The issue had come up again and again in various management meetings and company seminars. Novartis had too many products and needed to reduce the product proliferation that had occurred. Thomas Ebeling, Chief Operating Officer, Novartis Pharmaceuticals, wondered what he should do.
The merger of Ciba- Geigy and Sandoz to form Novartis
on December 20, 1996 had resulted in a significant increase in the pharmaceutical product portfolio of Novartis’s Pharma Sector. Combining the pharmaceutical product lines of Ciba- Geigy and Sandoz had given Novartis a leadership position in several therapeutic areas, including immunology and inflammatory dis-eases, as well as strong positions in central nervous system disorders, cardiovascular diseases, oncology, dermatology, and asthma. Novartis now had approximately 250 product brands (such as Sandimmun, Voltaren, Lamisil, and Foradil). The sales volumes of each of the different brands, however, were very different. In 1999, the top 20 brands accounted for 79% of pharmaceutical revenues while the remaining brands yielded 21% of revenues.
Novartis Exhibit 1 presents sales, anticipated sales growth rates, cost and other data for the 50 smallest global base business brands that account for CHF 422 million in sales (or approximately 2.7% of pharmaceutical product sales) in 1998. In addition to the base business brands listed in Novartis Exhibit 1, 15 other product brands contributed an additional CHF 2.4 million in revenues. Although these products generated very small revenues, they satisfied some important medical needs. For example, Visken had sales of CHF 114,000 in South Africa but it was unique among betablockers regarding the effect on serotonin 1a receptors for the onset of antidepressant action.
Required
1. Please refer to the data on Pertofran and Visergil in Novartis Exhibit 1. Would you recom-mend that Novartis drop these products because the total cost of these products exceeds the total revenues?
2. What strategic factors would you consider in deciding whether to drop all 50 products shown in Novartis Exhibit 1 and the 15 other product brands described in paragraph 3 of the case?
3. Would you recommend that Novartis drop all the 50 products shown in Novartis Exhibit 1? What is the net present value gained or lost from dropping all these 50 products? Assume a discount rate of 12%. What are the factors that go into determining this rate?
4. Suppose Novartis was able to find a buyer for all the 50 products shown in Novartis Exhibit 1. What price should Novartis charge the buyer?
5. Comment on the incentive issues described in the last paragraph of the case. What, if any-thing, would you do to address these issues?
6. What would you recommend Thomas Ebeling should do with respect to the 50 products shown in Novartis Exhibit 1 and the 15 product brands described in paragraph 3 of the case?
SOLUTION
To Trim or Not to Trim: That is the Question
This case gives students the opportunity to apply the concepts they have learned in Chapter 9 in the context of a real decision faced by Novartis about whether to trim their pharmaceutical product portfolio. Students must think through the decisions from a financial point of view but they must also think about the strategic, reputational, and ethical implications of the various alternative plans of action. Thus the case gives students the opportunity to consider and weigh nonfinancial considerations that managers often face when making decisions.
Assignment questions 3, 4, and 6 require net present value (NPV) calculations. If students are unfamiliar with NPV calculations, instructors may choose to assign only questions 1, 2, and 5 or wait till they have completed Chapter 11 on Capital Budgeting to assign the remaining questions. Yet another alternative is to only drop assignment question 3 and indicate that the value to Novartis of continuing to sell the 50 products is CHF 1,654.6 million before tax.
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| Pertofran | Pertofran | Pertofran | Pertofran | Pertofran | Visergil | Visergil | Visergil | |||
|---|---|---|---|---|---|---|---|---|---|---|
| Sales | Sales | Sales | 1.0 | 1.0 | 1.0 | 1.0 | 1.0 | |||
| Variable costs | Variable costs | Variable costs | 5.9 | 5.9 | 5.9 | 0.9 | 0.9 | 0.9 | ||
| Contribution margin | Contribution margin | Contribution margin | (4.9) | (4.9) | (4.9) | (4.9) | (4.9) | 0.1 | 0.1 | 0.1 |
| Fixed costs | Fixed costs | Fixed costs | 0.0 | 0.0 | 0.2 | 0.2 | 0.2 | |||
| Operating margin | Operating margin | Operating margin | ( 4.9) | ( 4.9) | ( 4.9) | ( 4.9) | ( 4.9) | (0.1) | (0.1) | (0.1) |
| Drop because | Drop because | Drop because | Drop because | Drop because | Keep because contribution | Keep because contribution | Keep because contribution | |||
| contribution margin | contribution margin | contribution margin | contribution margin | contribution margin | margin is positive and | margin is positive and | margin is positive and | |||
| is negative | is negative | is negative | is negative | is negative | contributes towards | contributes towards | contributes towards | |||
| recovering fixed costs | recovering fixed costs | recovering fixed costs |
Question 1
In deciding whether to drop or keep Pertofran and Visergil, we need to compare relevant revenues and relevant costs and not simply revenues and total costs of the products. For each product, relevant costs are expected future costs and relevant revenues are expected future revenues that differ if the product is dropped or kept. One way to get a better understanding of relevant revenues and relevant costs is to prepare a contribution margin income statement for each product as shown below:
Purpose of aiding classroom instructors in the use of “To Trim or Not to Trim: That is the Question,” HBS No. 100-105. It provides analysis and questions that are intended to present alternative approaches to deepening students’ comprehension of business issues and energizing classroom discussion. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Fixed costs would be incurred and cannot be saved whether or not Pertofran or Visergil is dropped and hence these costs are irrelevant to the analysis. On the basis of financial considerations alone, Pertofran should be dropped because variable costs exceed sales—it has a negative contribution margin. Visergil should be kept because revenues exceed variable costs—it has a positive contribution margin.
An alternative way to see this is to analyze what revenues would be lost and what costs would be saved by dropping these products.
| Pertofran | Pertofran | Pertofran | Visergil | Visergil | Visergil | |
|---|---|---|---|---|---|---|
| Revenues lost | (1.0) | (1.0) | (1.0) | (1.0) | (1.0) | (1.0) |
| Costs saved | 5.9 | 5.9 | 0.9 | 0.9 | ||
| Net benefit/(cost) | (4.9) | (4.9) | (4.9) | (0.1) | (0.1) | (0.1) |
Some students might argue that some of the fixed costs will be saved if a product is dropped (if a student does not raise this point the instructor may want to bring it up on his or her own). The instructor might want to ask the student, how much of the fixed costs will be saved. The student will most likely say some fraction (or 100%) of the fixed cost presented in Exhibit 1. Following some discussion, the instructor will want the student to understand that the fixed costs shown in Exhibit 1 are allocated costs. The relevant fixed costs are the fixed costs that would actually be saved not the fixed cost that happens to be allocated to the product by the accounting system. That is, the allocated fixed costs recorded in the accounting system and presented in Exhibit 1 are irrelevant.