Philips: Back On The Beam

Its upturn looks solid, but previous ones have quickly flamed out

Shoppers at the Darty electronics store near Place des Ternes in Paris are a picky bunch. In the TV section, real estate agent Henri Durand, 48, stares at the flickering screens, checks price tags, and studies spec sheets. A third of the models come from Dutch giant Royal Philips Electronics, but there are also goods from Sony (SNE ), JVC, Thomson, and others. Durand picks Philips. "I'm no specialist, but I trust Philips," he says. "It's European."

Such sentiments are music to Philips Chief Executive Gerard J. Kleisterlee. Since stepping into the top job in 2001, he has battled through one of the worst crises ever to hit a company long known for missteps and seemingly endless restructurings. Now, Philips seems to be getting back on track. Thanks to cost cutting, more efficient manufacturing, and solid sales of chips and flat-panel displays, it booked net earnings of $872 million in 2003, on revenues of $36.5 billion. Among the highlights: Sales in China soared 34%, and the troubled U.S. consumer electronics unit ended the year with its first quarterly profit in a decade.

It has been a long, tough climb for Kleisterlee. Revenues have fallen 23% in the past three years, and the company racked up $5.6 billion in losses in 2001 and 2002. Some 55,000 employees -- a quarter of the total when Kleisterlee took over -- have been shown the door. And Europe's No. 1 electronics maker still faces questions about its place in an industry dominated by Asian giants such as Sony Corp. and Samsung Electronics.

DEMONS AT REST? For now, at least, Kleisterlee's turnaround seems solid. On Apr. 13, Philips reported first-quarter net income of $670 million on a 2% gain in sales over the same period last year. Analysts predict Philips will remain profitable into 2005. What's more, investors looking for a recovery have bid up its shares 58% in the past 12 months. On Apr. 21, the stock closed at $28.45 in Amsterdam.

To merit investors' faith, Kleisterlee now has to get Philips growing again. "I see a lot of momentum in many of our businesses," the 58-year-old CEO says with measured optimism. Indeed, Philips has delivered several bona fide hits in recent years, from its Senseo coffeemaker to recordable DVDs. Its joint venture with Korea's LG Electronics to produce large-format liquid crystal displays for TVs and PCs grabbed the No. 1 position from Samsung last year, according to iSuppli/Stanford Resources, a researcher in Santa Clara, Calif. And its long-troubled semiconductor division is enjoying an upswing, with 20% year-on-year growth.

It's enough to suggest the Philips of old. With 100,000 patents to its name, Philips has a rich, 113-year history of innovation. It pioneered medical X-rays, electric shavers, audiocassettes, and compact disks, and for years it was emblematic of European technical prowess. But the same engineering culture that produced such excellence also generated products that flopped, from a 1980s rival to VHS and Beta VCRs to an interactive entertainment system. "Philips has always been great at innovation, but it has had big problems with marketing," says Paul O'Donovan, an analyst at researcher Gartner Inc. (IT ) in Egham, outside London.

The big question is whether Philips has put its demons to rest. The company nearly collapsed in the early 1990s; revenues are barely above where they were 10 years ago. Although profitability has been restored, analysts forecast slow overall growth in the next few years. Morgan Stanley (MWD ) predicts revenues will edge up only 2.8% this year and 3.4% in 2005.

To pick up the pace, Kleisterlee, a 30-year Philips veteran, started by once again reorganizing the company. He divested $850 million in poorly performing or noncore businesses and squeezed out more than $1.2 billion in operating expenses. He has also shuttered a dozen factories, outsourced nearly all consumer electronics and appliance manufacturing, and farmed out chip production. These changes are showing up in improved returns on assets and capital, benchmarks by which Philips outpaces rivals Sony and Matsushita.

Now the goal is to refocus Philips around its fastest-growing and most profitable sectors, especially medical systems, while pushing products from analog to digital. "No question, it's a much more focused company," says René Verhoef of Fortis Bank in Amsterdam. Key to the tighter focus is Kleisterlee's plan to break down the walls separating Philips' fiercely independent divisions and get them to communicate. "We're transforming ourselves into a single company," he says. Under the rubric "One Philips," the CEO is centralizing functions such as marketing and human resources to eliminate duplication. Two years ago, Philips used more than 225 management software systems; by the end of 2004 that number will be 75% smaller. Kleisterlee also has brought in fresh talent. John McClure, a 40-year-old American from Sun Microsystems Inc. (SUNW ), is vice-president in charge of strategy; Andrea Ragnetti, a 43-year-old Italian from the consumer division of Telecom Italia (TI ), is now chief marketing officer.

"FLEETER OF FOOT". The new execs are bearing Kleisterlee's one-company gospel to the ranks. A month after Ragnetti joined Philips in January, 2003, he held a meeting in the U.S. for division marketing managers, many of whom were meeting for the first time. Now they hold monthly checkups to coordinate activities.

Such links are blurring the lines between units. The medical products group has started offering products to serve home health care. It has scored hits with a portable defibrillator for heart patients and easy-to-use devices for monitoring heart rate and blood pressure. The lighting group is working with consumer electronics to create "ambient" illumination systems that enhance TV-watching. Kleisterlee is also accelerating development -- and beating rivals to market with products such as MP3 players and digital camera pendants. A flat-panel TV that doubles as a mirror when not in use went from lab to stores in just over a year. "Philips is much fleeter of foot than it used to be," says O'Donovan.

The company's latest push is wireless. The goal is to enable products to communicate over the air via technologies such as Wi-Fi. To make it fly, the company has to collaborate with rivals on standards. That's why Philips is backing joint efforts such as the creation of an ultralow-power radio technology called ZigBee, which can connect coffeemakers, security systems, and even lightbulbs. "It's better to team up than to fight," says Kleisterlee.

Philips has staged apparent turnarounds before, only to see them flame out. Steady businesses such as lightbulbs help keep the ship afloat, but prices for flat panels are already falling, and the chip business will invariably cycle down again. Still, Kleisterlee is determined to break the pattern for good. If he succeeds, Philips' old demons could be knocked out cold.

By Andy Reinhardt in Paris

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