Is Pfizer's New CEO Laying Off the Wrong Employees?

Put yourself in the shoes of Ian Read, Pfizer (PFE)'s new CEO, who gave his first quarterly conference call yesterday. Your sales, marketing and manufacturing costs are rising faster than your revenues; you know you're heading into a period of declining revenues as Lipitor and other big brands lose their market exclusivity; the good news is your R&D expenses are flat, however.

So, what is your first big strategic decision?

The obvious answer is to cut sales costs in line with your revenue declines and to try to wring efficiencies out of your supply chain (you're making and selling fewer pills, after all). But Read said the opposite yesterday: Cut R&D -- in the form of 1,100 jobs gone in Groton, Conn., and 2,400 jobs lost in Sandwich, U.K. The cuts will save Pfizer nearly $3 billion, Read told Wall Street:

First, we will sharpen our focus to the core research areas that give us the best promise at scientific and commercial success. We will maintain or increase investment in neuroscience, CB med, oncology, inflammation and immunology and vaccines.

We will stop funding in areas of greater risk and/or less productivity, such as allergy and respiratory, urology, internal medicine and tissue repair, ...

As an underlying principle, we want to ensure that the whole is greater than some of the parts. ... The most fundamental question that Pfizer has to fix is our innovative core.

• Revenues up 6 percent to $17.5 billion.
• Sales and marketing up 7 percent to $5.7 billion
• Manufacturing costs up 9 percent to $4.3 billion
• R&D costs flat at $2.8 billion

Of course, Read's world is a little more complicated than this: R&D investment doesn't pay off until about a decade later, so he has to balance what he knows now with what he thinks will happen in the future.

Nonetheless, there's no excuse for not keeping your day-to-day operating costs in line with your sales. Here's what that lack of discipline is doing to Pfizer's operating leverage. This chart shows the return in revenues of every $1 spent on sales and marketing expenses:

Over the last six years, Pfizer has axed 40,000 jobs and is in the middle of a 19,000 reduction triggered by its merger with Wyeth. But that merger occurred in 2009, so efficiencies ought to be showing up already. Yet, as the downward-pointing pink line shows, Pfizer is heading back to the bad old days of 2007 when it couldn't get more than $3 in revenues for every buck it spent on drug sales reps and advertising.

Analyst Tim Anderson of Bernstein Research noticed this too. On the call he asked why Read wasn't reducing SG&A, and Read replied it was because the company is ramping up in China:

Anderson: Many of the 2012 guidance elements looked decent but the one area that kind of surprises me is SG&A, and I guess I can say the same thing with 2011 SG&A. In the setting of a big merger like Wyeth, I would've expected more reductions in this line item, and I'm just wondering if you can describe in more detail what's keeping it on the flatter side?

Read: We look at SG&A very carefully. We look at it from bottom up through the point of view of what do the brands need to continue to grow or to give a return as acceptable as we spend in those brands. We look at it on the context of what we need to do to compete in Emerging Markets, which is not a trivial exercise as we go from 2,000 to 3,000 to 4,000 reps in China,

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