, at ICN these days, it's Panic's future that's up in the air. Kevin Kelly in Chicago and Zachary Schiller in Cleveland, with James B. Treece in Detroit and Bureau Reports; Douglas Harbrecht in Washington, with Geri Smith in Mexico City and William C. Symonds in Toronto; Larry Armstrong in Los Angeles