Novartis Sees Success With New Unit Focusing on Functional Foods.

In an effort to make food healthier, Novartis AG believes consumers will agree to pay more for foods that promise to ward off illness. The world's second-largest drugmaker is revamping its foods unit, best known for Wasa crispbreads and Ovaltine malt beverages, to focus on products it says are formulated to prevent diseases.

Entering the market for functional foods -- such as calcium-fortified orange juice and oat bran-laden baked goods -- is a gamble. None of Novartis' other units look set to power earnings growth, observers say, and rival drugmakers like Roche Holding AG still seek profit m doctors' offices instead of grocery stores. While the $24.7-billion market for functional foods is less than one-tenth of the $302 billion spent last year on drugs, it is growing three times as fast -- enough to attract some companies besides Novartis, according to industry sources. Johnson & Johnson, Danone SA and Nestle SA (the world's largest foodmaker) also are expanding their offerings.

Potential pitfalls are big: FDA delayed the U.S. introduction of a cholesterol-cutting margarines both by Johnson & Johnson and Unilever by challenging the health claims made for the product. Industry observers acknowledge that such problems can undermine the public's perception of functional foods before the products catch on, so food companies are eager to not overstate claims. Advocates say functional foods are worth the effort because these products, unlike most drugs, promise a steady income: consumers seeking to avoid osteoporosis, for example, may buy calcium-laced drinks regularly for decades.

Novartis has been selling some of its conventional foods businesses, such as Wasa, to spend more on functional foods. It said it plans to introduce several such products in Europe this year. Choices range from nutraceuticals to bioactive foods. Some, such as Danone's Actimel yogurt, are touted to promote general health, while others, including Johnson & Johnson's cholesterol-cutting Benecol spreads, claim to help prevent diseases. Equally unclear is the border between these foods and supplements, such as vitamins. Datamonitor, a U.K. research firm, forecasts the sales of functional foods will grow 10 percent annually for at least the next four years. That would outpace the growth of conventional pharmaceuticals, even if those sales rebound to 8 percent a year from 3 percent last year, as forecast by IMS Health, which tracks drug prescriptions.

Aside from growth, Novartis and others say they are in the market because functional foods promise higher gross margins than traditional health foods, and because they offer a higher on return investment than drugs.