Patients versus Profits at Johnson & Johnson: Has the Company Lost its Way?Published: February 15, 2012 in Knowledge@Wharton
For a corporate icon long held up as the gold standard in business ethics, Johnson & Johnson has suffered some stunning setbacks in recent years. Among the headaches: a seemingly endless string of product recalls, from Tylenol Arthritis Pain caplets to Benadryl to Rolaids; safety issues with the company's artificial hips, and lawsuits brought by numerous states over the marketing of its anti-psychotic medication Risperdal.
And for a company that set the benchmark for crisis management in its response to the Tylenol tampering incident 30 years ago, J&J has looked sloppy and ineffective in its handling of these crises. While the company has not suffered a fatal hit to its brand, the stumbles have certainly tarnished its halo among consumers and created challenges for CEO William Weldon, who must convince consumers and investors alike that J&J's problems are behind it.
The recent troubles are a major reversal of fortune for J&J. The company cemented its reputation for responsible management in 1982 when bottles of Tylenol were found to contain traces of cyanide, resulting in seven deaths. Then-CEO James Burke recalled millions of bottles of Tylenol and replaced them with new tamper-proof packaging. Burke's handling of the crisis put J&J's credo -- outlined in a mission statement that clearly says patients come before profits -- front and center. That credo, says Wharton professor of legal studies and business ethics Thomas Donaldson, is "in J&J's blood.... There is a real sense of what the credo means" for how the company operates.
The recent setbacks at J&J, however, have caused many to question whether the firm has lost sight of that credo. The company's problems with plants in Fort Washington, Pa., Lancaster, Pa., and Puerto Rico -- the sites of recalls of over-the-counter products like Benadryl and Children's Tylenol -- dragged on for years. In addition, an outside contractor for the company was found to have led a "phantom recall," sending employees to buy all the painkiller Motrin on store shelves after it was found to be dissolving improperly. Two hip devices were recalled in 2010 after the shredding of metal fragments led to post-surgical complications in some patients. And the company agreed to pay $158 million to the state of Texas to settle claims it improperly marked the anti-psychotic drug Risperdal to patients on Medicaid. Other suits surrounding the marketing of this drug are ongoing. Recalls of surgical sutures and contact lenses have been announced as well.
It comes as no surprise, then, that J&J's stock has been a weak performer, gaining just 3% over the past two years while the S&P 500 is up more than 23% during that period. "It's been one blunder after another," says Michael Krensavage, founder of investment firm Krensavage Partners. "It's hard to explain."
For some, the problems are evidence that J&J has lost its way. "I think the credo used to be quite real there," says Erik Gordon, a professor at the University of Michigan's Ross School of Business. "There was a time when people really believed in it and took great pride in it. But those days are long gone." Now, he says, "the major function of the credo is similar to mommy's skirt -- which you hid behind -- or like wrapping yourself in the American flag. It is to distract people from what is going on."
A Tricky Balance
Gordon argues that CEO Weldon's relentless focus on the bottom line -- the company's website touts its record of 27 consecutive years of adjusted earnings increases and 49 consecutive years of dividend increases -- is the reason for the current woes. "Bill Weldon sets the priorities and the culture for the company," says Gordon. And the problems, from overly aggressive marketing to underinvestment in safety and quality systems, reflect "people trying to get their bonuses, hit their numbers and keep their job."
No doubt the global economic collapse in 2008 put renewed pressure on managers at multinationals like Johnson & Johnson. John Kimberly -- a Wharton management professor and executive director of the Wharton/INSEAD Alliance who has worked with J&J executives in Europe since the late 1990s -- says he detected a shift among those managers starting in 2008. "I got the sense that there were some things happening at corporate, and that messages were being sent about the need to deliver profitability," Kimberly notes. "It seemed as though the people I was working with were feeling pressure from above to pay closer attention to the bottom line. It was a palpable, tangible change."
Wharton's Donaldson gives J&J management credit for the aggressive steps the company is now taking to overhaul its manufacturing processes and plants. But he also notes that the balance between profits and patients is a tricky one. Managers at J&J, he says, "are juggling a lot of balls. In the credo, they say they put patients first and stockholders further down the line. But there is a red ball that every manager knows about, [which is] profit -- and they don't let that red ball drop." Figuring out how to serve patients well and still deliver for Wall Street is not easy. "J&J believes they can do both those things," Donaldson says. "But if the weight of one side of that formula gets too heavy, the entire structure collapses."
If the drive to boost earnings is one piece of this puzzle, another factor may be J&J's decentralized management structure. The company is well known for allowing significant autonomy for the more than 250 operating companies within the J&J portfolio. That has allowed for creativity and innovation among the various units -- but it also means there is not central control of manufacturing processes and the like.
Yoram "Jerry" Wind, Wharton marketing professor and director of the SEI Center for Advanced Studies in Management, does not believe that J&J's decentralized structure is behind the recent setbacks. "I don't think it is decentralization or centralization that is the problem," Wind says. "It is the quality of management. What we have here is a failure of management at all levels -- senior management and management at the business unit level." Wind also says companies need to be more responsive than ever to potential problems. "The world has changed. The minute you have a problem, it is immediately being broadcast to the world through the Internet, social media and the like. One can't hide from it."
These days, J&J is wrestling with how to fine-tune its management structure to ensure that problems are not left to fester. Since 2010, the company has been putting more centralized reporting processes in place for certain functions, including manufacturing quality control. "Our efforts in this area are already paying off with better inspection records, despite an increase in regulatory activity," Weldon recently told Wall Street analysts.
"Part of it is cost savings, but I also think bringing the rigorous compliance standards in the pharmaceutical business to the over-the-counter operation is where they got behind the curve," Cowen & Co. analyst Ian Sanderson says, adding, however, that a move to exert greater control over business units may come with a price. "They have always been able to acquire top notch technologies because of that decentralized management style. Companies loved to be acquired by J&J because they don't mess with you." The question now: Does a shift toward more centralized operation change that dynamic?
Wharton's Wind says J&J needs to find the right balance between autonomy and centralized control. "Quality control has to work primarily at the unit level -- that is where the rubber meets the road. Each unit must have its own quality control processes but you also need to have a corporate function that shares best practices across units. So if corporate learns what a unit is doing that is good -- or bad -- they can share that with other units. But in the end, it all depends on leadership."
For his part, J&J's Weldon has acknowledged the company's mistakes. During testimony before Congress in September of 2010 in a hearing focused on the OTC (over the counter) recalls, Weldon said: "We recognized then, and we recognize now, that we need to do better, and we will work hard to restore the public's faith and trust in Johnson & Johnson, and strive to ensure that something like this never happens again." He also outlined steps the company was taking to address the recalls, including more than $100 million in investments in facilities, equipment and manufacturing improvements.
The Halo Effect
So have the recent recalls and legal problems seriously hurt the J&J image? According to YouGov's BrandIndex service, which tracks public perceptions of brands, J&J's rating has declined in recent years. In 2009, the company's score -- a measure of whether consumers had a positive or negative impression of the company -- was 70.7 (the scale ranges from -100 to +100). By early 2012, it had fallen to 52.6. "J&J is a strong brand, as evidenced by its strongly positive scores," says Ted Marzilli, YouGov senior vice-president. "That said, the decline in scores, particularly over the last two years, shows that even the strongest of brands can be negatively impacted by repeated and very public missteps."
At the same time, the hit to J&J's brand may be dampened by the fact that the company is "a house of brands rather than a branded house," says Wharton marketing professor David Reibstein. That means that consumers may not associate problems with brands like Rolaids or Acuvue contact lenses with Johnson & Johnson. "I would be shocked if people who buy J&J's Band-Aids are thinking about recalls of other J&J products," says Reibstein. "One of the advantages they have is that if one of the brands is damaged, the house does not collapse."
Reibstein also argues that the halo effect observers may have believed the company had from its well known and trusted brand name wasn't quite as significant as some may have thought. "If you walked around the halls of J&J and asked [employees], 'What is the real asset of J&J?' they would say 'trust,'" Reibstein suggests. "My guess is they have lost a lot of that trust. But I think they had overplayed that in their own minds. I think that trust was nice for those products that carried the J&J name, like baby shampoo, and maybe for some intermediaries like a retailer who felt good buying a portfolio of products from J&J. But I think it was overplayed. And as a result, it is not as damaging now that they have had these problems."
Some of J&J's stumbles reflect the challenges faced by the pharmaceutical industry in general. J&J gets 37% of sales and 44% of operating profit from the drug operation. And, like others in recent years, the company has struggled with patent expirations and less-than-robust new product pipelines. At the same time, the regulatory landscape shifted following the Food & Drug Administration's decision to put greater focus on safety after the high profile withdrawal of the Merck painkiller Vioxx in 2004.
"In the late 1980s moving into the 1990s, there was a public health crisis connected to AIDS," says Ira Loss, senior healthcare analyst at Washington Analysis, a political and economic advisory firm. "There was a huge push to force the development of products to move more quickly through the pipeline because people were dying. But any time you try to take a system that is designed to go 40 m.p.h. and make it go 60 m.p.h., there will be accidents. Vioxx caused the pendulum to swing the other way." That not only slowed down approval of some new products emerging from pharma labs, but it also caused the FDA to take a harder line on promotion of drugs for unapproved uses.
In addition, the pharmaceutical industry is caught up in a shift among the public toward greater skepticism of big institutions in general, says Wharton marketing professor Patti Williams. "Mass media and social networking make it easier for that skepticism to be contagious and for the [negative] stories to have legs." The pharmaceutical industry's aggressive consumer advertising campaigns over the last two decades has fed into that. "Direct to consumer advertising did great things for the industry, but it also brought them increased scrutiny from consumers," Williams notes. "They look like quintessential aggressive marketers."
For Weldon, there is limited time to right the J&J ship. At 63, he is expected to retire in the next couple years. Observers predict that his successor will be one of two executives: Alex Gorsky, vice chairman and head of the medical devices and diagnostics group, or Sheri McCoy, vice chairman and head of the pharmaceutical and consumer business units. "The interesting question is who the successor is going to be, what the priorities will be for the board and how they are going to think about this issue of decentralization, flexibility and control," says Wharton's Kimberly.
The next J&J chief executive may take the helm of a company primed for a bit of a resurgence. Cowen's Sanderson says that J&J is through the worst of its drug patent expirations, and that the company's pharmaceutical pipeline has improved, thanks in part of acquisitions and partnerships. "Pharma will drive the majority of growth," says Sanderson. At the same time, if J&J can show it has fixed manufacturing, Ira Loss figures they will regain much of their market share in consumer products. "They are a superb marketing organization," he notes. "If I was going to pick a company to make Lazarus rise from the [dead], they would be the one."