The Complex Task of Simplicity

By Adam Smith / Eindhoven

Inside an empty former electronics factory in the Dutch town of Eindhoven, hundreds of Philips employees sit around endless rows of tables. Split into small groups, staffers of the Amsterdam-based firm--maker of everything from lightbulbs and toothbrushes to TVs and X-ray machines--get to work. "We're not always an easy company to deal with," says Theo van Deursen, boss of Philips' lighting division. From a platform in the center of the vast space--still latticed with girders and pipes, its walls temporarily lined with giant TV screens--Van Deursen lays down a challenge. "We have to find ways to make the company more simple," he says. "And we can all play a role in this."

And he means everyone. On that same day in mid-November, Europe's biggest consumer-electronics company invited all of its 125,000 workers worldwide to stop work and instead think about simplifying it. (The brightest ideas would be shared company-wide.) Dubbed "Simplicity Day," it was also part of a longer-term work in progress. Over the past few years, Philips has struggled to assemble the right collection of businesses and the structure with which to run them. The company has shed unwieldy chunks of an overweight, underperforming portfolio. In a classic make-or-buy decision, Philips dumped its chips and electronics-components units--too capital intensive and too cyclical. Now it is narrowing its focus to consumer technology, lighting and health care. "There's a lot to be done," Van Deursen told his Philips staff in Eindhoven. "Are you ready for it?"

Many are about to find out. On Jan. 1, Philips unleashed its latest simplification: a leaner company structure that cuts its divisions from five to three. The sleek new shape, Philips hopes, will help boost its profit margin, before tax, interest and other charges, from last year's 7.7% to beyond 10% by 2010. That would add some $900 million to those earnings based on last year's sales of $39 billion. Preoccupied with its overhaul in recent years, "we haven't been growing to our potential," admits Gerard Kleisterlee, 61, Philips' CEO since 2001. Reversing that, he says, means "making the company more agile."

Agile was not an adjective normally associated with Philips. Sprawling, complex or plodding seemed an apt description. "They'd sell something I didn't even know they had," says Scott Geels, analyst at Sanford C. Bernstein in London. "And I wasn't the only one." Kleisterlee took a carving knife to Philips' abstruse portfolio. The semiconductor business--where even his own father labored--as well as other component businesses got the chop. "In the economic reality of today, you have to make a choice," Kleisterlee says. "We focus on the brand; we focus on marketing; we focus on downstream. We are very, very close to our customer."

And while it rewired its electronics business, Philips expanded in health care and lighting. The gradual switch to greener lighting and the rising sums being spent on health care for aging populations offered Philips the prospect of steadier growth. Flush with cash from selling unwanted units, Philips has splashed more than $7 billion on lighting and health-care companies, from Genlyte, a U.S. commercial lighting-fixtures firm it bought in November for $2.7 billion--the biggest buy it ever completed--to Lifeline, a Massachusetts-based provider of home medical-alert systems.

Having reduced the company to three core interests, Kleisterlee had a second big challenge: devising an operating structure to suit. "One of the important steps we still needed to take was to organize ourselves around markets," he says. "So we said, 'We're going to organize from the outside in.'" It's a huge decision. Organize however you like: around product lines, manufacturing, markets, geography, customers, etc. But get it wrong, and your company will wobble in the wrong orbit for years.

One big result of Kleisterlee's decision is that two separate divisions supplying retailers--DVD players were churned out by the Consumer Electronics (CE) business, for instance, and electric razors were sold by the Domestic Appliances and Personal Care unit--have been joined into a single Consumer Lifestyle business. Similarly, the Medical Systems division, which developed imaging equipment for hospitals, moved in with another health-care business, one that offered semiprofessional services, like Lifeline, for the home. The combined division is called Healthcare.

Vital signs at Philips' new health-care unit are strong. Imaging technology such as X-rays and ultrasound scanners as well as devices for monitoring patient health helped generate almost a quarter of Philips' sales in 2006; operating profits at the professional medical division soared 17%, to $1.1 billion.

Another way the firm thinks it can stand out: extending treatment to the home, where the brand is well known. For instance, heart patients can be monitored from their living rooms using Philips' new Motiva device, which checks vital signs via a broadband link to a hospital. If something is out of whack, a nurse will intervene; a regular checkup might uncover the problem too late.

Growth in home health care may not offset issues in the far larger professional segment, though. U.S. regulations have slashed Medicare payments for imaging services performed outside hospitals. That has pared lucrative sales of new imaging machines in the U.S.--Philips' largest health-care market--as much as 10% last year, according to research by JPMorgan. Still, "Philips probably has the most defensive exposure to the nonhospital imaging market" compared with rivals Siemens and GE, according to Citigroup.

A couple of years spent beefing up its lighting division is causing Philips no such pain. With revenues touching $9 billion in 2007, the company leads the global market--illuminating offices and airports, streets and sports arenas. And with a slew of acquisitions in advanced light-emitting diode (LED) know-how, Philips is "'light' years ahead" of the competition, says JPMorgan analyst Andreas Willi.

In this simplified, consumer-focused Philips, the idea is that advances in lighting technology can migrate quickly to other parts of the company. At the Catharina Hospital in Eindhoven, heart patients visiting Philips' Ambient Experience catheterization lab can choose from a range of lighting themes, projected onto ceiling screens, to help them relax. And in Philips' new Aurea TV, the shades of light in whatever you're watching are mirrored by lights inside the frame around the screen, luring the viewer in.

If only attracting attention to consumer electronics were that simple. Fact is, for Philips to hit its ambitious growth targets, the company must take on the trickier challenges inherent in the new consumer-lifestyle business--like defining the category. "This notion of the consumer-electronics company," Kleisterlee says, is "of the past." These days, state of mind and body are increasingly what matters, Philips reckons. And both will influence shoppers' behavior to a greater degree. So for lifestyle, read products "that cater for those consumers interested in health and well-being." Take your alarm clock, for one. Instead of a loud buzzer jolting you out of bed, Philips wants to sell you a wake-up light that mimics a sunrise in slowly coaxing you out of slumber. Consumer lifestyle means going beyond "just a company that does flat-screen TVs," Kleisterlee says.

Yet neither consumers nor competitors, damn them, are obligated to think that way, especially when it comes to big-ticket items like TVs. Philips' LCD-TV business is losing money in the insanely competitive U.S. market, under pressure from the likes of Sony and Samsung. Globally, profit margins in the $15 billion consumer-electronics business are flat-screen thin. With TVs accounting for about 60% of sales at the former CE division, "if you look at [Philips'] strategic targets--stable growth and higher profitability," says SNS Securities' analyst Victor Bareno, "then the core business of consumer electronics is not really a good fit."

Philips says it will differentiate its products through lifestyle-driven innovation. On that score, it's enjoying greater success. In 2006, 53% of group sales came from products launched in the previous three years. That's more than double the level of 2003. Last March, for instance, Philips--in partnership with Swarovski--launched the Active Crystals line, turning high-tech devices like memory sticks into high fashion. New items like that have helped triple sales at Philips' accessories unit in the past three years. "I've said many times, consumer electronics should be a lifestyle business; it should be a fashion business," says Rudy Provoost, the former CEO of Consumer Electronics who is set to run the lighting division starting in April. "There's too much electronics in consumer electronics and not enough consumer."

With the heaviest lifting behind it, Philips needs to address its underperforming share price: the stock has slid 20% on the Amsterdam bourse since July. Citigroup analysts are bullish, however, calling Philips "a growth company masquerading as a restructuring story." Whatever happens, Philips has faced tougher times. Just a short drive across town from the Eindhoven plant, you can visit the company's first factory, where beginning in 1891 it manufactured incandescent lightbulbs for ships and hotels. Back then, the company needed to churn out 500 each day to turn a profit. At the start, it could manage only 400. In case Van Deursen needs any encouragement: things have a habit of getting simpler.

With reporting by With Reporting by Bill Saporito / Washington