Is Schering-Plough’s ‘Productivity Transformation Program’ Actually Making S-P Less Productive?

August 1, 2008

Lots of bad news for Schering-Plough today. You can read that here.

But if you go back to S-P’s second quarter earnings call, you’ll note that the company is on a cost-cutting drive.

They have a name for that drive, the “Productivity Transformation Program.”

So, just how productive is it?

CFO Robert J. Bertolini said this:

“To date, we have achieved about $100 million in savings, including about $70 million this quarter. Most of the savings were in SG&A.”

Sounds pretty impressive. But does it hold up to analysis?

Regular readers will remember that NRx recently did an experiment regarding SG&A at drug companies. I asked, How efficiently do drug companies handle their selling, general and administrative budgets? And how profitable are the results of those budgets? By comparing SG&A to revenues and gross profits, we can plot the growth – or lack thereof – of the productivity of SG&A.

(Don’t understand this? All you need to “get” is that we’re figuring how many dollars each company makes in revenue and gross profit for each single dollar it spent on marketing.)

Here’s a chart of growth rates of revenue and gross margin yield from S-P’s SG&A spend. (In general, you want to see the pink and blue lines either flat or pointing upward, and above the 0% level.)

As you can see, despite cutting $100 million ($70 million this quarter!) the growth in S-P’s yields declined. The revenue yield of its marketing investment actually declined into negative territory. And the growth in profitability of that investment slowed considerably, from nearly 15% to less than 10%, meaning that the company is currently destroying the value of its SG&A investments, not increasing it.

So much for PTP.

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3 Responses to “Is Schering-Plough’s ‘Productivity Transformation Program’ Actually Making S-P Less Productive?”

  1. Condor Says:

    I decided to leave this as comment box matter, for now, because I want to go back and look at your formulae against Pfizer, and Novartis et al. — the ones that started your thinking and writing, linked above. . . .

    Now, after I looked at Cost of Sales for Q2 2008, at Schering-Plough, I began to wonder whether this measure isn’t actually ALSO recording a fair amount of “noise” — noise in the form of Cost of Sales (or what is more generally referred to as “CoGS” in accounting-speak) variances driven by Organon integration variances:

    “. . . .Cost of sales for the three and six months ended June 30, 2008 include purchase accounting adjustments of $354 million and $1.0 billion, respectively, related to the acquisition of [Organon]. . . .”

    That is Note 2 to Schering’s Q2 Press Release — Now, the Q1 Note 2 text:

    “. . . .Cost of sales for the three months ended March 31, 2008 includes purchase accounting adjustments of $688 million related to the acquisition of [Organon]. . . .”

    [NOTE: these are, generally-speaking, mostly inventory re-valuation charges — and as such, are likely mean little to future operating results. They may reflect some unduly optimistic assumptions about inventory values, in PRIOR periods, though.]

    In any event, I am struck by the quarter-to-quarter volatility there — $688M in Q1, but “only” $354M in Q2. . . .

    Two to one, almost. And this would likely hold to a common pattern — at most companies with large restructurings (and thus charges) in process. . . .

    That volatility, in turn, will distort your ratio of Gross Profit to S,G&A — as it flows right through, right?

    I think so.

    That said, I think your general points are very cogent — and well made. I simply think the measure you are focusing on — is kind of “noisy” — and, certainly it is, at Schering-Plough.

    Namste

  2. jimedwardsnrx Says:

    You’re absolutely right that the analysis contains “noise.” I agree with everything you wrote.

    Revenues and gross profit may go up and down for reasons such as COGS that are not in control of the execs responsible for SG&A. But if we assume that the company knows that it is going to see price hikes for raw materials, reducing its margins, does it make sense for it to continue its marketing investment at the same level? Particularly if you’re trying to deliver net income and free cashflow for Wall Street?

    Bottom line: I think this measure is interesting because regardless of the noise it tells you whether a company’s SG&A is trending better or worse over time. This is important because SG&A is twice R&D at most companies. There ought to be SOME measure of the effectiveness of a company’s biggest expense!

  3. Condor Says:

    Quite so — I agree with what you wrote, as well, Jim.

    Mine was really referring to the portion of your measures that make a ratio out of S,G&A over Gross Profits. Gross Profit is “noisy.” The ratio of S,G&A to R&D is a little less noisy.

    So, yep — very interesting!

    Kind regards,

    — Condor


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