CASE 31 JOHNSON & JOHNSON*

On January 20, 2015, Johnson & Johnson CEO Alex Gorsky proudly announced
that his firm had sales of $74.3 billion during the previous year, representing
an increase of 4.2 percent over 2013. Most of this growth came from the
firm’s pharmaceutical division, which Gorsky pointed out was clearly
generating the largest revenues and was the fastest-growing such division in
the drug industry in the United States. The results of this division
compensated the relatively modest increases In revenue from the firm’s
medical devices and consumer health divisions, both of which were
recovering from lawsuits and recalls.

Several years earlier, Johnson & Johnson (J&J) had settled with an estimated
8,000 patients over problems with its flawed all-metal artificial hip. The
device had a design flaw that caused it to shed large quantities of metallic
debris after implantation. It was finally recalled by the firm in 2010, after
Johnson & Johnson had covered up the problems for almost five years after
they began to surface. The settlement cost the firm as much as $3 billion to
compensate patients who had to have the artificial hip replaced. The
problems with this device would classify it as one of the largest medical
failures in recent history.

The problems with the medical devices unit were compounded by serious
issues that arose with the consumer products unit, leading it to recall many
of its products—including the biggest children’s drug recall of all time—that
were potentially contaminated with dark particles. The Food and Drug
Administration also slapped a plant at one of its business units, McNeil
Consumer Healthcare, with a scalding inspection report,

Causing the company to close down the factory to bring it up to federal

standards. The publicity that arose from these problems tarnished the name
of one of the nation’s most trusted firms.

Much of the blame for Johnson & Johnson’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 (see Exhibits 1 and 2).
Critics said the company’s once-vaunted attention to quality had slipped
under his watch. Weldon,

Who had started out as a 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
the University of Michigan, elaborated on this philosophy: “We will make our
numbers for the analysts,

Period.”1 Weldon was replaced by Alex Gorsky, who had headed the medical
devices and diagnostics unit. Like his predecessor, Gorsky had worked his
way up by meeting tough performance targets as a sales representative,

And his appointment as CEO continued the firm’s 126-year tradition of hiring
leaders from within. “The future of Johnson & Johnson is in very capable
hands,” said Weldon.2 However, the decision to hire another insider raised
concerns that the firm was not very serious about changing the corporate
culture that had created so many of its recent problems. “As somebody
steeped in J.&J. culture, I would be very surprised to see big changes,” said
Les Funtleyder, a portfolio manager at a firm that owned J&J stock.

EXHIBIT 1

Income Statement ($ millions)

YEAR ENDING DECEMBER

2010 2011 2012 2013

Revenue 61,587 65,030 68,224 72,312
Gross profit 42,795 44,670 45,566 48,970
Operating 16,527 16,153 15,869 18,377
Income
Income 16,947 12,361 13,775 15,471
before taxes
Net income 13,334 9,682 10,593 13,831
Source: Johnson & Johnson.

EXHIBIT 2

Income Statement ($ millions)

YEAR ENDING DECEMBER

2010 2011 2012 2013

Total current 47,307 54,316 46,116 56,407
assets
Total assets 102,908 113,644 121,347 132, 683
Total current 23,072 22,811 24,262 25,675
liabilities
Total 46,329 56,564 56,521 58,630
 liabilities
Total 56,579 57,080 64,826 74,053
stockholders’
equity
Source: Johnson & Johnson.

Cultivating Entrepreneurship

Johnson & Johnson relied heavily upon acquisitions to enter into and expand
into a wide range of businesses that fell broadly under the category of health
care. It purchased more than 70 different firms over the past decade. Among
Johnson & Johnson’s recent moves was the $20 billion purchase of Synthes, a
leading player in trauma surgery. In November 2014, J&J completed its $1.75
billion acquisition of Alios BioPharma, which produced therapeutics for viral
infections.

As it grew, Johnson & Johnson developed into an astonishingly complex

enterprise, made up of over 250 different subsidiaries that were divided
among three different divisions. The most widely known of these was the
division that made consumer products such as Johnson & Johnson baby care
products, Band-Aid adhesive strips, and Visine eyedrops. The division grew
substantially after J&J acquired the consumer health unit of Pfizer in 2006 for
$16.6 billion, the biggest acquisition in its 120-year history. The acquisition
allowed J&J to add well-known products to its lineup, such as Listerine
mouthwash and Benadryl cough syrup.

But Johnson & Johnson reaped far more sales and profits from its other two
divisions. Its pharmaceuticals division sold several blockbuster drugs, such
as anemia drug Procrit and schizophrenia drug Risperdal. A new drug, named
Zytiga, prescribed to treat prostate cancer, was selling well. The medical
devices division was responsible for best-selling products such as DePuy
orthopedic joint replacements and Cypher coronary stents. These two
divisions generated operating profit margins of around 30 percent, 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 hinged on its unique structure and
culture. Most of its far-flung subsidiaries were acquired because of the
potential demonstrated by some promising new products in their pipelines.
Each of these units was therefore granted near-total autonomy to develop
and expand upon its best-selling products (see Exhibit 3).
That independence fostered an entrepreneurial attitude that kept J&J
intensely competitive as others around it faltered. The relative autonomy
that was accorded to the business units also provided the firm with the
ability to respond swiftly to emerging opportunities.

Johnson & Johnson was actually quite proud of the considerable freedom that
it gave to its different subsidiaries to develop and execute their own
strategies. Besides developing their strategies, these units were also allowed
to work with their own resources. Many of them even had their own finance
and human resources departments. While this degree of decentralization had
led to relatively high overhead costs, none of the executives who ran 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
clearly allowed the firm to show a consistent level of high performance.
Indeed, Johnson & Johnson had top-notch products in each of the areas in
which it operated. It had been spending heavily on research and
development for many years, taking its position among the world’s top
spenders (see Exhibit 4). In 2014, it spent about 12 percent of its sales on
about 9,000 scientists working in research laboratories around the world.
This allowed each of the three divisions to continually introduce promising
new products.

In spite of the benefits that Johnson & Johnson derived from giving its various
enterprises considerable autonomy, there were growing concerns that these
units could 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 might 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.

EXHIBIT 3

Segment Information ($ millions)

Johnson & Johnson was made up of over 250 different companies, many of
which it had acquire over the years. These individual companies were
assigned to three different divisions.

Segments of Business and Geographic Areas

Sales to Customers

Dollars in Millions 2014 2013 2012

Consumer
United States $5,096 5,162 5,046
International 9,400 9,535 9,401
Total 14,496 14,697 14,447

Pharmaceutical
United States 17,432 13,948 12,421
International 14,881 14,177 12,930
Total 32,313 28,125 25,351

Medical Devices
United States 12,254 12,800 12,363
International 15,268 15,690 15,063
Total 27,522 28,490 27,426

Worldwide Total $74,331 71,312 67,224

Segment Pretax Profit

Percent of Segment Sales

Dollars in 2014 2013 2014 2013

Millions
Consumer $1,941 1,973 13.4% 13.4
Pharmaceutic 11,696 9,178 36.2 32.6
al
Medical 7,953 5,261 28.9 18.5
Devices
Total 21,590 16,412 29.0 23.0
Less: 1,027 941
Expenses not
allocated to
segments
Earnings $20,563 15,471 27.7% 21.7
before
provision for
taxes on
income

This led Weldon to find ways to make J&J’s fiercely independent units 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 believed that the firm could become one of the few that
was actually able to attain that often-promised, rarely delivered idea of
synergy. 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.6 For the most part, however, Weldon confined himself to taking
steps to foster better communication and more frequent collaboration among
Johnson & Johnson’s disparate operations. He was convinced that such a
push for communication and coordination would allow the firm to develop the
synergy that 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 Cacciotti, 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.”

EXHIBIT 4

Research Expenditures ($ millions)

Year Expenditure
2014 $8,494
2013 8,183
2012 7,665
2011 7,548
2010 6,864
2009 6,986
2008 7,577
2007 7,680
2006 7,125
2005 6,462
EXHIBIT 5

Significant Innovations

Antiseptic Surgery (1888)

Three brothers start up a firm based on antiseptics designed for modern

surgical practices
Band-Alds (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 was 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.

These collaborative efforts did lead to the introduction of some highly

successful products (see Exhibit 5).

Even the company’s fabled consumer brands started to show growth as a

result of increased collaboration between the consumer products and
pharmaceutical divisions. The firm’s new liquid Band-Aid was based on a
material used in a wound-closing product sold by one of J&J’s hospital-supply
businesses. And J&J used its prescription antifungal treatment, Nizoral, to
develop a dandruff shampoo. In fact, products that were developed in large
part out of such cross-fertilization allowed the firm’s consumer business to
experience considerable internal growth.

Confronting Quality Issues

 Even as Johnson & Johnson was trying to get more involved with the efforts
of its business units, it ran into quality control problems with several over-
the-counter drugs made by McNeil Consumer Healthcare. Since 2008, FDA
inspectors had found significant violations of manufacturing standards at two
McNeil plants,

Leading to the temporary closure of one of them. These problems had forced
the firm to make several recalls of some of its best-selling products. Weldon
did admit that problems had surfaced, but he insisted that they were
confined to McNeil. He responded to them in an interview: “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.”8 Quality problems had arisen before, but
they were usually fixed on a regular basis. Analysts suggested that the
problems at McNeil might have exacerbated in 2006 when J&J decided to
combine McNeil with the newly acquired consumer health care unit from
Pfizer. Johnson & Johnson believed that it could achieve $500 million to $600
million in annual savings by merging the two units. After the merger, McNeil
was transferred from the heavily regulated pharmaceutical division to the
marketing-driven consumer products division,

Headed by Colleen Goggins. Because the consumer executives lacked

pharmaceutical experience, they began to demand several changes at
McNeil that led to a reduced emphasis on quality control.

Weldon realized the significance of the threat faced by Johnson & Johnson as
a result of its problems with quality. He was especially concerned about the
FDA’s allegation that the firm had initially tried to hide the problems that it
found with Motrin in 2009, hiring a contractor to quietly go from store to
store buying all of the packets on the shelves. McNeil’s conduct surrounding
the recalls led to an inquiry by both the House Committee on Oversight and
Investigations and the FDA’s Office of Criminal Investigations.

Various changes were subsequently made at McNeil to resolve these quality

issues. Goggins was pushed out of her post as senior executive in charge of
all consumer businesses. Weldon allocated more than $100 million to
upgrade McNeil’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 email:
“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.”9 The problems at
McNeil, coupled with growing problems with J&J’s artificial hips and contact
lenses, also led Johnson & Johnson to make changes to its corporate
oversight of its supply chain and manufacturing. In August 2010, the firm
appointed Ajit Shetty, a longtime executive, to oversee a new system of
companywide quality control that involved 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.”10
Passing the Baton In April 2012, Johnson & Johnson appointed Gorsky to lead
the health care conglomerate out of the difficulties that it had faced over the
previous 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 in Novartis. Shortly after his return to
Johnson & Johnson in 2008, he took over its medical device and diagnostic
group. Because of his extensive background with the firm, and with the
division that was being investigated about its faulty hip replacements,
Gorsky might have been regarded as the ideal person to take over the job.

When he took over, DePuy, the firm’s orthopedic unit, was already running
into trouble with its newest artificial hip. The firm finally recalled the artificial
hip, amid growing concerns about its failure among those who had received
the implant. Until then, however, executives from the firm had repeatedly
insisted that the device was safe. Andrew Ekdahl, the current president of
DePuy, recently reiterated that position. “This was purely a business
decision,” he said.11 In the trial in Los Angeles Superior Court regarding the
defective hipreplacement, however, Michael A. Kelly, the lawyer making the
case against Johnson & Johnson, suggested that company executives might
have concealed information out of concern for firm profits.

In spite of all these issues, Johnson & Johnson did not attempt to clarify what
information Gorsky might have had about the problems associated with the
artificial hip. Under the circumstances, his promotion to lead the firm
surprised Dr. Robert Hauser, a cardiologist and an advocate for improved
safety of medical devices.

“He’s been overseeing one of the major J&J quality issues and the board of
J&J sees fit to name him the new C.E.O.,” he questioned.12 These issues
raised concerns about the ability of the firm to effectively deal with the
quality concerns and to take steps to prevent them from recurring in the
future.
Gorksy’s first job as Johnson & Johnson’s chief executive was, in fact, to
reassure shareholders that the firm would move quickly to overcome its
problems with manufacturing defects, product recalls, and lawsuits.

“We’ve got to adapt faster than ever before, be more agile than ever
before,” he stated at the firm’s annual meeting after taking over.13 He
acknowledged that some of the problems could partly be attributed to the
firm’s attempt to continue to meet Wall Street’s increasingly short-term
demands. Gorsky announced that moving forward, J&J was committed to
managing for the long term, actively soliciting feedback from all quarters and
adhering to the mission that made customers the first priority.

Gorsky’s biggest challenge, however, came from a proposal that Johnson &
Johnson might be better off if it was broken 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
worldwide subsidiaries. Gorsky dismissed the proposal, claiming that J&J drew
substantial benefits from the diversified nature of its businesses. He did
concede, however, that the firm would have to be more selective, careful,
and decisive about the products that it would pursue.

Is There a Cure Ahead?

Under Gorksy, Johnson & Johnson began to divest some of its lower-growth
businesses and reduce annual costs by $1 billion. In 2014, the firm sold off
its blood-testing unit, called Ortho-Clinical Diagnostics, for $4.15 billion to
the private equity firm Carlyle Group. It was actively seeking a buyer for
Cordis, which made medical devices such as stents and catheters. Johnson &
Johnson, which had helped to develop the roughly $5 billion global market for
cardiac stents, announced that it was shifting its focus to other medical
technologies that showed more potential for growth.

To repair the damage to its reputation from the many recalls across two of its
divisions, Johnson & Johnson recently announced that it would remove a host
of potentially harmful chemicals, like formaldehyde, from its line of consumer
products by the end of 2015. It was the first major consumer products
company to make such a widespread commitment. “We’ve never really seen
a major personal care product company take the kind of move that they are
taking with this,” said Kenneth A. Cook, president of the Environmental
Working Group.14 As he tried to plot a course for the future of Johnson &
Johnson, Gorsky realized that he had to deal with a variety of issues. He was
aware that much of the firm’s success to date resulted from the relative
autonomy that it granted to each of its businesses. At the same time, he
realized that he had to provide more direction for the businesses to
collaborate with each other in order to pursue emerging opportunities. He
also understood that it was critical for J&J to develop sufficient controls that
could minimize future problems with quality control.

In overall terms, it was clear that the health care giant had to rethink the
process by which it managed its diversified portfolio of companies in order to
ensure that it could keep growing without creating issues that could 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.15 *
Case prepared by Jamal Shamsie, Michigan State University, with the
assistance of Professor Alan B. Eisner,

Pace University. Material has been drawn from published sources to be used
for purposes of class discussion.

Copyright © 2015 Jamal Shamsie and Alan B. Eisner.