What Would You Do?

Caterpillar Headquarters, Peoria, Illinois

Caterpillar dominates the construction and earth- moving equipment industry, with $50 billion per year in revenues. Komatsu, its next closest competitor, does $25 billion. However, Caterpillar has not been able to master the cyclical nature of its industry. When the heavy machinery industry booms, no one keeps up with demand, and everyone builds new factories and hires thousands of new employees. Indeed, Caterpil- lar doubled its workforce the last time global demand surged. But when the industry goes bust, factories are closed and tens of thousands of employees are laid off. What kind of dramatic swings does Caterpillar experi- ence? A 43 percent spike in sales in April 2004 and a 52 percent decline in September 2009. Caterpillar’s Doug Oberhelman had firsthand experience with an even larger sales swing in Argentina. He says, “We sold 1,200 machines a year in Argentina in the late ‘70s. In 1981, ‘82, and ‘83, while I was there, we sold four total.”

In sudden downturns, Caterpillar learned to switch from selling new equipment to refurbishing used equipment. For customers, the advantages of tak- ing apart, cleaning, repairing, and reassembling the engines, transmissions, and other major parts of heavy machinery are a new factory warranty and a 30 percent to 80 percent lower cost. Globally, the remanufactur- ing business is worth $100 billion a year, with profit margins as high as 40 percent. So, it has been a good way for Caterpillar to offset the boom-and-bust cycle to some extent.

The second way in which Caterpillar has dealt with sudden swings was to try to predict when they were going to occur. Company economists told your chief financial officer, “We’ve got good news and bad news. The good news is we found an indicator that predicts shifts in U.S. GDP with a lead time of six to nine months. The bad news is it’s our own sales to us- ers.” The problem, though, was that while they could generally predict when a shift in sales would occur, they couldn’t predict the severity. As a result, the last time a severe downturn occurred, Caterpillar laid off 35,000 managers and workers out of 120,000 worldwide.

Furthermore, it cut executive compensation by 50 percent, senior manager pay by up to 35 percent, and manager and support staff pay by 15 percent. To re- duce costs further, Caterpillar offered voluntary buyout packages to 25,000 salaried workers.

You’ve just been named Caterpillar’s next CEO, and you’ve got six months before you take over from the current CEO. You’ve decided to use this time to pick your 16 top managers and work with them to analyze the company. Caterpillar has entered a lot of businesses in the last two decades and every part, good, bad, and ugly, is on the table for review. The critical issue is how to better manage the cyclical nature of your industry, particularly downturns. While you can see them com- ing, you can’t predict their severity. So, what can the company do to better prepare itself and its customers, suppliers, and dealers for the next severe downturn? Also, what are your goals for company performance for the next downswing? Second, severe upswings, though preferable, are disruptive and difficult to manage, par- ticularly when it comes to hiring thousands of workers at one time, restarting mothballed production facili- ties, procuring the necessary parts from suppliers, and suddenly finding the cash to pay for it all. So, given that there’s little warning to when this is coming, what can be done to make sudden increases in production more manageable for you and your suppliers? Finally, sudden upswings and downswings produce opportunities for your competitors to steal customers by undercutting price, delivering products faster, or designing better products. What can Caterpillar and its dealers do to decrease customer losses and defections? What can top management do to make sure it keeps a stronger focus on customers?

If you were the new CEO at Caterpillar, what would you do?

Sources: I. Brat, “Caterpillar Gets Bugs Out of Old Equipment; Growing Remanufacturing Division Is Central to Earnings-Stabilization Plan,” The Wall Street Journal, 5 July 2006, A16; D. Cameron, “Corporate News: Caterpillar Wields Ax on Bonuses—Executive Compensation to Fall as Much as 50%; Other Cutbacks Are Set,” Wall Street Journal, 23 December 2008, B3; G. Colvin, “Caterpillar is Absolutely Crushing It,” Fortune, 23 May 2011, 136–144; S. Oster, “Caterpillar, China Are to Promote Remanufacturing,” The Wall Street Journal, 15 September 2006, A10; T. Van Hampton, “Down to Earth,” Engineering News-Record, 21 March 2011, 26–32.