ANALYSIS OF INDUSTRY

Characteristics & Factors

The EME industry is characterized by two things –Capital intensive business and cyclical

demand. Earlier the industry relied on high amount of labor to increase their profitability through

scale economies but as competition grew, the importance shifted towards increased reliability

and durability of the manufactured goods. This required the use of quality control measures

using electronically controlled equipment. This may reduce the labor cost but has added to

capital spending. Due to increase in competition from other developing nations which specialize

in a particular sector, the need for constant innovation has led to increased spending on R&D

activities at nearly 3-4% of sales.

Another factor is the cyclical demand of the industry. The construction industry is heavily

dependent on the state of the global economy. A dip in global GDP growth will cause a drastic

reduction in construction activity around the world and hence decreased sale of construction

equipment. The other industry where EME are heavily used is the mining sector. The mining

sector is heavily dependent on the market prices of the minerals being extracted. A drop in prices

causes a seizure of all mining related activities which affects the EME industry.

Another avenue which the EME manufactures have tapped is the after sales supply of spare

parts. Normally an EME commands a profit margin of anywhere between 5-15%. But sales of

spare parts contribute nearly 25-30% as margin.

Earlier the EME business was concentrated in North America and Western Europe, but with the

growing economies of Asia and Latin America, it caused an explosion in the entry of smaller

players who concentrate on a particular geographic region or a product portfolio.

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Caterpillar 2010

INTRODUCTION AND HISTORICAL ANALYSIS

Caterpillar Tractor Co (Cat), headquartered in Peoria, Illinois, has dominated the world in earth

moving, construction, and materials machinery for more than 50 years. Caterpillar is the world's

largest manufacturer of farm and construction machinery, including trucks, tractors, excavators,

and graders. Caterpillar also manufactures both gas and diesel engines which are used in

Caterpillar machinery and other equipment. They command over 50% market share in the EME

sector far ahead of their nearest rival.

Caterpillar has 22 production facilities in the United States and 11 production facilities abroad,

and has over 200 dealers in over a 100 countries. Forty four percent of Caterpillars business is in

the US and 56 % abroad.

Rise to a Multinational company-- Critical Incidents that led to its Development

Caterpillar was formed on April 15, 1925 with the merger of Holt Manufacturing

Company of Stockton, California and the C. L. Best Gas Traction Company of San Leandro,

California, forming the Caterpillar Tractor Co. Sales of the first year were US$13 million. By

1929, sales climbed to $52.8 million, and CAT continued to grow throughout the Great

Depression of the 1930s.

Defense Equipment Industry

After the companies merged, Caterpillar went through many changes, including the adoption of

the diesel engine. During World War II, Caterpillar products found fame with the Seabees,

Construction Battalions of the United States Navy, who built airfields and other facilities in

the Pacific Theater of Operations. During the post-war construction boom, the company grew at

a rapid pace and launched its first venture outside the U.S. in 1950, marking the beginning of

Caterpillar's development into a multinational corporation.

American Auto Industry Growth

Cat’s rise to global dominance stemmed from a mixture of good luck, analytical judgment and

world history. The company was fortunate to be based in United States where the proliferation of

highways that followed development of auto industry led to strong demand of EME.

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Caterpillar 2010

Post War Overseas Expansion

With the withdrawal of the US army from Asia and Europe, the machines were left for local use.

Foreign users became familiar with Cat machines and foreign workers learned servicing those

machine.

Setting up Independent Dealership

It established independent dealership to service machines left in Europe and Asia. Along with

US dealer they became an important part in Cat’s marketing strategy. In 1981 it had 216 world

wide dealers and 889 branch stores.

Spare part and Customer service focus

Cat played a right strategic card by developing a well oiled spare part business and customer

oriented service culture in the organization. When introducing new products the company built

up two months supply of spare parts and guaranteed a 48 hour supply of spare parts.

Acquisitions

In addition to increasing sales of its core products, much of Caterpillars growth has been through

acquisitions, including:

Company Location Date Products Notes

TowmotorMentor,

OH1965 Forklifts

Later became Caterpillar Mitsubishi Forklifts,

80% owned by Mitsubishi

Solar

Turbines

San Diego,

CA1981

Natural gas

turbines

Founded in 1927 as Prudden-San Diego

Airplane Company; assets acquired

from International Harvester

With almost 57% sales of Cat coming from overseas in 1981 it was truly and international

company.

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Caterpillar 2010

SWOT

SWOT analysis:

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Strengths

Global market leader

Robust financial condition Diversified geographical Reach

Good Product Mix

Strong dealership network

Weakness

Falling sales in Europe Inefficient Production systems Higher Direct Costs

Threats

Intense Competition and Rivalry Economic slowdown in US Dependency on Mining Industry Raw Material Prices

Opportunities

Opportunities in Middle East and Asia

pacific

Increasing construction activity due to

growing population

Joint development and acquisition

programs

Caterpillar 2010

Strengths: Global market leader: Caterpillar is the world’s largest manufacturer of earthmoving

machinery and construction and mining equipment

Technology leadership: They have strongest and broadest product offering through their focus on

R&D

Diversified geographical spread: The company generates revenues from most of the prominent

markets in the world, not relying heavily on a specific economy or geography.

Strong dealer network: Caterpillar has over 200 full-line dealers worldwide. The dealer network

is Caterpillar’s most significant asset. It is a key competitive differentiator.

Weakness: Bad hr relations: Their increasing move towards automation is causing a sense of

insecurity among the workers

Internal staffing: Managers and executives are internally bred and hence share a similar line of

thought which is preventing fresh ideas from coming in.

Centralized decision making: Lesser autonomy to the world wide units will be detrimental to

growth.

Opportunities: Developing economies: Increasing construction activity due to growing

population and infrastructure spending in Asia and Latin America.

Joint ventures: Entry into economies with high non tariff barriers through JVs.

Threats: Cost escalation: Rise in raw material prices will reduce operating margin

Cyclical demand: Demand for new equipment is highly cyclical and dependent on mineral

prices.

United Auto Workers association intrusion: Work disruptions, strikes and worker walkouts will

have a negative effect on production and revenue generation

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Caterpillar 2010

Recommendation Based on SWOT

Opportunities in Asia Pacific and Africa .

Developing economies in Asia pacific, Middle East are experiencing annual growth of 4-

7% per annum.

Infrastructure development and construction activities are rising at a fast rate in these

countries.

Asia continues to be a very large growth opportunity for Caterpillar, and it is an area in

which it should focus on increasing its presence.

A Case For Setting up Facilities in Low Cost Destinations—Dunning Eclectic Paradigm

A look at comparative cost component analysis of Komatsu will reveal that Komatsu has a

distinctive advantage over Cat in labour costs; this should be case with all other non US rivals.

An analysis of their sales mix to third world countries reveals that almost 70% of sales in third

world countries are via exports from US. Therefore there is case for Cat to setup manufacturing

facilities in low cost destinations like Japan, China etc and export back to US, thereby taking

location advantage.

Strategic Alliance and acquisition programs

The joint Development programs should be entered to improve the production systems of the

company and make them as good as Japanese TQM systems. Acquisitions should be done to

enhance capabilities and strength of the company.

Hedging for rise in raw material prices

There has been a continuous rise in the prices for key raw materials of the company, especially

metals, and these prices are expected to rise further as the global economy improves. The

increase in raw material prices will increase the company’s operating costs, and would limit the

magnitude of potential production increases and therefore incremental earnings power. One of

the ways to overcome this is by hedging in raw materials and thereby be sure about its cost

structure.

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Caterpillar 2010

Reducing Mining Industry depende ncy

Demand for new equipment is highly cyclical and dependent on mineral prices. The four major

minerals produced using mining equipment are coal, copper, iron, and gold. These four minerals

account for 87% of all mines using heavy mining equipment and for 88% of the population of

large mining machines. Although, the demand for these minerals, which is largely determined by

population growth and growth of GDP, is expected to be stable or increase in the future, there

remains an element of uncertainty. Therefore steps should be taken to derisk revenue streams

Labor Contracts and HR practices

Since early 1980’s the company has been in negotiations regarding workers’ contracts,

healthcare, wages and job security. The last meeting between the two was unsuccessful and had

led to work disruptions, strikes and worker walkouts. If the present meetings suffer the same fate

as the previous then further work disruptions can occur, which will have a negative effect on

production and revenue generation. Therefore proper labour contract and labour management

practices should be adopted.

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Caterpillar 2010

CATERPILLAR OPERATIONS STRATEGY

Caterpillar as an organization basically designed, manufactured and marketed two product

categories:

a) Earth moving, construction and materials handling machinery

b) Engines for the above machinery as well as trucks

However, they had also diversified into marine, petroleum, agricultural applications as well as

electric power generation systems. The broad geographic base and the above line of products

reduced the dependence on the domestic business cycle. Caterpillar’s product strategy was to

produce high quality products backed by effective service.

Caterpillar basically concentrated on Manufacturing excellence and similarity of products

anywhere in the world. Hence they had to invest heavily in state of the art component

manufacturing facilities mostly nearer to Preoria to meet the world demand. These centralized

facilities were useful for the overseas assembly plants which localized the product. Hence they

were able to avoid the high cost of transportation of end product and also it increased the

responsiveness of the company with respect to local needs.

General Operations: Though Caterpillar was continuously increasing the number of plants they

had, they also operated each of their plant with a capacity of less than 75% only. But still the

direction was to provide products at the promised or expected time giving 100% customer

satisfaction. Another aspect is that the company is backward integrated, that is they produce

more than 90% of their components in-house.

Futuristic Approach: Caterpillar recognized the future advantages that flexible manufacturing

can provide, initially, obsolete equipment were being replaced by electronically controlled

equipment. This was a form of fixed automation which will increase the productivity but is

difficult for bringing in flexibility in automation. Caterpillar was always behind Japanese

production systems, but that concept aligns Caterpillars intentions with their direction.

Caterpillar allows the competitor to enter the market first and they watch and learn.

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Caterpillar 2010

HR STRATEGIES

Caterpillar had a unique recruitment strategy of hiring individuals who were willing to spend the

entire career over there with dedication. They did not hire MBAs. Most of the top leaders grew

up the hierarchical ladder gradually and they were mostly from the neighborhood of Cat. The

leadership abilities were molded by the company conducting its own management development

program. In Geneva, most of the employees of the company lived in one suburb referred to

locally as “Caterpillar Village”.

Implications- This approach led to a close knit management group who were very much

dedicated to their work. Though being an American company their approach towards the

employees is similar to the Japanese.

They had a very close mouthed attitude when it came to disclosing about business to the press.

They also discouraged dealers from joining the Association of Equipment Distributors.

Implications- Being secretive about their products and strategies would leave the press guessing

and sometimes the rumors can work in their advantage. Since they consider dealers as very much

a part of them they would not want to create rent seeking behavior through Unionism.

“This is no place for Individual star performers”- Lee Morgan. They followed the value system

of being “severally responsible”.

Implications- Being a manufacturing set up a co-operative approach is important. But too much

collectivism can be detrimental in bringing out the best in each employee as there is no

recognition for their individual performance.

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Caterpillar 2010

FINANCIAL ANALYSIS

Under financial analysis we first look at the margin analysis of Cat over six year period, 1976-

1981.

1976 1977 1978 1979 1980 19810

2

4

6

8

10

12

14

16

Margin Analysis

PAT**Op IncEBT

** Only Operational PAT Margin is taken

As we can see that the recessionary environment took a toll on earning margin in year 1979 from

thereon the margins have improved continuously. However higher direct costs especially labour

costs are now showing on operating margin of the company.

Ratio Analysis

We have divided ratio analysis into four parts; we look at each of them in subsequent tables, the

case data only enables a time series analysis and hence Cat is measured against industry

standards

Profitability 1976 1977 1978 1979 1980 1981

ROE 18.90% 19.00% 20.58% 16.04% 16.46% 15.01%

ROA 9.84% 10.24% 11.26% 9.10% 9.26% 7.95%

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Caterpillar 2010

We see no inconsistency as regards to Return on Equity and Return on Assets they tend to follow

same pattern as net income changes. The area of more concern to top management is to increase

margin to previous levels both operating and net margin.

Liquidity 1976 1977 1978 1979 1980 1981

Liquid Ratio 1.04 1.01 0.89 0.68 0.69 0.56

Current Ratio 2.55 2.36 2.12 1.88 1.71 1.50

Inventory Turnover 2.99 3.35 3.51 3.53 3.79 3.31

DSO 43 40 38 32 38 39

The company seems to having more of non liquid assets as it is progressing, this might to

because of piling up of inventory, very interesting is simultaneous reduction of liquid ratio and

subsequent decrease of DSO. Usually they move in different direction, Management focus

should be on removing this ambiguity.

Leverage ratios 1976 1977 1978 1979 1980 1981

Debt/Asset 0.27 0.23 0.20 0.18 0.15 0.13

Debt/Equity 0.51 0.43 0.37 0.31 0.27 0.25

Times Covered Ratio 16.11 13.93 9.61 5.97 5.45 4.50

The Debt equity clearly shows the conservative behavior of company’s top management. There

has been a complete overhaul of capital structure of the company with debt being reduced.

However the times covered is reducing drastically showing operational inefficiency.

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Caterpillar 2010

Recommendations Based on Financial Analysis

The company needs to improve its production efficiency in order to reduce SGA

percentage of sales to levels to 1970’s. Economies of scale usually bring in lower direct

cost but that is not reflected because of inefficient production systems, therefore

investment needs to be made for getting efficient production systems and training of

employees

Company should in bring in more debt to capital structure and use that money for

expansion in other geographies as recommended in case previously

Inventory Turnover should be improved to improve liquidity position of the company

Excess funds can be deployed for generating more non product revenue.

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Caterpillar 2010

Marketing Perspective

EME marketing requires special attention to the technical needs of the costumer. This aspect makes its even more challenging specially in the wake of competition that either come up with new technologies on their own or duplicate them easily. In such a situation to stay ahead in your competition you need to adopt few strategies that could lead sustained market share or increase in sales. While we suggest these strategies from a marketing perspective, we should keep in mind that EME is a low sales and high margin product.

Challenge

Catterpillar is a market leader and that to by a higher margin globally but due to changes in the business environment and saturation of the presently high growth yielding markets and businesses, they are faced with a problem. They are looking as to how can they sustain their growth. We can put this in a simple form as

How to respond to changing industry

How to deal with growing competitors

Solution

Basically the situation here demands a relook into their strategy and what they want to achieve. For this we can make use of Ansoff matrix which can help us analyze and provide recommendations to deal with such a situation.

Ansoff Matrix

The Ansoff Product-Market Growth Matrix is a marketing tool created by Igor Ansoff and first published in his article "Strategies for Diversification" in the Harvard Business Review (1957). The matrix allows marketers to consider ways to grow the business via existing and/or new products, in existing and/or new markets – there are four possible product/market combinations. This matrix helps companies decide what course of action should be taken given current performance1. The matrix consists of four strategies:

Market penetration

In this situation Catterpillar needs to target existing customers with existing products. It is very less risky as the products and markets are already well defined.

1 http://www.mindtools.com/pages/article/newTMC_90.htm

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Caterpillar 2010

Recommendations

Focus on changing incidental clients into regular clients, and regular clients into heavy

clients.eg:- Of Caterpillars overseas sales only 9% comes from Canada, 17% from Latin

America etc2. They can build on such markets.

Increasing the sale of EME and increase the prices of spare parts.

Implementation

Typical methods are volume discounts, bonus cards and customer relationship

management.

Reduce the prices of EME and the reduction in margin here can be raised by increasing

the margins on spare parts as once the machines are bought the spare parts would be

required anyways.

Market Development

The basic idea here is to sell the well established products to new markets. The main advantage from this could be gain in revenue in a quick time.

Recommendation

Venture into new geographical territories such as Far east, Australia, ASEAN Countries

etc. which are showing hopeful signs of prospering in immediate future.

Use different sales channels, such as online or direct sales apart from the current

distribution channel

Implementation

Form a joint venture with a local contactor or agency to sell or use the equipments for

government contract or other big projects being handled by private players.

Set up a dedicated website which can mainly be used as lead generators specifically

dedicated to each of these countries mentioned above

2 Form 10-k reports

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Caterpillar 2010

Product Development

This doesn’t mean to develop new products but rather selling more variety of products to same customer. This could also mean providing an end to end service to the customer by supplying everything he needs.

Recommendation

Try to sell other products apart from those which are being sold to (regular) clients. This

can be accessories, add-ons, or completely new products.

Use existing communication channels for this as same market is to be targeted.

Implementation

Develop variants or customize as per the client requirements or sell them the required

spare parts along with the EME.

Diversification

Entering newer markets with newer products but the new products need not be related to earlier ones. Catterpillar, however, has got it right by going into related diversification like engine manufacturing etc.

Recommendation

horizontal diversification (new product, current market) – Like acquisition of solar

turbnes division of IH for engines they should go aggressively for more acquisitions in a

related industry.

vertical diversification (move into firms supplier's or customer's business) – Caterpillar

has a strong distribution network already but it should also enter into it to gain from

firsthand knowledge specifically entering a online distribution channel.

concentric diversification (new product closely related to current product in new market)

- New products such as earth movers which are centrally connected and operators get access

to real time information etc. can be developed.

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Caterpillar 2010

Implementation

Conduct a proper study as to where else can they diversify and then acquire them or try to

produce them. Eg:- they are not present in Backhoes3 which they can enter into as

competitors are already present but due to their reputation they will be able to sell better.

By setting up online channels they can get leads at the same time supply directly from

their manufacturing facilities.

Like the beadless tire more such products and for this proper resources should be

allocated

Appendix

3 Wertheim & Co., Inc.

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Caterpillar 2010

Ansoff Matrix

 

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