While Caterpillar has its own financing arm, firms are not only dependent on Caterpillar to provide financing. Moreover, with interest rates at historic lows and capital investment low, the financing arm cannot be counted on to deliver strong top or bottom line growth.
The present economic situation is a perfect storm for Caterpillar. Commodities prices have dropped dramatically over the past nine months. Credit is unavailable and when Caterpillar offers credit the rates are low. Economic activity is down, suppressing capital investment. The housing market is still stagnant. The economic malaise has spread to the four corners of the globe. Only countries with distorted, artificial economies and freedom from the constraints of democracy can justify a level of infrastructure spending that would make Caterpillar happy. In a nutshell, there are no real bright spots for Caterpillar right now. The company still expects to make money this year, but their estimates of those earnings are constantly dropping (Ibid).
Caterpillar has adopted a differentiated strategy. The firm produces high-performance products in industries where high performance is demanded and often necessary. The strategy has a few key elements, including innovation, financial strength and supply chain excellence.
Innovation has long been a key driver for Caterpillar. The company was at the fore of tractor technology development, such that co-founder Benjamin Holt has been inducted into the Inventors Hall of Fame (Cat.com, 2009). The company has been working on greener technology for a decade and has moved to the front of the curve in that subcategory. Caterpillar has invested over $1 billion in research and development in each of the past four years. This is in addition to $2.4 billion in facilities upgrades and other infrastructure investments. The organizational structure was altered to facilitate a more customer-centric R&D approach.
Financial strength is a key drive for Caterpillar. In good times, this is less in evidence but today we can see the importance of maintaining a strong balance sheet and healthy margins. Caterpillar is well-positioned for this economic downturn. It will be able to maintain dividend payments throughout the downturn. Moreover, Caterpillar is able to position itself to take advantage of the inevitable market upswing. The company is continuing to make capital investments so that it has the capacity and capability to meet market demands when the economy beings to recover.
A third driver of success for Caterpillar is supply chain excellence. The firm has manufacturing facilities spread across the globe. Not only does this bring them closer to their customers but it provides an element of geographic diversification as well. They also have committed to Six Sigma production, which aims to reduce errors improve quality. Six Sigma is typically applied throughout the supply chain. The company's competency in supply chain management has led to the development of another business line, Caterpillar Logistics Services. Efficient production and transportation flows enable the company to market to meet the needs of even the most demanding customers.
Caterpillar faces competition from a number of different firms. The most direct competitor is Komatsu, which entered into direct competition in 1967 when it arrived in the U.S. market with a specific mandate to take over Caterpillar's dominant industry position. There are several other competitors as well. These include John Deere, Mitsubishi, Liebherr, and CNH. John Deere operates primarily in farm equipment, Liebherr mainly in mining while Mitsubishi and CNH are competitive with Caterpillar in multiple businesses. Of this the biggest threat remains Komatsu, which dominates the construction and mining equipment industry in Asia and has made substantial inroads into Caterpillar's business in North America.
The arrival of Komatsu signaled a seismic shift in the nature of competition within the mining and construction equipment industry. First, it signaled that the industry was truly becoming global. Cat had international operations at the time, but had not made a major push into Asia. Komatsu's arrival marked the first time these major competitors had gone head-to-head. As the Japanese firm made inroads, the intensity of rivalry increased significantly. Caterpillar -- having gotten fat on monopoly riches -- suffered badly during the 1970s. By the 1980s, a turnaround was needed to salvage Caterpillar. Management and union leaders both had failed to recognize the competitive threat and suffered the consequences. Caterpillar revived itself, and the rivalry between the two firms has been intense ever since (Eckley, 1989).
Today Caterpillar operates in a highly competitive environment. The firm's dominant market position allowed it to weather the storm of Komatsu's arrival. As more firms have entered the marketplace, Caterpillar has benefited from the competition. It forced them to adopt a discernable strategy take the steps necessary to align their tactics with that strategy.
Competition is characterized by high intensity. Machine quality, service levels and cost are all factors in which firms in the industry compete. Products are segmented by task, with any given task having only a handful of different products available. The costs in the industry are high and many firms do not have other businesses.
For Caterpillar the intensity of competition has been defrayed somewhat by two factors. One is Cat's overall strength and sustainable competitive advantages. These have allowed the company to continue to grow despite intense competition. The industry overall has also grown, in response to growth in global commodity demand. This has helped Cat and other industry firms grow, as their core markets are not yet mature.
Employment, Production, Income
On the surface, the current economic crisis affects just the construction business directly. Yet, the ways in which employment, production and income are linked will inextricably impact all of Caterpillar's businesses. Of these three, income is the most volatile variable. Firms' income can rise and fall based on any number of variables. Earlier in this paper some of the key macroeconomic variables affecting Caterpillar were outlined.
A period of sustained income reduction will affect production. This is because as income is reduced, inventories build up. As inventories increase the need for production decreases. Eventually, the production is reduced to the point where it affects employment. Employment levels are typically a lagging indicator in the economy. Firms seldom eliminate workers incrementally -- they are dismissed in batches. Additionally, there are costs associated with eliminating workers, relative to the costs of temporary production shutdowns. As a result, by the time workers are laid off, the economy has already deteriorated for several months. Caterpillar's annual report is evidence of this, as the company has stated they are just going to start laying off workers this year, despite the fact that the housing market has been down for a couple of years and commodities prices falling for nine months.
When employment drops, the money available in the economy for consumer spending drops as well. This reduces demand, which results in even more inventory increases. Another round of production declines and layoffs ensues. Eventually, the cycle is broken and the economy begins to recover, following the same cycle in reverse.
Income, production and employment are all down at present. There is little indication that the economy is truly headed for recovery. Some pundits are estimated that the world economy will continue to contract this year before starting recovery in 2010. The IMF has said that the economy in China is showing signs of recovery already, mainly as a consequence of short-term support (Channel News Asia, 2009). Given the relative debt positions of China and the United States, it is reasonable that China would be in a position to lead the economic recovery.
This reality is significant for Caterpillar for a couple of reasons. One is that the recovery may begin sooner that expected if China can spur the recovery. China is a major consumer of commodities, so if demand there picks up, commodities prices will improve. This will drive a resurgence in the mining industry. The oil industry will see a similar uptick with strong growth coming from China.
The other ramification is less positive, however. Komatsu is the dominant player in China and Asia-Pacific in general. If that region improves first, this will give Komatsu a competitive edge. Its income will increase first, which will allow it to increase production and employment first, driving income even higher.
The good news for prospective investors of Caterpillar is that the company has to some extent disregarded the financial crisis. While they are embarking in cost-cutting measures, they are also continuing with their R&D and capital investment levels. In doing so, Caterpillar is ensuring that they will not lose a step in this key competitive driver even in the event that Komatsu benefits from an Asia-lead recovery.
Furthermore, Caterpillar is well-positioned to exploit weaknesses at some of their other competitors. While those competitors will also benefit from improvements in commodities prices, they may not be making the same investments in their futures as is Caterpillar. This is especially true of Cat's European competitors, which may are less likely to see their income increase during the first, Asia-oriented stages of recovery.