To Trim Or Not To Trim: That Is The Question

The issue had come up again and again in various management meetings and company seminars. Novartis had too many products and needed to reduce the product proliferation that had occurred. Thomas Ebeling, Chief Operating Officer, Novartis Pharmaceuticals, wondered what he should do.

The merger of Ciba- Geigy and Sandoz to form Novartis on December 20, 1996 had resulted in a significant increase in the pharmaceutical product portfolio of Novartis's Pharma Sector. Combining the pharmaceutical product lines of Ciba- Geigy and Sandoz had given Novartis a leadership position in several therapeutic areas, including immunology and inflammatory dis-eases, as well as strong positions in central nervous system disorders, cardiovascular diseases, oncology, dermatology, and asthma. Novartis now had approximately 250 product brands (such as Sandimmun, Voltaren, Lamisil, and Foradil). The sales volumes of each of the different brands, however, were very different. In 1999, the top 20 brands accounted for 79% of pharmaceutical revenues while the remaining brands yielded 21% of revenues.

Novartis Exhibit 1 presents sales, anticipated sales growth rates, cost and other data for the 50 smallest global base business brands that account for CHF 422 million in sales (or approximately 2.7% of pharmaceutical product sales) in 1998. In addition to the base business brands listed in Novartis Exhibit 1, 15 other product brands contributed an additional CHF 2.4 million in revenues. Although these products generated very small revenues, they satisfied some important medical needs. For example, Visken had sales of CHF 114,000 in South Africa but it was unique among betablockers regarding the effect on serotonin 1a receptors for the onset of antidepressant action.

Exhibit 1 subdivides costs into variable costs and fixed costs. A variable cost changes in total in proportion to changes in related level of total activity or volume. An example of a variable cost is direct materials used to make the product. If sales are small, variable costs are small. As sales increase, variable costs increase proportionately as well. A fixed cost remains unchanged in total or given time period despite wide changes in the related level of total activity or volume. Examples of fixed costs are costs of operating the plant and costs of drug regulatory affairs to maintain registration of products. In the long run, however, fixed costs can sometimes be adjusted to match the level needed to support future activity levels or product on volumes. Commenting on the fixed costs reported in Exhibit 1, Andre Khairallah, Head of Controlling, commented:

Dropping a few products out of the 50 products shown in Appendix 1 will not result in savings in fixed costs even in the long run. We already have idle capacity in our plants so dropping a few of these products will only result in even more idle capacity. If we drop all products, some of the fixed costs in technical operations, production scheduling, drug registration, warehousing and inventory management, and distribution will be saved. If we dropped all products. We can reduce the headcount and space used to support these products something we cannot do if we drop only two or three products. I estimate that we can save 50% of the total fixed costs if we dropped all 50 products. Of course, this ... in a one-time restructuring charge such as for severance costs and disposal of equipment of CHF 15 million (which is roughly equal to 1 years' savings in fixed costs).

Andrew Kay, Head of Global Marketing, reflected on the products in Exhibit 1.

Many of these products consist of products whose safe are declining mainly because Novartis is either unable to or does not find it worthwhile to put marketing resources behind them. Of course, these products constate a significant percentage of total sales in some countries and an insignificant percentage of others.

Exhibit 2 shows that brands slated for possible divestment constituted 11.1% of the sales in Chile but only 1.8% of the sales in Australia. One alternative before Ebeling was to simply stop producing these products. Novartis would lose revenues of these products but it would also save costs. Dropping products would simplify manufacturing operations and focus the organization and sales and marketing on a few key products. A concern was the negative effects such discontinuation or withdrawal would have on Novartis's relationship with Health Maintenance Organizations (HMOs), doctors, and patients in the different countries, particularly in countries where these products were a significant percentage of sales.

Ebeling wondered whether there were other alternatives to divestment that he should consider. One possibility was to increase the marketing resources put behind these products. Currently, the direct marketing costs incurred to support these products were minimal. The products were already in the mature phase of their life cycles and with little or no investment in them, the in the late stages of their life cycles, it was unclear whether devoting marketing resources to there products would have any effect.

Another possibility was so find a company willing to buy these products from Novartis. Typically, such a company, would be a smaller company with a lower cost structure than Novartis. A company buying these products would then have the right to produce, market, promote and sell these products over several years.

A final issue was the management reporting and incentive system. Country sector heads and their ... organizations were evaluated on the basis of sales minus local country costs - the items on the increase statements that the country managers could most directly influence. In their performance evaluation systems the countries were not charged by Basel for the costs incurred to manufacture the goods that were sold because the country managers had no control over these manufacturing costs. The effect of pruning or divesting products is that overall country sales revenue could be adversely affected without a corresponding decrease in local country costs. This would have a negative impact on a country's performance measures and hence on managers' bonus payments. Assignment Questions

1. Please refer to the data on Pertofran and Visergil in Novartis Exhibit 1. Would you recommend that Novartis drop these products because the total cost of these products exceeds the total revenues?

2. What strategic factors would you consider in deciding whether to drop all 50 products shown in Novartis Exhibit 1 and the 15 other product brands described in paragraph 3 of the case?

3. Would you recommend that Novartis drop all the 50 products shown in Novartis Exhibit 1? What is the net present value gained or lost from dropping all these 50 products? Assume a discount rate of 12%. What are the factors that go into determining this rate?

4. Suppose Novartis was able to find a buyer for all the 50 products shown in Novartis Exhibit 1. What price should Novartis charge the buyer?

5. Comment on the incentive issues described in the last paragraph of the case. What, if anything, would you do to address these issues?

6. What would you recommend Thomas Ebeling should do with respect to the 50 products shown in Novartis Exhibit 1 and the 15 product brands described in paragraph 3 of the case?