To what extent was market maturity the cause of Caterpillar’s restructuring? Critically examine the extent the new strategy transformed market, productive and financial performance.

The aim of this paper is to assess the extent to which market maturity influenced the restructuring phase that Caterpillar underwent after it was nearly put out of business in the 1980s. It will be argued that surely market maturity played a central role in the company’s restructuring, as the increase of competition and the need for product innovation brought up the need to develop an effective action plan. However, it was also the over-managed organization of the company itself that contributed to this degenerating stage and that therefore drove the restructuring process. Indeed it will be argued that because Caterpillar had enjoyed reliable profits, internal organizational issues had been ignored and the lack of information about the external environment decreased, causing Caterpillar to grew out of touch with the realities of the market. Therefore as the global recession grew along with the runaway inflation that kicked in in the 1980s, Caterpillar’s flawed structure was not able to successfully respond to the external environment and the company became an easy target for competitors. This argument will be developed throughout this essay according to the following structure: initially the implications of market maturity for Caterpillar will be assessed within the framework of the Product Life Cycle (PLC) theory; secondly the limits of Caterpillar’s original structure will be discussed in order to gain an insight into the internal problems that undermined the company’s opportunities; thirdly the restructuring process will be taken into consideration in order to assess how the company’s performance improved in terms of market, production, finance, and efficiency. Finally the conclusion will be drawn that both internal and external factors play a central role in a company’s restructuring process. It is indeed because of this two-fold dependence that a company’s long-term profitability cannot be ensured simply through a successful reorganization.

In order to successfully assess the role-played by market conditions in the interruption of the long-standing record of profitability and market leadership that Caterpillar enjoyed until 1982, it is firstly necessary to analyse the Product Life Cycle (PLC) theory and conceptualize the maturity stage that the markets undergo.
There are several variants of the PLC theory. As figure 1 shows, the predominant version argues that throughout time all new products follow a S-shaped curve and they pass through four stages of sales growth. During the first stage, namely introduction, the product’s novelty will result in low sales volume and slow growth pace; in this stage the curve will remain relatively flat. If the product is successful in the market, the stage of growth will follow; as market penetration accelerates and the product is recognized among a broader range of customers, the sales curve slopes upward. As the market saturates, the product market commences a maturity stage. In this stage the sales curve tends to flatten, as the revenue is mainly a result of sales to existing customers rather than new ones. Eventually, the product is entered into a decline stage: technologically superior products substitute the product causing the sales curve to follow a downward trend (Cox 1967; Porter 2004; Vernon 1966). For the purposes of this essay the most important transition to consider is the shift from the growth into the maturity phase of the PLC. In this stage intensive competition, which focuses on delivering more value to customers, replaces extensive competition, which aims at obtaining new customers. Therefore, in the mature market firms compete by improving quality, offering a broader range of products, and bundling their core product with other services. In this stage demand for the output of an organization is mostly depending on the replacement rates (Yoo 2010). The mature market is generally a cyclical market in which volume fluctuates at or around a steady pattern of demand: the value added for sales becomes cyclical and cash generation alternates from surplus to deficit (Neale, Haslam, Johal 2009).
In the case of the cyclical late capitalist product markets, which afflicted Caterpillar within its North American home-market, demand from the construction industry turned into fitful as infrastructural investement declined. The volume sales’ peak of 85.000 units in 1973 was not surpassed because the growth of new demand weakened, and the market in which Caterpillar acted became more cyclical. The overall revenue generated in Caterpillar’s product market fell, as market maturity was also combined with a sustained fall in unit costs. Indeed, as observable considering the unit value trends of the U.S. shovel loaders, in 1986 the real price per unit was only 70% of the 1972 price. This changed trajectory clearly reflects the increasingly difficult external environment represented by the saturation of the market. The repetitive manufacturing systems of the industry were stressed by switchback fluctuations in volume, and financial cost recovery were made more difficult as the final product prices diminished because of the producers’ ongoing competition to keep their factories going by discounting the product (Froud et al. 1998). The cost-based competition faced by Caterpillar was further enhanced as “high volume standardized production continued its ineluctable move to where labor is cheapest and most accessible around the world” (Reich 1991, p.210). This means that competition following the maturity stage did not only develop on a national scale, but also on an international one, as Caterpillar faced an unanticipated surge of competition from overseas, especially from the Japanese company Komatsu. However, it is important to specify, as Froud et al. (1998) successfully argue, that Komatsu has never had a productive advantage over Caterpillar. Presenting a comparative flow measure for the company in terms of a value added/stocks measure, Froud et al. (1998) indeed demonstrate that the company with a constantly superior flow from 1980 to 1995 is Caterpillar, not Komatsu. As observable in Table 1, over the years 1988-1995 Caterpillar average was indeed 2.3, whereas Komatsu’s 1.4.

Table 1: Komatsu and Caterpillar’s stock turns from 1980 to 1995 Source: Caterpillar and Komatsu Reports and Accounts, various years

Therefore, it stands to reason that the importance of the threat posed by the Japanese competition is represented rather by the fact that Komatsu was the first serious, global challenge that aimed at undermining Caterpillar’s dominance in the earth moving equipment. If before, according the Porter’s five forces analysis (2004), the threat of new entrants had been low, with the rise of Komatsu sales volume, the rules of engagement in Caterpillar’s competitive space changed. As Shaheen, group president of Caterpillar, declared, Komatsu was a “wake up call” that brought up the company’s fragility. Indeed while Caterpillar executives ignored the threat, the Japanese competitor had gained market share by offering low cost, high quality options in a variety of product lines, whereas Caterpillar did not innovate its offer and continued raising prices on an average of 10% a year.

Surely the difficulties following the maturation of the market made it necessary for Caterpillar to look for new product lines and new markets in which expand, in order to achieve real growth and easy cost recovery. Similarly Komatsu’s threatening invasion of Caterpillar’s markets represented an incentive for the company to consider a restructuring of its organization. However, as stated in the introduction, focusing exclusively on the external factors seems to be limiting when considering the downturn of Caterpillar’s production, whose losses in 1983 and 1984 accounted for a million dollars a day, seven days a week (Neilson & Pasternack 2005). Strategy must focus both on the conditions dictated by the market in which it acts and on the recognition of the fact that a firm must unlearn most of its past before it can successfully face the future. Therefore strategy is more than the mere allocation of scarce resources across the company’s competing projects. It is rather necessary for a company to pursuit better resource leverage, overcoming resource constraints (Hamel & Prahalad 1994). This paragraph will attempt draw the basis for understanding the ways in which Caterpillar’s restructuring took place. It will be therefore necessary to firstly analyse which structural features of the company posed a threat for its own success.
The company was originally organized into strong functional divisions named General Offices (GOs), each of which was responsible for part of Caterpillar’s overall business process, such as marketing, pricing, engineering, manufacturing, and other. However, the GOs were not tied together through metrics or motivators that would pull them towards shared goals, so that each GO served its narrow functional purpose, but an overall company purpose was missing. Furthermore, there was lack of accountability measures and Caterpillar had no visibility into its profitability by product or by country: the received data only regarded the company as a whole. Because of the lack of product or regional profitability measures, prices were not market- but rather cost-driven. Therefore, if the projections for the upcoming year were too low, pricing General Office would simply raise prices to make up the difference. The slow and centralized decision-making was further constrained by Caterpillar’s inability to penetrate overseas markets: the 1963 joint venture with Mitsubishi never amounted to much, in Europe Demag and JCB successfully resisted market fragmentation.

Before analyzing the ways in which Caterpillar was reorganized in order to successfully revert the downward sales trend, it is necessary to define what restructuring means and what are its implications for a company’s performance. Within the theoretical framework Caterpillar’s case study will be inserted. Because of the ever-changing character of the industry reality, any industry is likely to find its structures and skills progressively less attuned to the market expectations (Hamel & Prahalad 1994). Restructuring is a corporate management process, which aims at reorganizing the operational, legal, and ownership structures of a given firm. The purpose of such a process is to increase both the firm’s profitability and its internal organizational dynamics (Froud et al. 2006). The main reasons behind a company’s restructuring is the need to successfully respond to a crisis or competitive market, and to consequently improve competitiveness and profitability, as well as shareholders’ wealth (Jensen and Meckling 1976). When it came to the restructuring process, Schaefer, CEO from 1985 to 1990, decided to protect Caterpillar’s distribution system, by continuing selling to dealers at a price that allowed these to make a small profit on sales. Because the costs of such move were too high, the Plan With A Future (PWAF) program was launched. This program was cost-centric and it was developed around a $1.8 billion manufacturing modernization. This cost-reduction reduction strategy however did little to solve the problems that formerly had made the company internally focused, slow, and unresponsive. Successfully considering the environment in which the business was operating, Schaefer understood that competitive pressure on Caterpillar was likely to increase, and that PWAF only postponed the impact of longer-term structural deficiencies (Neilson and Pasternack 2005). For this reason a more drastic solution was pursued as accountability was moved downward in the organization, substituting the GOs with “accountable” business units that were to be judged upon divisional profitability. The divisions were given freedom and power to develop their own manufacturing processes and schedules, and set their own prices. Their performance was judged on a Return On Assets (ROA) basis: if the ROA was under 15%, the unity faced elimination. It clearly appears that the new Caterpillar’s model is a Profit-center one. Reinforcing the position of the economic perspective theory on the positive consequences of restructuring on economic performance (Mc Kinley et al, 2000), the reorganizational model pursued by Caterpillar proved to be successful. Indeed if Caterpillar registered a major $2.4 billion loss in 1992, in 1993 its profits turned to be positive again, and in 2004 they were $2 billion worth. On the same note, Caterpillar’s revenues nearly tripled since 1992, going from $10.2 billion to $30.3 billion in 2004 (Neilson & Pasternack 2005). The company’s diversification strategy enabled it to deliver favorable financial results even in a difficult economic climate. Between 1991 and 1999 Caterpillar entered a total of 39 mergers and joint venture agreements. Caterpillar also entered Latin American, Eastern European, and Asian markets. Furthermore, as the company became more focused on customers and profitability rather than on internal processes and budget, Caterpillar started developing products more in synch with what dealers and end customers wanted. Because of the independence of each product business unit, these teams were empowered to act quickly and responsively with broader information available to them (Cohen 2001). To achieve major responsiveness Caterpillar spends about $700 million annually on research and development, $200 million for engineering related to existing products. Among the diversified product lines there is the company’s compact construction equipment line, headed by the flagship skid steer loader, articulated trucks, and a new line of excavators (Neilson & Pasternack 2005). The success of the strategy also clearly appears in operational indicators, including dramatic increases in productivity. Caterpillar has managed to secure and sustain its competitive advantage by effectively exploiting its resources in such way that its competitors were unable to imitate its strategies (Grant 1991). Indeed, using its after-sale support and service capability as the foundation of its competitive structure, Caterpillar can now get spare parts and service personnel to any place in the world in 24 hours, significantly increasing its productivity pace (Javidan 1998). Furthermore, Caterpillar decreased its product development cycle to roughly 36 months (from 48 to 72 months before the restructuring). As assets were tied back to product profitability, the businesses no longer sought massive capital investments to renew manufacturing operations for every product upgrade, so capital requirements fell as well (Neilson & Pasternack 2005).

To sum up the aim of this paper was to assess the extent to which market maturity caused Caterpillar’s restructuring. Consequences of a mature market are increased competition, represented by Komatsu in the case of Caterpillar, and fall in demand according to the PLC. It follows that companies strive not to find new clients but rather to ensure that product loyalty is maintained through constant improvement of the products. The reason why market maturity was so effective in initiating the restructuring process that Caterpillar underwent is that the company’s internal structure was flawed and not capable of embracing the changes brought up by a hostile external environment. Therefore it was argued that it is necessary to also consider the internal weaknesses of Caterpillar in order to truly understand what caused its restructuring. The comprehensive argument of this paper therefore is that organizations are always constrained under the given conditions of the market in which they operate. However, a weaker structure is more likely to increase the threat of new entry and to suffer from major financial losses. Caterpillar’s restructuring improved the company’s financial performance through the establishment of enhanced responsiveness to customers’ needs and to global trends. This was possible because of a reorganization of the bureaucratic structure itself, which ceased being highly centralized and within which authority moved down the hierarchical scale.

Bibliography:

Internet Resources: http://www.caterpillar.com/investors/financial-information http://www.caterpillar.com/investors/stock-information

In-person interview with George Schaefer, retired chairman and CEO of Caterpillar Inc., Peoria, Il., October 20, 2004.
In-person interview with Glen Barton, retired chairman and CEO of Caterpillar Inc., Peoria, Il., October 20, 2004.

Academic Material:
Cohen, I. (2001), ‘The Comeback of The Caterpillar’, case study presented at the North American Case Research Association (NACRA) in October 2001.

Cox, E. (1967), ‘Product Life Cycles as Marketing Models’, The Journal of Business, 40(4): pp. 375-384.

Froud, W., Haslam, J., and Williams, J. (1998), ‘Caterpillar: Two Stories and an Argument’, Accounting, Organizations and Society, 23(7): pp. 685-708

Froud, J., Johal, S., Leaver A. and Williams, K. (2006), Financialization and Strategy: Narrative and Numbers, (London: Routledge, Taylor and Francis).

Grant, R. (1991) ‘Prospering in Dynamically Competitive Environments: Organizational Capability as Knowledge Integration’, Organization Science, 7(4): pp. 375-387.

Javidan, M. (1998), ‘Core Competence: What Does it Mean in Practice?’, Long Range Planning, 31(1): pp. 60-70.

Jensen, M. C., & Meckling, W. H. (1976), ‘Theory of the firm: Managerial behavior, agency costs and ownership structure’, Journal of financial economics, 3(4), 305-360.

Jensen, M. & Meckling, W. H., (1995) ‘Specific and General Knowledge and Organizational Structure’, Journal of Applied Corporate Finance, 8(2).

McKinley, W. et al. (2000) A socio-cognitive interpretation of organizational Downsizing, Academy of
Management Review, 25(1), pp. 227–243.

Neale, A., Haslam, C., & Johal, S. (2000). Economics in a business context (3rd ed.) (London: Thomson).

Neilson, G. and Pasternack, B. (2005), Result: keep what’s good, fix what’s wrong, and unlock great performance (Crown Publishing Group: New York).

Porter, M. E. (2004), Competitive advantage: Creating and sustaining superior performance (New York: Free Press).

Prahalad, C. K., & Hamel, G. (1994), Competing for the future (Boston, Mass: Harvard Business School).

Reich, R. (1991), The work of nations (New York: Knopf).

Vernon, R. (1966) ‘International Investment and International Trade in the Product Cycle’, Quarterly Journal of Economics 80(5): pp. 190-207.

Yoo, Christopher S. (2010), ‘Product Life Cycle Theory and the Maturation of the Internet’, Scholarship at Penn Law, Paper 297.