CAT IS BACK
An icon that once seemed headed for the dustbin, Caterpillar has made an impressive turnaround. Here’s how.
July 1 2005 by This Is The Byline / Author Section
Every time he glances out the windows of his seventh-floor office atop Caterpillar headquarters in Peoria, Ill., CEO Jim Owens takes in a very satisfying panorama: Hundreds of yellow bulldozers and other humongous Cat pieces are rebuilding Interstate 74 through town and across the Illinois River, in the largest highway reconstruction in downstate history. They spend all day crawling back and forth across his view.
Hundreds of sites like it around the world are teeming with more Cat equipment than ever before. “We’re sitting on the sweet spot as a company right now,” Owens says. “We’re well positioned with our products and in our markets. The competition is good€¦quot;but a lot more fragmented than we are.”
Caterpillar once seemed destined to join the Midwestern industrial scrap heap, succumbing to Japanese competition the same way the U.S. automobile industry is in the process of doing. But Caterpillar has bootstrapped its way to an impressive recovery from its early-1980s nadir. It still leads the heavy-equipment business worldwide, and is putting on one of the most impressive runs in recent manufacturing history.
The global infrastructure boom has surely helped, but credit also goes to the company’s long-term recovery strategy that was hatched by Owens’ predecessors and is currently being executed by the 59-year-old Owens. The plan has included decentralizing the company, playing tough with the United Auto Workers, making bold investments in technology, streamlining manufacturing, emphasizing leadership development, and being able to catch up with a burst in demand that materialized two years ago.
Cat’s sales were up 33 percent last year, to more than $30 billion, and Owens is trumpeting projections of a further sales increase to more than $35 billion this year. (See charts, right.) Profits for 2004 were a record $2 billion, and Cat forecasts another 35 to 40 percent increase this year (bolstering the reasoning behind the company’s 22 percent dividend bump and two-for-one stock split as of July 13). Amid national hand-wringing over manufacturing employment, Cat has added a stunning 5,500 full-time hourly jobs in the U.S. compared with a year ago. Worldwide employment rose to 80,000 at the end of the first quarter compared with fewer than 71,000 a year earlier.
Nearly every major industry served by Cat€¦quot;construction, mining, energy and marine€¦quot;is solidly on the upswing. Caterpillar is ideally suited to exploit that with a product line that ranges from a small skid loader to the $2.5-million, 797B mining truck, with a hydraulically controlled operator’s seat, a 3,550-hp. engine, a payload of up to 400 tons and 12-foot-diameter tires. “We sure didn’t do it with flim-flam,” says Owens, with a deliberate manner that bespeaks his background as an economist. “Big iron is really moving, and production at most of our manufacturing facilities is up 35 to 50 percent for the year.” Owens is quick to admit that even he, with his economics background, didn’t foresee the speed and size of the upturn. “The stars have shone on us,” he says.
It’s taken awhile. Founded in 1925, Caterpillar Tractor Co. eventually became synonymous with big construction projects around the world. But global markets fell off by 40 percent during the economic downturn of the early 1980s, just as Japan’s Komatsu was leveraging a cheap yen to target Cat’s dominance. CEO George Schaefer slashed U.S. capacity, pursued low-cost overseas suppliers and streamlined manufacturing.
Successor Donald Fites reorganized the company into many business units, each accountable for its own P&L, and outlasted the UAW’s 18-month strike in the mid-1990s. The next CEO, Glen Barton, made Cat a trailblazer by adopting Six Sigma practices companywide and investing hundreds of millions of dollars in new engine technology, called ACERT, that brought Cat in line with the Kyoto clean-air accords without compromising performance.
Consequently, Komatsu has been thwarted. Since the mid-1980s, Cat has built nicely on its market-share lead over the Japanese company, “and so they’re now a fairly distant No. 2,” notes Owens. Tweaking Cat nevertheless, Komatsu maintains a big billboard inside Peoria International Airport.
Peoria is the proverbial center of Middle America, but Cat is far from provincial. It manufactures in 22 countries, and its independently owned dealers sell and service equipment virtually everywhere such equipment is needed. The territory for Denver-based Wagner Equipment, for example, includes Colorado, New Mexico, Mongolia “and a piece of Siberia that is larger than the United States,” as dealership president Bruce Wagner puts it.
Owens is a product of both the Cat culture and his upbringing in Elizabeth City, N.C. His hopes for a college sports scholarship ended after he was injured running the football. And his future as a textiles engineer took a blow at North Carolina State when Owens discovered he was colorblind. But he did excel at economics, and after he received his M.B.A., Owens moved to Peoria in 1972 to join a manufacturer that understood the importance of currency-exchange rates.
He became Cat’s chief economist in Switzerland in 1975, where his first marriage broke up, leaving him as a single father with custody of two boys for two years. He juggled job responsibilities with duties as scoutmaster for a troop of 145 expatriate Cub Scouts and as commissioner of a baseball league for American kids. “My boys and I became like the Three Musketeers,” he says.
After assignments in product-source planning and accounting back in Peoria, Owens became managing director of the company’s joint venture in Indonesia. Owens then turned around the company’s solar turbines unit in San Diego before reluctantly accepting Fites’ invitation to return to Peoria as CFO in 1993. Owens was rewarded with a promotion to group president and became a member of Cat’s executive office in 1995.
It’s difficult to overstate how bad business was by the time Owens emerged as Barton’s heir apparent in 2003. The economic crisis in Asia in the late 1990s, the aftermath of the Sept. 11 terror attacks and uncertainty surrounding the Iraq war had created widespread timidity among executives when it came to investing in expensive new equipment. Cat’s markets in Southeast Asia dropped more than 80 percent, and in the U.S. by nearly 40 percent. Global mining activity hit a 25-year low. “But finally the equipment just got too old and people started to buy in 2003, which then helped confidence turn,” says John McGinty, the analyst who follows Cat for Credit Suisse First Boston. “From a standing stop, there was a 30 percent increase in sales.”
Owens’ predecessors had prepared the company to take advantage of the cycle turn. The company was positioned as No. 1 or No. 2 in all of its markets, with the broadest product line in its history and a cadre of managers who grasped the importance of the next upturn.
But Owens is neither just an order taker nor a caretaker. He has moved quickly to put his own mark on the company, with his most important challenge being the unexpected magnitude of Cat’s recent increase in orders. He obviously does not want to estrange customers, hurt product quality or ramp up overhead too quickly. Dealing with the flood of new business became even more complicated as prices for steel, oil and other commodities spiked.
Naturally, Cat raised prices, but Owens wouldn’t even think about trying to tack the higher stickers onto existing contracts with dealers. “We took arrows from Wall Street on our margins, but we took care of our customers first,” Owens says.
Purchasing is one major area that Owens quickly attacked. He dispatched purchasing executives to every global market, and they came back with new solutions to the bottleneck, such as buying Chinese steel. Cat recently found itself so desperate for alloyed steel for its gears that Owens okayed the purchase of a barge load of iron pellets sitting in the Mississippi River, knowing he could swap it for the coveted steel. “We were empowered to think and act as creatively as we could to solve this, as long as it was ethical,” says Dan Murphy, Cat’s vice president of global purchasing. “Jim said he’d make anything available that we needed.”
Owens himself took up schmoozing suppliers of especially tight goods, meeting a few times, for example, with Edouard Michelin, head of the French tire giant, to improve collaboration and discuss capacity constraints. He also met with top executives of Timken, which manufactures bearings for almost all Cat equipment.
At the same time, Owens also has worked to squeeze every possible improvement out of the Six Sigma approach that now pervades Caterpillar. Barton began Cat’s intense devotion to the manufacturing philosophy in 2001 as a way of driving down the company’s repair and warranty costs. That includes focusing Six Sigma methods “to prioritize which business units would get the iron from corporate to increase production,” Owens says. And the company had enough “black belts” that Owens could deploy some of them to suppliers to help figure out ways to break upstream production bottlenecks.
Just as important, Owens has had to count on each Cat plant to improve its performance. The East Peoria works, for example, is Cat’s original plant, where the company still makes several sizes of its track-type tractors at the rate of about a half-dozen a day. Thanks largely to lean-manufacturing principles and improving welding and machining, the plant has been able to improve its production velocity to 18 days after an order is placed. “We’re still working toward improving it down to 10 days,” Tim Williams, a plant manager, reassures a visiting Owens. “But a couple of years ago, it was 40 days.”
Trying to improve production flow while dealing with a major surge in demand “has been a huge challenge over the last year or so, particularly at times of commodity-price increases,” says David Goode, a Cat director and CEO of Norfolk Southern. “The mark of Jim’s tenure has been how he pulled his team together quickly and got them to address a more rapid buildup of business than anybody had predicted.”
Of course, Owens also has taken the old-fashioned step of adding bodies to Cat plants. “Not very many companies across the entire country are hiring like we are these days,” he says. Actually adding highly compensated jobs helped Owens to win an agreeable new labor contract with the UAW in January, which for the first time includes two-tier wages and health-insurance concessions. “We still had holistic health care, so in these negotiations we had to drive more consumerism,” Owens says.
At the same time, Owens is trying to upgrade the knowledge level of Cat workers by expanding technical-training programs for them at junior colleges around the country. To that same end, Owens has stepped up leadership-development activities for his executives; for example, Cat’s 30 vice presidents now spend one whole day together each year evaluating the company’s high-potential managers. “He’s steeped in the values of athletics and teamwork, and he creates a teamwork atmosphere,” says Stuart Levenick, one of Cat’s five group presidents. “He’s also an unassuming guy with small-town values, which plays well in our company€¦quot;and globally.”
To help prepare Cat for its future, Owens is attempting a serious deepening of Cat’s bonds with its suppliers, inviting supplier executives to address Cat’s management council and visiting at least five major suppliers this year. “He wants to draw the suppliers closer to us for the long term,” Murphy says, “not only to get through this demand curve.”
Owens is also expanding Cat’s efforts to sell its state-of-the-art heavy engines to adjacent businesses, such as garbage-truck manufacturing. He’s determined to leverage the company’s substantial expertise in logistics and remanufacturing.
Transporting ore and grading highways tend to wear mightily on the parts in Cat equipment. A customer can sacrifice thousands of dollars an hour in lost productivity while a piece of equipment sits idle. And Cat machines operate in the harshest, outermost regions of the earth. For those reasons, Owens says, “We have a global-distribution network that’s the envy of the industrial world, an incredible competitive strength, and we can sell that expertise to other companies.”
Owens wants to make Cat a higher-profile company. So, in a first for a Cat CEO, he joined analysts for the company’s quarterly conference call in April. He also iniated other corporate image-raising gambits, such as attending major trade shows so he can speak directly to customers and dealers. One reason? Owens hates the fact that Wall Street doesn’t give Cat its due. “He was flying back from Europe and complaining to me about that the other day,” says Bill Osborn, a Cat director for five years, who is chairman and CEO of Northern Trust. “But Wall Street thinks there’s going to be a slowdown, and even though you tell them otherwise, they factor it in and think the music will stop. I told him, €˜Jim, don’t worry about it. Just keep producing those earnings.’”
Plenty of challenges do remain for Cat. For one thing, Owens says Cat must play for keeps in China, where he expects his own Asian experience to come in handy. “Our strategy is to establish a Chinese manufacturing presence ourselves and to compete in China, pricing with the yuan and operating on a yuan cost basis,” he says. “We’ll also have Cat rental stores like we do in the rest of the world and strong dealer support.”
And even if Komatsu appears subdued, J.I. Case, Hitachi and other companies are strong and aggressive in parts of Cat’s business. Swedish conglomerate Volvo€¦quot;lighter after the sale of the automotive brand to Ford€¦quot;has acquired Samsung’s heavy-equipment operations. “They’re very vertically integrated and trying to emulate our strategy,” Owens says. “But our sail is set to win the global wars with Volvo.”
As Owens, the captain, remains sure of his craft, Owens, the economist, is confident in the friendliness of the seas€¦quot;foreseeing low inflation and low interest rates globally, a strong 4 percent overall growth rate and robust expansion in Asia for the decade ahead. “The last two recoveries after prolonged downturns lasted about seven years,” he says. “Last year was the best global GDP growth in 20-plus years. And it’ll take several years to satisfy the demand for Cat equipment that that is creating.”
That’s the kind of optimism that can get CEOs into trouble. But after many years and several different CEOs taking tough, long-term steps, there’s little doubt that Cat’s comeback is for real.
Why Wall Street Has Cat Wrong
Owens says investors don’t understand its strengths.
When Jim Owens became CEO of Caterpillar in February 2004, he inherited a company experiencing explosive growth. How long can it last? Here are excerpts from a conversation:
You’ve said Caterpillar has some building blocks that will enable the company to prosper over the long haul. What are they?
The strength of our brand and our product line is one. Another is that we’re investing more in technology than in anything else; we spend $4 million every day on our product line. Our ACERT engine technology is one result of that kind of investment. We have a global footprint, with a manufacturing presence on every continent but one. We’re naturally hedged for currency fluctuation. We have a longstanding history of financial integrity and good governance, a conservative balance sheet and strong funding of our pension plans.
Do you think Wall Street might be underestimating Cat’s potential?
In the 1970s, our price/earnings ratio was slightly better than that of the S&P 500. That’s a high standard, but I think now we’re a better company than the average S&P 500 company. But their average P/E is 16 to 19 whereas we’ve been trading at only 11 to 12 times earnings. Given the global strength of our brands and product lines, our manufacturing base and our leadership, we’re undervalued.
What’s an example of where Cat’s strengths might be underappreciated?
The energy-development market. Oil and gas is tight, and the energy companies have money now to buy equipment. They’re doing tar sands, coal gasification, oil-platform work and natural-gas development, and they use our equipment for all of that. These are the kinds of customers who depend on us.
Even distributed-power generation is a market we’re strong in. We’re a supplier of gas turbines and large reciprocating engines, which are crucial in this area as utilities begin to play more in it. And we can provide multiple generating units that can be put into place quickly for backup power for hospitals, sporting events and so on.
Your last few annual meetings have been dominated by dissidents’ discussion of the fact that Cat’s bulldozers are used by the Israeli military to raze buildings in the Gaza Strip.
Yes, and it’s frustrating. We sell a standard D9 tractor to the U.S. government, which then gives that equipment to Israel. But hundreds of these machines also are sold as used on the open market every week. There’s no possible way that we can control how the 2.5 million pieces of Caterpillar equipment still operating are used every day.
We’re all in favor of peace there, but we can’t create it. We’re not politicians. Yet this is the most intense negative-publicity effort that anyone has ever mounted against our company.
We also have a bad reputation in the environmental space. So I want to get more environmental groups out here to understand the investments we’re making in emissions-compliant engines, diesels and gas turbines. We’re also the largest industrial remanufacturer in the world, which makes us one of the biggest recyclers. We just haven’t been blowing our own horn enough to gain the kind of reputation that we think our team should have.