3M: A Lab for Growth?

CEO Jim McNerney--the first outsider boss--is overhauling a company long known for innovation

Throughout its 100-year history, 3M has had a surefire formula for growth: hire top-notch scientists in every field, give each an ample endowment, then stand back and let them do their thing. That anything-goes approach has yielded thousands of new products over the decades, from sandpaper and magnetic audio tape to Post-it Notes and Thinsulate insulation. Indeed, 3M generated $5.6 billion in sales in 2000--fully one-third of its revenues--from goods that didn't exist just four years earlier.

But that's not good enough for 3M's new boss. Sure, that record of innovation impresses Chairman and Chief Executive W. James McNerney Jr., the first outsider to take the helm. Yet he argues that even with a $1 billion budget and a staff of 7,000, 3M's vaunted products laboratory won't be able to achieve the growth he wants. And how much is that? McNerney audaciously predicts he can double the record numbers of 2000 in 10 years or less. Previously, it took the St. Paul (Minn.) conglomerate 15 years to do that.

In that regard, McNerney, 52, is off to a slow start. Sales and profits have fallen since he arrived from General Electric Co. on Jan. 1, 2001, with revenues dropping faster than at any time in the past 30 years. 3M's health-care unit has been growing rapidly, but telecom sales are off sharply. Building on some adept cost-cutting and improved efficiencies, 3M weathered 2001 well enough that industry analysts and institutional shareholders are bullish on McNerney's long-term plans. But achieving them will be far from easy.

To hit his targets of increasing sales by 11% a year and operating earnings by 12%--nearly twice the rate of the past decade--the newcomer concedes that he needs to pull off a string of decent-size acquisitions and plunge into services. As all sorts of companies have discovered recently, though, takeovers don't always pay off. Moreover, 3M has little experience in dealmaking beyond niche purchases. "One big, bad acquisition, and his targets are out," warns analyst John E. Roberts of Merrill Lynch & Co. On top of that, 3M's catalog of small-ticket products does not lend itself easily to add-on services. GE may be able to win service contracts to maintain expensive goods, such as jet engines, but do Scotch tape buyers really want 3M to ship their boxes?

McNerney's new course also runs the risk of stifling 3M's hallmark creativity. He and his lieutenants are already specifying where research and development dollars are spent and establishing uniform performance standards across 3M. That runs counter to its tradition of giving individual business chiefs free rein. "The most important thing about 3M--the single most important thing--is you get to do things your own way," says Ronald O. Baukol, executive vice-president for international operations and a 33-year veteran. 3M old-timers generally back McNerney, conceding that money wasn't always wisely spent. McNerney says he understands the balancing act: "My job is to add scale in a fast-moving, entrepreneurial environment. If I end up killing that entrepreneurial spirit. I will have failed."

Indeed, he'll need all the creative energy 3M can muster if he hopes to rev up growth once the recession ends. Many on Wall Street believe that 3M can add a percentage point to its growth rate simply by creating and launching products more efficiently, a process McNerney says should bear fruit with new rollouts this year. (He won't be more specific). He also wants to pump up international sales.

But Wall Street is mostly rooting for McNerney because 3M has held up relatively well during the recession. Credit some GE-like cost-cutting measures. Only weeks after succeeding L.D. DeSimone, McNerney announced the layoff of 5,000 of 3M's 75,000 employees. He also instituted the money-saving Six Sigma process-management system companywide. One small example: 3M had lost $1 million a year because its ceramics, used in dental works, sometimes cracked. A review showed that the material hadn't been properly cured, and the problem was fixed. 3M has also begun pooling purchases on a global basis to get lower prices.

The balance sheet shows his handiwork. 3M had piled up almost $440 million in cash as of Sept. 30, up 45% from the start of the year. Overhead expenses, meantime, were down 7% in the third quarter on a year-to-year basis. Altogether, the company's annual operating costs are $400 million below the level they were at when McNerney arrived. Add in savings from layoffs and shifts of manufacturing and R&D to lower-cost sites abroad, and McNerney thinks he can save $1 billion in 2002.

Investors appreciate the numbers. Even though 3M's stock price is down 2% since Jan. 1, 2001, that compares with a 9% decline in the Standard & Poor's 500-stock index. And since Sept. 21, 3M is up 34%, vs. 21% for the S&P 500. Matthew G. Baker, an equity analyst with MFS Investment Management in Boston, used to think 3M had let costs get too high and its brilliant researchers grow lazy. "The potential of the company was a lot better than what was showing up in its numbers," he says. He upgraded his opinion last March and has doubled his 3M stake to 6.4 million shares.

Unquestionably, however, McNerney's ambitions have been slowed by the economic downturn. Analyst J. Jeffrey Cianci of UBS Warburg estimates that 3M's 2001 profits fell 13%, to $1.61 billion from $1.86 billion in 2000, excluding one-time items such as a $600 million pretax restructuring charge, while revenue fell 4%, to $16.1 billion from $16.7 billion. The major culprit? 3M's battered telecom division, whose sales fell 10% in 2001 and may drop again this year. Even so, analysts say 3M's earnings should rise in 2002; Cianci, for instance, sees profits reaching $2 billion.

The clear darling of the new chief is 3M's health-care unit, which pumps out everything from medical equipment and tooth-colored dental fillings to pharmaceuticals. One of the hottest products is the antiviral salve Aldara, a genital-wart treatment that could also prove promising against herpes. Health-care sales were expected to total $3.4 billion in 2001, up 8% from 2000. "It is the highest-potential single thing we are doing," McNerney says. "If I could be twice as big in health care, I'd love it."

But don't expect him to sign blockbuster deals any time soon. McNerney says he has not even started a shopping list. He does, however, have some ideas about how to enter the service sector. 3M's telecom unit, for one, could cut deals to maintain the fiber-optic components it sells to phone companies. Whatever he adds to the mix, McNerney has vowed no massive reorganization at 3M. That, he says, could be demoralizing. "It's not a matter of machine-gunning the team because I'm new and I think I'm smarter and better," McNerney says. "This is taking a very good company and making it better."

3M's headquarters has a wall of fame featuring photos of its most innovative scientists, such as Richard G. Drew, who invented cellophane tape. Give McNerney time, and he could be there, too--as the man who turned a 100-year-old company back into a growth stock.

By Michael Arndt in St. Paul, Minn.

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