C 186 CASE 24 JOHNSON & JOHNSON* On March 13, 2019, a California jury awarded $29 million to a woman who claimed that asbestos in Johnson & Johnson's (J&J) talcum- powder-based products caused her cancer. The verdict marked the latest in a series of legal challenges that the world's largest healthcare company has faced about the quality of its products. In addition to having to settle misleading claims about its hip implants, J&J now faces more than 13,000 talc-related lawsuits across the United States-claims that some of its products, such as Johnson's Baby Powder, contain traces of asbestos that can cause cancer. Even though such talc-based products account for a very small share of J&J's overall sales, the firm's image has long been tied to the purity of these products. These lawsuits have posed a serious problem for the well-established reputation of J&J that has been developed over many years. With 260 operating companies in virtually every country. J&J has managed to develop under its banner the world's largest medical device business, an even bigger pharmaceutical business and a consumer products division with a dozen megabrands from Neutrogena to Tylenol. The firm's reputation has been derived from its diversified businesses that have reflected its wide range of expertise and allowed it to develop a customer base spanning from consumers to hospitals to governments. In fact, the financial stability that has resulted from its range of businesses has been J&J's calling card for decades. Its sales have risen on regular basis, although profits have dipped a bit in recent years (see Exhibit 1 and 2). The firm has raised its dividend for well over 50 years and it remains one of only two U.S. companies with an AAA credit rating from Standard and Poor's. "They're in a great position," said Kristen Stewart, an analyst at Deutsche Bank. "They have the luxury of time and the ability to look at different opportunities across different business units. That is what a diversified business platform affords them. 2 EXHIBIT 1 Income Statement (in $ millions) Year Ending 2018 2017 2016 Total Revenue $81,581 $76,450 $71,890 Gross Profit 54,490 51,011 51,101 Operating Income 20.049 18,489 20.862 Net Income 15,297 1.300 16,540 Source: Johnson & Johnson, Annual Report 2018. EXHIBIT 2 Balance Sheet (in $ millions) Year Ending 2018 2017 2016 Current Assets $ 46,033 $ 43,088 $ 65,032 Total Assets 152.954 157,303 141,208 Current Liabilities 31,230 30,537 26,287 Total Liabilities 93,202 97,143 70,790 Stockholder Equity 59,752 60,160 70.418 Source: Johnson & Johnson, Annual Report 2017-2018. However, even as it has grown and become more diversified, J&J has struggled to find a way to manage its vast portfolio of diversified businesses. Much of its growth has come from acquisitions and it has developed a culture of granting considerable autonomy to each of the firms that it has absorbed. Although this was intended to cultivate an entrepreneurial attitude among each of its units, this has prevented J&J from instilling a strong set of controls, such as for quality standards. It has also prevented the firm from pursuing opportunities on which its various units could combine their different areas of expertise. Over the past decade, William C. Weldon, who spearheaded a period of dramatic growth at J&J, began to direct his efforts at trying to exert more control over its different businesses. After Alex Gorsky took over as CEO in 2012, he has pushed harder to try and weave together the operations of the different units. The need for greater oversight became more urgent after the firm ran into quality issues with some of its well-known products. But like Weldon, Gorsky realizes that it must try to find a balance between its new push for greater control with its traditional emphasis on autonomy throughout the organization. C 187 Cultivating Entrepreneurship Johnson & Johnson was founded in 1886 by three brothers named Johnson. The company grew slowly for a generation before Robert Wood Johnson II decided reluctantly to take the family business public. He fretted about the effects that market pressures would have on the company's practices and values that led him to write a 307-word statement of corporate principles. This spelled out that J&J's primary responsibility was to patients and physicians, followed by employees, and then by communities. Shareholders were placed last on the list. This credo is inscribed in stone at the entrance of the firm's headquarters and is still routinely invoked around the company. Over the years, as J&J has grown by acquisitions of firms engaged in some aspect of health care, it has been guided by its credo. The task has become more challenging as J&J has developed into an astonishingly complex enterprise, made up of over 260 different subsidiaries that have been broken down into three different divisions. The most widely known of these is the division that makes consumer products such as Johnson & Johnson baby care products, Band-Aid adhesive strips, and Visine eye drops. Its pharmaceuticals division sells several blockbuster drugs such as anemia drug Procrit and schizophrenia drug Risperdal. Its medical devices division is responsible for best-selling products such as Depuy orthopedic joint replacements and Cypher coronary stents. In particular, J&J's credo has kept the firm focused on health care, even as it has expanded into several different business segments. Furthermore, it has pushed the company to adopt a decentralized approach in managing its different businesses. Most of its far-flung subsidiaries across its three divisions were acquired because of the potential demonstrated by some promising new products in its pipeline. Each of these units was therefore granted near-total autonomy to develop and expand upon their best-selling products in order to better serve their patients (see Exhibit 3) EXHIBIT 3 Segment Information Johnson & Johnson is made up of over 260 different companies, many of which it has acquired over the years. These individual companies have been assigned to three different divisions. Geographic Areas Sales to Customers (Dollars In Millions) 2018 2017 2016 Consumer- United States $ 5,761 $ 5,565 $ 5,420 International 8,092 8,037 7,887 Total 13,853 13,602 13,307 Pharmaceutical - United States 23,286 21,474 20,125 International 17,448 14,782 13,339 Total 40,734 36,256 33,464 Medical Devices- United States 12,837 12,824 12,266 International 14,157 13,768 12,853 Total 26,994 26,592 25.119 Worldwide total 81,581 76,450 71,890 Business Segments Income Before Tax Identifiable Assets (Dollars in Millions) 2018 2017 2016 2018 2017 Consumer $ 2,320 2,524 2.441 25,877 25,030 Pharmaceutical 12,568 11,083 12,827 56,636 59,450 Medical Devices 4,397 5,392 5,578 46,254 45,413 Total 19,285 18,999 20,846 128,767 129,893 Less: Expense not allocated to segments 1,286 1,326 1,043 General corporate 24,187 27,410 Worldwide total 17,999 17,673 19,803 152,954 157,303 Source: Johnson & Johnson, Annual Report 2018. It is widely believed that this independence has fostered an entrepreneurial attitude that has kept J&J intensely competitive as others around it have faltered. The relative autonomy that is accorded to the business units has also provided the firm with the ability to respond swiftly to emerging opportunities. A strong enough commitment from everyone throughout these units to the principles that have been laid out in the credo were considered to be sufficient to provide the necessary direction. J&J has actually been quite proud of the considerable freedom it has given to its different subsidiaries in order to develop and execute their own strategies. Besides developing their strategies, these units have also been allowed to work with their own resources. Many of them have even been able to operate their own finance and human resources departments. While this degree of decentralization has led to relatively high overhead costs, none of the executives that have run J&J-Weldon included-had ever thought that this was too high a price to pay. J&J is a huge company, but you didn't feel like you were in a big company," recalled a scientist who used to work there." Pushing for More Collaboration The entrepreneurial culture that Johnson & Johnson developed over the years has clearly allowed it to show a consistent level of high performance. Indeed, J&J has top-notch products in each of the areas in which it operates. It has been spending heavily on research and development for many years, taking its position among the world's top spenders (see Exhibit 4). It has been spending about 12 percent of its sales on about 9,000 scientists working in research laboratories around the world. This allows each of the three divisions to continually introduce promising new products, EXHIBIT 4 Research Expenditures (in $ millions) 2018 $10,775 2017 10,549 2016 9,095 2015 9,046 2014 8,494 2013 8.183 2012 7,665 2011 7,548 2010 6,864 2009 6,986 2008 7,577 2007 7,680 Source: Johnson & Johnson, Annual Report. In spite of the benefits that J&J has derived from giving its various enterprises considerable autonomy, there have been growing concerns that they can no longer be allowed to operate in near isolation. Shortly after Weldon had taken charge of the firm, he realized that J&J was in a strong position to exploit new opportunities by drawing on the diverse skills of its various subsidiaries across the three divisions. In particular, he was aware that his firm may be able to derive more benefits from the combination of its knowledge in drugs, devices, and diagnostics, since few companies were able to match its reach and strength in these basic areas. This had led Weldon to find ways to make its fiercely independent units to work together. In his own words: There is a convergence that will allow us to do things we haven't done before.** Through pushing the various far-flung units of the firm to pool their resources, Weldon had believed that firm could become one of the few that may actually be able to attain that often-promised, rarely delivered idea of synergy. In order to pursue this, he created a corporate office that would get business units to work together on promising new opportunities. "It's a recognition that there's a way to treat disease that's not in silos," Weldon stated, referring to the need for collaboration between J&J's largely independent businesses." 5 For the most part, however, Weldon confined himself to taking steps to foster better communication and more frequent collaboration among J&J's disparate operations. He was convinced that such a push for communication and coordination would allow the firm to develop the synergy he was seeking. But Weldon was also aware that any effort to get the different business units to collaborate must not quash the entrepreneurial spirit that had spearheaded most of the growth of the firm to date. Jerry Caccott, managing director consulting firm Strategic Decisions Group, emphasized that cultivating those alliances would be challenging in any organization, but particularly in an organization that has been so successful because of its decentralized culture." These collaborative efforts did lead to the introduction of some highly successful products (see Exhibit 5). Even the company's C188 fabled consumer brands have started to show growth as a result of increased collaboration between the consumer products and pharmaceutical divisions. Its new liquid Band-Aid is based on a material used in a wound-closing product sold by one of J&J's hospital- supply businesses. And J&J has used its prescription antifungal treatment, Nizoral, to develop a dandruff shampoo. In fact, products that have developed in large part out of such a form of cross-fertilization have allowed the firm's consumer business to experience considerable internal growth. 10 C 189 EXHIBIT 5 Significant Innovations Antiseptic Surgery (1888) Three brothers start up a firm based on antiseptics designed for modern surgical practices. Band-Aids (1921) Debuts the first commercial bandages that can be applied at home without oversight by a professional. No More Tears (1954) Introduces a soap-free shampoo that is gentle enough to clean babies' hair without irritating their eyes. Acuvue Contact Lenses (1987) Offers the first-ever disposable lenses that can be worn for up to a week and then thrown away. Sirturo (2012) Gets approval to launch a much-needed treatment for drug-resistant tuberculosis, the first new medication to fight this disease in more than 40 years. Source: Bluestein, Will Johnson & Johnson's New Innovation Centers Point The Way Toward Its Future! Fastcompany, February 10, 2014 Facing Quality Concerns Even as Johnson & Johnson has been trying to get more involved with the efforts of its business units, it ran into problems with quality control with two of its divisions. Its medical devices division had run into problems with its newest artificial hip. Although it did eventually recall the device, it was not before rumors had begun to circulate that company executives may have concealed information out of concern for firm profits. The problems with the medical devices unit were compounded by serious issues that arose with the consumer products unit, which led it to recall many of its products-including the biggest children's drug recall of all time. Quality problems have arisen before, but they were usually fixed on a regular basis. Analysts suggest that the problems at J&J's McNeil division may have exacerbated in 2006 when J&J decided to combine it with the newly acquired consumer health care unit from Pfizer. The firm believed that it could achieve $500 to $600 million in annual savings by merging the two units together. After the merger, McNeil was also transferred from the heavily regulated pharmaceutical division to the marketing driven consumer products division, which was not subjected to the same level of quality control. Much of the blame for J&J's stumbles fell on William C. Weldon who stepped down as CEO in April 2012 after presiding over one of the most tumultuous decades in the firm's history. Critics said the company's once vaunted attention to quality had slipped under his watch. Weldon, who had started out as sales representative at the firm, was believed to have been obsessed with meeting tough performance targets, even by cutting costs that might affect quality. Erik Gordon, who teaches business at University of Michigan elaborated on this philosophy: "We will make our numbers for the analysts, period, "7 In April 2012, J&J appointed Gorsky to lead the healthcare conglomerate out of the difficulties with quality that it had faced over the past few years. He had been with the firm since 1988, holding positions in its pharmaceutical businesses across Europe, Africa, and the Middle East before leaving for a few years to work at Novartis. Shortly after his return to J&J in 2008, he took over its medical devices unit that made the problematic hip implants. Since he took over, Gorsky has been dealing with the various lawsuits the firm faced over the problems with its hip replacements, paying out over $2.5 billion in settlements. Even as J&J was trying to get over its problems with the hip implants, there were rising concerns about the asbestos that might have contaminated its talcum powder-based products. Memos that were obtained during the court cases revealed that the firm may have known about this problem for years, but it tried to deny the charge and downplay any possible health threats from the use of their Baby Powder and other similar products. This ongoing with quality issues also forced Gorsky to find ways gain more oversight over the firm's 260- odd units. As such, he wanted to push further than Weldon to work with the various units of the firm to establish standard practices that would allow the firm to pursue opportunities without posing risks to the firm's long-established reputation. C 190 Pushing for Tighter Integration In order to gain more oversight over all of its units, Gorsky lured Sandra Peterson from Bayer and gave her the position of group worldwide chairman. The newly created position gave Peterson sweeping responsibly to oversee technology across the entire firm. Gorsky believed that the very nature of the job required him to hire an outsider who had not had much exposure to J&J's existing culture. Because decentralization had allowed each of the business units to make all of their own decisions, there had been no consistency in their different practices. Gorsky wanted to bring order to this unwieldly machine. "Sometimes a customer doesn't want to deal with 250 J&J's" he said. "O Peterson worked feverishly to align everything from HR policy to procurement processes from the 250 business units that had been making their own decisions independently. She covered everything from the timing of financial forecasts to employee car policies. She also consolidated all of the firm's dataall of its 120,000 employees to a single HR database. Her efforts to process tons of data each day led to the creation of a warehouse, which contained upwards of 500 terabytes of data. By the time Peterson decided to leave J&J in October 2018, she claimed that her streamlining process would save the firm about $1 billion. A far more significant effort had already been initiated by Paul Stoffels when he was appointed J&J's global head of pharmaceuticals a few years ago. All of the units that operated within the pharmaceutical division had also operated with complete autonomy. In particular, J&J's seven different drug R&D organizations had operated in completely siloed fashion. In some cases, multiple companies pursued the development of the same drugs and each had its own system for handling clinical or regulatory development. Stoffels began to merge all of the units under his purview into one group and organized it to target 11 different diseases. In the process, 12 of the division's 25 facilities were shuttered and nearly 200 projects were slashed. This new integrated unit developed a streamlined development process, a highly coordinated system that Stoffels calls Accererando. Under this model, global teams statisticians in China, data managers in India, regulatory folks in Europe-work 24/7 to speed drugs to market. The assembly-line approach has cut months and, in some cases, years off the development time. Its increase in drug approvals over the past decade have put J&J in a league of its own. No other company has come close to that," said Bernard Munos, a pharmaceutical innovation consultant." Stoffels has accomplished more than just reducing the time needed to bring drugs to market. He has begun to look for ideas from all sources, whether it is from any of J&J's own business units or from entrepreneurs or scientists outside the firm. He has set up four innovation centers in biotech clusters-Cambridge, MA; Menlo Park, CA; London; and Shanghai-around the world, places where scientific entrepreneurs can interact with J&J's own drug and technology scouts. His flexible approach with these outsiders lets J&J work with them more casually and helps build stronger relationships. Since 2013, the firm has reviewed more than 3,400 opportunities through these centers, leading to 200 partnerships. Is There a Cure Ahead? Gorsky's biggest challenge came from a demand that Johnson & Johnson might be better off if it was broken off into smaller companies, perhaps along the lines of its different divisions. There were growing concerns about the ability of the conglomerate to provide sufficient supervision to all of its subsidiaries that were spread all over the globe. Gorsky dismissed the proposal, claiming that J&J drew substantial benefits from the diversified nature of its businesses. Given the enormous shifts in the healthcare industry and the large number of government and institutional customers and partners involved, he believes that the firm's huge scale could be a rare asset for negotiating deals. In support of this belief, Gorsky has pointed to J&J's recent acquisition of Auris Health for approximately $3.4 billion in cash. The acquisition will accelerate the firm's entry into surgical robotics and other interventional applications that have shown considerable potential for growth. "We believe the combination of best-in-class robotics, advanced instrumentation, and unparalleled end-to-end connectivity will make a meaningful difference in patient outcomes," said Ashley McEvoy, executive vice president, who is in charge of J&J's medical devices division." In another step, the firm has been working on an app in collaboration with Apple for its watch that can provide better data on cardiac issues. Even as Gorsky plots a course for the future of J&J, he is aware that its stock has been struggling recently because of some slower-growing segments of its business. He realizes that it may not be possible to count on much growth from its existing model that grants considerable autonomy to each of its businesses. Above all, he feels strongly that he must provide more direction for these units, partly to encourage them to collaborate with each other in order to pursue emerging opportunities. He also understands that it is critical for J&J to take steps to develop sufficient controls that can minimize future problems with quality control. Overall, it is clear that the healthcare giant has to rethink the process by which it manages its diversified portfolio of companies in order to ensure it can keep growing without creating issues that can pose further threats to its reputation. This is a company that was purer than Caesar's wife, this was the gold standard, and all of a sudden it just seems like things are breaking down," said William Trombetta, a professor of pharmaceutical marketing at Saint Joseph's University in Philadephia." Identify and discuss the diversification efforts of Johnson & Johnson. 1. Type: What type of diversification is J&J pursuing (related, unrelated)? Explain this is the context of J&J and their history. (10 percent) 2. Actions: In what ways has J&J pursued a value enhancing/creating diversification path? In what ways, has the firm pursued diversification for non-value enhancing reasons? (40 percent) 1. Identify at least two specific actions as they managed the acquisition process that could be considered value enhancing and two that could be considered non-value enhancing, utilizing the textbook categories for support. 3. Acquisition Challenges: As J&J pursues future acquisitions, what are the pitfalls in the acquisition process that J&J needs to avoid that is most relevant to their processes? What conditions would have to be present in the acquisition or motivations of J&J for the acquisition to fail to create value? (30 percent) 4. Recommendation: What further recommendations would you have for J&J? Make specific, meaningful recommendations that build from the analysis above. (20 percent)