Speech Gerard Kleisterlee at the China Party School

May 25, 2010

(Dignitaries), ladies and gentlemen,

 

It is a great honor for me to return to the Party School of the Central Committee of the Communist Party of China here in Beijing. Almost two and a half years have passed since I made my latest address to the School in December 2007. As the Chinese economy has proved itself to be very resilient to the recent global recession, I am now even more convinced of China’s strength and potential. In reaction to the downturn, China aligned its stimulus initiatives with an effort to strengthen its physical infrastructure, widen the knowledge base of the Chinese economy, improve its energy-efficiency and solve environmental and social problems. As a result, the transformation of China’s growth model continues at a swift pace.

 

Today, as the CEO of Philips, I have been asked to talk about our own transformation process: the transformation of Philips over the last decade into a global leader in health and well-being. I will discuss the reasons behind our transformation, the challenges we faced, the three key elements of this process, the way we executed our transformation strategy and, of course, some lessons we have learned.

 

I am delighted to talk about this exciting subject here in China, because a strong focus on the growth opportunities in emerging markets was and is an essential part of our transformation process. Over the last decade, our sales in emerging markets have increased steadily as a percentage of our total sales and are now well over 30%. China is now our second largest market worldwide, surpassing Germany in the last quarter and in 2009 reporting sales of 1.7 billion Euros. We are one of the largest multinationals in the country; we operate in about 600 Chinese cities and employ 15,000 people in China. I sincerely hope that my reflections on Philips’ transformation may be of use to you in dealing with your own challenging tasks.

 

In the late nineteen nineties, Philips was a high-volume, technology driven electronics manufacturer with an uneven business performance and volatile financial results. Since then, we have transformed ourselves into a high-value, market driven business in health and well-being, a resilient and agile company with more stable results. Why did we embark on this radical process of transformation and how did we go about it?

 

At the end of the last century, it was clear that Philips had to change. The company lacked focus; Philips was a diversified conglomerate with too many activities that were only loosely connected. There was no clear vision and strategy gluing all different businesses together. As a result, the company was hard to understand for outsiders and difficult to manage for insiders. The organizational structure of our company was perceived being too complex: we had too many activities, many minority stakes, and an inextricable structure. For potential investors, it was not clear what proposition they were buying into if they thought about acquiring our shares. For managers, this complicated structure hampered quick and efficient action.

 

In the mid nineties, our shortcomings had translated into a series of negative financial results that threatened the very future of the company. That was a loud wake up call. When the tech bubble burst in the year 2000, the alarm went off again. It was by then very clear that we had no choice. We needed to become a much more focused, transparent, agile and resilient company. We had to choose which activities we wanted to focus on and we needed to simplify our organizational chart.

 

In other words, a profound transformation of Philips was necessary. This transformation process was propelled by three driving forces. The first two were objective developments in the world around us: On the one hand, changes in the electronics industry. On the other, long term global trends with profound social and economic consequences, such as the aging of world population and the rise of chronic diseases that result in  increasing costs of healthcare systems around the world, the increased focus on sustainability and energy efficiency and last of all the rise of emerging economies.

 

Taking into account these developments, we decided to start transforming Philips; from a traditional consumer electronics company into a company focused on products and applications in the health and well-being area. This strategic repositioning of our company resulted in the divestment of our Components and our Semiconductor businesses and parts of our traditional Consumer Electronics sector. At the same time we started to invest in our healthcare sector. This choice for a coherent portfolio focused on health and well-being meant that our commercial target audience became much more homogeneous. It allowed us to define a unified approach to branding and marketing across the entire company and all our activities, summarized in our brand proposition of ‘“sense and simplicity”’. This new, unified approach to marketing and brand became a third, important element in our transformation.

 

As a result of this, we are now well on our way to achieve our overarching goal: to become a global leader in the area of health and well-being. We have concentrated our business in three sectors: Healthcare, Consumer Lifestyle and Lighting. We strengthened our Healthcare and Lighting business through numerous acquisitions and organic growth. In Consumer Lifestyle we focus on market segments where our products can make a clear difference and where we can gain a competitive advantage. We try to address consumers’ broader lifestyle needs that go beyond mere gadgets and that are linked to emotions and experiences.

 

We now have a very balanced portfolio. Our three sectors each make up roughly one third of our revenues. The geographic spread of our sales confirms our truly global character. We have achieved many global leadership positions in the health and well-being markets we focus on, from home healthcare solutions to energy-efficient lighting and electric shavers. Let me now discuss the three key elements of our transformation in more detail, starting with the first driving force, changes in the electronics industry.

 

Around the turn of the century, it had become very clear to us that the era of the fully integrated electronics company was coming to an end. There was a clear tendency for companies to concentrate on one of three areas: technology and components; manufacturing and assembly; or the design and marketing of applications. We had to make a choice and we decided to focus on the last one.

 

This choice for applications was complemented by another important decision. Because it is nowadays much more difficult to gain a competitive advantage and create value in manufacturing, we decided to outsource many of our manufacturing activities, also to companies based in China. We still manufacture ourselves, of course, but only where we have a clear competitive advantage, for example, because of our expertise in shavers and many lighting solutions.

 

So we decided to focus on health and well-being and to simplify our structure, concentrating on R&D, design, brand building and sales power in the applications business. To that end, we had to take some quite radical steps over the last decade. We divested large chunks of our business, including Components and Semiconductors, and we have merged our consumer electronics and domestic appliance activities into one sector, Consumer Lifestyle.

 

Because of our focus on applications in health and well-being, the divestment of our Component and our Semiconductor businesses was logical. Logical doesn’t mean easy, however. For many years, these activities had been at the very heart of Philips. Emotions sometimes ran high. In order to get ‘buy in’ for difficult decisions during a transformation, such as the divestment of a large business, what is needed is a good combination of leadership and listening. Once you have taken a decision, you must show courage and leadership by following through, but before you come to a decision, it is essential to listen to stakeholders inside and outside the company.

 

You have to take people’s concerns seriously, whether they are employees, shareholders or other stakeholders. It is impossible to transform a company if you cannot engage your own employees. You must make them feel that the transformation is their transformation, that it makes their work more worthwhile, that their effort is essential for success.

 

You can only achieve that if you treat people well, even when you have to take hard decisions. Selling our Semiconductor business was such a hard decision. After all, it was a business with 37.000 employees and 4.6 billion Euros in revenues. In those transforming moments, it is even more important to stick to your principles. Therefore, the future viability of the Semiconductors business and a decent transition for our employees were important goals for us during the negotiations. Obviously, after the spin-off we were not responsible for the division and its people anymore, but we didn’t abandon the business and its people to its fate when we negotiated the deal. In other words, our considerations were not only financial.

 

Timing was another very important issue in the spin off of the Semiconductor business. The moment you take a strategic decision is not necessarily the best moment to execute that decision. Financial or market constraints may oblige you to postpone implementation. When we decided that the best future of our Semiconductors business was outside Philips, market conditions would not have allowed a sale under reasonable conditions, so we had to be patient. In the meantime, of course, we kept running the business as best we could.

 

Beyond divestments, we had to define the sectors we did want to focus on, of course. That brings me to the second driving force propelling our transformation. Our decision to concentrate on the health and well-being area was informed by the analysis of several important social trends and the opportunities they offered to Philips.

 

One of the trends we could clearly discern was the growing global importance of healthcare, both socially and economically. We saw the long term attractiveness of this sector for our company. At the end of last century, however, our Healthcare business was relatively small. Shortly after I became CEO of the company, many people asked us when Philips would sell off that business. But we had no such plans, on the contrary.

 

Populations in China, in Europe, in the US, in Japan are aging. Worldwide, chronic diseases are on the rise. We urgently need to find cost-efficient, user-friendly solutions to ensure that healthcare is available, accessible and affordable. Philips is in a good position to help find these solutions. So we decided to expand our Healthcare business rapidly.

 

Another important trend that influenced our strategic decision making is the growing importance of energy efficiency and reduction of environmental impact in the way we produce and consume. In recognition of that trend, we embedded sustainability in the way we conduct our business, from product design to manufacturing, from office management to branding. Over the last decade, Philips has dramatically reduced its own environmental impact by setting ourselves clear and demanding targets.

 

The global necessity to save energy and reduce greenhouse gas emissions opened up great opportunities for our Lighting business, as we were already leaders in energy-efficient lighting solutions. Over the last decade, we have strengthened this leadership position by actively expanding in Light Emitting Diodes or LEDs, currently the most energy-efficient lighting solution on the market. Here in China, for example, we won the contract to light the 610 meter high Guangzhou TV tower with our LED-based solutions. Our advanced lighting solutions clearly contribute to people’s well-being, as they make our environment more beautiful and safer in an environmentally responsible way.

 

Both in Healthcare and in Lighting, acquisitions played a very important role in our expansion plans. Through acquisitions, we strengthened our positions in existing businesses and entered new ones. Between 2000 and 2003, Philips spent 5 billion Euros on various acquisitions in the Healthcare sector, followed by another wave later on in the decade. In Lighting, we have strengthened our presence in LED-applications through various strategic acquisitions over the last five years.

 

Another striking development is the global rise of middle-class consumers who are increasingly interested in easy-to-use, customer-friendly solutions. Their focus is shifting from basic products to solutions that increase their health and well-being. In China, for example, consumers are looking for solutions to improve the air quality in their homes. In order to fulfill their aspirations, the starting point of any product design should be the needs and wishes of the user of the product, not technology. Therefore, Philips has taken a very people-centric approach over the last decade. Don’t get me wrong: we are still a very innovative company, we dedicate important resources to R&D, we develop and apply state-of-the-art technology. We will continue to do so. But technology should serve the user, not the other way around.

 

I have already mentioned a last important trend we took into account during our transformation process: the growing importance of emerging markets. For many years now, the highest economic growth figures have not been achieved in the US, Europe or Japan, but in emerging markets such as China, India and Brazil. As we want to grow our company, we have steadily increased the resources and the people we dedicate to these markets. This is very visible in China, too. Let me give you a few examples. In November 2009, we established a state-of-the-art lighting factory in Yizheng in the Jiangsu Province. This is Philips’ largest manufacturing facility for energy-efficient lighting in the APAC region. The very same month, we also announced a 36 million euro investment to set up a new industrial campus for medical Imaging Systems in Suzhou, also in the Jiangsu Province. This campus will have integrated facilities for R&D, manufacturing, assembly and sourcing. In 2008, we acquired Goldway, China’s second largest patient monitoring company. And in 2004, we formed a joint venture with Neusoft Medical Systems to jointly develop and manufacture medical imaging equipment.

 

The third important element of our transformation was and is the pursuit of a unified marketing approach and brand proposition. In the long run, you can only strengthen a brand if you have a credible brand promise on which you deliver. Our brand promise is “sense and simplicity”, not only in our products but in everything we do. We are constantly looking for ways to make our products more user-friendly; to focus even more on the customer’s wishes, feelings and needs; to follow a people-centric approach in all our activities. The fact that this brand promise and our actions to fulfill this promise resonate with consumers, is borne out by the global increase in the value of the Philips brand over the last decade. On the Interbrand ranking of most valuable brands, Philips has climbed consistently, from the number 65 spot in 2004 to number 42 in 2009.

 

Has our transformation been successful? I think it has. The positive impact of our transformation can be illustrated by comparing Philips’ financial results during the 2008-2009 recession to our results during the previous global downturn between 2000 and 2002. Although the global reduction in GDP growth was much sharper in the 2008-2009 recession than in the previous one, the reduction in our sales figures was more or less the same during both recessions, which is already remarkable. Even more interesting is our Ebita performance. In the 2000-2002 downturn, our Ebita took a very big hit and it took us many quarters to start making a meaningful profit again. In this recession, to the contrary, our Ebita contracted much less and, more importantly, our operating profits started to recover rapidly after only a couple of quarters. Our adjusted Ebita margin for the last quarter of 2009 was even excellent. We have indeed become a more agile, more resilient company, one of the goals we set out when we embarked on our transformation process. We were able to reduce our costs much more quickly, whereas our focus on emerging markets mitigated the negative effects of the downturn on our sales and profitability. Our strength was borne out by our financial results in the first quarter of this year. Our sales were up 12% compared to the same quarter in 2009, in emerging markets even 22%. We achieved operating profits, or EBITA, of 504 million Euros, a level we have not seen before in a first quarter. In the context of a still difficult economic environment, that is very encouraging indeed.

 

Ladies and Gentlemen,

 

To me personally, executing our transformation process felt a bit like playing chess on many boards at the same time. There are always many issues to take care of, many opinions to listen to and many decisions you need to take urgently. But it was definitely worthwhile, for our company and for all its stakeholders.

 

So what lessons can we learn from Philips’ transformation, lessons that may be valuable beyond Philips itself? I have already mentioned the importance of combining leadership and listening skills as well as the importance of good timing. Another example is the importance of finding a good balance between ambition and realism. After all, a company without ambition is like a person without a heart. A company without realism is like a person without a brain. Because of our ambition, we set ourselves the target to become a leader in various markets in the health and well-being area. Because of our realism, we knew we couldn’t become a leader in all markets and had to make tough choices about where to place our bets.

 

Again, because of our ambition, we kept investing in R&D and in our brand even when the going got tough in 2008 and 2009. Because of our realism, we did not give in to suggestions from financial markets to load up on debt when that seemed an easy option before the credit crunch. We maintained a solid balance sheet all through our transformation process. We had learned our lesson in the nineteen nineties. This strong financial position was of great help when we had to weather the economic downturn in 2008 and 2009, when suddenly the financial markets considered that ‘cash was king’.

 

Another important feature of our transformation process I would like to mention was our willingness to partner. When I spoke here in December 2007, the subject was ‘Innovation’ and I explained how nowadays ‘innovation’ is ‘open innovation’. In this day and age, new solutions, new technologies, new products are more often than not the result of a cooperative effort of various companies, universities and research institutes. More generally, we try to engage our business partners. We build up long term relationships based on mutual trust with important suppliers. We are in a constant dialogue with consumers about existing and new products.

 

Transforming a company never ends, but after a decade, it is fair to say that we have come a long way towards our goal of becoming a global leader in health and well-being. We offer many solutions to improve people’s health and well-being, in China as well as in other countries. The Chinese government has embarked on the important task of healthcare reform in order to improve access in the context of an aging population. Hence, the enormous investments in primary care and in the overall efficiency of the rapidly growing healthcare sector. At the same time, China has rightly stated that energy efficiency and a reduction of the environmental impact of economic activities are essential for further harmonious growth. And the rapidly growing Chinese middle class is very interested in solutions that increase their well-being beyond the consumption of basic necessities.

 

In all these areas, Philips has engaged with China in a long term relationship we are eager to continue. We are partnering with many Chinese hospitals and companies in joint efforts to improve the Chinese healthcare system, from programs in chronic disease management and breast screening to training of rural physicians. Philips lighting solutions are already helping to contain electricity consumption in many Chinese offices, houses and streets.

Philips is a strong, trusted brand in China. Over the last ten years, we have transformed ourselves into a people-centric company, a transformation that was propelled by three driving forces: the changes in the electronics industry, global social trends and our unified brand strategy. Because of our transformation, we are now a leading health and well-being business. Thanks to this transformation, we are a more agile and resilient company with a balanced portfolio, a market-driven approach to business and less volatile financial results. We offer solutions to some pressing challenges the world faces.  In summary, we are now more ready than ever to continue our mutually beneficial relationship with China’s people, government and companies.

 

Thank you very much for your attention.