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J&J Stops Babying Itself


The Corporation: Strategies

J&J Stops Babying Itself

It's cutting deals and tightening R&D to catch up with rivals

At Johnson & Johnson, managing for the long term takes on a whole different meaning. J&J Chairman and Chief Executive Officer Ralph S. Larsen is quick to point out its remarkably steady track record--posting average annual sales and net income growth of nearly 11%--over the past 100 years. That has made J&J seem as immutable as its decades-old brands of baby powder and baby oil.

But there's a thin line between being proud of your roots and getting stuck in the mud. And over the past two years, frustrated investors grew increasingly worried that J&J had fallen behind rivals in some key areas. The once-unfailing health-care products company suffered through a series of stumbles, including drug development flops and a battering in the coronary-stent business. J&J's annual sales growth slowed to 4.5% in 1998, and net income gained just 11% before charges, down from a 15.5% average pace for the past five years. "Last year was a wake-up call," says Steve Paspal, a senior analyst with John Hancock Funds, which owns nearly 1.2 million J&J shares. "I think it made them realize they had to do things differently."

That explains the rumbling you hear from within the New Brunswick (N.J.) health-care giant these days. Larsen and his team are cutting costs by overhauling J&J's far-flung factories, putting more stringent controls on drug development, and pursuing aggressive dealmaking to fill the pharmaceutical pipeline--capped by the $4.9 billion purchase of biotech company Centocor Inc. in July. Wall Street has voiced its approval. After lagging well behind major rivals for most of '97 and '98, J&J's stock price has risen 25% since Jan. 1, compared with a 1% drop for the Standard & Poor's Health Care Composite index.ONE-TIME BOOST. Look for more changes ahead. Analysts expect J&J to take further steps to patch up its drug portfolio and strengthen or divest weaker businesses, such as its $600 million diagnostic unit. It has little choice. This year looks strong, partly thanks to savvy marketing of drugs like the antipsychotic Risperdal and the anemia drug Procrit. But J&J is also getting a one-time sales boost from the $3.7 billion buy of orthopedic products maker DePuy Inc. Without another big deal, comparisons will get tougher. Salomon Smith Barney analyst Anne P. Malone expects sales in 1999 to jump 14.8%, to $27.2 billion, while net income rises 12.7%, to $4.1 billion. But Malone figures annual sales growth could soon slow, to around 10%, while earnings climb less than 13%.

Larsen won't comment on possible deals or divestitures, other than to say: "Are there businesses we are in today that we won't be in in five years? Sure." But Larsen--who's been with the company for 35 years and became CEO in 1989--insists there's no need to depart from the basic J&J model. For decades, the company has competed in a broad range of health-care businesses--from Band-Aids to surgical equipment--through scores of decentralized units. Indeed, while many competitors, including Pfizer Inc. and Eli Lilly & Co., have sold off medical devices and other businesses to focus on drug operations, Larsen pushed J&J into new areas such as cholesterol-lowering foods and high-tech wheelchairs.

Larsen argues that the mix gives J&J a healthy balance. Today, 36% of sales comes from drugs, 28% from consumer products, and 36% from professional health-care products like sutures and stents, the metal scaffolds that keep arteries open after angioplasty. But some are clearly far healthier than others. The fast-growing drug unit provides a hefty 60% of operating profits."OVERDUE." Moreover, the last two years raised serious questions about whether the J&J way was still working. The most dramatic problem was the company's failure to develop a good second generation of its pioneering coronary stent. Competitors such as Guidant Corp. and Medtronic Inc. jumped in with better stents, and J&J's business collapsed from $700 million in sales in 1996 to just over $200 million last year. Says Dr. Stephen N. Oesterle, director of invasive cardiology services at Massachusetts General Hospital: "They didn't anticipate how quickly this technology would move, and that physicians wouldn't be loyal." J&J is now getting ready to launch a more flexible stent in the U.S. that cardiologists say could help the company win some market share back.

As sales growth slowed last year, J&J had to face a more fundamental flaw. Despite waves of consolidation that have hit the industry in recent years, it had moved too slowly to trim its own sprawling network of factories. That led to last year's restructuring and J&J's first big operational write-off since 1986. Larsen says the overhaul was in the works for two years, and wasn't related to slowing sales. Still, by shuttering 36 out of 158 plants and cutting 4,100 jobs, J&J figures to save as much as $300 million a year. "This was overdue," says Andrew F. Morey, research analyst at State Street Research & Management Co., which holds nearly 2 million J&J shares.

More pressing, however, is the need to improve J&J's drug development machine. Nine drugs in development fizzled in testing, failed to get government approval, or were delayed in 1997 and 1998, says Morgan Stanley Dean Witter analyst Glenn M. Reicin. That gave J&J one of the industry's skimpier pipelines, he says. Here, too, the company's decentralized structure was partly to blame. J&J has two separate drug research and development operations, the R.W. Johnson Pharmaceutical Research Institute (PRI) in the U.S. and Janssen Research Foundation in Belgium. Each used to make its own decisions about which products to send into the costly final phase of human testing. But stricter oversight may have flagged problems that torpedoed late-stage products such as Pramlintide, a diabetes drug J&J invested more than $130 million to develop with partner Amylin Pharmaceuticals Inc. J&J pulled out last year after lackluster test results.

Now, J&J is moving in line with the way the rest of the drug industry handles R&D. In June, 1998, Larsen put William C. Weldon, an up-and-coming executive overseeing J&J's surgical-instrument unit, in charge of its pharmaceutical business. Weldon created one committee, which includes representatives from Janssen and PRI, to meet monthly for presentations from researchers on projects they would like to move along in testing. The group decides whether to give the O.K., ask for more information, or kill the project. Stephen S. Tang, vice-president at consultant A.T. Kearney Inc., says rivals have practiced such stringent decisionmaking for years. "They are playing a bit of catch-up here," he says. And it's critical that every dollar counts--J&J spends less on pharmaceutical R&D, $1.4 billion last year, than rivals Merck, at $1.8 billion, or Pfizer, at $2.3 billion.BOLD DEAL. It will be years, however, before changes in drug development pay off. So J&J has stepped up its dealmaking. The boldest deal was the purchase of Centocor. The biotech company brings promising expertise in monoclonal antibodies--which attack disease-causing agents in the body--as well as ReoPro, a heart drug, and Remicade, a drug for Crohn's disease. If Remicade, as expected, is also approved by the Food & Drug Administration for rheumatoid arthritis, J.P. Morgan & Co. analyst Michael N. Weinstein figures it could add more than $300 million to J&J's top line by 2001.

Shoring up the product lineup will become even more critical as J&J faces a major threat to the $2.1 billion anemia drug Procrit, which it licensed from Amgen Inc. in 1985. Late last year, an arbitration panel decided the deal didn't give J&J the rights to a next-generation Procrit that Amgen has in the works. If Amgen begins selling the new drug in late 2000, it is expected to eat into existing Procrit sales. J&J is developing its own new version, but is about a year behind Amgen.

If the folks at J&J are worried, they don't show it. And Larsen vows that the recent changes demonstrate the company learns from any missteps. "I can't recall the last business we got chased out of," he says. The more J&J embraces change, the better its chances of extending its growth streak another 100 years.By Amy Barrett in PhiladelphiaReturn to top


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