Driving the Business Mentality

Caterpillar’s Ed Rapp uses an evolving methodology to align shareholder and employee interests.

Caterpillar’s business has roared back from the lows seen during the financial crisis, when its revenue fell to 32.4 billion in 2009 from $51.3 billion in 2008. Revenue nearly doubled in 2011, to $60 billion. Also last year, the Peoria, Ill.-based company completed the $8.6 billion acquisition of Bucyrus using only its cash flows. Caterpillar plans to do the same with its acquisition of China’s ERA Mining Machinery, a deal that is awaiting government approval. Ed Rapp, Caterpillar’s group president since 2007 and CFO since 2010, discusses the evolving methodology the company has applied to outperform through the challenges and volatility of the last few years.

T&R: Caterpillar has maintained strong cash flow as well as its dividend and credit rating while pursuing several acquisitions. What’s the crux of the company’s success?

Rapp: It comes down to having great clarity about what the goal is. We used the very same methodology.

T&R: Can you elaborate?

Rapp: You break the [goal] down into pieces, and you have a team leader working receivables issues, one working payables, another inventory, and down the list. We meet once a week, and each team leader says what was delivered that week and what will be delivered in the next week. It creates an edge, that sense of urgency, and we’ve found it to be an effective way to make significant progress on issues that go across a very broad enterprise.

T&R: Who is involved in those meetings?

Rapp: People come from all parts of the organization, from treasury type functions to people coming out of the marketing companies, because a lot of our receivables are with dealers. There are people from global purchasing because of the impact it has on the supply base, and people from our Caterpillar production system division, because they’re heavily involved with inventory. In a large enterprise, where a matrix is the reality, the combination of a clear goal and a clear cadence is how I really think you make the matrix work.

T&R: Where does Caterpillar’s new performance measure, operating profit after capital charge (OPACC), fit in with that methodology?

Rapp: You want that approach to become a part of your corporate culture, and OPACC is that next step. You have your operating profit, and then we apply a charge for the assets deployed against that operating profit that we think approximates the type of return shareholders expect if we want to be in the upper quartile of the S&P 500. Using OPACC, everyone knows what the target is. We used it to measure business performance in 2011, and we also piloted it as an incentive compensation metric.

T&R: How does that work in terms of incentives?

Rapp: We lay out our plan for the year and hitting that plan is a payout factor of 1.0. Wages are made up of a base salary plus the incentive compensation factor at target. If you deliver more OPACC than in the plan, then that factor can go up to as high as 2.0 and, if you fall short, as low as zero. It’s one of the ways we align the interests of shareholders with the interests of our employees—having an incentive compensation metric that’s tied directly to shareholder value.

T&R: Can OPACC be applied elsewhere in the organization?

Rapp: We apply OPACC at the highest level and then we break it down by individual business unit. What we’re trying to drive is the business mentality. When we fund M&A activity or a product development program or additional capacity, the people who request and spend the money are thinking about it from the perspective of what kind of return they need to generate to make sure this is a better deal for the shareholder. 




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