Caterpillar in Emerging Markets - Essay Example

Running Head: assignment Caterpillar of the of the of the Introduction Caterpillar Inc is world’s leading manufacturer of mining and construction instruments, industrial gas turbines, and diesel and natural gas engines (Caterpillar Inc, 2010). It was ranked number one company in its industry and number 44 worldwide in 2009 edition of Fortune 500. The company is based out of Peoria, Illinois. James W Owens is the CEO and the chairman of Caterpillar. Apart from manufacturing, Caterpillar also designs, markets and sells the instruments and the engines. In addition, it also arranges for financing, training, and maintenance. Caterpillar’s income for Financial Year 2009 was US $895 million and the total assets of the company were worth $61 billion. Caterpillar employs more than 90,000 people worldwide. This report will look at the variations in Caterpillar’s performance in the last decade and explain the reasons for them. It will also recommend strategic moves which can improve Caterpillar’s performance over the next decade. History of Caterpillar (1925 – 2000) The predecessor of Caterpillar was the Holt Caterpillar company which was established by Benjamin Holt in 1909. Caterpillar was formed in 1925 when market leader Holt Caterpillar merged with C L Best Gas Tractor Company. The merged entity consolidated its product lines, shifted from gasoline engines to diesel engines, and continued to grow at an even pace even during the Great Depression. During the Second World War, Caterpillar’s products were widely used by the construction units of the United States Navy in the Pacific theatre of war for construction of airfields and other facilities. After the end of the war, the company grew rapidly on the back of the construction boom. Caterpillar used acquisition as a major vehicle for growth from 1950 onwards. Its first major acquisition was Trackson, based in Milwaukee. Over the year, it has acquired companies throughout the globe in order to drive up its sales. During the 1980s, the company was threatened by a decrease in demand because of heightened competition with its Japanese rival Komatsu. Moreover, US embargo against USSR also harmed the company because the company was all set to sell equipments worth millions of dollars to the USSR. The results of these losses were lay-offs and labour union issues subsequently. Caterpillar, in response to strike called by its unionized workforce, farmed out much of its production and warehousing to outside firms. It also started shifting its facilities to Southern states where labour laws were more favourable for non unionized workers. Caterpillar’s Performance during the Last Decade In the late 1990s, Caterpillar was hurt by the Asian crisis. It had to close down Caterpillar Shanghai Engine, a joint venture with the Chinese government owned Shanghai Diesel. In 2000, it received loans worth $29 million from an arm of World Bank to save a loss making unit in China (Tait, 2000). Low commodity prices existing in mining, agriculture, oil and gas, lead to a lower demand of Caterpillar’s equipments. The sales were also depressed by price competition from its rivals. While the Asia Pacific market recovered after the Asian crisis, the North American market became sluggish as dealers began cutting inventory. On the back of low borrowing rates, European and American markets for heavy construction equipments rebounded because of a surge in construction activities. Caterpillar, along with its competitors, also gained from this. (Marsh, 2000) In 2000, Caterpillar posted a strong performance on the basis of the unexpectedly high volume of sale of its engines. Although, the sale of its machinery was not as strong as expected, and the earnings were also reduced due to foreign exchange fluctuations, the company managed to remain in black because of its leaner operations. Caterpillar has also made the strategic move to diversify in to different geographical areas and had also expanded its product catalogue. This also helped the company remain profitable unlike in past when the company became unprofitable during recessions (Funding Universe, 2005). In 2001, Caterpillar decided to exit the agriculture equipment business. Although Caterpillar has started out as agriculture equipment manufacturer, getting out of this business was important because it was contributing only 4% to the company’s revenues. It sold its tractor line to AGCO Corporation in late 2001. The earnings fell down by 12% on the back of stagnant sales and increasing costs. The company responded by committing to cut down its expenses by $1 billion in the next three years. It also sought to further diversify its operations to increase the revenues. 2002 was the one of the worst year for Caterpillar. Its earnings to shareholders came down to just $798 millions, amounting to a profit margin of just 4%. The sales figures also fell to $20.15 billion from $20.42 billion last year. In 2003, Caterpillar rebounded strongly by generating revenues worth $22.76 billion which was a 12.9% increase from what it had sold last year. Correspondingly, the profit figures also rose to $1.1 billion. This strong performance resulted from improved macroeconomic conditions. The commodity prices were on the rise, prompting investment in mining, gas, and oil. In February 2003, the company entered in to a five year contract with mining company BHP Billiton to supply about $1.5 billion worth of mining machinery and other equipments. Also, the decision to diversify geographically was reaping benefits as the economy of China and ASEAN nations picked up momentum. During the next five years, Caterpillar enjoyed an unprecedented growth. It also started earning most of its revenue from outside North America. The continued investment in infrastructure in China meant that Caterpillar’s equipments had a ready buyer present. In China, the company concentrated on the sophisticated end of the market building engines with highest fuel efficiency and conforming to the latest environment norms, thus avoiding the crowded mid tier and low end market (Financial Times, 2005). Also, as the other emerging markets started concentrating on their infrastructure, Caterpillar was sure of continuing this growth. From 2003 to 2008, Caterpillar maintained a compounded annual growth rate (CAGR) of 24% in its Earnings per Share (EPS) which was quite phenomenal (Caterpillar Inc, 2008). Caterpillar took the tactical decision to outsource some of its work to expensive contractors rather than build capacity. This decision was taken so that the company could be profitable in the trough as well. In 2005, CEO Jim Owens said, “We would rather shave earnings off the peak to have better earnings in the trough.” It was punished by the markets for is cautiousness but the decision proved to be a wise one when the downturn came. Also, it tried to reduce its inventory and shift to build-to-order model it follows in case of larger engines and mining equipments (Financial Times, 2005). During the recession, initially, the company was unaffected because the decrease in income from the North American market was more than compensated by the increase in income from Asia Pacific and Latin American markets. But, as the recession set in, the company suffered a setback in all the markets. The North American market was badly hit and the sales figure fell by around 40% in 2009. As the construction activities virtually stopped, the machinery business was the worst affected as sales fell from $31 billion in 2008 to $18 billion in 2009 (Caterpillar Inc, 2009). Analysis of the Ratios Figure 1 - Comparison of Caterpillars and Komatsus Debt ratios A quick comparison of Komatsu and Caterpillar’s debt ratio (Fig 1) shows that Caterpillar is mostly financed by debt. Generally, in cyclical industries like manufacturing, the debt equity ratio is low. But caterpillar defied the trend and financed itself with debt. This was because of its focus on diversification during the boom period of 2003 – 2007. Similarly, the interest coverage ratio (Fig 2) of Caterpillar is very low as compared to Komatsu, although it is much more stable. Barring 2009, Caterpillar was able to raise its operating income much faster than the interest it had to pay. Figure 2 - Comparison of Interest Coverage of Caterpillar and Komatsu Despite all the talk of cutting down on inventory, Caterpillar was not able to make much of a difference as its inventory turnover (Fig 3) shows. Its inventory turnover ratios are lower than the industry average. Especially in a year like 2009, Caterpillar was badly affected by inventory pile up. This means that the company has still not been able to move to the build-to-order model which it was trying to reach. Figure 3 - Comparison of Inventory Turnover of Caterpillar and Komatsu Figure 4 - Comparison of ROA of Caterpillar and Komatsu Figure 5 - Comparison of Quick Ratios of Caterpillar and Komatsu The comparison of the quick ratio (Fig 4) gives an interesting observation. Despite operating with a heavy leverage, Caterpillar has been able to maintain a decent quick ration which implies that the reserves of cash it holds has increased at the same rate as its short term liabilities. The company has also not let its receivables go out of hand. The Road Ahead for Caterpillar This section would deal with the issues which are pertinent to Caterpillar’s success and provide recommendations which can lead the company to growth in the today’s volatile business scenario. Caterpillar’s industry is very much dependent on the macroeconomic realities of the world. The effect of the ongoing recession on Caterpillar’s top line is there to see. The only way Caterpillar can defend itself in this global battlefield is by hedging its bets by spreading out geographically. Already, nearly 60% of its revenues come from outside North America. It should try to reduce its dependence on the developed economies of the west even further and target the growing markets. It has a strong presence in China but is not a major player in India. With the Indian government planning to do a major infrastructural overhaul, Caterpillar cannot afford to miss this golden opportunity to claim a major market share in one of the fastest growing economies of the world. The solution is to not loom at the emerging economies as just an outsourcing centre but to cultivate them as a market as well. Caterpillar should also look towards customization of its products to suit the local markets. Currently, it makes the same product regardless of the country it is selling it in. In this age of ‘Think Global, Act Local’, Caterpillar has to be able to adapt its products according to the tastes of consumers in foreign countries. To become a truly multinational corporation, Caterpillar should also look to change its management structure to foster cross national learning. The best way to do this would be by giving the junior management cadre a global experience. The real challenge is to become an organization where units from each nation have the same level of commitment towards the success of the firm (Kidger, 2002). This can only be achieved by decentralizing and giving away as much decision making authority as possible. If Porter’s five force analysis is done on Caterpillar, it is seen that the most important force with respect to Caterpillar is the force of competitive rivalry. Because of its vast dealer network and the fact that it supplies engines also, Caterpillar has a locked in market. Therefore, buyer’s power is not the biggest issue in front of Caterpillar. Also, since Caterpillar is a major buyer of resources from its suppliers, it cannot easily be threatened by supplier power. The earth moving equipment industry requires huge amounts of investments. Therefore, it is not easy for a new player to get into this industry or for an existing player to get out of this industry on a short notice. Thus, the industry has situation which is conducive for the dominance of a few big firms – oligopoly. Since, the entry and exit of players is not easy, this force is also insignificant for Caterpillar. On the other hand, threat of substitute products is a credible threat. Caterpillar generally caters to the upper tier segment and in times of recession, these buyers may be tempted by a low priced variant introduced by the competitor. To guard against this threat, Caterpillar should be thinking about how it plans to retain the customers it already has. One way of doing this would be to provide more services than the competitor. As an example, Caterpillar can provide consulting services to its clients in the earth moving sector. This way, it can leverage its experience of more than 80 years. Low cost producers would find it difficult to match these services. Another area where Caterpillar should be looking closely at is its high debt ratio. In an industry which is really cyclical in nature, having a high debt ratio is always dangerous. But Caterpillar decided it would take the risk of having high leverage in order to fund its diversification. Caterpillar should try to reduce the debt levels by constantly checking on its businesses and selling off those businesses which are not doing well. This way it would constantly be on guard against complacency setting in and it would also lower its debt level by using the cash gained by selling the ailing businesses to pay back its loans. For example, it took a brave and correct decision to sell off its agricultural equipment business to AGCO Inc. In order to grow, it should follow its current strategy of acquiring companies which are of strategic use to it. It would not be possible for Caterpillar to maintain the growth it had in last few years (except 2009) organically. It will have to look to acquire key resources in geographical areas or business areas where it wants to expand. As a final recommendation, Caterpillar should try to move up in the value chain all the time. Applying Haberberg and Reiple’s VIRUS criteria to check the competence of Caterpillar, we can see that the true core competence of Caterpillar is their ability to use their 80 years of experience in the industry. They should nurture this competence and try to develop other competences. Care must be taken to develop other competencies as well so that Caterpillar does not remain dependent on only one competency. Conclusion Caterpillar has seen a lot of ups and downs. But, the last few years have especially been tumultuous for the company. This report starts with a brief history of Caterpillar and then concentrates on the last decade. The main problem of Caterpillar was its overdependence on debt and expanding too rapidly during the boom period. Although the management tried to put a brake on the speed at which the firm was expanding, they failed. This lead to a huge fall in the earnings as the recession spread to all parts of the world. To guard against this happening again, Caterpillar should try to expand geographically. It should also move into businesses which are counter cyclical which would help Caterpillar in softening the blow it would receive from the next recession. To succeed globally, Caterpillar should become a truly global company. It can do so by decentralizing its management structure. References Caterpillar Inc, 2008. Caterpillar in Emerging Markets. [Online] Available at: HYPERLINK "http://www.slideshare.net/finance5/caterpillar-clsa-asia-investors-forum" http://www.slideshare.net/finance5/caterpillar-clsa-asia-investors-forum [Accessed 04 May 2010]. Caterpillar Inc, 2009. Caterpillar 2009 in review. [Online] Available at: HYPERLINK "http://producttour.cat.com/Microsites/US/ARSR2009/AR2009/sales-profit.html" http://producttour.cat.com/Microsites/US/ARSR2009/AR2009/sales-profit.html [Accessed 6 May 2010]. 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Management Structure in Multinational Enterprises. Employee Relations, 24(1), pp.69-85. Marsh, P., 2000. Buoyant European economy lifts sales of construction machines. [Online] Available at: HYPERLINK "http://global.factiva.com/ha/default.aspx" http://global.factiva.com/ha/default.aspx [Accessed 5 May 2010]. Tait, N., 2000. IFC joins backers of Sino-US joint venture. [Online] Financial Times Available at: HYPERLINK "http://global.factiva.com/ha/default.aspx" http://global.factiva.com/ha/default.aspx [Accessed 6 May 2010]. Read More