Midwest Revival

The American Midwest has long suffered the loss of manufacturing jobs, but now the forces of globalization also are stripping out service sector jobs.

February 1 2004 by Dale Buss


In a dingy, defunct, red-brick manufacturing complex in a nondescript quarter of Akron, Ohio, the old order of Midwestern manufacturing is literally giving birth to a new, lighter-weight generation. The 146,000-square-foot complex, once a B.F. Goodrich tire plant, today is home to 21 start-up companies that lease space from the Akron Industrial Incubator, a city- and state-sponsored cooperative that helps small businesses get off the ground.

At one of these companies, in a small office and laboratory on the fourth floor, Sebastian Kanackkanatt is trying to become a player in the industrial renaissance of northeastern Ohio. The retired University of Akron polymers professor founded his company, United Polymer Technologies, three years ago, and has developed new materials that range from the very practical (a resilient filler for the soles of athletic shoes) to the highly fanciful (white candles that take on deep colors when lit). Kanackkanatt says that he’s close to obtaining enough purchase orders to justify setting up a manufacturing plant nearby, and he hopes to have more than 100 people turning out three or four product lines by the end of 2004.

“With an initial investment of just $250,000, we can triple or quadruple business every year,” says the 65-year-old native Pakistani. “Plus, everything I’ve developed is patented, and there’s no direct competition for it.”

What may be brewing in Kanackkanatt’s lair is an example of what CEOs and economic development officials across the Midwest are after these days. With manufacturing facing continued, brutal global pressure, the Midwesterners are striving to establish clusters of fast-growing, high-technology businesses.

This isn’t quite the same game that already has been played and won by Silicon Valley, the Boston tech corridor, and Research Triangle, N.C. Befitting “Flyover Country,” the technology push going on in many pockets of the Midwest is less ambitious and more adaptive to its traditional strengths in manufacturing. “Economic development works best when it’s enhancing, not trying to create something out of vapor,” says Diane Swonk, chief economist for Bank One in Chicago. “The Midwest will never be Silicon Valley, and to accept that is the first thing. And we really wouldn’t want to be, because you don’t want to have to ride the peaks and troughs of information technology.”

Yet whatever the shape of the process, clearly the region faces an urgent need to get on with it. The Midwest lost more than a half-million manufacturing jobs in just the past three years, says William Testa, a research vice president with the Federal Reserve Bank of Chicago, and very few of them will ever return. What’s more, many Midwestern cities and states exacerbated their pain by participating for more than two decades in a derby to chase branch plants of global manufacturers with multimillion-dollar tax abatements, worker-training grants and other huge incentives. It was largely an expensive and unproductive effort, says Testa.

In response, hopeful CEOs and officials in metropolitan regions throughout the Midwest have been getting into the new-technology derby. A team from Columbus went to Austin to figure out what the Texas capital, a mecca of development for semiconductors and other computer ware, was doing right. Detroit is assembling an industrial park around its growing strength in alternative-energy technologies. Pittsburgh is trying to capitalize on the sway of its big universities in computer science and medical technology. Iowa is holding receptions for software developers and other young, technologically astute émigrés just to convince them to consider moving themselves-and their brains-back to the state.

Facing Tough Challenges

Three Gaining Ground

Three regions are working to leverage their relative strengths to recruit and retain top talent to the Midwest. Here is a look at what they’ve got cooking:

CHAMPAIGN-URBANA

  • Collaboration between venture capital firms and the University of Illinois helps set up new businesses with commercial technology and the planning and financing assistance they need to succeed.
  • Affordable housing for employees and lower cost of living encourages retention.

NORTHEASTERN OHIO

  • Region leveraged its history in tire-making to build up polymers, which, at $50 billion, is now the second-largest industry in Ohio, behind
    agriculture.
  • Team NEO, a new business development group comprised of five chambers of commerce in the region and two large organizations of CEOs, now must help develop high-growth businesses.

TWIN CITIES

  • Strong in medical device technology. Industry association Medical Alley serves the needs of medical technology firms. State has developed specialized curricula at two-year colleges to train students on Food & Drug Administration compliance for medical devices.
  • A strong heritage in food processing and durable goods manufacturing helps keep product development and manufacturing in the area.

In some spots, the change of approach has worked. There’s already a medical cluster around Minnesota’s Twin Cities, for example, called Medical Alley. “We’ve been booming for five or 10 years, with large companies like Medtronic leading the way,” says Tim Scanlan, CEO of Scanlan Group, a St. Paul-based surgical equipment manufacturer. “Behind the big companies are close to 500 other medical companies in the state, and they’ve continued to develop even through the tough times.”

If only the transformation could happen as magically throughout the entire region as Kanackkanatt’s polymers change color. But the Midwest is twice as concentrated in manufacturing as the rest of the U.S., Testa says, and is likely to continue to be. The high cost of labor keeps degrading the region’s competitiveness against overseas factories. Severe state budget woes make it difficult right now for officials to fund development efforts. And the recent recession drove more than 34,000 25- to 34-year-olds, about one in 20, from Detroit alone. Meanwhile, any new regional economy must be able to absorb the woeful legacy of heavy manufacturing’s decline, including funding health care for the growing wave of millions of new retirees-most of whom do want to stay put. The irony is that this is exactly the same demographic group that has proven least supportive of the education spending required to undergird new-technology development.

The Midwest cities and regions with the best chance of overcoming the odds and developing substantial, long-lived technology clusters meet each of a handful of crucial criteria. They have a work force with higher-than-average intellectual skills; an adequate combination of venture and institutional investment funds devoted to the cause; state and local tax and other policies that encourage technology development; and, perhaps most important, they have access to robust technological research capabilities of major universities.

“Several of the big state schools are near the top in terms of the amount of research they do that drives inventions, but they also have the biggest discrepancies in where the economic benefits of their output end up going,” says Jim Adox, partner in EDF Ventures, an Ann Arbor, Mich.-based venture-capital firm that mainly seeds Midwestern technology companies. That is, the technology innovations may brew in Midwestern universities, but the fruits of their labor tend to benefit the coasts, because that’s where the IT companies are clustered.

But if a Midwestern location has all of that, it may be able to capitalize on the intangible benefits long associated with America’s heartland. “I’ve been able to recruit people from Silicon Valley, Austin and New York because of their disillusionment with those areas of the country-and the quality of life here,” says Jay Coughlan, CEO of Lawson Software in St. Paul.

Three regions that can boast of meeting those criteria are using different approaches to try to leverage them, with varying degrees of success:

Champaign-Urbana, Ill. Local economic development officials were reminded last fall of the frustrations of chasing jobs with incentives when NTN of Japan chose Columbia, Ind., instead of Champaign-Urbana to locate a new plant employing 100 people making driveshafts and other automotive parts. Budget-strapped Illinois couldn’t match Indiana’s lure of an $8-million tax credit based on a new program that rewards 30 percent of the capital investment made by a company that already has a plant in the state.

But Champaign County and the state, working with the University of Illinois, are making progress in establishing a cluster of growing companies around the university’s abundant digital expertise. Campus executives are focusing more on identifying promising commercial possibilities that they can hand off to a new regional entity called Illinois Ventures, which provides startups with business planning, market assessments, legal help and gap financing. “We need to nurture companies that already are here, make sure they stay here and, if they have ideas of expansion, that they expand here,” says Mike Fritz, head of the university’s technology-management office and a former economic-development official.

Early successes with this approach include ChemSensing, a two-year-old company that has developed a sort of digital form of litmus paper, for detecting chemicals, ready to go into production. Renew Power plans to have prototypes of its fuel cells for laptops and cell phones ready this year. And Volition, a 10-year-old company, develops games for Playstation 2 boxes.

Now that Volition has grown to employ more than 70 people, founder and president Mike Kulas is constructing a new, 130,000-square-foot headquarters building just a half-mile from the university. Easy access to campus, he says, will increase the flow of people and ideas back and forth. Kulas also is confident of Volition’s future there, in part because the reasonable cost of living has helped him lure capable employees from all over. “Lots of my employees can afford houses here even though they’re only in their late 20s,” says the 42-year-old Kulas, who sold his company three years ago to THG, a video-game publisher in California. “They sure couldn’t be buying houses in San Jose. And when you can buy a house, you start digging roots. It’s a great employee-retention tool.”

Polymers and Medical Tech

Northeastern Ohio. The Akron-Cleveland corridor is bubbling with activity around information technology, instrumentation and controls, fuel cells and biotechnology, but some denizens believe the most promising focus is polymers. At $50 billion in annual sales, it’s already the second-largest business in Ohio, behind agriculture. And over the past generation or so, the region has established a tremendous infrastructure for polymer development as it evolved from the carcass of a highly related business: tire-making.

Now it’s a matter of teasing truly high-growth businesses from new technologies in polymers and other advanced materials such as ceramics. There are nearly 3,000 polymer companies of some sort in the region, about half in and around Akron, including a half-dozen in the incubator alone. “Broadly defined, this is a mature industry,” says Luis Proenza, president of the University of Akron. “But there’s lots of room for major process improvements and value-added competitive advantage, which can put our polymer companies at the cutting edge of the global economy.” Proenza also is excited about the potential impact of a new group called Team NEO, consisting of five major chambers of commerce in the region and two large organizations of CEOs.

But fractionalism has thwarted efforts so far to get the polymer industry to cooperate efficiently; the Ohio Polymer Enterprise Development Corp., just three years young, folded in June. “There are a lot of competitive issues, such as the portability of tooling, that have caused everyone to kind of hunker down and play things close to the vest,” says Alan Robbins, president and CEO of Plastic Lumber in Akron. It also didn’t help that a $500-million bond issue to fund a major piece of the state’s efforts to grow “knowledge-based industries” was trounced by Ohio voters in November.

“We’re obviously not there yet,” says Dorothy Baunach, executive director of NorTech, a Cleveland-based regional economic development organization. “This is a giant transformation of a very old Midwestern economy through great structural change.”

The Twin Cities. Champaign-Urbana and northeastern Ohio would be happy to end up with a technology cluster resembling the one already ensconced in east-central Minnesota around Minneapolis and St. Paul and south to Rochester, home of the world-famous Mayo Clinic. Scanlan’s grandfather made surgical scissors for the Mayo Brothers in the 1920s, and Scanlan believes that medical-device businesses still have only bright horizons because of the aging of Western populations.

Other executives cite advantages from the Twin Cities’ strong heritage in food processing and manufacturing of durable goods such as snowmobiles and farm equipment. “The availability of a strong manufacturing work force is as important as a good base on the science and technical side, because it enables you to keep product development and manufacturing processes hand in hand at one location,” says Fred Colen, chief technology officer of Boston Scientific’s Maple Grove, Minn., facility, which employs more than 2,800 people.

But locals aren’t wont to take all of this for granted. An industry association called Medical Alley maintains a high profile for med-tech firms’ needs and desires. The state has helped by developing and deploying at two-year colleges some highly specialized curricula, such as one that trains people to comply with complex Food & Drug Administration quality-control standards for medical devices, and by coordinating efforts to get federal research grants among medical companies, the University of Minnesota and other parties. “We’ll even partner with other states if that’s what it takes to put together a winning team to get a [federal] grant that will bring a significant amount of the funding here,” says Matt Kramer, a state economic development commissioner.

Wherever Midwestern cities and regions currently fall on the spectrum of success in developing technology clusters, they have no choice but to stay on that track. “We’ve recognized that the old game of industrial incentives doesn’t play itself out well,” says Ed Morrison, an expert on regional economic issues at Case Western Reserve University in Cleveland. “Now there’s a whole other set of partnerships and incentives that have to be developed to deal with the €˜perfect storm’ of globalization that’s facing us.”


Back on Track

How an old-fashioned Kansan with railroading in his blood breathed new life into the UP. BY PETER GALUSZKA

By any account, Union Pacific’s takeover of Southern Pacific in 1996 and 1997 was a train wreck. Rail cars bound for Houston from Chicago ended up in Los Angeles, thanks to incompatible software and a shortage of locomotives. Coal didn’t reach electric utilities. Plastics molders didn’t get their pellets. All in all, the botched merger cost Union Pacific’s customers $2 billion. In turn, investors punished the venerable, Omaha-based company, forcing down its stock price from $73 in 1996 to $37 in 2000, wiping out about $9 billion in market capitalization.

Yet this is a company planted firmly in prairie sod, where an exec’s word is a bond. Had Union Pacific been a high-flying firm typical of the go-go ’90s, its chief executive might have bailed out on a golden parachute or brazenly proposed yet another merger.

Not so Richard K. Davidson, who became Union Pacific’s CEO during the height of the crisis, in early 1997. The spare-worded Kansan and former railroad brakeman characteristically took the heat himself. “I lived on an airplane for about, oh golly, six or nine months,” he says in a flat Midwestern accent. “I went from meeting to meeting and government agency to agency apologizing for what was happening but assuring people that we would get it fixed.” When he faced a hostile Surface Transportation Board hearing, his statement was notably lacking in hubris: “Our company is embarrassed at the time it has taken to recover from our congestion crisis.”

Dick Davidson’s mid-American values seem to consist of straight talk, a steady gaze and a handshake. Not one to throw $2-million toga parties in Sardinia, he lives modestly with his wife, Trish, near the more down-to-earth Omaha. For fun, he goes to work, although he’s been known to head off into the fields, shotgun in hand, searching for pheasant or quail. “You look at the other CEOs out there and a lot of them are accountants or lawyers,” says Davidson. “I think it’s just my good fortune that I know what I am-a son of toil.”

This proletarian mind-set, combined with vast investments in advanced information technology, saved Union Pacific. Davidson spent $2.8 billion beefing up computer systems and integrating car coding and routing between the underfinanced Southern Pacific and its new owner. The pieces are still not all in place. Just this past fall, the railroad, along with its competitors, was blindsided by a bumper grain crop and a shortage of rail cars, causing more foul-ups. But Union Pacific has made a solid comeback. Its stock is up to the $65-per-share level and recent third-quarter earnings beat Street estimates by 6 cents and earned record revenues.

The re-energized UP is serving up strong competition against Burlington Northern Sante Fe, its historic and faltering competitor in the West and Midwest. The two railroads battle over low-sulfur coal from Wyoming, NAFTA products from Mexico and cheap consumer goods from China arriving at West Coast ports. UP directors are happy with the results. “I’ve always been a strong advocate of Dick. He’s a no-nonsense, up-from-the-ranks kind of guy who understands the business,” says Philip F. Anschutz, the Denver billionaire who is Union Pacific’s chairman.

Davidson, his colleagues say, never forgets where he is from-a poor farm family making a tough living in the middle of Kansas. When he was 18, in 1960, he embarked on a career and style that would serve him the rest of his life. Lacking college money, he began working nights and weekends as a brakeman on the Missouri Pacific railroad, later bought out by Union Pacific. He climbed the ladder of the working rails, becoming a conductor and later, supervisor, while earning a history degree from Washburn University in Topeka.

He learned many practical lessons along the way. One of the sharpest came in 1965 from Downing B. Jenks, the late chairman of the Missouri Pacific. There was a massive flood in Texas and the railroad sent all the young members of its management training program, including Davidson, down there to get experience handling emergencies. Recalls Davidson: “Lo and behold, there I was up to my waist in water working on a piece of track that was washed out. Here came Mr. Jenks-the chairman of the company and the vice president of operations. That really set a tremendous leadership example of how you get out and just prove to everybody that you’re willing to work as hard as or harder than anyone else in the company.”

Unbeknown to Davidson, such experiences were prepping him for his career’s biggest challenge, fixing the merger mess. As part of that, he needed to finesse the very different corporate cultures of several railroads. For example, the Missouri Pacific, which was bought by Union Pacific in 1982, had a reputation of being a laid-back, good-old-boy kind of route. By contrast, Southern Pacific was seen as a penny-pinching, second-best outfit struggling to survive.

The aristocrat of the bunch was Union Pacific. Its predecessor company had pounded in the golden spike in Promontory, Utah, in 1869 with the Central Pacific railroad, creating the first transcontinental line. Later, international troubleshooter Averill Harriman, a major shareholder, added to UP’s classy image. In rail’s golden age in the 1930s and 1940s, UP’s mustard-colored streamliners whisked celebrities like Mickey Rooney and Judy Garland across the country.

So pervasive was Union Pacific’s cachet that when the merger went afoul years later, some Southern Pacific officials just threw in the towel, assuming that UP was simply abusing them, as it always had. Having come from the also-modest Missouri Pacific, Davidson was able to squelch that sentiment and move the newly combined teams quickly toward resolving practical problems.

Another change Davidson initiated was improving ties with customers. Historically, railroads have tended to hold shippers hostage on rates and operations. In this regard, Union Pacific was no shrinking violet. But after the disastrous 1996 merger, Davidson knew he had to win customers back, primarily to keep them from shifting even more to trucks. So, he began a wholesale change in sales attitude and created new, express services, such as the so-called I-5 Corridor, which expedites freight along Interstate 5 running from Seattle to Los Angeles. One new service cuts three days off the transport of interposal cargo from Mexico to markets in the eastern U.S., while a “Blue Streak” line rushes containers west to east.

Customers have noticed. “We went in to bid for coal business,” says David L. Sokol, chairman and CEO of MidAmerican Energy Holdings, an Omaha-based energy firm, “and Dick and his team came up with innovative approaches. Usually, innovation in rail is an oxymoron.”

IT: The Key to Survival

The biggest changes of all have involved rewiring the train and cargo controls covering 33,000 miles of track across 23 states. The two railroads faced major integration challenges. “We had a modern up-to-date computer system,” says Davidson. “Southern Pacific had outsourced their work to IBM and so hadn’t had much modernization over the years.” The biggest problems showed up in former Southern Pacific territory around Houston and then across SP’s southern route from Texas to California. Solving those issues took at least a year. Conflicting union rules between the two roads didn’t help.

Even today, routing for the area around parts of Texas is still handled locally, in part because not all of the former Southern Pacific’s systems are integrated. For most of UP, routing and traffic control are directed at Omaha’s Harriman dispatching center, an old boxcar repair shop that has been converted into a tornado- and terrorist-proof bunker. Inside the darkened structure, 23,000 miles of tracks are displayed in color-coded monitors stretching hundreds of feet down big walls. L. Merrill Bryan Jr., the company’s CIO, says the railroad spends about $200 million a year on its IT system. Another system to locate locomotives by remote control will cost $70 million.

IT is the key to survival, Bryan says. “We are extremely capital intensive,” he says. “So we need to get more out of what we have.” At the moment, 90 percent of customer reports, such as bills of lading, are online. But there’s still room to grow; only 50 percent of “event” reporting, including accidents, is done electronically.

Logjams still occur, notably with grain shipments last fall. For the first time in several years, the U.S. has had a bountiful grain crop throughout much of the corn belt. It caught railroads short, causing growers to complain of slow shipments. A UP spokeswoman says reasons for the shortages include a dearth of rail cars: UP has 23,500 cars in grain service and has leased another 1,200. More grain is being exported to Mexico, which is positive, but it also takes cars longer to make their return trips for new loads. And UP has been short of train crews and locomotives. In late November, UP signed for 175 late-model SD70M locomotives with General Motors’ Electro-Motive Division. It was UP’s biggest buy since 1999 and is worth several hundred million dollars, signaling a strengthening economy.

Overall, Davidson, who is due to retire in two years, says Union Pacific’s comeback should be replicated by the entire U.S. railroad industry. Rails may not be as fast as trucks, he adds, but trucking faces some of the same woes that bedeviled rails for years. “The infrastructure is getting crowded, it’s getting worn out and there’s not enough money to renew it all,” Davidson continues. And, in fact, UP is jettisoning Overnite, its trucking unit.

Whether or not railroading achieves a big revival remains to be seen. Other railroads that went through the same type of merger blues as Union Pacific in the 1990s-Norfolk Southern, Burlington Northern Sante Fe and CSX-have not made as strong a recovery. But Davidson has the advantage of having railroading in his blood. That may very well be what it takes to transform UP into a 21st-century competitor.