UK: WHY FOCUS FAVOURS SMITH & NEPHEW.

UK: WHY FOCUS FAVOURS SMITH & NEPHEW. - Rumours of a takeover should not obscure S&N's feat of re-engineering which turned it into a focused world leader in medical supplies.

by Andrew Lorenz.
Last Updated: 31 Aug 2010

Rumours of a takeover should not obscure S&N's feat of re-engineering which turned it into a focused world leader in medical supplies.

Inside David Astor's former town house - an ornate feast of wood-carved mock baroque by the Thames in central London - directors of Smith & Nephew are marvelling at their new-found celebrity. For years, they have been told that their company is the most low-profile international group on the stock market. Yet in the first 10 months of last year, according to a media monitoring organisation which reports to S&N, the healthcare equipment maker was among the top 10 FTSE-100 companies in terms of press coverage.

There is a catch. The reason why S&N has suddenly jumped into the public eye is not its growth - which is beating inflation, its market share - which is rising almost across the board, its margins - holding up at around 18%, or its latest innovations - pathfinding though these are. Its prominence is due to a resurgence of the recurrent rumour that S&N is about to be the target of a bid by its American rival Johnson & Johnson. So annoying to S&N is this renewed bout of bid speculation that in August the group's quietly spoken chief executive, John Robinson, took the unusual step of publicly dismisssing it. S&N, he said, had received no approaches from Johnson or anyone else.

The truth of the matter is that the idea has probably been rendered obsolete by a combination of structural changes in the world healthcare industry and the subtle but radical reformation of S&N executed by Robinson, 54, since he succeeded Eric Kinder, now the group's chairman, five years ago. In the future, whatever acquiring revolves around S&N is much more likely to see the British group in the role of buyer. Robinson says: 'There will be a lot of consolidation in the healthcare industry, and that will create many more opportunities for us in the next five years than we have had in the past five.' Not that the past five years have been uneventful for S&N or Robinson, a former ICI and steel executive who brought an outsider's objectivity to the job. The chief executive's reorientation of the group ranks as a neglected classic of business re-engineering. 'When I joined Smith & Nephew in 1988,' says Chris O'Donnell, head of the medical division, 'it was a loose conglomerate. If something was medical, we would buy it, sell it, make it or whatever. John has turned the company into a focused medical specialist business in tissue repair and protection. About 90% of our products fall into that category. In the bone, the ligament or the skin, either we have the tools to do something about a problem, or we have the material that repairs, protects or replaces.' It is characteristic of S&N's public image - or lack of one - that it is still most regularly identified with two of the consumer products that generate the 10% minority of its sales: Elastoplast and Nivea. Indeed, it no longer owns Nivea - one of Robinson's more striking early decisions was to sell the world's biggest skincare brand to the German company, Beiersdorf, a rival of S&N's in other areas, in 1992 for £46.5 million. S&N kept the UK distribution rights. The deal highlighted several facets of Robinson's regime - portfolio concentration, marketing awareness, financial nous - but what it demonstrated most of all was his ability to reconcile apparently conflicting objectives. Far from losing anything significant, S&N was actually strengthened by the terms of the sale.

'Nivea is a mass-market toiletry, the one mass-market product we had,' says Robinson. 'We saw ourselves coming into competition with the big boys such as Unilever and Procter & Gamble. That's not our scene, but the Germans are into that. So we got the best of both worlds: we get a 17% royalty for selling and distributing the product in the UK; they do all the product development and spend all the advertising money. Since that was done, the sales have accelerated: it is a mutually beneficial arrangement. And Boots still think we are Nivea - we are, in their terms. It is important to us that we should still have the brand in our portfolio, because if we had lost it, that would have weakened us in the market.' Similarly, S&N retains Elastoplast - and Lil-Lets, its other big consumer brand - because their distribution system overlaps with that for S&N's core products.

These stretch from cameras used in keyhole surgery through products used for treating wounds, burns and breaks to replacement knees and hips. Among the 'wound management' range are high-tech dressings which heal the kind of gaping holes that can afflict elderly people but were irremediable until S&N devised a solution. Innovation, to which the group is committed, may be absolute or progressive: S&N still makes plaster of Paris, its first big-seller in the 1920s, but has radically updated the technology.

Such continuity is mirrored in the culture of the group, which Robinson would call evolutionary rather than revolutionary. That culture is epitomised by the presence of Kinder as chairman. In the early 1980s, it was Kinder, now approaching 40 years with S&N, who started the transformation of the business from a modest British healthcare and consumer products company with export markets in the old Imperial, now Commonwealth, countries.

Kinder, says Alan Fryer, head of the UK and Europe with 26 years at S&N under his belt, 'recognised that to maximise returns on new products and to give ourselves maximum leverage, we had to get much greater geographic coverage and to find new areas of business activity. We were too narrow and traditional.' As a result, says Fryer, 'the added value of S&N products compared with that in 1980 has moved significantly, from being closer to commodity products to being very strongly branded thanks to the added value from new technologies that we have either developed or acquired'.

Virtually all of Kinder's acquisitions - such as the 1986 purchase of Richards, a Memphis-based expert in trauma (fractures and breaks) and orthopaedics - added an extra dimension from which the group is now reaping good returns. Others - notably the $230 million purchase in 1989 of Ioptex, a maker of replacement lenses used in operations for cataracts - came a cropper. Shortly after S&N bought the company, the US government clamped down on lens charges with the result that prices tumbled by 60%. S&N finally extricated itself from Ioptex last year, selling the business for a mere £11 million and having to take a £148 million exceptional loss on the disposal. The loss, together with the costs of a rationalisation programme, more than wiped out pre-tax profits last year, reducing S&N to a £5.5 million pre-tax deficit.

This year, with the Ioptex ghost laid to rest, S&N will resume the steady progression that saw pre-tax profits rise from £125.1 million in 1990 to £157.6 million in 1993. For Robinson, Kinder's deputy at the time of the deal, Ioptex is the last of a number of non-core or non-performing assets to be cleaned out of the S&N portfolio. 'We have focused the business and got rid of everything that is not either healthcare or high value,' Robinson says.

In tandem with the disposals have come a range of selective acquisitions and joint ventures. This year, for instance, S&N paid £29 million for Homecraft, which makes aids for the elderly and disabled, and £90 million for Acufex, a subsidiary of American Home Products, which makes endoscopic hand-held surgical instruments, soft-tissue fixation devices, related instruments and accessories. All acquisitions are aimed at reinforcing S&N businesses in line with Robinson's key criteria: 'We must be number one, two or three in a sector, or have 15% of the market.' Almost all the businesses now fulfil at least the first requirement - hip replacement needs strengthening - and overall, Robinson reckons, S&N stands fifth in the near £5 billion world healthcare supplies market. Among manufacturers, it is higher, particularly after the recent decision by Baxter, the US leader in healthcare, to demerge its low-margin distribution business. Moreover, S&N has the broadest product range of all the main players, which include 3M and Bristol Myers-Squibb, owner of the eponymous framemaker Zimmer, Johnson and Beiersdorf.

Geographically, S&N has also moved rapidly ahead in recent years. A glance at its map of European operations in the early 1980s shows that its only wholly-owned subsidiaries outside Britain and Ireland were in Belgium and Denmark. By 1997, the group will cover the map, with subsidiaries throughout western Europe save for joint ventures in Portugal and Finland, and distribution in Greece and Turkey. Sales in mainland Europe totalled £37 million in 1984. This year, they will exceed £200 million. Now S&N is moving into central Europe having established an organisation to manage this expansion. But it still has to crack the German market: 'We won't rest easily until we have trebled our sales in Germany,' says Fryer. 'That is our aim by the year 2000, and we are well on track.' Thanks to the diligent expansionism of both Kinder and Robinson, about 40% of S&N's sales now come from America, the world's largest healthcare market. But, says Robinson: 'Not even the US is big enough now for us. We have to have world products.' Accordingly, the group is pushing into the Far East, where the market is growing at 25% a year. S&N entered Japan five years ago, and now has annual sales of over £30 million there. It is drawing no distinctions between other countries in Southeast Asia: it is aiming for a presence in all of them. India, Robinson believes, will be among the 10 biggest healthcare markets by 2020. China will be even larger: 'Probably the third largest healthcare market in the world by then'. S&N opened its first office in China on 1 January last year in Shanghai. It has since opened a second, in southern China, and this month it opened in Beijing. These are all sales and marketing operations, but it is now planning to start manufacturing bandages and adhesive in Shanghai.

The geographical expansion, the product focusing, the selective acquisitions: these make Robinson's S&N a textbook case of corporate reformation and development. Many other British firms have trodden a similar path in the past decade. Where S&N parts company with most is in its management of research and development, and its integration of innovation and marketing to maximise the returns on that R&D effort. 'Over a five to 10-year time-scale, R&D will make the difference between S&N and the rest,' says Robinson. 'We put a lot of time as well as money into R&D. Otherwise, it's a way of burning pound notes.' The cornerstone of this radical strategy was laid three years ago, with the establishment of 10 centres of excellence to lead both the development and the marketing of individual product areas. The concept, devised by O'Donnell, was straightforward: 'Each centre has the strategic responsibility for managing the growth of a product sector on a worldwide basis. Local planning and product delivery on a tactical basis is done by regional and national managers.' The strategic-tactical split broke the traditional mould in S&N, which was ultimately controlled by its country managers. 'Before the centres of excellence, the country manager was king,' Robinson says. 'He sold what he wanted to sell.' In some cases, the mind-set was not changed without a struggle: 'It was a big culture shock for the country managers to be told to do things,' O'Donnell says.

The logic of the new system was irrefutable. If S&N was to achieve world critical mass in its selected areas of activity, central co-ordination was essential. That way, individual products could be globally marketed, and a range of products could be marketed on a co-ordinated basis under the S&N name in an individual country. In the UK, which was exempted from the new system until early last year, the benefits have been instant: 'In the first half of this year, we have increased sales to hospitals by 12%, mainly because of our better focus on sales and marketing and our ability to give buying groups better deals because we are selling the range,' Robinson says. 'The customer doesn't buy more just because he likes you.' The global-local approach is mirrored in S&N's product presentation: 'We are making a very conscious effort to ensure that people know something is an S&N product without destroying the brand itself,' says Jack Blair, who heads North America and Japan.

The same principle, designed to put S&N's resources to best use by making management as market-responsive as possible, is reflected in the organisation of research and development, the group's engine-room. Twice a year, Robinson and his top executive directors meet with Alan Suggett, S&N's research and development chief, and his colleagues from round the world to review the research programme. 'We discuss how much money we should spend, what projects we should focus on, and so on,' says Robinson. 'You have got to ensure that research is driven from the top down, not the bottom up. That way, you make sure that the money goes where the long-term strategic needs of the company demand.' In 1993, Robinson and Suggett moved S&N's research centre from Gilston Park, a Victorian mansion in rural Essex, to a purpose-built site on the York Science Park, close to York University which has a highly-regarded research output. Suggett says, 'Moving to York has been a transformation, beyond my wildest dreams. It hasn't just changed the way we work; it has offered an opportunity to reorganise and restructure. It has changed the attitude to research generally within the whole group, because we saw the move as an opportunity to publicise and involve people in the process. Our whole ethos now is to build teams between marketing, manufacturing, research and development. And the relationship with the academic world has been reinforced; we are getting so much more back from our contacts.' In terms of research itself, Suggett says that S&N's underlying thrust in several of its key product areas is 'trying to move from replacement to repair to regeneration: the maximum preservation of the natural tissue plus the ability to heal the bits nature can't heal for itself'.

Suggett dislikes the term biotechnology, and S&N will stay this side of genetic engineering, but it is moving fast into the area of biological approaches to repair. One important step has been the formation of a joint venture with Advanced Tissue Sciences, a California company. The two companies will produce and market laboratory-grown cartilage cells, which could obviate the need for expensive major surgery which is the present norm when cartilage is damaged. 'It's a $1 billion market if it works,' says Robinson. 'It has a 50% chance of doing nothing and a 50% chance of transforming this business. The long-term stuff is all 50%: if it isn't, it is not exciting enough. We are trying to get half a dozen of these, and then if we get it half right, the statistics will work in our favour.' Alongside its organic growth prospects, S&N will also enjoy extensive acquisition opportunities thanks to the restructuring of the healthcare industry. Two factors are working in its favour, says Harri Taranto, managing director of The Wilkerson Group, a New York-based analysis firm which is an expert on the industry. 'There are a number of smaller companies that over time could offer nice complementary product lines,' he says. 'And all across the healthcare spectrum, we see companies divesting certain businesses that are either too small or in which they are now able to develop true excellence. We think that is going to continue. If anything, we expect a dramatic increase in the amount of shaking up that is occurring, as companies are focused in a much more ruthless manner than in the past.' Taranto has little doubt that, amid the current turmoil in the sector, S&N will emerge as a clear winner. 'Here you have a company which, from the board down, is focused entirely on medical supplies and devices. The directors have taken an international and analytical approach to their businesses; they are a dynamic management in an industry which generally has not welcomed the advent of change. Healthcare has achieved a high level of turbulence very quickly and a number of companies have been knocked off balance by that. But S&N makes that turbulence work to its advantage.'

SMITH & NEPHEW: FINANCIAL FACTS

Turnover Profit

(£m) (£m)

Healthcare 788.9 124.5

Consumer products 161.0 21.0

Discontinued operations 14.7 (1.4)

Operating totals 964.6 144.1

Loss on disposal (150.3)

Interest 0.7

Net loss before tax (5.5)

Shareholders' funds 440.9

Number of employees 12,223

Accounts to 31 December 1994

Andrew Lorenz is business editor of the Sunday Times.

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