Philips' big idea: can Gerard Kleisterlee and his team make Philips Electronics the leading player in health care technology?

After years of earnings disappointments, Royal Philips Electronics is attempting a transformation it hopes will catapult it into a leadership role in the U.S. health care technology market. CEO Gerard Kleisterlee and his management board sat down in New York to explain their strategy. Here are highlights:

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Q: How are you trying to change Philips?

Kleisterlee: We are trying to create a company that, in a more predictable way, generates value for its stakeholders and particularly shareholders. We have to create a portfolio that is less volatile. In the portfolio I inherited, medical systems has stability and good margins. We also felt we could generate more growth in our lighting division by driving innovation and also in our domestic appliances and particularly personal care products such as shaving and dental care. That is the part of the portfolio where we have margins in the teens and opportunity to drive growth through innovation or acquisition.

Q: What about the less promising areas?

Kleisterlee: On the other side of the portfolio, you have volatile, low-margin businesses, such as the high-volume electronics businesses. The consumer electronics division is an element of that. We were fully integrated vertically with a components division where we made cathode ray tubes, liquid crystal displays and optical drives. The components division was getting squeezed in the middle, so we dissolved it and divested a number of operations. We de-verticalized our consumer electronics business. We said, "We have to emulate the Dell model. This is an industry that's going to work like the computer industry, which means you focus on designing your product, sourcing it in Asia, then leveraging your brand and your clout in your distribution channels. "We've done that successfully in the U.S. and elsewhere, and turned more than 10 years of loss-making operations into a profitable and fast-growing market position.

Q: So China and other manufacturing countries are commoditizing some areas of your business and you need to get repositioned in a hurry?

Kleisterlee: Yes, we've done that well ahead of most of our competitors. We use the strong presence that we have in China to optimize our sourcing. Most of our electronics comes out of China.

Q: But your real emphasis is on the higher value pieces of your portfolio?

Kleisterlee: Yes, we've made significant investments, particularly in the U.S., to strengthen our medical business. We acquired five companies in the U.S. by 1998 and took some time to consolidate. Most recently, we've acquired a medical information technology company in Brisbane, Calif., called Stentor. We've strengthened our lighting division by acquiring Lumileds, which had been a joint venture with Agilent Technologies.

Q: Lighting seems like it would be a commodity sector.

Kleisterlee: Not at all. That's a huge misconception. When you talk about lighting, most people think about buying lamps in Wal-Mart. But most of the lighting we do is office lighting and public lighting, and we have a number of OEM activities such as automotive lighting. We are aimed at the professional segment, not the consumer.

Q: Give me some numbers that show the overall magnitude of what you're trying to do.

Kleisterlee: Six years ago, medical systems represented 9 percent of our activity in the U.S. That's now 41 percent. Other activities such as the component division represented 23 percent of our business. That's now down to 4 percent. Most of that is gone. It's been replaced by health care. Globally, medical systems used to be 9 percent of our portfolio and now it's 21 percent.

Q: Why does medical seem more predictable?

Kleisterlee: There is no seasonality in people getting ill. Demographics also point toward health care being a growth industry everywhere around the world. Spending on health care globally is growing faster than GNP. People are getting older and they'd like to be healthier. They demand more and better care--and technology can provide that.

Q: Which of your technologies are most promising in the medical sector?

Ad Huijser, chief technology officer: We have long been very strong in X-rays and X-ray applications. We also have introduced a broad spectrum of new technologies, including in magnetic resonance and ultrasound. But it's not only the technology that counts; it's the way that doctors use these technologies in their hospitals. The ease of use, the simplicity and the economics are very important.

Kleisterlee: If you take an MRI or a high-speed CT, you get a terabyte of data.

Huijser: Yes, and we can do that in real time, which makes it possible to have real-time imaging and observe what happens when organs act, when a heart beats. We call that 4D, with the fourth dimension being time.

Q: The American health care system in some ways is very primitive. Other sectors of this economy are much more computerized.

Huijser: It's not just the American health care system. That's all over the place. It has to do with the fact that doctors, once they have their education, don't want to change the procedures they have learned. There are only a few who innovate, particularly in the academic hospitals. We're in those clinics with our researchers.

Q: Is the American system going to embrace some of these newer technologies by perhaps allowing patient records to be automated or allow X-rays to move across networks better?

Huijser: That's going to happen everywhere, at a rapid pace, because of the efficiency. The health care bill is rising everywhere.

Kleisterlee: There are big opportunities in health care IT. It's going to be rolled out. While you say that the health care system is primitive in the U.S., it's more primitive elsewhere. Most of the health care IT spending globally is done in the U.S. If you look at the leading health care IT companies and the split of their revenues, a majority of it is in the U.S. But what has held it back from being even bigger is the lack of standardization of data and standardization of processes.

Q: This direction will take you into more direct competition against Siemens and General Electric, right?

Kleisterlee: No, it will not take us into more direct competition--we are already in direct competition. In the good old days of X-rays, those companies were our leading competitors and that hasn't changed.

Q: Do you have an advantage or technological edge?

Kleisterlee: Yes, in certain areas, at times, because this is an industry where all players at the end of the day pursue similar technologies and similar solutions.

But a differentiator that gets fed back to us from our customers is that we are leading in customer service and that we are more patient-oriented than some of our competitors.

Q: How can you be more patient-oriented?

Kleisterlee: A revolutionary example is at Lutheran Children's Hospital in Chicago. There, we built a room for a patient-oriented CT system. Even we as adults are sometimes uncomfortable going through such a procedure. You can imagine that children can be traumatized. We have tried to use the skills we have in lighting and consumer electronics to make it easier. We use images. We use our wireless technology. When the child is being prepared for the procedure, the nurse talks with the child about a number of environments and shows him cartoon characters or whatever. The child can choose the environment he likes. The doctor gets a smart card and sees who the patient is and what environment he likes. The patient is put at ease.

Q: Does it work?

Kleisterlee: We got an email from a doctor after he had done his first real procedure there. It looked like the child might have to be sedated, and the mother was panicking about the child being sedated. But with this technology, the child was at ease and there was no sedation.

Q: How is your research and development playing a role in this competitive battle?

Huijser: In the medical domain, we spend 9 to 10 percent of sales on R & D.

Q: You're among the world's top patent receivers, are you not?

Huijser: Absolutely. In Europe, we rank No. 1 and in the U.S., now we are No. 15. We have an average of 3,000 patent filings a year.

Q: How have you shifted your R & D strategy in view of your new business thrust?

Huijser: Our R & D used to be spread all over the place from emerging to mature businesses, but now we've shifted it away from the mature businesses to the early stages of the life cycle of products. At the end of the life cycle, we turn to others to make the products. We source 90 percent of those mature products, built to our specifications, but we don't spend money on R & D for those products.

Kleisterlee: The mature businesses spent a chunk of our R & D trying to make a better light bulb or the next CRT television. The big change now is that the money is going to emerging and growing applications. That's a huge change.

Q: So how much time do you have to complete your transformation? Haven't your sales been flat?

Kleisterlee: The answer is yes, on balance. There are always parts of the portfolio that grow, but then you shed some other businesses. Yes, sales have been flat for a long time. The big challenge is to consistently get growth. Lighting is a division that had been growing at 1 or 2 percent a year. It's now turning out 4 or 5 percent, and it can do better. Medical will do 5 or 6 percent or more this year. The small appliance area is where we still have some work. So getting the whole company to grow at 5 or 6 percent is still the challenge we face. We're in a critical phase.

Q: Why is now a critical moment?

Kleisterlee: We have been transforming the company and re-engineering the portfolio, downsizing, rightsizing, whatever you want to call it, for a number of years. Most of that is behind us. We now have a very focused set of divisions. We have a company where already for many quarters, every division turns in a profit, which historically was not the case. But it still isn't growing at the pace we need to see.

Q: What went wrong at Philips?

Kleisterlee: An old company loses its focus over time. If you look at Philips in the 1980s, it was in any kind of business you could imagine that even remotely had something to do with electronics. We made fertilizers and vitamin pills. In the U.S., we had Carolina Coach, we had Selmer Instruments, we made furniture, we made trumpets. It was a sprawling conglomerate and you lose track at the top. Once you're in a downward spiral, that is difficult to reverse. For many years, you're basically cleaning up your portfolio. It's only in recent years that we have a focus on the businesses that we understand. Now we need to get the growth.

Q: How are you changing the culture?

Kleisterlee: There is a big cultural change. If you have a history like we have, you're bound to get into a phase of internal bureaucracy, slow decision-making and being more internally focused than market-oriented. In the last four or five years, we changed by trying to drive innovation and by making the company outward-oriented by bringing the marketing and customer focus in. We've strengthened the whole marketing operation. We've repositioned the brand. We came up with the "Sense of Simplicity" campaign, rather than the "Let's Make Things Better" campaign that we had had.

We've stepped up the marketing as a profession but also as a mind-set. When we come up with new ideas, it starts with the customer. What is the benefit to the customer? What are the unique insights we're using? Then we work back. For a long time, we were a "technology out" company. We said, "This is the way we do things at Philips. We have a brilliant invention. Why don't customers buy it?"

Q: When will this transformation process be completed?

Kleisterlee: Never. We may complete projects and programs, but you can never afford to stand still and think that you're done. But the direction is clear. In a couple of years, you'll see that we have built up the health care part of our portfolio. We must be able to show that we can grow top line and bottom line, and that Philips is a more valuable company.

Q: In the U.S., how far will you go in the medical area? What is your objective in terms of a percentage of your U.S. sales?

Kleisterlee: If it goes in the direction of 50 percent, that's fine with me, as long as the other businesses also show healthy growth.

RELATED ARTICLE: At A Glance

2004 U.S. Sales

World total sales $37.6 billion

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U.S. Sales Composition

Medical                41%
Consumer Electronics*  59%

*lighting, domestic & personal care appliances, semiconductors, others

Note: Table made from pie chart.

Source: Royal Philips Electronics

RELATED ARTICLE: Philips' Management

Gerard Kleisterlee Dutch, is president/CEO and chairman of the Board of Management. He began his career with Philips in 1974 in the medical systems division and became CEO in 2001.

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Ad Huijser Dutch, is executive vice president and chief technology officer. He joined Philips in 1970 in its research laboratories.

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Gottfried Dutine German, is executive vice president. All geographies and business units report to him. He worked for Rockwell-Collins, Motorola, Robert Bosch and Alcatel before joining Philips in 2002.

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Pierre-Jean Sivignon French, is chief financial officer. He worked for Peat Marwick Mitchell, the Schlumberger Group and Faurecia, a supplier of automotive equipment, prior to joining Philips in 2005.

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Source: Royal Philips Electronics