Caterpillar – Economic Evaluation

January 10, 2012

Caterpillar – An Economic Analysis
Caterpillar Inc. (formerly Caterpillar Tractor Company) is a leading manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. Currently, the world headquarters is in Peoria, Illinois. The average number of employees for the last five years is over 100,000. In 2011 sales were 57 billion, 70 percent of which were sales outside of the United States. There is a vast array of product groups and industries served which include, but are not limited to, power systems, construction industries, and financial products. Stock is currently valued at $92.47 per share. While they are an extremely well ran, profitable company, they also strive to be seen as a socially responsible organization as well. Support of the United Way exceeded $10.6 million in 2011 in contributions from the corporation as well as from the employees. In addition, they have made over $50 million in philanthropic investments worldwide.
Caterpillar Inc. – Supply

Caterpillar Incorporated (CAT) has a distinct advantage as a large company as its supply of products is in high demand around the world. According to their home page on their website (2012),
“For more than 85 years Caterpillar Inc. has been making sustainable progress possible and driving positive change on every continent. With 2011 sales and revenues of $60.138 billion, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. The company also is a leading services provider through Caterpillar Financial Services, Caterpillar Remanufacturing Services, Caterpillar Logistics Services, and Progress Rail Services”.

The organization has strategically developed their company to be highly competitive, customer-focused, and well balanced providing not only industrial products, but logistic and financial services to its multi-national customers.
Although CAT is renowned for their industrial equipment manufacturing in the U.S., the economic downturn had a significant effect on their sales. The resulting decline in the new housing market and infrastructure development hit the company hard. Having a strong portfolio of product lines and services, CAT focused their business initiatives in the international market, particularly in China, Canada, and Africa where infrastructure development was growing. They built strong business relationships in the global market and were able to successfully supply their products and services in areas of development. Again noted in the 4-trader article, CAT successfully secured a business contract where they would supply SJ Petroleum Machinery Company in Beijing, China, the engine and transmission package. The SJ Petroleum Company is one of China’s largest manufacturers of petroleum drilling and production equipment. This contract signifies the successful efforts CAT has in supplying its products in the global market.
Caterpillar Inc. – Product Demand
With relatively few competitors, CAT has become an oligopoly with significant market power. It utilizes its well-developed business strength as a large multi-national corporation to pursue business interests in the foreign market. Using a highly evolved business initiative of 85 years, CAT pursues business opportunities in countries such as Africa, Mexico, China, and India, where there is an emerging growth trend in infrastructure development. What is important in their pursuit is their ability to create high demand for their products in areas where development is emerging but there is a significant lack of equipment to accomplish the projects. According to the wikinvest article, Caterpillar (CAT) (2012),
“From an economic perspective, machinery has a higher marginal utility in places where it is underutilized. If a town has no tractors, 1 more tractor is far more significant than it would be for a town that already has 80 tractors. Thus, Caterpillar equipment will drive more value in developing markets. Look out for the stability of these markets, as their continued development bodes well for Caterpillar's business. Of course, political change, terrorism, and corruption are also risks worth following because they are associated with the governments of most developing countries.”
For obvious demand reasons, CAT has become very competitive and highly successful in supplying their product lines in the global market, as well as seeking out areas with high demand.
Elasticity
The law of demand says that when the price of a product goes down, the demand for that product goes up. The concept of elasticity is to measure how much demand responds to a change in its determinants. The determinants could include the price of the product, number of consumers, income, future expectations about prices, consumer tastes and preferences, as well as prices of related goods. When there is more competition in a market, it is easy for customers to substitute another product, if the price of the product they are currently buying increases. Caterpillar is the world’s leading manufacturer of construction and mining equipment. There are few competitors in this market that can compare with Caterpillar. Therefore, the availability of substitute goods is low. What this means is that Caterpillar can increase prices without worrying about losing sales. If the price is increased, and the demand goes down slightly, the total revenue will still increase. This makes the demand for Caterpillar’s products more inelastic.
Caterpillar’s principal competitor is Komatsu Ltd. of Japan. At one time, Komatsu held 60% of the market share within Japan. However, Caterpillar formed a joint venture with another competitor, Mitsubishi, and penetrated the Japanese market. They are now the number two manufacturer of construction and mining equipment in Japan. Komatsu realized that to compete with Caterpillar, they had to explore into other markets in various countries. Caterpillar still had an advantage because of their strong global dealer relationships, which Komatsu lacked (Jao, 2002).
Caterpillar, Inc – A Near Oligopoly

Most companies thought to be oligopolies or near oligopolies are usually in the gasoline, beer, cigarette or similar industries. Many economists, however, have said that Caterpillar is very near an oligopoly. An oligopoly by definition is an economic condition in which there are so few independent suppliers of a particular product that competitive pricing does not take place. In many countries this is the case with Caterpillar. In some markets in the countries they produce and sell to, there is little or no competition; therefore their pricing structure does not need to have much flexibility. In countries where there is more competition, Caterpillar is aggressively setting up service centers and remanufactured supply centers to be able to better service the customers after the sale. This is a very strategic move that puts Caterpillar back in the forefront of vendors in most global markets.

Or is it a near Monopoly? Caterpillar has made some great strategic and economic moves to make themselves the leader of the industry, especially in large mining equipment. At a time when many large corporations have gotten out of the banking industry, Caterpillar is forging into this territory at tremendous speed and is a force to be dealt with in many ways. They sell the product, for example, a large earth moving machine. Caterpillar also finances that machine by the lending arm of the company called Cat Financial. Then you have the service after the sale with genuine Cat parts. When the equipment is used for a very stressful application Caterpillar also offers remanufactured engines and other parts. They essentially have the customer after the sale for the duration of the life of the equipment. While there is still some competition at this time, no other business within the industry has the ability to offer all these services during and after the sale.
Production
In order to understand the logistical mindset Caterpillar maintains, we must first comprehend the way they handle their production function. In layman’s terms, a production function is based on the relationship between the flow of inputs and the resulting flow of outputs in the production process. This is primarily focused around the physical relationship between their production process and the opportunities they find to make it more efficient. Now that we have grasped the underlying factors of the production function, we can see how Caterpillar distinguishes the differences in their fixed and variable inputs of production.
Just as the name suggests, a fixed input is something Caterpillar cannot change during the production process. For example, this could include all of their production facilities and the equipment used in assembling their engines. On the other hand, their variable inputs are something they can control to adjust the number of outputs. A few examples of variable inputs: number of workers, hours worked, materials used, and other variable factors that could be implemented in a short time period. With this being said, every production function can be labeled as either short-run or long-run. To distinguish the difference a short-run production function has at least one fixed input where as a long-run production function is comprised of all variable inputs.
Production Changes across the Industry

Within any industry there will be opportunities for growth, and the companies that seize them will be the ones with the most prevalent long-term success. “Caterpillar has long been in love with the kind of growth prospects that emerging markets provide the company” (2011). In a no-nonsense approach, Caterpillar simply goes where the growth is and this approach hasn’t failed them yet. Caterpillar’s Emerging Market Strategy has taken them into countries such as
China and India. In these countries they lead the forefront in supplying the market with machines for road construction and infrastructure –development projects. Emerging market growth is critical for established companies such as Caterpillar and they recognize and position the company accordingly. They invest strategically in countries with trends of infrastructure growth and they find ways to meet those industry specific needs. With changes in the market, various decisions have to be made which alters a company’s direction. Every decision has a cost and for Caterpillar this couldn’t be any truer. As previously mentioned, with all growth comes some inherit cost to a company and for Caterpillar these decisions usually are in the realm of hundreds of millions of dollars. In any business setting, you must evaluate your company’s opportunity cost and see if your decisions are paying dividend. If you invest money into building up your business in less developed countries then you are keeping revenue from maintaining your current operations. Caterpillar keeps track of their cost and splits them into two categories: explicit and implicit. Explicit costs are usually found in a company’s bookkeeping or financial records whereas implicit costs are harder to track. The importance of evaluating your company’s opportunity cost comes with great challenge as you can never predict the future. This is where companies separate themselves from their competition as only the top companies successfully position themselves for success. The real key is turning implicit cost into explicit cost where your company can show it is making money. Caterpillar invests a lot of their income in setting up fixed variables where there is no guarantee in making the necessary revenues in return. It’s only upon long-term sustainability that Caterpillar capitalizes on their investments.
Economic Highs and Lows Like many large scale companies, Caterpillar is intelligently investing in a philanthropic way. Fifty million dollars has been invested worldwide with one focus of clean water in countries where that is an issue. Another 10.6 million has been given to the United Way globally. This is a way to build good will with other countries and in turn increases the bottom line more than is being paid out in charitable giving. But while any company would like to focus only on the good that they do, not all moves that Caterpillar are currently making are seen as good. This month in Canada a brutal battle is underway with the union in a Canadian facility. Caterpillar is attempting to cut wages by fifty percent, making the income of a general factory worker only $24,000.00 annually. Furthermore, to make matters even worse for the Canadian workers, Caterpillar is threatening to move the production from this location to Muncie, Indiana where the company cites there are workers ready willing and able, even desperate to work. Many decisions made by large corporations are not going to please all people and all organizations working with them all of the time. At the end of the day Caterpillar’s success is built on very good business decisions derived by a team of leaders that include multiple economists, financial analysts, and world class business leaders.
Conclusion
Caterpillar is a very forward thinking organization and has a strategic plan in place that specifically lists goals and objectives through at least the year 2020. They have the resources, both financial and in manpower, to continue to make the best economical decisions to continue to be a world leader in their industry. Caterpillar’s claim is that they will provide the customer with what they need so that the customers can provide what the world needs. As forward thinkers in the industrial machinery marketplace, Caterpillar demonstrates an ability to remain successful by ensuring their products meet the needs of their customers, as well as other business functions to support their extended needs. This ability ensures Caterpillar Inc. will be a withstanding organization in lean times as well as in fortuitous times.

References

Caterpillar (CAT). (2012) Wikinvest. Retrieved from http://www.wikinvest.com/stock/Caterpillar_ Caterpillar Inc.: Caterpillar Selected to Supply Engine and Transmission Package for New
Fracturing Truck. (2012) 4-traders. Retrieved from http://www.4-traders.com/CATERPILLAR-INC-4817/news/Caterpillar-Inc-Caterpillar-Selected-to-Supply-Engine-and-Transmission-Package-for-New-Fracturing-14227911/
Staying Ahead. (2012) European Supply Chain Management (ESCM). Retrieved from http://www.europeansupplychainmanagement.co.uk/article- page.php?contentid=6919&issueid=228
Jao, Angelina. Caterpillar vs. Komatsu: Four decades of global competition. (2002). Retrieved from: http://angelinajao.wordpress.com/2002/10/29/caterpillar-vs-komatsu-four-decades-of-global-competition/