From the May 2011 issue of Treasury & Risk magazine

Heavy Lifting in a Competitive World

CFO Ed Rapp tells how Caterpillar’s global manufacturing footprint and the finance team’s staying strong through the downturn put the company on the fast track to growth.

The recession hit Caterpillar hard. In 2009, its revenue fell 37% to $32.4 billion from $51.3 billion in 2008. But the Peoria, Ill.-based maker of distinctive yellow construction and mining equipment is now thriving, no small feat in a shrinking sector. U.S. manufacturing now represents just 11.2% of the nation’s GDP, down from 14.2% in 2000 and from its peak of 28.3% in 1953.

Caterpillar’s blueprint for success? The global nature of the company’s business and its long track record not only at selling overseas but also manufacturing there, says CFO and Group President Ed Rapp. “We’ve been playing in the emerging markets forever,” he says. “We’ve been in Brazil with a manufacturing base for more than 50 years.” The company’s 2010 revenue rose 31.4% to $42.6 billion, and its net profit surged to 6.3%, from 2.8% in 2009. And a few strategic acquisitions last year have put Caterpillar in a strong position to build on its global foundation.

U.S. locomotive manufacturer Electro-Motive Diesel, German engine maker MWM Holding and U.S. mining equipment manufacturer Bucyrus International “were just perfect strategic fits,” Rapp says, and “provide a tremendous platform for growth going forward.”

Caterpillar does business in virtually every country in the world, and has manufacturing facilities in 27 countries. And when it comes to breaking into new parts of the world, like China and India, it is a seasoned player. “The corporate approach from the beginning is that we give no one free rein in their home country,” Rapp says. He cites Caterpillar’s 1960 entry into Japan via a joint venture, an effort that has evolved into a business with more than 5,000 employees. “We compete very effectively in Japan vs. Japanese competitors,” he says.

Rapp says the company is using a similar approach in China, where Caterpillar has “significant” manufacturing operations and is assembling a dealer organization. “We’re going to build out that business model that really brings value to the customer from not only the new equipment but the product support for that equipment over the lifetime,” he says. “Our intent as we’ve laid out our strategy is to win in China.”

The company’s global manufacturing footprint provides advantages, Rapp notes. Caterpillar divides the world into three regions—the Americas; Europe, the Middle East and Africa; and Asia—and manufactures high-volume products in each region. “What that gives us is a pretty natural hedge against the most significant movements in exchange rates,” he says. As a result, significant foreign exchange volatility in 2008 and 2009 had little impact on the company’s results, Rapp says.

Manufacturing in various worldwide locations also minimizes supply chain problems. “The fact that you’re sourcing the products in each of those different regions actually protects you from the kind of disruption that can happen,” he says.

And the rise in the cost of raw materials that is unnerving many manufacturers actually offers promise from Caterpillar’s point of view. While the company will probably have to pay more for materials, it’s also likely to benefit from the good fortunes of the industries that extract the raw materials, Rapp says. “Typically rising commodity costs are good for our overall business. Higher commodity prices typically mean good activity in mining, which means business for us.”

Doing business globally forces companies to be more competitive, he says, pointing to the U.S. car industry as an example.

“How good do you think the cars you get from Ford, Chrysler or GM would be if they didn’t have to compete with the likes of Toyota, Honda and others?” he says. “Think about all the things in life that have continued to improve in quality and come down in cost. I think it comes from the competition.”

Rapp has had the finance team reporting to him since 2007, when he was named group president, and added the CFO title in June 2010 as part of a restructuring of Caterpillar’s executive ranks.

Caterpillar’s gains last year resulted from the way it handled the economic crisis, he says. The finance team responded to the slowdown with a program dubbed Stay Strong, whose three goals were to keep Caterpillar in the black; preserve the company’s credit rating; and maintain its dividend and the confidence of its investors. Stay Strong involved the close monitoring of 13 different measures, Rapp says, as finance focused on managing working capital to boost its cash and enhanced its monitoring of suppliers to avoid supply chain disruptions.

“We did some things up front to send a very clear message to the organization that this is not your typical recession,” Rapp says. For example, for the first time in Caterpillar’s history, it allowed dealers to cancel orders. “In an event like this, you need a trigger point, something that really sends the message to the organization that it’s a challenging time, and we’ve got to be prepared,” he says.

As a part of its efforts, Caterpillar launched a global supply chain finance program with JP Morgan in 2009.

“It really served two purposes,” Rapp says. “It supported us in terms of our drive to improve cash flow but it also supported our suppliers in terms of getting them faster access to payables and really helped them support their growth, which facilitates ours.”

Amid the hard times of 2009, Caterpillar decided to make some of its contribution to its defined-benefit pension plan in the form of $650 million worth of company stock, at a price of $35.74 a share. The move was designed to preserve cash, but the company’s history showed “that we’re typically a strong performer from trough to peak relative to stock performance.” Rapp says. True to form, Caterpillar’s stock rebounded—trading around $107 in mid-April. “It has done a tremendous job of boosting pension performance,” he says.

Amid the downturn, Caterpillar executives were looking ahead. “We spent a lot of time in late ’09, early 2010, charting where we want to go from here,” Rapp says. Part of that involved a strategic review that assessed the attractiveness of various industries and how each industry fit with Caterpillar’s business model, which emphasizes not only selling equipment but also providing product support over the life of the equipment. “And when you look at those two criteria, mining, electric power, oil and gas, and rail all fall up in that upper right-hand quadrant,” Rapp notes.

The strategic review informed the string of acquisitions the company embarked on last year. The $820 million purchase of Electro- Motive Diesel, announced in June, augments Caterpillar’s railroad offerings; the $810 million buy of MWM Holding, the German maker of gas and diesel engines, in October, expands its sustainable power products; and the $7.6 billion purchase of mining equipment manufacturer Bucyrus in November fills out the company’s line-up of mining equipment.

“The update to the corporate strategy clearly pointed us at those three opportunities,” Rapp says. “And based on the collective performance of Caterpillar and our people, we had the financial strength to pull it off.”

Going forward, the financing of the Bucyrus deal is one challenge facing the finance team. Caterpillar originally said it would use $2 billion of equity as part of its financing but announced in March that it will try to reduce or eliminate that and instead fund that $2 billion out of cash flow. “The finance organization is right smack in the middle of that,” he says.

The finance team has also come up with a better way to measure performance than the traditional standards it has relied on, like profits and return on assets. The new concept focuses on operating profit after capital charge, or OPACC. “We’re rolling that out across our organization, and we think it will bring better balance to the management of the business,” Rapp says. “I think it’s going to help us in resource allocation: Where are we truly adding value to the shareholder?”

The new measure, however, raises the issue of education, he says. “When you come up with a new measure like OPACC, it’s one thing to do that at the top level of the organization; it’s another to drive its execution down the organization, where you get every employee understanding how the actions that they take positively or negatively impact that OPACC number. So there’s a tremendous challenge relative to education.”

Since joining Caterpillar in 1979, right out of college, Rapp has worked mostly in operations, in jobs involving pricing, production scheduling, marketing and manufacturing, among other functions, in Switzerland and Africa as well as the U.S.. He sees that background as an advantage.

“The experience that Caterpillar afforded me in multiple operations in multiple parts of the world provided the learning ground for becoming CFO,” he says. “To be effective at this job, you have to understand how the business operates. What levers do you need to pull? How do you bring value to customers?

“When you sit down with major investors, the questions aren’t about the balance-sheet ratios,” he adds. “The questions are, ‘How do you win in the emerging markets?’”

And Rapp is eager to extend the finance team’s realm. “A lot of times the finance organization can kind of be in the back office,” he says. “The thing that we’re trying to do, and Stay Strong was one example, is to get the finance organization out to support the business. The way we capture it is: When the business wins, we win.”

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