CHAPTER 1

The Caterpillar Story: How Three Successive CEOs Used Strategic Thinking toRegain Supremacy

"For 60 years Cat was a rocket. This company could do no wrong. Then in theearly eighties, our business underwent profound change. We had 60 years, allvery successful, in which we built what we said the customers wanted and needed.Then the whole ballgame had changed," said George Schaefer, CEO of Caterpillar(Cat) from 1986 to 1990. Recognizing that his company was in grave danger, heset in motion one of the most remarkable turnarounds in history.

Boosted by a worldwide infrastructure building boom for most of the twentiethcentury, Caterpillar had been a seemingly invincible juggernaut. Anchored by avast network of Caterpillar dealers in all of the growth areas of the world, Cathad the products, distribution, and service to dominate the global market forearth-moving equipment and spare parts. Cat also had been able to support thatnetwork with the right components—knowledgeable and dedicated people,extensive global manufacturing, a huge field population of machines and engines,and service facilities within easy reach of customers literally everywhere.

But like the Big Three automakers in Detroit, Caterpillar was caught by surprisein the early 1980s when new offshore competitors began to arrive on the scenewith high-quality products and disruptive marketing and sales approaches. Thebiggest threat among Caterpillar's new rivals was a Japanese company calledKomatsu. "Eat the Cat" had been Komatsu's war cry since its inception in theyears after World War II. Komatsu's plan, which it methodically implemented, wasto circumvent Caterpillar's service advantage by making machines that "don'tbreak down," thus rendering the leader's key strategic capability irrelevant.

By 1986, the little-known Komatsu was succeeding in their plan. Workingtirelessly to undermine the strategic strength of Cat's dealers, they madesignificant inroads in convincing heavy equipment owners that Komatsu's newequipment did not break down as often and needed far less service thanCaterpillar's—and was therefore less dependent on a local dealer to keepoperations running. Their strategy had effectively changed the rules of play ina market Cat had ruled as long as anyone could remember. Further crippled by awidespread building recession that had taken place in the early eighties, Catwas in trouble.

But as impressive as Komatsu's feat may seem, the fact is that they had notreally done anything particularly brilliant. The Komatsu attack was actuallymade possible by previous Caterpillar executives in the 1970s as they lost sightof the strategy that had made Caterpillar successful for so many decades.Throughout its first 60 years, Caterpillar had been practicing what we at DPIcall a "Product-driven strategy." The bottom line for a company whose strategyis focused around a single product (heavy earth-moving machinery, in Cat's case)is very simple: the best product wins. As such, resources need to be continuallyreinvested so a company can ensure that its products are always the best.

In Caterpillar's case, the leaders had forgotten what had put them out in frontall those years. And as Cat was generating more cash than the company needed inthe 1970s, management became distracted by this development and began lookingfor a "big acquisition." They found one in a company called Towmotor.Caterpillar management rationalized that "moving material"—Towmotor'sbusiness—was very similar to their own business of "moving dirt."

That assumption proved to be very wrong and very costly over the next decade.The strategies of Caterpillar and Towmotor were incompatible, a mismatch thatundermined both businesses, leading to huge losses and depleting Cat's strategicadvantage.

THE CAT AWAKENS

Fast-forward 10 years, and the impact of the Towmotor acquisition combined withthe attack by Komatsu had taken its toll. "This was in the late eighties," saidDon Fites, Cat's CEO from 1990 to 1999, who was president at the time. "We'dexperienced a decade without really any shareholder value being created ... wewere very concerned about our Japanese competitors. When I joined this company,all of our competitors had been American companies—and most of them wereput out of business by the Japanese and Europeans, who are fierce competitors.Survival was a word that we were talking about around here."

As U.S. competitors such as International Harvester succumbed one by one to thisnew environment, Cat management could find no clear path to regaining its growthof the past. Not that they didn't try.

"A lot of people had written us off, as they had many American 'Rust Belt'companies," says Caterpillar CEO Glen Barton (2000-2004), who at that time wasrunning the Solar Turbines division. "We went through a period of time in whichwe closed a lot of factories and tried to become a low-cost source, notnecessarily to compete on price, but to make a profit on the prices at which wewere already selling our products. We still wanted to concentrate on sellingvalue, and we still do that today. We believed, and still do, that our productshave more value than our competitors' offerings, with the combination ofperformance, reliability, resale value of the product, and the ultimate life ofthe product. We have that distinct advantage today. But, in order to compete,then we had to sell our products at a price where we couldn't make any margin,and obviously, we couldn't do that forever.

"Komatsu had been making inroads outside the United States, not much inside theUnited States," Barton recalls. "When they started taking us on in the homemarket, we bit the bullet and decided that we had to maintain our marketposition regardless of circumstances, until we could get our own house in order,which we then embarked upon doing."

Cat's management went about the task of seeking the best advice on strategy itcould find among America's top business minds. As Barton remembers, "We wentthrough a number of different consultants who worked with us. Among severalothers, we had the top strategy consultant at the time, Michael Porter, and NoelTichy, who was a facilitator that had worked with General Electric on theirbreakout process. At the same time we were in the process of visiting othercorporations to see what they had done and what guidance they could provide us."

None of these efforts yielded useful answers, as red ink continued to mount. AsGeorge Schaefer put it: "We were floundering despite help from the topconsultants available. We had too much good advice."

Recalls Barton: "Somewhere or other we came across Michel Robert's book thattalked about the Strategic Thinking Process. We were all impressed by thesimplicity of his approach. Rather than spending two or three years getting thebackground material, as a traditional strategy consultant like Michael Portermight have wanted to do before he was ready to move forward, we felt that theDPI process was a much more straightforward approach. It was one we believedwe'd feel comfortable working with and get faster results, which at that timewas important."

Schaefer's team believed the Strategic Thinking Process might be the tool theyneeded to mine the hundreds of worker-years of experience residing right therein the heads of their people in Peoria. They reasoned that creating their ownstrategy based on that knowledge would lead to a better strategy than one basedon studies done by outsiders. But more than anything else, Schaefer, as CEO, wasdetermined to find a way to gain consensus and commitment to a strategy thatwould revive the struggling Cat.

STRATEGIC THINKING COMES TO PEORIA

So a call came into DPI's offices from Caterpillar asking me to go to Peoria andmake a presentation to the executive committee. Of course I accepted, and duringthe presentation I asked them to tell me Caterpillar's "bumper-sticker" strategystatement. One of them replied that it used to be "earth-moving machines" butthat it had been changed to "earth-moving and material-handling machines." Ithen asked them if the addition of the words material-handling had been madebefore or after the acquisition of Towmotor. There was a dead silence in theroom and I thought that surely the question had just cost me an opportunity towork with Caterpillar. But they were wiser men than I was giving them creditfor. They understood the meaning of the question and the implications of theirtacit answer, and decided to proceed with our process.

Says Glen Barton of that first session: "I will always remember a comment MikeRobert made to us at the meeting, that 90 percent of what we needed to know torestructure our business was already in the heads of the people in that room.And I think if we contrasted that with Porter's approach, he would have saidthat less than 5 percent of what we needed to know was in the heads of thepeople in our company. Mike's point hit home with us.

"The idea of going out and doing a lot of surveys of individual market segmentsand collecting a lot of information about customer groupings and logical fits ofcustomer groupings didn't appeal to us at all. We'd already done some of that,and it didn't work all that well," says Barton. "Some of these projects neverend, they just keep rolling along and become bigger and bigger, and longer andlonger, and more involved. I think we all welcomed and still appreciate the factthat there's a finite course that you go through with DPI. In the last 10 years,we have used the Strategic Thinking Process many times and when we undertake itwe know that there's an end. When we get to the end, there are decisions we'regoing to make and directions we're going to take and move on from that."

A MEETING OF THE MINDS

Caterpillar assembled an exceptionally strong team of senior managers to gothrough the process, among them the three men who would be Cat CEOs through thenext 15 years—George Schaefer, Don Fites, and Glen Barton.

Very quickly, during the initial Strategic Thinking session, it became clearwhat had gone wrong in the business. Cat, they realized, had gradually growncomplacent over the years, neglecting to nurture the fundamentals of itsProduct-driven strategy. And the acquisition of Towmotor had dragged the wholecompany off its course.

Through the logic of the process, Caterpillar executives quickly discovered that"moving dirt" was generally a horizontal operation, while "handling material"was generally a vertical operation. It also became apparent that the skillsrequired for each business were completely different and most were nottransferable from one business to the other. Just about everything about the twostrategies was different:

• Manufacturing processes

• Customers

• Distribution methods

• Selling methods

• Service requirements

• Design factors

• IT requirements

• Suppliers

• Competitors

The clash of the two fundamentally different strategies was dragging both partsof the business down into the mud. Enormous amounts of cash were diverted tomake up for the losses in the material-handling division. Product qualitylagged, and service had lost touch with the real needs of its customers. Evenworse, as part of an attempt to pay for Towmotor and cover the losses that beganto occur immediately after the acquisition, Caterpillar management made a nearlyfatal decision. They reduced the Product Development budget from a high of 7.8percent of sales to about 1 percent of sales. This gutting of R&D crippledCaterpillar's ability to continue making the "best product," giving Komatsu theopening it needed to close the gap between the performance of their machines andCaterpillar's. The good news was that it also quickly became obvious what theyneeded to do to reestablish their product-driven dominance.

Said Schaefer: "Mike and his process helped us sort everything out. We knew thatwe were moving in a more orderly and focused fashion. We saw it all: businessesentered without commensurate expertise, misunderstood market share, and so on.It was priceless. Noses got bent out of shape ... but when noses get bent out ofshape, you generally get better decisions."

Recalls Barton: "One thing that impressed us as we moved through DPI's processwas the fact that, first off, it was excellent to have such a skilledfacilitator. With all the people who had worked with us before, we would come upagainst a touchy issue and we'd get stuck. I think that one of the things welearned was that having a strong facilitator is very good for moving themeetings forward and keeping us talking, even though we would come up against aroadblock from time to time. These were sometimes very sensitive issues to a lotof people, and the directions that the group might decide to go were maybedisappointing to certain individuals within the group. But Mike drove theprocess, drove us through considerations of what kind of company we wanted tobe, whether we were Product-driven or a Market-driven company, or a Technologyor a Production Capability-driven company. We logically arrived, through theprocess, at what we thought we were and what we still think we are today, whichis a Product-driven company. That helped us a lot as we moved forward in tryingto strategize how we could better organize this Product-driven company to servethe needs of the marketplace."

Schaefer saw the recognition of Caterpillar's Driving Force as the turning pointin Cat's strategic awakening. "It helped us to understand our options andalternatives," he said. "This was critically important to helping us understandour strengths and weaknesses, and to delineate the Critical Issues for the nextdecade. The discipline of the approach gave us the confidence that we were righton track."

DIFFICULT AND COURAGEOUS DECISIONS

During that work session, Cat's management team made a number of what haveproven to be historic decisions for the company. By recognizing their DrivingForce and the related Areas of Excellence, concepts we will talk more aboutlater, Cat's senior management team had no trouble deciding on the followingactions:

• To divest themselves of Towmotor and take a loss of nearly $300 million

• To remain a U.S.-based manufacturing company due to the fact that moving their14 Illinois plants abroad would have been a major blow to the economy of thatstate

• To invest $2.5 billion in a program named PWAF (Plant With A Future), whichwas intended to significantly reduce costs by a factor of 10, converting theirbatch-oriented plants into fully automated ones

• To restore the Product Development budget to the previous level of nearly 8percent of sales and rededicate themselves to making and selling the "bestproduct"

• To refuse to accept a labor contract "patterned" for the automobile industryand not to Caterpillar's distinctive needs, and to accept a union strike if need be

• To be profitable at the "bottom of the trough." Caterpillar, historically, hadsuffered wild swings in its profit results, with the price of its sharesfollowing suit—reaching record highs during good economic times and recordlows during economic downturns. During that first work session, they decidedthey needed to be profitable all the time.

All of these decisions, Cat's Critical Issues, were implemented between 1987 and1990, and their impact on Caterpillar and its shareholders was "nothing short ofspectacular," as Don Fites said at the time.

Fites, who took the CEO reins in 1996, recalls: "The first sessions were anhonest, hard look at who we were, how we were organized, and how we were goingabout doing business. It's a difficult process. It's easier to have somebodyelse tell you what you are and what needs to be done. In our case, though, Ithink this process was exactly the right approach to take, because ours is acompany where most of the people spend their lifetime.

"We're very attached to the business and the equipment. We know the market andthe customers. We know the business very well, and it's not a business that iseasy to grasp. I mean, there aren't a whole lot of companies—there aren'treally any companies—in the world like Caterpillar. We don't have anymodels to follow. Forcing us to do that assessment was exactly the right thing,because only we, in the end, could have made that assessment, arrived at theconclusions, and taken the path that we eventually did.

"I think that the idea of someone from the outside telling people who have spenttheir whole life in a company that something will or won't work is not really agood idea. They don't have the insight into what really makes the company tick.I think the thing that this process does very well, and I've seen it done overand over again in different circumstances, is it forces you to come up with thegood news and the bad news. And you find the answers to these issuesyourselves."

CAT FIGHTS BACK

Immediately after the first work session, Fites had an inspiration: Could the 20people at Caterpillar with the greatest knowledge of Komatsu use DPI's StrategicThinking Process to determine Komatsu's strategy and develop an anti-Komatsuplan?