Chief Executive’s Review

We were tested in 2001. We had studied for some of the questions on the exam. Others were unexpected. We used our imagination in answering them, but some stumped us...at first. It will be a couple of years before we get our final grade, but we know this was the kind of test that can prove what we’re made of and what the long-term value of this company is. We were exhilarated (well, bruised a little, too) by the experience, but I think our shareholders will be pleased with the result in the end.

We began to work on the current version of Pearson in 1997. We wanted to create a company that could do two things: perform consistently at the top, and combine first-rank businesses that really belonged together and could profit from shared parentage.

We have that company now. Of course we’re never finished changing, but we’re now in three related businesses that have market strength and mutual advantages including a shared culture strong enough to turn those advantages into practical benefits. The work we’ve done building the current Pearson has had its cost, but the early investments have already begun to add value, and the newer ones will be integrated and begin to benefit us in 2002 as well. In this new shape, we are sturdier and more competitive and more able to meet our performance goals, and we expect this will ultimately be reflected in the market’s value of Pearson.

For shareholders who have suffered through the euphoric highs and the disappointing lows of our share price over the last year, reference to the future may be small comfort, as may be knowing that our stock was not alone in its fall in 2001. The media sector in the UK in particular and media stocks all over the world in general have had the same kind of pain. We believe the ache will recede as our earnings grow. But to give you confidence, let me rehearse how we faced the tests we had last year and how we’ll face the expectations we have for 2002.

2001

We had a collection of challenges in this year, many of them shared with other companies:

The economic downturn led by business Falls in corporate profits and corporate confidence hit our newspaper, magazine and television advertising revenue like a ton of bricks. The decline was twice as fast as in previous cyclical downturns, and knocked a bigger hole in our profits. If our ad sales had merely stayed even with the year 2000 and all other parts of Pearson had performed as they did, we would have had a good profit increase this year.

The bursting of the technology bubble As with big innovations throughout history, people are too optimistic at the beginning and too pessimistic in the middle of the dawning of a new way of doing things. So it was with the internet and the technology revolution. People went from believing the internet was a new life form to believing it was a lower life form. And because we invested in it aggressively for our education and information businesses, our share price fell when the internet began to look like a naked emperor.

This view about the internet was partly prompted by a disaffection with technology in general, which hurt us as well. It reduced our sales of computer books (of which we’re the world’s largest publisher) and enrolments in computer courses (which require the textbooks we publish, too).

The war The terrorist attacks in America hit our management education business directly because it was in the World Trade Center. They also further depressed the confidence of our customers – businesses stopped worrying about management development for a while and started worrying about survival; businesses that were still advertising stopped altogether, unsure of their messages.

With the benefit of hindsight, there are some things we wish we had done differently. We assumed that this advertising cycle would act like other cycles, but it didn’t; it was faster and sharper. We failed to see that our year-end projections for our Latin American education business were thinning out (in spite of the fact that the economies we were operating in were known for their volatility). We underestimated the severity of the systems problems with Dorling Kindersley, and they’ve taken longer to clear up.

2002

But, with the strong pull of all the people who work in Pearson, we got a lot more right than we got wrong, and we’re moving ahead with confidence for good reasons:

We’ve performed better than our competitors The advertising volume in the Financial Times (down 29%) has held up better than that of other business newspapers, and our revenue is down less than our volume because our rates have held. Meanwhile, FT.com was up more than 20% in advertising. The FT’s margins are still in double digits, and they’re 50% higher than we were able to achieve in the last advertising recession.

We held or gained share in all our education businesses. Our technology publishing revenue is off less, and our margins are much better, than our two large competitors in this field. Our technology titles gained share on the bestseller lists and sustained our margin at 18% even though revenues fell 20%.

We’ve had faster growth in bestsellers, an important and stable source of sales, and we’ve sustained higher margins in the consumer book business than any other company.

Our "internet enterprises" will begin to come into their own this year The investment in our main internet businesses is mostly behind us. The cost is much smaller for 2002, and they are all now merged into the business information and education businesses. This year, we will start to see the bottom line benefit of their reduced losses. And we make much more extensive use of the internet than the ventures that appear on our profit and loss statement as "Internet Enterprises" indicate. We have used the internet to invigorate our business throughout the company, and we now have more than £1bn of profitable online related revenue.

The acquisitions we’ve made will benefit this year Our investments in Putnam Berkeley and Simon & Schuster in 1997 and ‘98 are making a return greater than the cost of the capital to acquire them. In 2002 our two other large acquisitions, NCS and Dorling Kindersley, will begin to shine through with new products and new markets, and they’ll see the full benefit of the integration into Pearson. This will add to our bottom line, too.

How will we take on the future?

Making efficient use of our capital As the world’s largest book publisher, we have a great deal of our capital, about £1bn at any one time, tied up in things that aren’t making money for us at that moment. Piles of books in inventory, accounts due to us from customers, authors’ advances, long creation and production lead times. If we can improve our efficiency in all these areas, we’ll be able to put that money to more active use. So we’ve undertaken a project across the company that involves everyone – not just finance people – in the job of releasing our idle capital.

Never forgetting that it’s all about our customers Our approach to them has to be innovative and personal. The products have to be what they want, delivered in just the way each one wants, no matter how many customers we have. Special for each one, but produced with the economics of mass production. More than that, customer service has to be our competitive advantage. We have to talk plainly and personally to our customers – no excuses or arguments.

We also realise that the world is no longer divided into "suppliers" and "customers". To have an efficient economic relationship and get the most from each other, we have to become our customers’ partners – help them solve their problems. We have to exchange information with them that we used to think was proprietary if we’re going to improve terms for both sides – and for the person who ultimately buys our goods and services.

Making collaboration work to our greater advantage Now that our businesses are more alike, there’s more we can share with each other: assets (images, data, archives, stories, characters); skills (design, marketing, technology, people management); operating machinery (systems, data centres, services, purchasing); ideas (about anything and everything).

We already collaborate on a range of ventures from creating science programs to selling newspapers. Almost all of us are shareholders in Pearson, so we share an interest in the company’s performance. And we share a common attitude toward each other, and ideas about the right way to do things. Our values help us make important strategic and operating decisions. They help us know where the boundaries are. This cultural affinity contributes mightily to our effectiveness.

We’ve learned a lot in this testing year, and we’ve done a lot about what we’ve learned. We go into 2002 with a stronger company and, though we never thought it would be possible, a stronger resolve about what we want to accomplish. We’re confident about 2002 because of all this, but also because, as Dennis said, we have the people who can do it. They have passion and ideas and know-how. They are the reason we’ll pass the test.

Marjorie Scardino