Schering-Plough's Productivity (Layoffs) Program Has Murky Results

When Schering-Plough declared its Q4 2008 earnings a few days ago, the management team there got about half-a-dozen questions about the company’s sales and marketing expenses — more than the usual number.

Schering has played up its Productivity Transformation Program to Wall Street, which is essentially a layoffs program designed to cut $1.5 billion from the company’s operating structure. As you can imagine, it’s really “popular” with the rank and file.

The depressing news for sales reps and administrators is that Schering is less than half way through this program, which won’t end until 2010.

But if you actually measure the gross productivity of Schering’s sales and marketing investment, it’s not at all clear that this program is making the company more productive. Here’s CFO Robert J. Bertolini’s version of events, from the conference call:

Before turning to SG&A, let me remind you that we would be making steady progress to achieving our $1.5 billion target for PTP.

For the full year 2008, we’ve achieved more than $600 million in PTP savings. So you can see we’re well on our way. And we are seeing the affects of these savings across all of our business units. In the fourth quarter, SG&A expenses were $1.6 billion, roughly flat quarter-over-quarter.

CEO Fred Hassan had the same take, unsurprisingly:

During ‘08, we started our Productivity Transformation Program or PTP for short. We had said we would take tough actions, if tough actions were needed and we did that with PTP. We reduced cost. We took actions to become stronger, leaner and more productive around the world. So we accomplished a lot in ‘08.

OK, so what does this “more productive” company look like? Here’s a couple of graphs (see below, click on them to get full-size). One shows how many dollars in revenue and gross profit the company gets per dollar spent on SG&A. The other shows the growth or decline of that revenue and gross profit.

What’s surprising about the graphs is that the lines are all over the place. If a company is good at managing its margins, these lines ought to move in parallel.

And the overall trend is that the company’s productivity is plateauing, not getting better. Obviously, you do not want the results of your productivity program to peak when you’re only half way through.

There seemed to be a sense among the analysts on the call that management of SG&A was becoming a bit of a mystery. Here’s one exchange:

Roopesh Patel - UBS: In terms of the SG&A and R&D growth reported this quarter, what would it have been excluding foreign exchange? I’m curious as to whether or not this rate of spend can be sustained through 2009, there’s almost a flat spend that was achieved in the fourth quarter? Thanks.

Robert Bertolini: … On the pieces for SG&A and PTP, FX did benefit the quarter. If I looked at R&D sequentially, I think it was about $40 million benefit we had from Q3 to Q4 in R&D to give you some sense. And on the SG&A, I don’t have it in front of me, but it was by order of magnitude, maybe in the 70 to $80 million range, it’s kind of by order of magnitude as what I recall.

Translation: A lot of the gains you’re seeing in sales productivity are actually the positive effects of the dollar sinking of the dollar against foreign currencies; when those foreign savings are changed into dollars,* dollars are changed into foreign currency, Schering gets better value for money. That ain’t productivity — that’s blind luck in the foreign exchange markets.

One last point: Note that the pink lines, measuring gross profit (i.e. revenues minus manufacturing costs) are doing better than the blue lines (revenues per dollar spent on sales expenses). As Hassan noted:

Fred Hassan: we’re absolutely committed … to getting savings out of our supply chain and we are just doing it in a very careful manner. We had said last year it was going to take a little longer time with the supply chains. But the people we have in charge of that have done a lot of work in other companies. So we are going to do this the right way and you can expect a lot of basis points coming out of the cost structure as a result of the supply chain rationalization.

So here, unlike on the sales side, Hassan’s rhetoric actually seems to match reality. It’s interesting because in Pfizer’s Q4 results that company also found some cuts to make in supply costs (and thus boosted its gross profit).

Which begs a question: Perhaps it’s about time drug company CEOs stopped obsessing over sales rep salaries and started to pay a bit more attention to the cost of chemicals. There might be more money in it.

* Apologies — got my foreign currency fluctuations backward. Kudos to Shearlings Got Plowed for spotting the error.