All the CEOs who read our magazine want to know how you’ve achieved such incredible performance.
We have great franchises. You have to consider their tenure and duration. Our companies go back for a very, very long time. They’ve normally been market leaders. Otis Elevator has led its market every year since it was formed. It’s done that over and over for 152 years. Today, it’s probably twice the size of the next nearest competitor. It’s a pretty amazing accomplishment.
You also have to consider the tenure of the CEO. Short service runs are two or three years and longer service runs are 12, 13, 14 years. Maybe a little bit longer in cases like Michael Eisner. But you have to realize that what you do today always builds on the back of what happened before.
How did you personally get to this position?
I think I was extraordinarily fortunate. I sort of fell backward into Otis Elevator Company in 1975 when Otis fell backward into one of the first big hostile takeovers to United Technologies Corporation. I joined the company in 1975 and we had this hostile takeover literally a few months after I joined.
I was a young person. I was over-titled, overpaid and under-experienced. I thought I’d get blown up. In fact, I was sure I was going to get blown up. What I realize now with the benefit of hindsight is that what really counts is the power of the franchise. There is enormous intellectual property in these companies. I mean that’s what a company is; it’s the distillation of the intellectual property of the current and prior employees, which is a huge, huge number of people. I’ll bet you more than a half a million people have worked in and around UTC over its lifetime. I’m one person out of a half a million.
But you drive the organization. How do you do that?
I think the role of the CEO is first of all to set standards. You set a bar and you raise the bar and you’re always pulling. It’s very important in a big multi-national, multi-product company like ourselves to have a powerful financial system. Finance is the look-ahead function in the company. Engineering looks ahead toward products and marketing looks ahead toward customer requirements. But the fact is that the finance is the control system. Finance is the skeleton; everything kind of hangs off of that.
I’ve found over many years that you have to pull on the financial system all the time. Management has to demand things out of finance. Obviously, you want things like good, tight controls and conservative accounting. That’s all the backward looking stuff. But also management has to pull on finance to shine a light on the future. Like, “Where are we going to go? What’s the forecast? How do things look? What are the decisions? What’s important to us?” Finance does all that. I had an early background not directly in finance, but indirectly. I can think back so many times in my tenure just pulling on finance. “Give me more information. More precise information. Give me uniformity, definition and clarity of presentation.”
You’ve been advertising your company with the slogan, “This is momentum.” What does that mean?
You have 200,000 people around the world and you have these huge five-year product cycles for things like aircraft engines and helicopters and aircraft systems and everything we make. The fact is that every time you make a change you lose momentum. You have to have a certain amount of linearity and continuity to insert energy into the system. And that’s why a long-tenure chief executive is actually a very important part of success in a company. Because you have the same value sets. You have the same beliefs. People come to rely upon each other. You have the same trusting relationships. You know people. They know you. They can predict you, you can predict them.
All that begins to kind of work and it accelerates over the tenure of a CEO. If you have people bouncing in and out every second or third year every single time, that’s not good. We have important competitors in the world. We work around them and against them over long period of time. Every now and then, there’s going to be a CEO transition and there is, not atypically, an opportunity for us because there will be a restart. There will be a change. They will lose a little bit of loss of momentum. Same thing with an acquisition. We’ve seen competitors acquired by other companies and invariably they kind of miss a step. If you’re there and you’re moving, then you get some competitive edge.
You’re talking about the Jack Welch transition at General Electric?
I guess I’m going to dodge naming names, but you can go back and look and see who’s been acquired by whom and situations like that.
This is a well-known thing. There are opportunities when there are CEO transitions because it’s all kind of a restart and if a company is going to get sold or merged or combined in some way it often happens around a CEO transition. You need linearity and continuity. You get a lot of benefit just by doing the same things by repetition.
Conglomerates are not exactly in fashion. How do you manage one?
One of the things that was very important to us happened around the time that I became the corporation’s president in 1992. The parent company used to be a much bigger financial entity. It had three times the staff that it has today and it had a much bigger balance sheet and lots of costs and asset categories that today are in the division.
I’m a tremendous believer in profit center management. The ultimate discipline is to have the customer’s revenues butted up against management’s cost and what you’re looking for is the difference between the two and then use the discipline of the market to cause the companies to perform. So if you can get profit centers, which means subdivided entities, in a big company like ourselves, you’re way better off because then you can have an individual manager go after a part of the problem. That’s better than if it’s all centralized and consolidated. Then you have one person, me, worrying about it. And I can’t worry about all this stuff.
So that changes the motivation for people actually running the businesses?
Yes, the second thing was we began to put the division presidents in front of the investor population. And the third thing we did was we lined up so-called measurement or management reporting with segment reporting. So all of a sudden, we had a Pratt and Whitney segment of UTC. Same thing for Otis and Carrier and Sikorsky. We had the presidents of these units stand in front of the analysts meeting. They get up and they get up and they talk for 10-15 minutes about their business. We go through the day and the division presidents would say okay, “Here’s my goal and here’s my three or four year sales outlook and I’m trying to get the operating income margin to go from this to this to this” and the analysts would all write that down. The key point is this process. It has given a shareholder value agenda to the individual operating heads of the company.
It didn’t work that way before?
No, this really is the punch line, when I was a kid at UTC running one of our businesses, like the North American elevator business for Otis, to me the protagonist, the guy I was always negotiating with, was the parent company. So my whole deal was to plan low and get a little bit better than plan and earn good incentive compensation. The corporate police would say, “Everything is fine.” I didn’t care about shareholder value agenda.
So compensation systems obviously a major driver?
This goes back to Tax Reform Act of 1986 which put the cap on the deductibility of non-performance compensation. It put the cap at a million dollars and beyond that if it was non-performance it was not deductible to a company paying the compensation. That moved the world towards stock option compensation, which was performance variable because obviously it’s sharing in the rewards of the enterprise. So we did that like everybody else did. And our stock option program is always benchmarked right down the middle. It’s absolutely in the median for corporate performance for companies of our size and type.
So by having presidents standing in front of investors and knowing that they were responsible, the results began to get better and the stock price went up and the options became worth a lot. It was a virtuous cycle. People said, “Hey, this is pretty cool.” It wasn’t me saying it was pretty cool. It was our 1,000- person executive team. We’ve had this thousand percent total shareholder return since 1992 and all that has created a certain amount of money for management. It’s created a truckload more for investors. I think the gain for investors in shareholder value has been something like 15 to 20 times higher than they had been for management. The investors took 95 percent of the returns. Management got a little bit but management made it happen.
Options have been a target of much criticism lately.
We’re a case where I think stock options actually work very well. Even though some of the governance police today like ISS do not count normal vanilla time-vested options as performance compensation, I represent that it absolutely is. Because frankly if the stock goes down, it’s worthless.
There is a kaizen-like, or continuous improvement, feeling to the way you drive the company. Did your association with Matsushita’s Yuzuru Ito help shape that?
Absolutely, it has. I went to Japan in the late 1960s. That was just a fortuitous thing. I actually ended up going back several times a year for the next 30 years. For a long time, I chaired the board of our Japanese elevator company. Because of that, I had real exposure to Japanese lean manufacturing and quality assurance methodology.
In the late 1980s, we had some problems with quality in our Japanese elevator company–we were not at the Japanese market standard. Our partner in that business for 30 years has been Matsushita Electric. They got pretty excited because we were using a joint trademark, theirs and ours, and they said, “You can’t use our trademark on your product if you don’t meet the Japanese market standards.” So they were all over us. I learned a lot out of that.
Then we had this wonderful guy, Ito, who was the former quality executive from Matsushita. He retired in his early 60s and he worked for us for six or seven years. He actually moved to Farmington , Connecticut which is an amazing thing. Typically, older Japanese executives go into the sunset and retire. He was so motivated. Actually, his career fulfillment happened in UTC and not in Matsushita Electric. The real capstone was with us.
What exactly did you learn?
I learned a bunch of very basic principles. Our quality methodology is absolutely Japanese. It is a good deal simpler than techniques like Six Sigma. We use Six Sigma, which is basically statistical process control, in large parts of our business. But our methodology runs at a much simpler level and it relies upon involving each and every employee of the company. Ito used to say to me that if 200,000 people don’t do things right, you’re not going to have good product. So you have to get the 200,000 people involved in the process.
He taught me things like that the typical American quality methodology 20 years ago was end-of-line inspect. You build a product and you look at it, if it works or it doesn’t. If it doesn’t work, it goes up to a shop for some rework. What Ito taught us instead was to move the quality inspection and the process control up the line to the individual production people and that meant gauging tooling and process control for each individual employee. The whole theory behind the Japanese system is you don’t build bad product in the first place. We deployed that and we have in my opinion a powerful repetitive discipline. It’s been in place now for a dozen years.
What else did you learn?
The other element is lean manufacturing, which is nothing more nor less than turning formerly sequential work to simultaneous work. You used to do things in 15 separate steps in a plant. You’d do something and put it in a pile. That’s inventory. Inventory is waste. Pick it up again, work with it some more, leave it 100 feet in the plant. Do something, put it in a pile. More inventory, more waste. Move it another 100 feet.
What lean does is simply it does simultaneous work. It puts things in cells and you do the work with one operator at the same time. Fifteen steps become three. We’ve done a huge amount of “lean” in our company. In my opinion, more than half of the shareholder value gains at UTC in this time period are due to the disciplines of Achieving Competitive Excellence (ACE). That’s just basic, simple, grind it out stuff. There’s no glamour here. There’s no Hail Mary pass.
Back to the conglomerate theme, how do you make it work when so many have failed?
I don’t know if we like that word. I prefer even multi-industry, multi-national. There’s a basic goodness about multi-industry, multi-national and here’s what it is; investors always ask, “Why can’t we make the decisions ourselves about whether we want to invest in Otis Elevator or Pratt & Whitney or Sikorsky?”
My response to that is two fold: first, the one thing that they hate worse than not being able to make individual company decisions is they hate surprises. Investors hate bad news. It drives them absolutely crazy. The way you get no bad news is by virtue of having the company be very far flung both geographically and product wise.
Commercial aviation exploded on September 11, 2001 . We had a third of the profitability of the company, certainly a quarter, in commercial aviation and all of that exploded literally in one day. Yet we went through the succeeding four years with the highest earnings per share growth rate of any one of our dozen peer companies including Boeing and General Electric and Textron and Collins and Honeywell. We beat them all on earnings per share growth rate.
It was all about balance because what happened was commercial aviation went down, but military aviation went way up. Military aerospace now is a slightly higher percentage of sales than is commercial aerospace in UTC. On top of that we had the commercial companies that have steadily grown as their percentage of the company and I think it’s up now to 64 percent.
How does geographic diversity help?
Yes, we had another meltdown when Asia exploded in 1998. About 18 or 19 percent of our sales were in Asia , but went down to 13 or 14 percent because all of the economies were in drama. And we went right past that. It’s all because of balance in the company. It’s a powerful element.
The second thing I tell investors is they get is no bad news because we have a lot of product cycles that all work in. And on top of that you get active management of the parent company. Investors are not going to put ACE in the operating companies. They’re not – we are. That’s what you get with both General Electric and us and why people liked GE so much 10 or 15 years ago; they like Welch a lot for management discipline and management methodology and value insertion into their operating companies which are very disparate. They got a lot of business balance. That’s why investors like GE. That’s why investors like us.
How do you manage your methodologies and disciplines different from what they do at GE? Are they better or just different?
Of course, they’re better. They’re much better in some very different ways. I think we have a very flat organization structure. Super flat. And we have the ability to make decisions really quickly. That’s in part because of continuity momentum. It’s also the high tenure of management. This team has been together for a long time. Everybody kind of knows each other. I race big sailboats and, this is my analogy: in the size of boat that I race, we race with crews of 12. There’s a lot of agile, high strength movement that goes on. It’s like choreography. What happens is you drop a new person in the boat and you come to tack, that is change direction, and people will start bumping into each other. Somebody will get an elbow in the nose, which his bad.
When the crew has been together and it’s a regular core crew they don’t get elbows in the nose because you know what’s going to happen. Well, business is the same way. You don’t want an elbow in the nose and you get that when you know your teammate who stands right beside you. So that’s a big piece. I think we’re a very agile company in that way.
How else would your management philosophy differ from Jack’s?
Welch always used to say, “Get rid of the bottom 10 percent.” Well, we do a certain amount of that and that’s okay. But I prefer to work on the top 10 percent. Because the people that move the company are the top 10 percent of the company. In fact. it’s even a narrower population than that. There are about 100 people who really make the decisions. They actually move this enterprise around. The ones that you have to work on super, super hard are those people. The place where the value insertion comes from me is in the top 10 percent.
How far can you go in sales? People say $80 or $100 billion isn’t crazy.
Higher, faster, farther. It’s just like an airplane. I don’t think there’s any limit to what we can do. Our growth rate is pretty high. We made this huge organic growth rate in 2004 and we told the Street it will be 6 percent in 2005 and we raised that forecast for them at the investor meeting. Of course, organic growth is not all there is for us because we will pick up some growth through acquisitions. We’ll pick up some more growth out of foreign exchange. That’s the weaker dollar and since we had 60 percent of sales in other currencies than the U.S. dollar as our dollar gets weaker those sales get bigger when translated back into dollars. We told the Street that we raised the revenue number to $41 billion but that’s before the role in the impact of a couple of acquisitions. So the company is growing well. Further, faster, higher.
Clearly you’re in a growth mode. You’re not just standing pat.
We have an amazing product lineup right now. Actually I’m gratified and to tell you the truth I’m even a little surprised by how good it is. I look at these products like Gen2 in Otis which is literally remaking the elevator business. Otis is on the offensive. Otis is increasing market share on the back of a superior product and a superior management system.
What about Carrier?
Carrier’s got this new redesign, responding to a new federal standard. We led the industry on that and I think we’re going to find that’s a great product line for us.
The PW600 engine I think is going to remake general aviation. For the last 30 or 40 years, we’ve always had turboprops. Pratt & Whitney Canada is the market leader in turboprops and always has been and we’re going to switch out now for general aviation. It’s possible there’s a taxi market for these very light jets.
NASA has studied this forever. There’s a lot of influence during the long tenure of Dan Goldin at NASA. A favorite theme of his was, “Let’s unload the hubs and start to use more small airports with much smaller aircraft with much more point-to-point service.” Pratt & Whitney is very powerful in this general aviation market with a couple of good placements. One is the Cessna Mustang. The second is the Eclipse aircraft. We had a big impact on that program. There’s another one coming. The Embraer light jet and very light jet class is up for award.
What is the source of your optimism in this field?
If you ask anybody in the aviation business who knows small aircraft about the PT6, they just smile. It’s a wonderfully reliable, super powerful, super good engine with a huge pedigree over a really long time period. We want the PW600 to step right into the class of the PT6.
Same thing with Hamilton Sundstrand. We have an underscoring of the success of the Hamilton Sundstrand merger which happened in 1999 that was underscored in a huge way on the Boeing 787 system awards where we won eight of nine systems we bid. And against our traditional competitor, we were up against them on seven systems. We won seven, they won zero. That’s an incredible underlining of the excellence of engineering and product development. Hamilton Sundstrand is a wonderful company.
You also seem to be on a roll with Pratt & Whitney military engines.
Pratt writes the book on new technologies in engines. We outspend on R&D and this applies to both commercial aviation and military engines. We have outspent our competitors in the last five years by a lot. We are the technical leader in the world. The place you see that is at the leading edge which is with fighter aircraft in the United States Air Force where we’ve done all the F-15s. We’ve done 70 percent of the F-16s and we have today under contract 100 percent of the next generation the Joint Strike Fighter and the F-22 . We’ve got the S92 Helicopter, which didn’t win for our president. That was a disappointment. But I think we got a way good helicopter that I think is way better than the other guy on the merits.
How does it feel to be moving out from under the shadow of your cross state competitors at General Electric?
I never thought we were in the shadow in the first place. They’re bigger but we’re the same kinds of companies. I’ve had a very good relationship with Welch for a long time. There’s a lot of mutual respect. They were tough competitors in the engine business but he runs a great company. I think I’ve learned lots of things from him and he might even have learned a thing or two from me. I don’t know that. You’d have to ask him.
That goes back to my earlier point about how a company works. It works on momentum. How many initiatives, how many management programs are there in a company? In our case, there are thousands and thousands. If you have restarts in those because you have a new executive or a new executive team or a new strategy, you lose momentum. And when you have a thousand or ten thousand different things that are underway in a company you get goodness. That’s why change is very expensive and conversely why “not change” is very beneficial. You can feel acceleration in UTC after this long period of continuity and linearity.
Why do you think so many CEOs have not gotten the job done properly and have been booted out or been forced to resign?
I think there’s some very basic rules you have to follow. You have to have a bullet proof financial system. You have to have a bullet proof compliance and ethics system. You have to be a good corporate citizen and measure it across a broad set of dimensions, environmental goodness, community impact, things like that. You have to build very good products. You have to have very low cost. You have to constantly restructure. You have to recruit, develop employees and management at all levels in the company. All these things take time and they also take focus by the CEO on the right things. Those are core values. You might notice I didn’t mention earnings per share. Not in an individual quarter.
This is a personal story. There are two lanes on entry into UTC and I can see people take these lanes. One of them is sort of financial management. The idea there is you understand the P&L, the balance sheet and all the math and all the numbers and if you can manage those then goodness can happen.
The other lane is the product. If you make the product work then goodness will happen. Too many CEOs, I believe, fall into the trap that they get into the other lane about manage the balance sheet and goodness will happen. The answer is the balance sheet is the scorecard. It’s what comes at the end of the day. The front end of it is to manage the product and manage the people and manage the factories and manage the cost and manage the selling and the delivery of the product so you have greatness there. If you have greatness, there you will have greatness in the P&L. Too many CEOs go down the wrong lane.