Below is the transcript of an interview with Royal Philips CEO Frans van Houten. The interview will play out in CNBC's latest episode of Managing Asia on 12 April 2019, 5.30PM SG/HK (in APAC) and 11.00PM BST time (in EMEA). If you choose to use anything, please attribute to CNBC and Christine Tan.
Christine Tan: Frans, you joined Philips straight after college. You've been a company man –spent your entire life with the company, worked your way up the ranks and made CEO in 2011. Did you ever think you would be the one making the tough decisions, selling businesses that Philips was well known for?
Frans van Houten: As you grow up in a company, you get to see the good things, but also the not so good things. I spun out together with the semiconductor division in 2004 and then after seven years, I was invited to come back to the company. So I got an outside-in perspective of a company that I also know from the inside and I realized that we were at risk of losing our relevance. So in 2011, we had a deep reflection on what will make Philips successful for the years to come. To be set as an innovator, we cannot continue in categories like television where we were not really making a difference. We chose to focus on health as it is a big societal challenge where innovation can really move the needle and we said we will go all in. So rather than being a conglomerate that does a little of many things, we said we will narrow the focus and go deep into health and health technology, becoming the innovator that will transform how health and healthcare is being delivered.
C: So it was a matter of survival.
F: Yeah, in a way it always is, right. You want to focus on somewhere where you can be successful. In 2011, we had three profit warnings in a row. Our profit and our share price were low and the company was not growing. Now, eight years later, we are growing five percent. We have tripled our profitability and we are doing acquisitions, so it's going well.
C: Back then how did you get your employees – 114,000 employees to be exact – to embrace these changes?
F: Well, we had to do a lot of change management. Change is not easy and at first, people will all hide, lean back and be afraid. So we did a lot of co-creation and we even did an internal crowd sourcing to have people think about stories about how innovations improve their lives and maybe how one of their family members was rescued by a Philips innovation. We got people to follow the 'North Star' of the future, of what Philips could become as a health technology company.
C: It was basically to get everybody aligned with your vision.
F: Yes, and that worked very well. One of the challenges was actually in the Netherlands when we had to explain to the general public that we would get out of lighting, because lighting was our birthright – it's where the company started. We also IPOed the lighting company as a standalone company, which is today called 'Signify. I think that was a little bit of a shock to external stakeholders, but eventually that was well understood. I always say to people, you need to embrace change if you want to be impactful and meaningful.
C: Apart from lighting, one of the first decisions you made was to really get out of television as well. Do you remember the reaction you received the day, when you made the announcement?
F: Well, getting out of television was a lot easier than getting out of lighting. Philips was losing money in television whereas the lighting business was still successful, but we basically said we cannot be successful in everything at the same time. Yeah, I remember that day exactly. In fact, I had made up my mind to get out of television even before I was appointed to become the CEO.
C: What was the reaction like? Do you remember?
F: Yeah, people are shocked when you take a tough decision and it affects a lot of people. We should not take these decisions lightly – people's lives depend on it. But when you explain why, you also show a way that the future can be more successful. Today, you can still buy a television with the Philips brand name on it and we actually make money because we have licensed the brand to an Asian company that runs these television operations. Today, it's successful. So when making tough choices, take people along on the change and explain what that means for them, and eventually I think everybody understands that.
C: These days you're focused on the more profitable healthcare technology business and you're zooming in on areas like personal appliances, medical scanners, and equipment patient monitoring and analytics. The latter sounds like you're trying to be more than just a hardware company. Is that your business model?
F: Well definitely, because if you analyze the challenges around health, you can wait until somebody is very sick and need acute or episodic care. But the 'Holy Grail' in health is to understand and detect disease much earlier. This is where data will play a huge role and we envisage a world where we will quantify disease and health in a much earlier phase, where consumers or people are connected through the cloud to health coaches, and where A.I. will assist in understanding how people are doing. We talk about the concept of the "digital twin" to conceptualize and visualize your health situation so that you can get coaching – maybe on your cholesterol, on your diet or on your exercise. For all the people that have a chronic disease, to support them in living with congestive heart failure or COPD and in the future, maybe even cancer will become a chronic disease. We want to alleviate the burden of healthcare costs on society and also to make it easier for people to live with a chronic disease. We envisage that technology will radically change the way healthcare is being provided, and so we take this entire health continuum approach, from healthy living to prevention, diagnosis, intervention and chronic disease management. We see that data and analytics is the foundation to bind it all together, and Philips is shifting from originally a hardware company to provide solutions that consist of systems, software and services – where we even go to different business models, with Philips taking co-accountability for health outcomes, the patient experience and improving productivity in healthcare.
C: It sounds like you're becoming a whole technology company.
F: We are a technology company, but we are all also embracing consultancy skills to help transform the way healthcare is being delivered. For me, it's not good enough to just focus on technology. We have deep clinical knowledge and we understand behavioral science because if you want to impact the future of healthcare, it is about how people will change their habits to live with a chronic disease or even avoid disease in the first place. It is about helping healthcare providers deliver healthcare in a much more productive way. Did you know that more than 30 percent of waste is generated by how healthcare is being delivered? If we can come to a precision diagnosis by, for example, combining radiology, pathology and genomics to get to an integrated view of what the matter is with a person, then through predictive clinical decision support, choose the treatment pathway that is best suited for the individual so that we can treat the person faster and better, I think that is the 'Holy Grail' of healthcare.
C: You've been making acquisitions to strengthen Philips' healthcare portfolio and you've actually driven a lot of investments into areas like digital pathology and medical wearables. What sort of demand do you see out there for these healthcare products, services and solutions that you offer?
F: I see a huge demand and the more we can provide integral solutions, the better it is. Therefore, we invest a lot in research and development. About 10 percent of revenue or 1.8 billion euro goes into research and development for organic growth, but even that is not enough. So we also invest in startups and we participate in venturing and sometimes we acquire companies through M&A in order to deepen our portfolio reach so that we can provide solutions to our customers. Over the last three years, we have become much more active in doing M&A. As an example, we said we wanted innovations in minimally-invasive procedures for heart disease. As a result, we have acquired several device companies in order to integrate them with our visualization techniques so that doctors can operate without opening up the patients through minimally-invasive catheterized procedures.
C: What's out there that you would like to acquire?
F: At the moment, we are investing a lot in artificial intelligence, which we call adaptive intelligence because it needs to support the doctors, nurses and patients in an inobtrusive way and a comfortable way to become more effective. We have hired a lot of data scientists, but I also see a lot of smart startups in the AI world that we are partnering with to create breakthroughs in the way healthcare is being delivered, so this is an exciting space. In Asia and China in particular, there's actually a lot of smart AI companies that I'm impressed with and that we team up with.
C: So you're making acquisitions in Asia?
F: Absolutely, and even here in Singapore. So in Singapore, we are partnering with the EDB and we have a venture activity where today, we are a shareholder of two startups.
C: In the area of healthcare scanners, equipment and treatment, Philips is still trailing behind well-entrenched rivals like Siemens and GE. What are you doing to catch up?
F: Well actually, we are the number three health technology company in the world. We are more of a solutions company than some of the competitors that you mentioned. Philips provides platforms consisting of systems and software services. We partner with our customers. If I take an example in Australia, last year we had two large technology managed services agreements with the New South Wales Health District. We team up for a long partnership period to transform the way healthcare is being delivered. Philips is pioneering these new business models where we share in the risk and success of our customers, which I think is the future. Healthcare can only be redesigned if we go beyond being a product supplier and we go deep into how medicine is being practiced and care is being delivered. As a nice example, if I stick with Australia for a moment, we have pioneered telehealth in Queensland to support people with chronic heart disease and COPD, and we were able to reduce the rehospitalization rate by almost 50 percent. Can you imagine what that does to the patients and also to the cost of the health system? Reduction of rehospitalization, where people do not have to go to the emergency department, is a win-win for everybody. Now, that is what innovation can do if you couple technology with new business models and a partnership with the healthcare provider.
C: When you look at Philips today, it's a much smaller company, but more profitable. Your share price is up more than 50 percent since you took over. What are your revenue streams and margins like? Can you break it down for us?
F: Yeah of course, we are a company with 18 billion euro of revenue, currently growing five percent per year. Around 65 percent is in health technology for hospitals and about 35 percent is in health technology for consumers. 25 percent is already in health informatics, which integrates across all these products to provide cloud-based ecosystems for care. About 35 percent comes from North America, 30 percent from Europe and 35 percent from Asia. We have a strong presence in China, so we are a global player.
C: Where are you seeing the most margins?
F: In terms of profitability, United States is the biggest healthcare market and unsurprisingly, it's also still the largest profit pool today.
C: In terms of product line where are you seeing the most margins?
F: I see a lot of growth in Asia and we are doing well in China. We are excited about the opportunities in health informatics there. When you look at the large unserved population in China, how do you bring all these services into rural areas where perhaps, the doctors do not have the capabilities to provide cancer care? China has a vision around the future of healthcare and is embracing telehealth, so we are partnering on teleradiology, telepathology and teleoncology. So I see a lot of opportunities in Asia and China in particular in the future.
C: Across the different product segments, where are you seeing the most margins?
F: I see good margins across the entire portfolio and especially when they embrace this notion of being a solutions provider rather than just being a product supplier. I see that success and that opportunity to grow and expand margins.
C: In the last couple of years, you've been trying to reduce the number of factories you have from 50 to about 30. What's driving the push to narrow your manufacturing footprint?
F: Philips had historically built factories for every business unit that we had. The consequence is that you have relatively small factories. Fast forward to today, you see all the innovation taking place, including new manufacturing techniques, rendering the capabilities that you can have in these small factories insufficient. So we have chosen to create regional manufacturing hubs and larger sites where we will produce multiple product lines, which give us the capabilities to be really successful. The additional benefit of having regional manufacturing hubs is that you can be more flexible in terms of what you make and where you make them. Then if a trade war erupts like we have seen, we can react by shifting manufacturing into the region for that region, thereby having a less global good flow while avoiding the impact of duties, such as those imposed last year.
C: As you narrow your manufacturing footprint, you've actually closed down your factory in the U.K. involving some 400 jobs. Did fears of a hard Brexit weigh heavily on your decision?
F: Well, we were on a path to reduce the diversity of our factories in any case. But obviously, you also look at the geopolitical situation when deciding where you want to concentrate those larger regional manufacturing hubs. And yeah, the risk around the UK situation made it less easy for us to choose that location.
C: So that was part and parcel of your decision.
F: In the end, yes.
C: Do you see production eventually returning to the U.K.?
F: We also have other activities and a strong presence in the U.K.. In the U.K., we have many customers, we do research and development, we even acquired a company last year here, so I think it's an attractive market with a lot of competence. So definitely, that answer is yes.
C: How do you see the entire Brexit process? Do you have any insights from where you sit as CEO of Philips? What you think the outcome might be?
F: I leave that to the politicians. Last year, as part of the European industrial companies, we did reach out to the U.K. government. We shared our concerns and emphasized that seamless customs exchanges had to be achieved. But otherwise, we stay away from the politics and hope that a good outcome can be achieved. I want to say this: Europe needs each other, and I hope that we can find a very good and friendly coexistence.
C: Just how disruptive would it be if there is no customs union?
F: It would be very disruptive for supply chains, and I think it would create a lose-lose situation for everybody.
C: In the process, you've also had to react to the U.S.-China trade war and the impact it might have on your production lines as well as your supply chains. What major changes have you done to your production lines as a result of what is going on between U.S. and China?
F: Yeah, I believe that global trade and globalization have actually done a lot of good to the world. So from that perspective, it is sad to see that currently, duties are being imposed on that globalized supply chain. Nevertheless, as a company, we need to react on it and we are leveraging our regional manufacturing hubs to redirect supply chains so that we can avoid duties that impact our margins. On a component level, supply chains are very complex and cannot be completely avoided. I can only hope that the big powers in the world will come to agreement and that globalization can still continue.
C: Do you think you've done everything you possibly can to mitigate the impact of higher tariffs? Or do you still see some sort of impact on your bottom line?
F: We still see impact and we're still working on some of the solutions because it takes time to redirect supply chains. We are a company in medical products, which is a regulated business. So to shift supply chains can easily take nine to 12 months. We started in the middle of last year to mitigate impact and to some extent, we're still working on it.
C: When you look at earnings this year, what sort of impact do you talk about when you build in higher tariffs?
F: Well, we have communicated to our shareholders and capital markets that Philips is on a good path. We have a growth target of 46 percent, a profit expansion target of a 100 basis points per year and we are confident in our ability to achieve that regardless of some of these headwinds. We see that for the coming years, Philips is in a very good place to benefit from growth. Let's not forget that the world population needs more healthcare and innovations can transform the way healthcare is being delivered. With our focus on this market, we see that we have a lot of tailwind in fact, because of our strategy.
C: Let's talk more about that because last year, Philips did very well. You pulled in global revenues of 18.1 billion euros and higher operating income of 1.7 billion euros. But this year, a lot of the headwinds like you alluded to have not completely gone away, apart from a slowdown in China, now with additional fears of a recession in the US. How do you expect Philips to do this year? Where will growth come from?
F: Well, let's first deal with what you said about recession – I don't see that yet. I see continued growth. Maybe the world is a bit more risky and maybe a bit more uncertain. But I continue to see growth, especially in North America and in China, while Latin America is improving a bit. In fact, Europe is the flattest market. But the autonomous growth in healthcare continues regardless of what happens on the political scene. That has to do with a global ageing population and more lifestyle diseases, which drive continued demand for healthcare services. Given that society struggles with the cost of healthcare, our solutions to improve health outcomes and health productivity are very much in demand. Given that we then also go with business models where we don't mind going at risk – where we are rewarded for the health outcomes and health productivity – we see that we can grow also in a market that is a little bit more uncertain.
C: So in short, robust demand? That's what you're predicting?
F: Yeah. We had 10 percent order growth last year, so that just indicates how much traction we have had for the innovations we bring to market and I see that across the world. I've just been on a seven day tour in Asia where I engaged with a lot of customers, and I can see how much appreciation there is for being a dedicated healthcare innovator.
C: Apart from driving the transformation of Philips into a global health technology company, you've also put sustainability at the core of the company's strategy. What exactly does that mean in terms of process and the way you do business?
F: I see sustainability both as a moral obligation and a business opportunity. I believe we all need to be accountable for how we operate in the world and the consequences we create by doing business. Philips has a comprehensive sustainability strategy. We have decided to become carbon neutral and in fact, by next year we will achieve a net carbon neutral operation. We have a policy of zero waste to landfill and we have embraced circularity in our business model. What that means is that we want to get all our products back, starting with the medical products, and we will be at around 15 percent of circularity in our healthcare business.
C: Could you do better?
F: Of course, 15 percent is not a lot, right. It's thousands of products but it's by far not where we want to be. We have said that by 2025 we want to take all our healthcare modalities back from our customers, and then we can either give it a second life or we can harvest components from these systems and repurpose that technology for a second life. We want to make sure that our products are the most energy efficient. Now I can go on – we use recycled plastics. People think that sustainability is just corporate social responsibility. But I actually believe that if sustainability is embedded in your business model, it doesn't have to be added cost. It is about how you do business, and so we have embraced this as part of our strategy.
C: And how does it benefit Philips in terms of the margins you generate and the cost savings you have actually achieved as a result?
F: Today, I would classify our sustainability strategy as cost neutral. It is not improving margins but it's also not deteriorating margins. But thinking ahead, there may be a carbon tax on businesses, and then Philips would be in a great shape. Our customers are increasingly looking at sustainability as a criterion to choose a vendor and so we have benefits. Now I see governments having sustainability criteria in their procurement policies too, so we are in great shape. Moreover, I envisage business models where we do not sell products but we sell the benefits of the product, and so you go to technology as a service. In that way, you get actually a deeper relationship with your customer instead of being transactional where you ship a product and then you don't care. Now, you stay engaged with your customer to optimize the benefit of the technology. It's in fact a much better business model than just trying to be a supplier.
C: Are your shareholders happy as a result?
F: Our shareholders start to appreciate sustainability more but they are not all there yet.
C: Was it easy convincing them? Was it tough?
F: Well, I think that businesses need to have their own 'North Star', and growth and profitability is an outcome of your strategy. Businesses need to have the courage to set their own path and if shareholders are not immediately clapping, I am confident that it will come. So we need to be the leaders in this and not refrain from doing it because we are afraid. So, I believe that shareholder appreciation is starting to grow for sustainability, and more and more investment funds are putting this now as a criterion for the future.
C: Philips, once a light bulb and television company, now transforming itself into a global health technology company. You're the man driving that transformation and that journey hasn't been easy. What were some of the hard lessons you learnt along the way?
F: Well, sometimes I still look back and say, if only I had taken that decision faster. So it is all about courage. And when you feel you should take a decision, take that decision. So that's one of my lessons learnt. The other thing is that you can never do it alone. It's not a one man show. You need a team of people that are on the bus with you to transform a company, and to make sure that your team is having the same 'North Star', the same conviction to climb and conquer the Mount Everest together. You need to spend time with each other and that was difficult in the first year. I had to make changes in my team to get to a team of people who were all pulling on the rope from the same side. That's maybe my second lesson.
C: Were you disheartened?
F: No, I was never disheartened because I had a deep conviction that innovation is not only about technology but also about how you do business and what the company stands for. I felt that for a company that is 128 years old, unless you reinvent yourself, you may not have a future. The average lifespan of a Standard & Poor's company is less than 20 years. For a company to have longevity, you've got to disrupt yourself, and I had a deep conviction that was necessary.
C: Well, transforming a company as big as Philips is not easy. Were you confident right from the start you could pull it off?
F: Yes. That doesn't mean you are certain, but yes, confident.
C: You're a company man – you've spent your entire life with Philips and worked your way up the ranks to become CEO in 2011. Even your father had a long history working for the company as well. How would you describe your leadership and your management style?
F: (Laughs) Well, on the one hand, a deep passion which I think inspires people, authentic – what I mean is that in the end, honesty is the best way to get to the bottom of a challenge and get everybody on the same page, and persistent – where you don't give up and you keep going. I think those three characteristics determine me.
C: What drives you? What motivates you? What keeps you going?
F: I love to see success for the company and not just for me. The best success is shared success. That gives great satisfaction.
C: Thank you so much for talking to me Frans.
F: You're welcome.
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