How to Avoid Making a Bad Situation Worse
One sixth of all the prescriptions written in this country are for drugs produced by the Israel-based pharmaceutical firm Teva. For Teva, that statistic represents an enormous success. Yet today, Teva’s current situation feels more problematic than successful. As a result, last December, the firm announced that it would lay off 14,000 employees, approximately one quarter of its workforce. The company also announced its intention to close manufacturing and research facilities around the world, and to omit its dividend. In February, Teva’s management provided a gloomy outlook for the rest of 2018, and its stock dropped by more than 10 percent.
No company is immune from experiencing unfavorable events. However, because of psychological propensities, some companies are prone to make a bad situation worse with self-inflicted wounds, which is what happened to Teva. They threw good money at a bad situation, thereby taking imprudent risks.
History Repeats Itself
Pharmaceutical firms are particularly prone to throw good money after bad. I learned this firsthand during the 1980s, when one of my MBA students, now one of our alumni, worked at the pharmaceutical firm Syntex, which was then based in Palo Alto. She told me that Syntex’s revenues relied heavily on just one drug, Naprosyn, which was due to go off patent in 1992. Frantic to find a replacement drug, Syntex’s executives spent money on a new ulcer drug, named Enprostil, which the company’s own scientists judged to be a dud. The scientists were right. In 1992, Naprosyn went off patent, and began to be sold over the counter as Aleve. The company struggled, and in 1995, Swiss-based Roche bought Syntex.
Like Syntex, Teva relied on a single brand name drug as a major revenue source. The drug is Copaxone, which recently went off patent. Frantic to find a replacement, in 2015 Teva bought the generic division of its rival Allergan, and they borrowed heavily to do so. The decision was doubly imprudent, as Teva overpaid, and as a result the new products did not generate enough revenue to cover the interest on the new debt.
The Perils of Imprudent Risk
The psychological tendency to take imprudent risks instead of accepting outcomes viewed as losses is called “aversion to a sure loss.” Copaxone going off patent was a looming sure loss. In fact, in 2013, Teva’s CEO actually tried to initiate a cost-cutting plan with layoffs. However, Teva’s board could not accept the associated decline in profitability. It refused to go through with the plan and instead fired the CEO. And in 2015, the board hired a new CEO whose decisions led Teva to overpay for risky acquisitions and to take on too much debt. Teva’s operating income fell over the next two years, raising the specter that it would default on its debt, a state of affairs which prompted the company’s December announcement about huge layoffs.
What Would Andy Grove Have Done?
The late Andy Grove, who was Intel’s president for many years, figured out a sensible way to think about issues like those faced by Teva and Syntex. When Intel was facing the rapid decline of its core business in memory chips, Grove and CEO Gordon Moore felt the pressure to spend more money on memory chip projects. However, Grove suggested to Moore that they ask themselves what their replacements might do, were the board to fire them. Moore said that he thought their replacements would move Intel out of memory chips and into microprocessors. Grove responded by suggesting that they fire themselves, and then rehire themselves, acting as they believed their replacements would. And so they did, with the rest being history.
Andy Grove was an iconic Silicon Valley leader. Corporate managers would do well to emulate him when dealing with adversity.