Business: Caterpillar’s Restructuring

Introduction

When an organisation operates in a mature market, it experiences challenges of growth and profitability. Such organisations have products, which have reached their peak and lack any prospect for further growth. A mature market is a market that has achieved a state of equilibrium, insignificant growth, and innovation. Michael Hammer and James Champy look at the restructuring process as “the fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance such as cost, quality, service, and speed” (Hammer and Champy, 2004). The common features of a mature market include:

• Slow market growth.
• Heightened competition for market share with a focus on pricing.
• Decline in the industry profitability.
• There are few innovations in products.
• Some experienced buyers leverage on different products.

The restructuring was necessary for Caterpillar as a way for creating new products, increasing demands, sales, and growing profitability.

Restructuring at Caterpillar

In the 1980s, Caterpillar faced challenges of market maturity. Therefore, restructuring in functional areas like accounting, engineering, and manufacturing was inevitable for continued growth. The restructuring efforts aimed at transforming functional areas, which would, in turn, meet customers’ demands (Pomerleano and Shaw, 2005). This strategy focused on ensuring the growth of the corporation.

The company started its restructuring efforts by creating “13 profit centres and four service centres” (Hendricks, DeFreitas and Walker, 1996). It also created product groups within the profit centres to cater for the needs of customers of a single product line. Managers of product groups had to manage engineering, production, and marketing activities. On the other hand, the accounting division focused on financial services among various products of the company.

The major aim of the restructuring initiative was to enhance flexibility, responsiveness, and improve the focus on customers’ needs. In this regard, Caterpillar created various business units to cater for the needs of customers who needed specific products. The model provided opportunities for every division of the company to concentrate on specific product features, production, design, and pricing for every customer.

The restructuring also aimed at facilitating decision-making processes, enhancing authority, and responsibility within the company. The company empowered its employees and hold them accountable for results. Caterpillar aimed at developing a business-oriented team throughout the entire organisation. In turn, every employee would use his or her expertise, experiences, and innovativeness sufficiently.

Market transformation and productive performance

For Caterpillar to remain competitive in a mature market, it had to restructure its production and marketing strategies. The company used a balanced approach, which covered both financial and non-financial areas. The initiatives had to “relate directly to the organisation’s mission, objectives, strategies, and critical success factors such as customer delivery, quality, flexibility, productivity, and financial performance” (Hendricks, DeFreitas and Walker, 1996). These elements enabled Caterpillar to understand its current position and areas that needed changes.

Restructuring at Caterpillar affected its employees. In the 1980s, Caterpillar almost went bankrupt due to fierce competition from its main rival, the Japanese Komatsu. This problem persisted into the 1990s in which Caterpillar had serious industrial strikes from its unionised workers. Therefore, the human resource department underwent a serious restructuring. The striking workers were vulnerable to restructuring measures. For instance, the demand for products affected revenue generation.

As a result, Caterpillar started to lay off some of its unionised workers. At the same time, there were piling stocks of new products from factories, which had not reached the market. The company turned to the management team for labour to reduce the effects of strikes on its production. It replaced striking workers with engineers from the research and development department. The main aim of laying off workers was to reduce costs. It implies that Caterpillar had to rely on a few workers to accomplish normal processes.

Caterpillar also reacted to the workers’ strike by outsourcing most of its production processes to other firms. This strategy is aimed at reducing the vulnerability of the production department. In addition, the company also started to open and operate small plants known as focus facilities in states where workers were willing to work.

The company started with the Wheel Loaders and Excavators Division (WLED). Caterpillar changed its business processes from functional bureaucratic to profit centres during restructuring. In other words, employees had to make decisions at the manufacturing level. Managers had to align every product line with market demands, prices, and employees’ contributions. This strategy brought about success within the division. In addition, there were also performance measures to guide employees under the restructuring programme.

The change was possible in production and marketing strategies because the company aligned all processes with both financial and non-financial instruments, which focused on short-term and long-term objectives.

Under non-financial measures in the restructuring programme, Caterpillar introduced changes in the production system about labour (Vance, 2010). The company introduced the efficiency ratio in which it linked labour to the performance of employees. Caterpillar was able to use the efficiency ratio to compute profitability in the production processes within the WLED. This process aimed to ensure that employees invent equipment, which met the demands of customers. Employees reported high levels of congruence between efficiency ratio and the division’s current strategies, critical success factors, and production processes.

In this regard, restructuring involved measuring delivery time, materials required, the due date of the equipment, inventory, and quality of production. Caterpillar created a team that would ensure that all restructuring initiatives were successful in all divisions. The WLED aimed at linking its performance measures with specific products and other major parts within the company.

Restructuring in production processes was real-time. Therefore, the division could report its progress on a timely basis. This enabled Caterpillar to identify any challenges within the production system so that it could avert any negative repercussions on the financial performance of the company.

Production processes ensured that the company only manufactured equipment, which was in demand within the market. Therefore, restructuring processes had to change products, marketing, sales, and distribution strategies. Caterpillar introduced new products that it developed based on customer needs. In the previous system, the customer had to contact a distributor or dealer who would then contact Caterpillar to inquire about the product. However, restructuring brought about a new approach to customer management. In the current system, the customer would contact a dealer who still had the same role, but the WLED division would respond to the customer’s demands.

Financial performance

Until 1982, Caterpillar was the best performing and market leader in the industry. However, the growing competition from Japanese companies nearly made the company bankrupt (Orlemann, 2003). Caterpillar adopted restructuring strategies so that it could improve production, products, marketing, distribution, and customers’ satisfaction. As a result, Caterpillar became profitable within a few years after the start of restructuring (Michaelson, 2002).

The company renegotiated labour contracts with employees in an attempt to save costs and improve financial performance. Sudarsanam notes that a decrease in the cost of labour results in an increase in the net profits of a firm (Sudarsanam, 1995). The company can use such savings for expansion to increase revenues and profitability.

In the production division of WLED, Caterpillar created many product groups with profit centres. The company also used its major divisions to determine the profitability of the company by measuring performances from machine structures, parts, and other components. This strategy is aimed at identifying costs, revenues, and profitability of every segment of the organisation.

The company used prices from distributors to determine the revenue of a given product and its components. Caterpillar also used “market-based transfer prices to determine income for internal transfers because they provided an objective, arm’s-length measure of revenue and cost” (Hendricks, DeFreitas and Walker, 1996). It had to rely on market-based transfer processes to develop effective financial measures for the entire firm. The financial restructuring also aimed at getting the accuracy of costs. Therefore, Caterpillar had to account for all indirect costs of every segment by using a cause-and-effect strategy. As a result, it eliminated arbitrary allocation of indirect costs to any units so that allocation of profits would be simple.

Caterpillar derived benefits by classifying profitability under major divisions, and sub-divisions within the company. Every unit had to account for its revenues, costs, and profits. The strategy aimed at strengthening the cost ownership model that the company adopted for the WLED. In the cost ownership model, various units, such as marketing, accounting, production, and purchasing, worked together as a way of reducing costs in every stage. Consequently, Caterpillar was able to identify specific areas of the business that required improvement. Restructuring efforts also focused on financial ratios by analysing profits from various divisions, product lines, and other sub-units (Bragg, 2007). It also accounted for cash flows, fixed assets, inventory, and warranty expenditures.

Since Caterpillar started restructuring initiatives, its profits have grown steadily over the years (Zilka, 2009). However, it experienced drops in profits due to the economic crisis of 2008. The tables below show the financial performance of the company for the last ten years.

Table 1: Financials CAT.

Source: Morningstar, Inc 2013.

Table 2: CAT Growth.

Source: Morningstar, Inc 2013.

Table 3: CAT Profitability.

Source: Morningstar, Inc 2013.

Conclusion

Caterpillar turned to restructure because of market maturity and fierce competition from rivals. Consequently, it changed key functional areas of the company such as accounting, manufacturing, distribution, and marketing. All these areas became profit centres rather than functional areas.

Caterpillar had to change its products by engaging in a series of restructuring. It changed product development processes in which all members of a division and customers provided their inputs during the process. The strategy enabled Caterpillar to change any poor process, which could result in poor performance and affect the financial growth of the company. The restructuring also led to a reduction in the number of employees at the company. Caterpillar also focused on the importance of customers to the organisation. Products had to meet customers’ requirements. It improved the relationship with customers by allowing dealers to connect customers with the concerned division for inquiries.

The financial engineering led to accountability among various divisions, product lines, and sub-units of the company. Every unit had to account for its costs, revenues, and profitability.

Restructuring at Caterpillar shows that firms, which operate in mature markets can restructure and improve products, distribution, sales, marketing, and profitability. The company has been able to sustain rapid growth for the last decade due to the effects of restructuring.

References

Bragg, S. 2007. Management Accounting Best Practices: A Guide for the Professional Accountant, John Wiley & Sons, New York.

Hammer, M, and Champy, J. 2004. Reengineering the Corporation: A Manifesto for Business Revolution, Harper Business Publications, London.

Hendricks, J, DeFreitas, D and Walker, D. 1996. ‘Changing Performance Measures’, Management Accounting, vol. 24, pp. 18-22.

Michaelson, J. 2002. Restructuring for Growth: Alternative Financial Strategies to Increase Shareholder Value, McGraw-Hill, New York.

Morningstar, Inc. 2013. Caterpillar Inc. Web.

Orlemann, E. 2003. The Caterpillar Century, MBI Publishing Company, Osceola, WI.

Pomerleano, M and Shaw, W. 2005. Corporate Restructuring: Lessons from Experience, World Bank Publications, Washington, DC.

Sudarsanam, S. 1995. The essence of mergers and acquisitions, Prentice-Hall, London.

Vance, D. 2010. Corporate Restructuring: From Cause Analysis to Execution, Springer, New York.

Zilka, C. 2009. Business Restructuring: An Action Template for Reducing Cost and Growing Profit, John Wiley & Sons, New York.