"Like many American manufacturers, Cat operated in an ideal environment for decades. Cat commanded a significant price premium as demand exceeded supply. There was little foreign competition and Cat's product and service superiority were well recognised" (Howell, 1992, p. 164)
Caterpillar was founded in 1925, in Peoria, Illinois, which remains the base for much of today's production. Their ideal environment stemmed from demand created during World War II, when large parts of Europe and Asia needed rebuilding. This paved the way for healthy growth and profitability right through to the early 1980s. Caterpillar's main form of competition came from the Japanese earth moving equipment (EME) manufacturer, Komatsu, who held an estimated 60% of the Japanese EME market, and were the second largest manufacturer in the world (Tharp, 1980).
The first half of this essay will focus almost exclusively on how and why Caterpillar's trajectory changed, with the factors investigated being Caterpillar's international deployment, overexpansion, slower economic growth, and labour costs. The essay will then move to argue the impact of Komatsu as a source of foreign competition, and discuss the power of their low wages against Caterpillar's incumbent advantage and core competencies, while making reference to the role played by exchange rates.
In 1982, 57% of Caterpillar's sales were made abroad while 82% of sales were manufactured in the U.S. Expansion abroad could certainly be justified by such a high level of foreign sales, instead Caterpillar created jobs domestically, and were it not for such a great imbalance between manufacturing and sales their 1980s recovery would have been easier (Gardner, Caterpillar Tractor - Prospects, 1983). Caterpillar was an extreme case of a company depending on its ability to export, and came second only to Boeing - by the early 1990s Caterpillar accounted for 1% of total U.S exports.
Donald Fites described Caterpillar as a 'global company from a U.S base', with 75% of employees and 70% of production residing in the U.S (Wall Street Journal, 1992). The proportion of Caterpillar's output made abroad did not change until the crisis of the 1980s when such heavy reliance on U.S production was called into question.
Figure 1 (adapted from Froud, Williams, Haslam, Johal, & Williams, 1998) shows the location of Caterpillar employees; what stands out the most, is despite the clear cuts that were made to staff in the 1979-1995 period, the company configuration remains the same with 75% of employment in America. This displays a commitment to U.S employment, as was noted at the time, 'Caterpillar has chosen to compete internationally from primarily a U.S manufacturing base, thereby maintaining high quality US production jobs' (Flaherty, 1993). U.S manufacturing, however, does decline by 12% between 1983 and 1992.
Over Expansion and Slower Economic Growth
"Managements accustomed to successful expansion do not look much at the possibility of contraction. Those who neglect adverse exposures, however, invite catastrophe" (Eckley, 1989).
As figure 2 (Thomson Research, Various) shows, Caterpillar saw negative earnings in 1982 for the first time in 50 years, and this trend continued for eleven quarters with one single exception. The record $578,900 profit of 1981 vanished and was replaced by losses that over the course of three years would accumulate to nearly $1 billion.
Worldwide sales of construction machinery had plunged. Such a change in global demand could have been foreseen with the end of the long-boom in the 1970s and the following decline of western manufacturing activities. Three factors, however, as identified by Eckley (1989), masked the ensuing troubles until the early 1980s. Firstly the oil crisis brought huge earnings to oil producing nations, enabling them to acquire large quantities of equipment. Secondly, the value of the dollar depreciated during the 1970s, making American exports attractive. Finally the external debt of less-developed countries grew rapidly, resulting in large purchases of capital goods.
Figure 3 (Thomson Research, Various) highlights the slowing of economic activity, as growth began to decline in 1981 and fell sharply in 1982; the depressed worldwide capital goods industry saw a further fall in sales for Caterpillar. The first quarter 1983 sales were 34% below the year-ago period (Gardner, Caterpillar Tractor Company Report, 1983). Eckley's earlier quote is fitting to the situation faced; countless years of expansion quickly followed by stagnation. Leading up to 1982 Caterpillar had been increasing plant capacity by 5% annually at a cost of $750 million, despite sales peaking in 1978 (Froud, Williams, Haslam, Johal, & Williams, 1998). Coupled with the need for less than 50% of current capacity, overexpansion was unmistakeable, and Caterpillar's management had failed to recognize the severity of the market downturn.
The initial response of Caterpillar management to the falling trajectory was to cut costs by 22% through traditional means, such as plant closing and research and development cutbacks (Howell, 1992, p. 168). The strength possessed by the United Auto Workers (UAW) Union led to spiralling wage and compensation premiums not seen by foreign competitors.
In 1982, Caterpillar claimed its wage and benefit package was 90% higher than that of its Japanese competitor, Komatsu (Eckley, 1989). Caterpillar tried to reduce this inequality through union bargaining and was willing to withstand a strike because management correctly insisted that the company would be severely strained in its efforts to compete with its Japanese competitor (Gardner, Caterpillar Tractor - Prospects, 1983). The resulting 205 day strike was the longest in UAW history. Although Caterpillar backed down on key issues, the company secured a 3-year wage freeze.
As identified by Froud (1998) a generalisation in a western manufacturing firm is for the labour share of value added (LSVA) to be held at, or below 70% for the firm to meet internal and external requirements. For an extent of 1983, Caterpillar was operating at less than 20% of capacity, due to the economic slowdown, strikes and over expansion. Add to this the escalating labour costs and the company's reliance on American production, and Caterpillar's LSVA soared throughout the 1980s. This trend only returns towards the 70% mark following the implementation of Plant with a Future (PWAF) in 1984, when LSVA drops from an unprecedented high of 97% down to 76%, as figure 4 (Froud, Williams, Haslam, Johal, & Williams, 1998) shows.
PWAF was the second round of cost reduction measures, and was influenced by the success of Komatsu, who were capitalising on the American company's misfortunes and competing on a cost basis. As Caterpillar recognised, Komatsu was the new competitive threat, and their employees were doing the same job but at less cost (Miller & O'Leary, 1994), between 1978 and 1985 unit labour costs in U.S manufacturing rose 39% relative to Japan (Eckley, 1989). PWAF was implemented at 88 plants, and involved the introduction of flexible manufacturing systems, automated materials handling, global sourcing to achieve lowest costs, manufacturing space consolidation to promote efficiency, and a Just-In-Time inventory system. Further to this employment was cut by nearly 40%, along with ten plant closures, with all but two in the U.S.
Foreign Competition and Exchange Rate
It can be seen that Caterpillar relied too heavily on its U.S production base, and many years of success and growth were readily consolidated with little regard shown to the possibility of economic slowdown. When the worst post war recession hit the U.S in 1981, Caterpillar was already entering a period of great transition as effects masking the end of the long-boom began to erode. This led to costs far greater than those experienced by its closest rival Komatsu, and the need for urgent action by management. PWAF was obviously the clearest example of Caterpillar's attempts to reconcile costs, and the promised $2.2 billion capital expenditure for its implementation brought about improved sales and profitability from the start (Froud, Williams, Haslam, Johal, & Williams, 1998). Overexpansion and soaring labour costs for a company built on a US base, however, were not the only reasons why Caterpillar's trajectory changed. The cost leadership of Komatsu and an appreciating dollar to the Yen also had a major impact on Caterpillar's trajectory in the 1980s.
Komatsu set itself the target of catching and surpassing Caterpillar and their competitive advantage stemmed from their careful cost control and ever-improving product lines. When the market deteriorated in the early 1980s Komatsu seized the opportunity to penetrate the American market, as Caterpillar's sales and growth fell. Figure 5 (Thomson Research, Various) demonstrates Komastu's continued profitability in a highly unfavourable economy, whilst Caterpillar recorded losses of over $3 billion in real terms.
Komatsu competed on a purely cost basis, as they never had a productive advantage at company level. Caterpillar had raised prices 10% annually from 1973-1982, which opened an opportunity for Komatsu to penetrate the U.S market with prices 30-40% lower than Caterpillar (Howell, 1992). These great disparities in price were emphasized further by the depreciation of the Yen from 1980-1985, making Caterpillar's products comparatively more expensive at home and abroad.
The Yen-Dollar relationship is identifiable as the catalyst for the changing advantage between the two manufacturers. Komatsu's threat depended largely on a favourable exchange rate between the Yen and Dollar in the early 1980s, and when the Yen appreciated post 1985, Komastu's low labour costs vanished and so did the company's competitive advantage, as figure 6 (adapted from Leaver, 2009) exhibits. When Caterpillar's total $7.1 billion expenditure on PWAF is considered over seven years, its implementation appears to coincide with an improving trajectory. The dollar, however, climbed 30% against the Yen from early 1989, making Japanese goods cheaper in the U.S and in third-country markets, thereby reinstating Komatsu's a substantial competitive advantage. This alone meant 'the difference in exchange rates has slashed Komatsu's costs by a greater percentage than the reductions Cat anticipates from its entire modernization programme' (Rose, 1990). This fact further supports the idea that exchange rates were influential to Komatsu's competitive advantage, and also bear major impact on Caterpillar's recovery. Exchange rate variations had a profound effect on Komatsu's challenge to Caterpillar, and blemish the case for their cost reducing production in factories.
With the impact of the exchange rates Caterpillar commenced price competition in 1983, and by 1985 had reduced prices by 8%. This action was clearly necessary to avoid further erosion of market share. The competition between the two companies was extremely intense; one slogan at Komatsu was 'maru C' or, 'encircle Cat' (Stalk & Abegglen, 1985). Between 1983 and 1987, as figure 7 (Froud, Williams, Haslam, Johal, & Williams, 1998) shows, Komastu achieved its declared aims of increasing market share. As Froud (1998) identifies, Komatsu is the only serious, global, broad line competitor to Caterpillar, and launched its challenge having built a volume base and market share on its protected Japanese home market. A steady share of 7% in the U.S market in the early 1980s rose to a peak of 22% in 1987, before falling away into the teens.
Caterpillar's Core Competences
Komatsu's challenge mounted many problems for Caterpillar, but as discussed, the greatest problem faced was exchange rate fluctuations, which delivered Komatsu their low wages and cost advantage, and in four years saw Caterpillar move from price leader to price follower.
Caterpillar's core competence, which offered a competitive advantage through the turbulence of the 1980s, was their dealership networks. They offered access to global markets, and significantly contributed to perceived customer satisfaction, most importantly though, they could not be imitated by Komatsu (Hamel & Prahalad, 1994). This competence was capitalized on by Caterpillar, and a decision was undertaken to augment the products with the services customers deemed most important. For Caterpillar, the dealerships enhanced their competitiveness as a manufacturer, and sustained their success in the face of Komatsu's entry to the U.S market (Cavusgil, 1990).
Caterpillar's strong dealer network provided a major barrier to entry, and offered accurate analysis of local market conditions, from which it could shift its attention between changing market segments. Caterpillar's incumbency led to a large and well entrenched dealer network, with 96 dealerships located in the US and 132 overseas as of 1990. Meanwhile, Komatsu's weakest link was its dealer network. Whilst the company could claim superiority in design and technology it could not compete on the same level as Caterpillar's global networks.
As Cavusgil (1990) concludes, Caterpillar's incumbency gave it the largest market share in both the US and worldwide markets, but its competitive advantage lay with its highly competent dealership organization within the industry.
Caterpillar was very much structured in the new economy model, with up market, knowledge intensive products that relied on a loose network of specialists. Resource Based Theory (RBT) can be applied to Caterpillar at this time, as it is evident they identified their key resources and capabilities and adapted a strategy to breed further competitive advantage. To maximise this resource Caterpillar initiated the Sales Team Development System (STDS), and in its 12 month pilot period participating dealers increased their net revenues by 102% (Cavusgil, 1990).
This essay has looked to pin point how and why Caterpillar's trajectory changed, and to investigate the impact of Komatsu's low wages against the core competences and incumbent advantage possessed by Caterpillar.
During the 1980s Caterpillar's trajectory varied greatly, but no year saw such a great change in trajectory as 1982. The troubles experienced by the company through the 1980s opened the way for increased foreign competition, most notably from the Japanese capital goods manufacturer Komatsu.
Firstly Caterpillar's lack of international deployment and commitment to an American production base was identified as a source of trouble. At a time when Caterpillar was looking to maintain 75% American employment, Komatsu was moving its production processes to Indonesia and other less-developed countries, along with many American manufacturing giants (Rose, 1990). When combined with the depreciated Yen, Caterpillar's reliance on American exportation was highly questionable, and led to the company's termination of price leadership.
Further problems arose from a lack of management awareness with regard to a slowing world economy, and more specifically, a maturing capital goods market, as worldwide sales of construction machinery plunged to an unprecedented level. Until that point, Caterpillar had continued with rapid expansion at an annual cost of $750 million, with market warnings of the 1970s left unnoticed. This overexpansion added further to the cost burden that Caterpillar was about to face as Komatsu made its surge on the US market.
Komatsu's labour costs averaged 38% lower than Caterpillars from 1980-1986, and managements initial response was to cut costs by 22%. Caterpillar withstood a 205 day strike when bargaining with the UAW in a bid to reduce the cost inequalities between themselves and their Japanese counterparts. The implementation of PWAF saw employment cuts of 40% and the closure of ten plants through the 1980s, in a bid to reduce to production time, costs, and space.
Most damaging to Caterpillar's trajectory in the 1980s were the Yen-Dollar exchange rates. Where Caterpillar accumulated real losses of $3 billion, Komatsu was profitable to the tune of $1.5 billion for the same period. The 1980-1987 period, saw Komatsu's US market share rise from 7% to a high of 22%. The capture of US market share was driven by prices up to 40% lower than those set by Caterpillar. This was a result of Komatsu's apparent low wages and resulting low prices fuelled by the favourable exchange rates.
Caterpillar realised they could not compete on design and technology, and instead focused on their dealer networks, which Komatsu simply could not imitate. This demonstrated the powerful position that the incumbent had created through years of successful expansion and was a key factor in Caterpillar's sustained success. Even with low wages, and cost reducing production, Komatsu's threat to Caterpillar was short lived, as the company could not compete on reputation or service. By 1992, with a U.S market share of 17% Komatsu renounced its mission of catching up to, and surpassing Caterpillar.
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