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Insight: Philips restores profit by rediscovering relevance

Philips Electronics Chief Executive Frans van Houten shows a LED bulb which can be controlled directly from an iOS or Android device, during
Philips Electronics Chief Executive Frans van Houten shows a LED bulb which can be controlled directly from an iOS or Android device, during

By Sara Webb

AMSTERDAM (Reuters) - Every year Singaporeans and Malaysians choke on smoke when farmers and plantation firms in neighboring Indonesia clear the land with fires during the dry season.

Last summer, Philips diverted stocks of air purifiers from Hong Kong and China to the area in time for the worst pollution in 16 years.

The switch of supplies was emblematic of a more nimble approach fostered by Chief Executive Frans van Houten that has helped Philips reinvent itself in healthcare, lighting and consumer goods and revived the company's fortunes.

By the middle of the last decade the Dutch firm's television business had lost its battle with cheaper competition from Asian firms such as Samsung Electronics and LG Electronics. In 2007 its TV division turned to an operating loss which ballooned to 436 million euros ($601.26 million)the following year.

Philips response was turn to new products and business lines. Van Houten, architect of the new strategy, wants Philips to be much more entrepreneurial in culture.

"It's too early to declare victory - companies stop too quickly in changing. Change needs to be permanent and only after five years perhaps can you say 'yes the new culture has been anchored into the company'," said Van Houten, who has been CEO of Philips since April 2011.

"We're not done yet".

Philips' turnaround has been propelled in large part by improvements at its consumer and lighting businesses. Gains at those two businesses accounted for much of the 54 percent rise in group earnings in the third quarter. Philips' shares have hit their highest since mid-2010.

Philips' problem child had long been its consumer electronics business - which included its TV, audio and video business. In April 2012, it sold the TV business. It is still looking for a buyer for its audio and video business.

At the same time Philips has invested in other consumer products to win market share from rivals such as Procter & Gamble's Braun, which makes electric shavers and is the market leader in Germany in electric toothbrushes, and France's SEB, owner of Moulinex kitchen appliances.

The air purifiers also went through a redesign.

Customers said they wanted to be able to monitor air pollution at home and outdoors, and to switch the machine on or off remotely to avoid big electricity bills, so Philips developed a smartphone app.

A model with those features, priced at 600-700 euros plus about 50 euros a year for filters, will be launched next year in the fast-growing Chinese market where Philips is now the leader.

"Parents are busy at work: they want to know that when their children are at home the air they breathe is okay," said Pieter Nota, head of Philips' consumer business, whose products are pitched at middle class buyers seeking a healthy lifestyle.

SOY OR SOUP

Van Houten, 53, has been at Philips most of his career. He earned a reputation as a restructuring executive after knocking the former Philips semiconductor unit NXP into shape.

He also had a stint advising ING Groep on its split into insurance and banking operations before rejoining Philips in late 2010, becoming chief operating officer in January 2011. He took over from Gerard Kleisterlee at the helm three months later when the company was reeling from a prolonged downturn in the United States and Europe, two of its most important markets.

On a visit to France he found a team demoralized by the shrinking consumer business that had lost space on the shelves of major retailers such as Auchan and Darty.

"We did a store visit and the store managers said 'well of course Philips gets less and less shelf space, why can't you do something that we want? The word relevance was triggered by those discussions," Van Houten said.

Philips had already developed a soy milk maker which sold well in China, where consumers worry about food safety. They adapted it for the French market to make soup.

Such products have helped the turnaround in performance of the consumer business, where comparable sales in fast-growing markets such as Asia rose 15 percent in the third quarter, after gains of about a fifth in both the first and second quarters.

INCENTIVES

As CEO, Van Houten set out a new strategy and performance targets to turn Philips into a business with a greater share of sales and profits from emerging markets.

To encourage innovation, Van Houten earmarked more money for research and development. He also targeted 1.5 billion euros in cuts in overhead costs, chopping layers of management and simplifying the number of IT platforms. Philips has shed more than 5,000 jobs, or 4.4 percent of the workforce, since the end of 2011.

He has also shaken up the corporate culture.

Philips had a reputation as a design-oriented company that took its time perfecting products, only to find it had missed its chance or been beaten on price by a more nimble rival.

"It was complacent," said Hans Slob, an analyst at Rabobank who covers Philips. "Now it's very hands-on, more agile, more streamlined."

More than half the top 200 managers have been replaced or re-assigned while about 1,800 staff have been put through programs with a focus on performance culture. There are financial incentives too, with remuneration now tied to the performance of where someone works, not the whole group.

"In the past, if we did well, we were all paid the same. All of that has completely changed," one employee said.

LIGHTING UP THE REMBRANDTS

The change in culture involved not just new products but new ways of selling those to make customers more loyal and stave off the threat from lower-cost rivals at a time of weak consumer, corporate and government spending in the United States and Europe.

Locking in customers is particularly important in the lighting division, where the focus has shifted to projects such as street lighting, and in the healthcare unit, which sells scanners and other medical equipment to hospitals, and had led to Philips offering complete lighting or hospital equipment arrangements, or pay-per-use deals.

When the Rijksmuseum in Amsterdam underwent a decade-long renovation, Philips worked with the museum directors and architects to redo the lighting system for the entire collection ranging from marble statues to Rembrandt's "The Night Watch".

The contract was a coup for Philips, and one which it hopes will lead to similar deals. More recently, Philips agreed to refurbish 262 government buildings with LED in Dubai, where it will be paid out of the actual savings made.

"The conventional way of selling products out of the catalogue no longer works, the relationship needs to become more sticky," Van Houten said.

In healthcare, Philips is betting on a growing middle class and greater longevity which has increased demand for medical equipment, both at home and in hospitals.

More tailored deals have helped to sell healthcare equipment such as scanners which can reduce a patient's exposure to dangerous x-rays, improve the quality of images from inside a patient, or allow a far less invasive approach to treatment, thus cutting the time spent recuperating in hospital.

The division accounted for 40 percent of group revenue and nearly 60 percent of operating profit by the third quarter, when earnings rose nearly 8 percent, a performance in line with its rivals General Electric and Siemens.

Last year, it agreed a partnership with Abu Dhabi's new, 196-bed Burjeel Hospital to supply, install, maintain and upgrade medical equipment including MRI and CT scanners, digital mammography units and ultrasound machines.

An alliance with Georgia Regents Medical Center, a not-for-profit corporation in Augusta, Georgia, in June provided a breakthrough in the United States where uncertainty over spending plans and healthcare reforms has held back orders.

Under the terms of the $300 million deal, Philips will provide consulting services, advanced medical technologies, planning and maintenance services with pre-determined monthly operational costs over a 15-year term.

NEXT TEST

Philips' rebound means its shares now trade on a forward price-earnings multiple of 14.7, or a 9 percent premium to its peer average, according to StarMine SmartEstimates.

The next test will be the fourth-quarter results which will show whether or not Philips has met its 2013 targets of sales growth between 4 and 6 percent, a margin on earnings before tax, interest and amortization of 10 to 12 percent and a return on invested capital of 12 to 14 percent.

The fourth quarter is usually its strongest. Consumer spending picks up in the holiday season, and hospitals and government agencies which have refrained from blowing their annual budgets must now place orders or risk losing the funds.

Even so, Rabobank's Slob thinks Philips will struggle to achieve its sales target given that concerns about Obamacare in the United States have made American hospitals reluctant to spend because of uncertainty over the impact of reforms.

He also says it will be hard to maintain the momentum in growth in the lighting and consumer businesses.

"The focus will be on the healthcare business. You'd need a pretty good acceleration in the fourth quarter," Slob said. "But longer term they are very well positioned for recovery." ($1 = 0.7251 euros)

(Additional reporting by Matt Smith in Dubai; editing by Anna Willard and Janet McBride)

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