Authors: Richard Kluger
At this juncture, Ross Johnson, by now well wired into Wilson’s problems with the board, let the directors know that he did not plan to remain long in the No. 2 managerial slot at the company. The directors were thus forced to choose, in effect, between retaining the truculent, hard-nosed Wilson and the quick brown fox who had flashed into view, bedazzling in the Oleg Cassini sportswear ads for which he posed, emblematic of the contrast between Johnson and the frumpy Reynolds style of life and doing business. The gladsome newcomer may have made them nervous, but he was a welcome change from Wilson, and there was no gainsaying his financial track record, despite an inclination to elect radical surgery in place of tender loving care for the ailing parts of any business he ran. Within fourteen months of his arrival at RJR, Ross Johnson was named to replace the man who had enlisted him.
Once in charge, Johnson lost little time revealing his disdain for the Reynolds corporate culture. In a symbolical move, he sold off Prince Albert pipe tobacco, the product that had been the foundation of the company’s explosive growth at the beginning of the century. Then, quipping that Winston-Salem was a great town for raising a family but inconvenient to serve as headquarters for a corporate giant, he ordered the top managerial staff slashed by two-thirds and moved to a characterless glass tower in a suburban Atlanta mall, presumably for better flight connections with the Nabisco executive team up north and contractors, bankers, and anyone else from the faster-paced world wanting to do business with the company. Though its 12,000 or so manufacturing jobs were not affected by the shift, Winston’s pride was badly wounded. Then there was the added display of arrogance in a sybaritic, late-night-and-long-weekend lifestyle that Johnson pursued. Reynolds executives soon had at their disposal a ten-plane RJR air force with thirty-six full-time pilots, housed in a costly new hangar facility, while their fast-stepping chairman set a standard for peripatetic extravagance: he had five homes, several of which he managed
to visit each week, and held memberships in twenty-four country clubs—all, of course, suitable for advancing his business interests. His fondness for hobnobbing with star athletes was not unrelated to the millions the company lavished on a single golf tourney, the Dinah Shore Open. A few million here or there, Johnson was heard to say more than once, were lost in the sands of time. His managerial methods seemed similarly arbitrary and feckless. For no compelling reason, for example, the Nabisco unit producing Planters peanuts and Life Savers was assigned to the tobacco division, and executives were shifted around often and chaotically, like so many toy soldiers, to the point where a Johnson-inspired gag ran through the company corridors to the effect that nobody had a fixed job and title anymore, only a temporary assignment.
But Johnson was wily enough to mute effective criticism by lathering up potential adversaries. Chief among these was Ed Horrigan, who had not trusted Johnson from the first but now found himself artfully cosseted with higher pay and more power—full sway over the tobacco business, which Johnson knew little about and needed Horrigan, or someone both energetic and pliable, to preside over—plus perks like his own private plane and the latchkey to an RJR executive apartment in New York. If Horrigan had never had it so good, the same could be said for more than thirty other top RJR Nabisco executives, whose remuneration now averaged well over $400,000 a year. The all-important board of directors was similarly romanced. The fee for their attending meetings was raised to a $50,000 annual nugget; directors received gifts of 1,500 shares of restricted company stock; and side deals and rewards were doled out to key board members, like a $250,000 annual consultant’s fee to Sticht, who had never been a wealthy man, and smaller ones to others, along with endowed professorships named for them at Duke. It was all very flattering, and Johnson’s spendthrift indulgences seemed to have scant impact on the RJR bottom line. In 1987, his first full year at the helm, earnings per share rose 23 percent.
Yet Johnson was antsy about Wall Street’s continuing reluctance to bid up RJR’s stock to a price commensurate with its earnings. Security analysts were uneasy about Johnson’s future path and RJR’s ongoing loss of ground in tobacco to Philip Morris, whose stock was priced notably higher, even though Reynolds was outpacing it in the food business, which the New York company had entered in a big way a few months after RJR’s mid-1985 buyout of Nabisco.
V
A
s rumors intensified on Wall Street that General Foods, with its gold-plated trademarks but bloated overhead, low-margin coffee business, and sluggish earnings growth, was a prime takeover candidate, influential Kidder, Peabody tobacco and food analyst Roy Burry wrote that he doubted Philip Morris would be dumb enough to be the buyer. That got him a quick summons to Hamish Maxwell’s office, where the PM chairman asked, “Roy, what would you have me do?”
To any other course of action, as Burry remembered, Maxwell had a plausible if not entirely persuasive counterargument. For Philip Morris to pay off all debts, slowly contract its business, and raise dividends at a still faster rate than the 20 to 25 percent annual hikes PM was already managing would not really have been a service to its stockholders, Maxwell contended, since they would then have to pay higher income taxes on their dividends, which already reflected the government’s corporate income tax bite. Better to build investors’ equity by retaining earnings and acquiring strong new assets, even if the added operations posted lower margins than the tobacco business—as almost every other form of enterprise did. Stock buybacks, instead of further diversification, also brought with them a serious problem: the smaller the stockholder base—that is, the more tightly the company was held and the more nearly it resembled a private operation—the more of a target for carping do-gooders and critics it would become. Finally, for Philip Morris to plunge its surplus cash into a capital-intensive business, particularly in the technologically exotic fields, was exceedingly chancy, as RJR’s misadventures in the shipping business had shown. Such industries were usually competitive in the extreme and often highly cyclical; they guzzled cash for state-of-the-art plant and equipment, and, as Maxwell explained to Burry, “We have to be able to talk to these people”—no small matter, particularly in the high-tech fields, where the vocabulary, frames of reference, and profit margins were so different.
And so Maxwell proceeded with a preemptive, all-cash tender offer of $120 a share for General Foods, a premium of nearly 50 percent above the market price. No one else could or wanted to match it, as Hans Storr reeled in his loan pledges, some 70 percent of which came from foreign banks, to meet the buyout price of $5.8 billion and make Philip Morris the biggest U.S. consumer products company, a title RJR Nabisco had held for just three months. A number of analysts wrote that PM had overpaid for General Foods—the price was 3.5 times book value (the difference between a company’s assets and liabilities), compared with the 3.2 ratio Reynolds had paid for higher-earning
Nabisco. But Maxwell insisted that it was a fine catch and that the GF brands had great global potential. Probably a more candid assessment was Storr’s retrospective remark that “From day one we realized General Foods was a company with real problems that would be a big headache.”
To help focus Philip Morris’s attention on absorbing its huge acquisition, Maxwell sold off troubled Seven-Up in 1986 for about half the money PM had sunk into the spirited, though somewhat bullheaded, effort. Maxwell let the new food executives function with minimal restraint and, while watching, learned the hard truth about their new business—it was not one enterprise but many, each product line with its own agricultural sources, government oversight of sanitary conditions and ingredients, and manufacturing, pricing, distribution, and competitive dynamics. Jell-O, in short, was not interchangeable with Sanka, or dry cereals with cured ham.
Even as they learned, though, Philip Morris executives grew disenchanted with the General Foods management, which got better pay and more perks than they did but, as one top younger PM sales executive put it, “They were dead from their ankles up. … Their arrogance was exceeded only by their sloth.” The GF plants, in the eyes of Philip Morris operations people, used to immaculate facilities, were sloppy, and, far worse, the bellwether product line—Maxwell House and other coffee brands—had been diluted in quality in a conscious decision to economize by buying cheaper beans and cutting corners in the processing. As a result, Folgers and other competitors had cut deeply into GF’s coffee business.
Maxwell began to clean house by advancing younger managers who addressed the coffee problem, especially the taste of Sanka, with a new, costly decaffeination process; then he sold off GF’s unrewarding sideline ventures like toys and a seed business, pruned 2,000 jobs from the payroll, and restructured the whole operation. But there were no miracle cures. Results for 1986 showed GF accounting for 40 percent of Philip Morris’s revenues but only 20 percent of the profit. And in 1987, things did not change appreciably. The move into big-time food was no disaster, surely; GF was netting 7 percent on $10 billion in sales and legitimizing Philip Morris’s overall corporate identity, as the stock market reacted more favorably to the General Foods venture than results could yet justify. But when youthful GF chairman Philip Smith accepted an invitation to run Pillsbury without a superchief like Maxwell hovering over his shoulder, there was no rush to replace him.
Instead, Maxwell explored his options. Among these was listening politely to overtures from his fleet archrival, Ross Johnson, always on the prowl for new worlds to conquer. The former cordiality between RJR and Philip Morris had frayed over the years with the latter’s ascendancy. But, as Maxwell recounted, “Ross was everyone’s pal—he was willing to talk about anything and everything,” even while sulking about the undeservedly low price at which his
company’s stock was trading. The two were miles apart in manner and temperament, Johnson a quick study but the shallow, impetuous hare to Maxwell’s pensive and patient tortoise, with a vision of where he wanted to take his company. Johnson struck him as “a restless man who liked to make deals better than live with a situation.” Johnson proposed that the two companies pool their overseas tobacco business or perhaps their food divisions, with the RJR Nabisco chairman running the latter. Maxwell, aware that only one chief executive survived whenever Johnson was involved in a merger, did not take the bait. As a consolation prize, he urged Johnson not to fret unduly over how his company was faring in the daily gyrations of the stock market so long as he was advancing its earnings smartly each year.
VI
SPURNED
by his savvy competitor, Ross Johnson turned to his chief subordinate, Edward Horrigan, to push ahead with RJR’s pet developmental program, the “smokeless” Spa cigarette. If it worked, Johnson figured, it could truly revolutionize the tobacco industry and put RJR back on top, driving its stock price up where it belonged. Horrigan, feisty as ever and sharing his chairman’s ambition, did not require much prodding to advance the timetable for the project.
But Horrigan was apprehensive about Spa. It was too big an idea for the company to risk falling on its face by pushing out an inadequate or legally vulnerable product. Johnson, a high-stakes roller, was ready to toss caution to the wind, even if it proved ill. “Ross wanted it so bad you wouldn’t believe it,” Horrigan recalled of Johnson’s enthusiasm for the daring departure. “He treated [the experimental version] almost recklessly, leaving samples around on airplanes.” Plainly he wanted word to get out that his company was about to hatch something enormous. Horrigan’s claimed preference was to ease the smokeless brand into small test markets, working out the bugs before chancing a national rollout. Meanwhile, and not by accident, word spread on Wall Street about the internal debate, and Reynolds’s lawyers advised that securities regulations required general disclosure of the planned new product as a “material” factor that might affect the stock’s orderly trading. And so, in September 1987, amid much media hype, the company staged a New York press conference, complete with information kits, charts, and cutaway diagrams of the new cigarette. The chief claim for it was that it looked, lit, tasted, and smoked like other cigarettes but had no ash, produced virtually no smoke after the first puff or two, and if left alone, would extinguish itself rather than igniting any surface with which it came into contact.
It was an ingenious contraption, a cylinder of tobacco wrapped around a
carbon rod that was ignited and burned down, warming the air drawn in by the smoker’s inhalation and passing over a small aluminum capsule implanted in the center containing beads of tobacco extracts, nicotine in particular, and flavorants. A cellulose acetate filter was attached, but what value it had for an essentially smokeless cigarette was not explained. In lawyer-crafted language, Horrigan stated that since the tobacco did not burn, the compounds normally produced by cigarettes “are eliminated or greatly reduced, including most compounds that are often associated with the smoking and health controversy. Simply put, we think that this is the world’s cleanest cigarette … [and] addresses the desires and perceptions of many of today’s smokers.”
But when he tried to elaborate on the nature and purpose of the radical device, Horrigan lapsed into language that disclosed the manufacturer’s dilemma in presenting it to the public. “We’re not saying it’s a safe or safer cigarette,” he said. “We’re saying many allegations about the burning of tobacco and elimination of those compounds should be greatly reduced with this product.” Beneath that double-talk was the unmistakable implication that here was a less hazardous cigarette—otherwise, why was Reynolds going to market it? Just to meet “the perceptions of many of today’s smokers”? That would make the product a mere piece of trickery.
That the company was truly trying to address the scientific and medical communities’ concerns without putting itself out of business was suggested a few days later by a Reynolds attorney, Peter Hutt, a member of the Washington firm of Covington & Burling. At a private session with top HHS Department officials arranged through Vice President George Bush’s office, Hutt explained, according to Office on Smoking and Health director Ronald Davis (and corroborated later by Surgeon General Koop), that the new product would provide “important health benefits by reducing the risk of cancer in smokers.” And if the public took to the innovative brand, RJR’s researchers would work “to find ways to reduce the nicotine and carbon monoxide levels so as to reduce the risk of heart disease,” Hutt repeatedly said, trying to reassure, if not obtain an outright endorsement from, key federal public-health authorities. “I was rather surprised that [Hutt] referred to cancer [and] chronic lung and heart disease as problems related to smoking,” Davis recounted, and the OSH head asked the Reynolds attorney if he was speaking for the company. When Hutt said yes, Davis asked if the potential health benefits attributed to the new product had been part of the public press briefing in New York the week before. “He said they were not and asked in effect not to be quoted as saying that smoking was hazardous.” Davis, though pledging not to quote him publicly, did record Hutt’s remarks in a memorandum, which Tobacco Products Liability Project Director Richard Daynard learned of from Davis and obtained after threatening to invoke the Freedom of Information Act.