Johnson & Johnson Case Study

On January 26, 2011, health care conglomerate Johnson & Johnson announced that earnings had declined in the fourth quarter of the previous year, and lowered its estimates for its earnings for 2010. The firm claimed that the weaker results could be attributed to the depressed economy and to a string of product recalls. Sales figures do indicate that Johnson and Johnson has clearly been hurt by 17 recalls since September 2009, covering several over-the-counter medicines, a batch of contact lenses and some hip replacements.

The most serious problems have surfaced at McNeil Consumer Healthcare, which has had to recall many of its products, including one for an estimated 136 million bottles of children’s Tylenol, Motrin, Benadryl and Zyrtec – the biggest children’s drug recall of all time – that were potentially contaminated with dark particles.

Johnson & Johnson has been excoriated by the Food and Drug Administration for failing to catch McNeil’s quality problems. The agency slapped one of McNeil’s plants with a scalding inspection report, causing the company to close down the factory until 2011.

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In response to these problems, Johnson & Johnson recently announced that it intended to revamp its quality controls, creating a single framework for its consumer, pharmaceutical and medical device divisions. Ajit Shetty, the corporate vice president responsible for supply chain operations, will oversee the new system, reporting directly to William C. Weldon, the firm’s chief executive. The company said it also planned to appoint chief quality officers for each of its three major divisions.

The decision to create a more centralized form of quality control was a difficult one for Weldon.

The firm has relied heavily on acquisitions to grow over the years, resulting in a collection of as many as 250 different operating companies that are spread over 60 countries. Johnson & Johnson has been committed to providing each of these units as much autonomy as possible in order to preserve an entrepreneurial culture throughout the organization. “The company really operates more like a mutual fund than anything else,” commented Pat Dorsey, director of equity research at Morningstar.1

In spite of the benefits that Johnson &Johnson may derive from such an arrangement, Weldon had already been thinking about taking steps to be more actively involved with its far flung business units. He recently told investors that he has been particularly concerned about pushing for more internal growth: “We’ll come at it from a variety of different ways, to accelerate top and bottom-line growth.”2 Given the scope of the businesses that J&J manages, he believes that the best opportunities may come from increased collaboration between its different units. But even as he has been pushing for some form of stronger direction for its units, Weldon does not want to threaten the strong entrepreneurial spirit that has been the basis of much of its success. The concerns over quality control have pushed the firm to try to find a more effective method of running its businesses without stripping them of their relative autonomy.

Case developed by Jamal Shamsie, Michigan State University. Material has been drawn from published sources. To be used for purposes of class discussion. Cultivating Entrepreneurship

Johnson & Johnson has relied heavily upon acquisitions to enter into and to expand into a wide range of businesses which fall broadly under the category of health care. Over the last decade alone, the firm has spent nearly $50 billion on 70 different purchases. Since 2008, J&J has made eight acquisitions, including a $1.1 billion acquisition of Mentor Corporation, a leading supplier of products for the global aesthetic market. The acquisition allowed the firm to make substantial move into the growing field of cosmetic drugs and devices. “It’s a natural extension of where J&J would want to go,” said Michael Weinstein, an analyst who specializes in the medical sector for J.P. Morgan Chase & Company.3

As it has grown, Johnson & Johnson has developed into an astonishingly complex enterprise, made up of over 250 different businesses 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. The division grew substantially after J&J acquired the consumer health unit of Pfizer in 2006 for $16.6 billion, the biggest in its 120-year old history. The acquisition allowed the firm to add well known products to its line up such as Listerine mouth wash and Benadryl cough syrup.

But Johnson & Johnson has reaped far more sales and profits from its other two divisions. Its pharmaceuticals division sells several blockbuster drugs such as anemia drug Procit and schizophrenia drug Risperdal. Its medical devices division is responsible for best selling products such as Depuy orthopedic joint replacements and Cyper coronary stents. These two divisions tend to generate operating profit margins of around 30%, almost double those generated by the consumer business.

To a large extent, however, Johnson & Johnson's success across its three divisions and many different businesses has hinged on its unique structure and culture. Most of its far-flung business units 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. That 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.

Johnson & Johnson has been quite proud of the considerable freedom that it has given to its different business units 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 the businesses even have their own finance and human resources departments. While this degree of decentralization makes for relatively high overhead costs, none of the executives that have run J&J, Weldon included, has 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.4

Restructuring for Synergies

In spite of the benefits that Johnson & Johnson 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. Weldon has begun to realize that J&J is in a strong position to exploit new opportunities by drawing on the diverse skills of its various business units across the three divisions. He is well aware that his firm can benefit from the combination of its knowledge in drugs, devices, and diagnostics, since few companies can match its reach and strength in these basic areas.

Indeed, Johnson & Johnson 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. It currently spends about 12% of its sales or almost $7 billion 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. Its pharmaceutical division, for example, is currently working on a drug to prevent strokes and one to treat prostrate cancer.

Weldon believed, however, that Johnson & Johnson can profit from this convergence by finding ways to make its fiercely independent businesses to work together. In his own words: “There is a convergence that will allow us to do things we haven't done before.”5 Through pushing the various far-flung units of the firm to pool their resources, Weldon believes that firm could become one of the few that may actually be able to attain that often-promised, rarely delivered idea of synergy.

Even as Weldon has been supportive of the efforts underway at each of its divisions, he is also pushing for all of its units to work with each other to address different health problems. He has appointed one of its rising stars, Nicholas Valeriani to head a new Office of Strategy and Growth that would attempt to 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 J&J’s largely independent businesses.6

Such a push for communication and coordination would allow Johnson & Johnson to develop the synergy that Weldon was seeking. But any effort to get the different business units to collaborate must not quash the entrepreneurial spirit that has spearheaded most of the growth of the firm to date. Jerry Caccott, managing director of 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.”7

Benefiting from Collaboration

Weldon, like every other leader in the company's history, has worked his way up through the ranks. His long tenure within the firm has turned him into a true believer in the Johnson & Johnson system. He certainly does not want to undermine the entrepreneurial spirit that has resulted from the autonomy that has been given to each of the businesses. Consequently, even though Weldon may talk incessantly about synergy and convergence, he has cautious in the actual steps he has taken to push J&J’s units to collaborate with each other.

For the most part, Weldon has confined himself to taking steps to foster better communication and more frequent collaboration among Johnson &Johnson's disparate operations. “They are the experts who know the marketplace, know the hospitals,” he once said of the people who work in the firm’s various business units.8 Besides the appointment of Valeriani, he has worked with James T. Lenehan, vice-chairman and president of J&J, to set up groups that draw people from across the firm to focus their efforts on specific diseases. Each of the groups has been reporting every six months on potential strategies and projects.

Perhaps the most promising result of this new collaborative approach has been J&J's drug-coated stent, called Cypher. The highly successful new addition to the firm’s lineup was a result of the efforts of teams that combined people from the drug business with others from the device business. They collaborated on manufacturing the stent, which props open arteries after angioplasty. Weldon claims that if J&J had not been able to bring together people with different types of expertise, it could not have developed the stent without getting assistance from outside the firm.

Even the company's fabled consumer brands have been starting 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.

Some of the projects that Johnson & Johnson is currently working on could produce even more significant results. Researchers working on genomic studies in the firm’s labs were building a massive database using gene patterns that correlate to a certain disease or to someone's likely response to a particular drug. Weldon encouraged them to share this data with the various business units. As a result, the diagnostics team has been working on a test that the researchers in the pharmaceutical division could use to predict which patients would benefit from an experimental cancer therapy.

Dealing with Setbacks

Even as Johnson & Johnson has been trying to get more involved with the efforts of its business units, it has run into problems with quality control with several over-the-counter drugs that are made by McNeil Consumer Healthcare. Since 2008, F.D.A. inspectors have found significant violations of manufacturing standards at two McNeil plants, leading to the temporary closure of one of these. These problems have forced the firm to make several recalls of some of its best selling products. Weldon admitted that problems had surfaced, but he insisted that these were confined to McNeil. In a recent interview he stated: “This is one of the most difficult situations I’ve ever had to personally deal with. It hits at the core of who J&J is. Our first responsibility is to the people who use our products. We’ve let them down.”9

Quality problems have arisen before, but they were usually fixed on a regular basis. Analysts suggest that the problems at McNeil 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, headed by Collen Goggins. Because these consumer executives lacked pharmaceutical experience, they began to demand several changes at McNeil that led to a reduction in emphasis on quality control.

Weldon is well aware of the threat faced by Johnson & Johnson as a result of its problems with quality. He is especially concerned about the allegation by F.D.A. that the firm initially tried to hide the problems that it found with Motrin in 2009, hiring a contractor to quietly go around from store to store, buying all of the packets off the shelves. McNeils’ conduct surrounding the recalls has led to an inquiry by both the House Committee on Oversight and Investigations and by the F.D.A.’s office of criminal investigations.

Various changes are underway at McNeil to resolve these quality issues. Goggins was pushed out of her post as senior executive in charge of all consumer businesses. Weldon has allocated more than $100 million to upgrade McNeils’s plants and equipment, appoint new manufacturing executives and hire a third-party consulting firm to improve procedures and systems. Bonnie Jacobs, a McNeil spokeswoman wrote in a recent e-mail: “We will invest the necessary resources and make whatever changes are needed to do so, and we will take the time to do it right.”10

The problems at McNeil, coupled with the recalls of contact lenses and hip replacements, have led Johnson & Johnson to make changes to its corporate oversight of its supply chain and manufacturing. In August 2010, the firm appointed Shetty, a longtime executive to oversee a new systems of companywide quality control that involves a single framework for quality across all of the operating units and a new reporting system. The need for these changes was highlighted by Erik Gordon, a professor at the Ross School of Business at the University of Michigan: “Nothing is more valuable to Johnson & Johnson than the brand bond of trust with consumers.”11

Is there a Cure Ahead?

Weldon realizes that the recalls have presented additional challenges for Johnson &Johnson which is already facing a tougher economic environment. Sales of its various consumer products such as Tylenol, Benadryl and Rolaids have shown a substantial decline over the last six months of 2010. Weldon has been working hard to reassure analysts, investors and consumers that it was already dealing with its quality problems. But Les Funtleyder, who invests in health stocks for his investment firm said: “These problems are accumulating. At some point investors are going to start to question J&J’s management.”12

But the firm’s diversified portfolio of products that are spread across various areas of heath care have helped it to weather the various problems that it has encountered. In particular, Johnson & Johnson has managed to offset its loss of sales in over-the-counter medications with relatively strong sales from pharmaceuticals and devices. “With interests spread out all over the health-care industry, J&J does not live or die by any one product,” remarked Herman Saftlas, a pharmaceutical analyst for Standard & Poor’s.13

Moving forward, Weldon is hoping to strike a balance between direction and freedom for Johnson &Johnson’s business units as he pushes to get the firm to start to grow again. Until the first quarter of 2009, the firm had managed to increase its earnings, adjusted for special items, for 94 consecutive quarters. Weldon believes that he can only resume Johnson &Johnson’s record growth by pushing its businesses to work more closely together than they have ever done in the past. The firm can tap into many more opportunities when it tries to bring together the various skills that it has managed to develop across different divisions.

At the same time, Weldon has become acutely aware of the problems that can arise when the corporate managers start to push the business units to become more effective or efficient. To a large extent, the quality problems at McNeil can be attributed to the decision by J&J to merge it with the consumer health care unit that it had acquired from Pfizer. The larger merged unit was then moved away from the pharmaceutical division and subjected to more centralized control within the consumer division. As a result of all of these efforts to wring more profits out of McNeil, the firm had to resort to a string of recalls that have tarnished the image of J&J.

Above all, Weldon is acutely aware that much of Johnson & Johnson’s success has resulted from the relative autonomy that it has granted to each of its business units. He knows that even as he strives to push for more control and direction, he does not want to threaten the entrepreneurial spirit that has served his firm so well. But it is clear to Weldon that he has to rethink the process by which his firm manages its diversified portfolio of companies in order to ensure that there are no 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.14

1. Shirley S. Wang & Rhonda L. Rundle. J&J to Acquire Breast-Implant Maker. Wall Street Journal, December 2, 2008, p. B1. 2. Amy Barrett. Staying on top. Business Week, May 5, 2003, p. 61 3. Christopher Bowe. J&J Reveals its Guidant Motive. Financial Times, January 25, 2006, p. 17. 4. Peter Loftus & Shirley S. Wang. J&J Sales Show Health Care Feels the Pinch. Wall Street Journal, January 21, 2009, p. B1. 5. Avery Johnson. J&J’s Consumer Play Paces Growth. Wall Street Journal, January 24, 2007, p. A3. 6. Holly Hubbard Preston. Drug Giant Provides a Model of Consistency. Herald Tribune, March 12-13, 2005, p. 12. 7. Business Week, May 5, 2003, p. 62.

8. Avery Johnson. J&J Realigns Managers, Revamps Units. Wall Street Journal, November 16, 2007, p. A10. 9. Business Week, May 5, 2003, p. 62.
10. Natasha Singer & Reed Abelson. Can Johnson & Johnson Get its Act Together? New York Times, January 16, 2011, p. B4. 11. New York Times, January 16, 2011, p. B4.
12. Natasha Singer & Reed Abelson. After Recall of Drugs, a Congressional Spotlight on J.&J.’s Chief. New York Times, September 29, 2010, p. B4. 13. Johanna Bennett. J&J: A Balm for Your Portfolio. Barron’s, October 27, 2008, p. 39. 14. Natasha Singer. Hip Implants are Recalled by J&J Unit. New York Times, August 27, 2010, p. B1.