Heavy Metal

September 1 1995 by JP Donlon

During the 1980s, prevailing management wisdom had written off Caterpillar as another arrogant rust-belt producer that might go the way of International Harvester, Allis-Chalmers, and Euclid. With the demise of these once-prime competitors, Caterpillar, the $14 billion Peoria, IL-based producer of earth-moving equipment and engines founded in 1925, realized the danger of being knocked from its perch as the world leader. Like many U.S. companies, it operated for decades in an ideal environment in which demand exceeded capacity. But by the 1980s, higher interest rates and a pummeled dollar combined with closing mines and fewer highway construction projects to expose weaknesses. Costs were too high. Non-U.S. competitors, such as Japan‘s Komatsu Ltd. and Hitachi, had as much as a 40 percent cost advantage in some product categories. Komatsu’s ambition was summed up in “maru-C”–to encircle Caterpillar by picking off product and market segments where it was said to be weak.

The company depends largely on its reputation for quality and the service provided by its 187 dealers worldwide. The stuff ain’t cheap either. A heavy truck runs between $1.3 million and $1.7 million, and even a modest wheel loader can cost $73,000.

When Don Fites, 61, succeeded George Schaefer as chairman and chief executive in 1990, years of cost cutting had been underway. A seven-year, $1.8 billion factory modernization program started in 1987. It reduced throughput-the time it takes to process a part from start to finish-from 25 days to six. A year into the job, Fites faced a collapsed world market resulting in a $404 million loss on an 11 percent decline in sales.

Born in Tippecanoe, IN, the son of a subsistence farmer, Fites had worked 39 years with the company, 16 of them in Europe, Africa, South America, and Asia. As a Sloan Fellow at MIT in 1971, he wrote his thesis on whether U.S. manufacturers could compete globally with Japan. (He met his wife, Sylvia, while stationed in South Africa.) Aside from giving him a working knowledge of German, Portuguese, and some Japanese, the overseas experience left its mark. More than anything, Fites is driven to ensure that Caterpillar is globally competitive.

To this end, he set about a complete reorganization of the company from a centralized hierarchy into 13 profit centers, despite the misgivings of some who thought Cat’s corporate culture too ingrained to change much.

As if Fites hadn’t enough on his plate, in June 1994, 11,000 UAW workers, mostly in Peoria and Decatur, walked off their jobs over job security and work-rule changes. (An earlier five-and-a-halfmonth strike in 1991 and 1992 was settled.) The company countered by hiring temporary workers and reassigning 6,000 white-collar staff. Lawyers welded. Secretaries operated assembly-line process controllers. Today, the number of reassigned employees is down to 500 as more union workers have crossed picket lines. The company asserts that the dispute has had no material impact on manufacturing quality or financial results. (With an average hourly wage rate of $18.70, a typical Caterpillar employee earns $55, 000. When first-dollar health and dental coverage are added, the hourly rate comes to $39.)

Money is less an issue than the UAW’s insistence that the company accept “pattern contracts” modeled on those of GM, Ford, and Deere. As these are not Caterpillar’s primary competitors and such a move would severely inhibit its global competitiveness, Fites steadfastly resists, maintaining that nothing less than control of the company’s destiny is at stake. The largest current labor dispute in the U.S. may yet be resolved as the newly elected UAW leader, Steve Yokich, a pragmatist, has resumed talks.

Fites, who is said to resemble actor Gene Hackman, can point to some promising results. Total Jive-year annual average return to shareholders is 15.48 percent. Recently, the company reported its sixth consecutive quarter of record earnings. It holds the No. 1 market-share position in every market it serves except Japan, where it is second. (Caterpillar’s joint venture with Mitsubishi is first in Japan‘s heavy truck market.) It has moved up to the No. 2 position behind Cummins as supplier of diesel engines in North America. The company has four joint ventures in Russia and the CIS and two in China and is positioned to capitalize on future mining, natural gas production, and infrastructure projects.

To date, Fites has earned laurels from competitors and customers alike. Varity Corp. CEO Victor Rice thinks Fites is one of America‘s best managers. Magma Copper Chief Burgess Winter reckons the efficiency of use balances Caterpillar’s higher prices for equipment the mining company uses. “Caterpillar does great development work. It’s very innovative,” he says. Unmanned, satellite-controlled mining equipment is one innovation in the offing. Fites still has his work cut out, though. Wall Street, although generally appreciative, tends to discourage easily. The trade dispute with Japan alarms Fites, a diligent free trader who chairs the U.S.-Japan Business Council. CE Editor J.P. Donlon recently talked with the plain-spoken Caterpillar chief at his Peoria headquarters.

DESPERATION DRAMA

You have said that one of the things that scares you is wanting Caterpillar to be globally competitive.

Yes, that’s true. Over the short term, you can price your products to be competitive in the marketplace, but not be competitive overall. We did that during the 1980s and lost a billion dollars-a million dollars a day for three straight years.

That’s what sparked the reorganization of our structure, culture, and operations. “Desperation’s the mother of invention,” I think the saying goes. I told the organization we simply couldn’t go through another decade like the ’80s.

Has Caterpillar’s reorganization strategy paid off?

Yes. Caterpillar went from a $10 billion company to a $15 billion company with 20 percent fewer salaried management people. It has really paid off in decision making. We pushed accountability and responsibility down into the organization, making decisions at the lowest possible functional level, instead of spending 60 percent of our time writing letters to each other and 90 percent of our time worrying about what’s going on where the customers and dealers are. That changed our culture almost 180 degrees.

We also now base all our incentive compensation on return on assets. Our old system rated employees on how many people worked for them and how many assets they controlled. Thus, if you wanted a higher-rated job and bigger salary, you would hire more people or spend more money. I can’t think of a system that drives wrong behavior more than that.

Our biggest advantage today is our worldwide distribution organization, which allows us to deliver parts and service anywhere in the world within 24 to 48 hours. Until about 2010, distribution-meaning logistics; the distribution of after-sales, product-application, and service information; and the distribution of financing-will be what separates the winners from the losers in the global economy.

We have spent several hundred million dollars to install electronic communication processes connecting all our dealers, factories, and distribution centers around the world. Thus, a mechanic working on one of our brand-new products in Calcutta will be able, through the interactive computers in the shop, to communicate directly with our parts distribution or service organization. The next step is that each of these products will have a built-in capability to communicate to the dealer or to the factory how it’s doing that day.

For example, we are beginning to equip our big mining vehicles with electronic sensors that warn the user if something is going wrong, such as an overheated engine, too much aluminum in the crank case oil, or fuel inefficiency.

Today, large, sophisticated customers who do service work on their Caterpillar equipment are becoming rarer; they are relying on us for servicing.

Do you foresee Caterpillar moving more into a sort of integrated systems consulting and manufacturing business in the future?

That’s not really where our skills are. We do not want to become experts in copper mining or road construction. We have to understand the application well enough to provide customers with the best product, but we are good at designing, manufacturing, distributing, and servicing products. Our customers bring the expertise in mining the ore, building the road, or erecting the dam. We do not want to compete with our own customers.

GLOBAL GROWTH

U.S. construction growth must be somewhat constrained by the fact that no dams or interstates are being built at this stage. So are you looking for growth outside the U.S.?

Yes. By 2010, we think 75 percent of our sales will be outside the U.S. For several years, it’s been 50-50. At one time, the U.S. had 40 percent of the world gross domestic product; now the figure is about 20 percent. It’s not that we’ve stopped growing in the U.S., it’s the fact that the rest of the world is pulling itself out of the poverty and misery that countries such as China have experienced. However, that doesn’t mean we’re not going to grow in the U.S., especially since this country’s infrastructure has been ignored for so long-some U.S. cities, for example, have 100-year-old sewage systems. This problem will have to be rectified eventually.

Where will the international growth come from?

The Far East is our fastest-growing area. Latin America is getting its political act together and should begin to experience strong growth. I don’t see much light at the end of the tunnel yet for Africa, but it could be a tremendous area of growth for us if and when the political situation becomes more stable. Central Europe is going to be a big growth market for us.

DERAILING TRADE DISPUTES

You are the chairman of the U.S.-Japan Business Council and an ardent free trader. How does the current U.S. trade policy toward Japan affect your business going forward?

It’s a little scary. Even though the crisis was averted in the automotive area, other U.S. industries face similar problems. For example, if Kodak and Fuji can’t reach some sort of accommodation, the governments probably will get involved again. This creates even more problems because of the personal/political agendas involved. President Clinton backed the U.S. automotive industry, viewing it as a clear political win. And the Japanese negotiator, Hashimoto, stood by his country, seeing the stance as a ticket to the prime minister’s position. These two trains were heading down one track, and there was a good chance there would be a collision.

If that had happened-meaning the U.S. imposed sanctions-the Japanese probably would have retaliated in kind against agriculture products. This would not only damage the trade relations between our countries, it could significantly impact the world economy.

For years, we’ve been telling our Japanese colleagues that we need to solve these problems on a business-to-business, sectorial basis, otherwise the governments will step in, and we probably won’t like the solution.

How can U.S. businesspeople get around this difficulty?

Persistence is the answer. They must be prepared to invest a lot of money up front and a lot of time to earn the business of Japanese customers. For instance, Japanese car salesmen call on housewives and spend three or four months trying to sell them a car. I always encourage the automotive CEOs such as GM’s Jack Smith, Chrysler’s Bob Eaton, and Ford’s Alex Trotman to keep plugging. Eventually they’ll get into the market. And when they do, they’ll find it’s rewarding.

ALL ABOARD

When speaking about the trade dispute with Japan, you used the metaphor of two railroad trains hurtling down the same track. Does this hold true for Caterpillar and the UAW?

I wouldn’t use that metaphor, because there’s no collision in front of us. We can continue going down the track as we are. We’d be happy to slow down a bit and let the UAW board the train, but we’re prepared to operate indefinitely the way we have for the past five years.

The UAW has a new leader now. Is this an opportunity to resolve the longstanding quarrel between Caterpillar and the union?

It could be. We haven’t had a serious give-and-take bargaining session in the five years since this problem started. The union always took the position, “You’re going to sign a pattern contract, or we’re going to put you out of business.”

But we’ve demonstrated that we can operate quite well without doing that. Would we like to see a settlement? Sure, but we can’t let 15 percent of the work force dictate how we’re going to run the rest of the company.

BUILT TO LAST

What would you most like to see accomplished in the three-and-a-half years remaining before your mandatory retirement at age 65?

For the first time in two decades, Caterpillar is positioned to go through a recession and still be quite profitable. I’m not hoping for a recession, but when it comes, I want this organization to demonstrate that ability to investors. We are cyclical, but not to the point that we’re going to fall back into the red if we have a 20 percent downturn in sales.

Also, I’ve been with this company since I was 22; I want to leave it in better condition than I inherited it.

When did you know that you wanted to be the CEO?

When I became president in 1989. When I first started at the company, I figured maybe some day I’d be a vice president. That was like being God, you know.

Very few people set out to become CEO. Along the way, you pick up some competence, gain some confidence, and then see what happens. It wouldn’t have been the end of my life if I hadn’t become CEO; I could have easily served in somebody else’s job.