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Closing Case Caterpillar Inc. Caterpillar Inc. (Cat) is the world's largest manufacturer of heavy earthmoving equipment. Earthmoving equipment typically represents about 70 percent of the annual dollar sales of construction equipment worldwide. In 1980, Cat held 53.3 percent of the global market for earthmoving equipment. Its closest competitor was Komatsu of Japan, with 60 percent of the Japanese market but only 15.2 percent worldwide. In 1980, Caterpillar was widely considered one of the premier manufacturing and exporting companies in the United States. The company had enjoyed 50 consecutive years of profits and returns on shareholders equity as high as 27 percent. In 1981, 57 percent of its sales were outside the United States, and roughly two-thirds of these orders were filled by exports. Cat was the third largest US exporter. Reflecting this underlying strength, Cat recorded record pretax profits of $579 million in 1981. However, the next three years were disastrous. Caterpillar lost a total of $1 billion and saw its market share slip to as low as 40 percent in 1985, while Komatsu increased its share to 25 percent. Three factors explain this startling turn of events: the higher productivity of Komatsu, the rise in the value of the dollar, and the Third World debt crisis. In retrospect, Komatsu had been creeping up on Cat for a long time. In the 1960s, the company had a minuscule presence outside of Japan. By 1974, it had increased its global market share of heavy earthmoving equipment to 9 percent, and by 1980 it was over 15 percent. Part of Komatsu's growth was due to its superior labor productivity; throughout the 1970s, it had been able to price its machines 10 to 15 percent below Caterpillar's. However, Komatsu lacked an extensive dealer network outside of Japan, and Cat's worldwide dealer network and superior after-sale service and support functions were seen as justifying a price premium for Cat machines. For these reasons, many industry observers believed Komatsu would not increase its share much beyond its 1980 level. An unprecedented rise in the value of the dollar against most major world currencies changed the picture. Between 1980 and 1987, the dollar rose an average of 87 percent against the currencies of 10 other industrialized countries. The dollar was driven up by strong economic growth in the United States, which attracted heavy inflows of capital from foreign investors seeking high returns on capital assets. High real interest rates attracted foreign investors seeking high returns on financial assets. At the same time, political turmoil in other parts of the world and relatively slow economic growth in Europe helped create the view that the United States was a good place in which to invest. These inflows of capital increased the demand for dollars in the foreign exchange market, which pushed the value of the dollar upward against other currencies. The strong dollar substantially increased the dollar price of Cat's machines. At the same time, the dollar price of Komatsu products imported into the United States fell. Because of the shift in the relative values of the dollar and the yen, Komatsu priced its machines as much as 40 percent below Caterpillar's prices by 1985. In light of this enormous price difference, many consumers chose to forgo Caterpillar's superior after-sale service and support and bought Komatsu machines. The third factor, the Third World debt crisis, became apparent in 1982. During the early 1970s, the nations of OPEC quadrupled the price of oil, which resulted in a massive flow of funds into these nations. Commercial banks borrowed this money from the OPEC countries and lent it to the governments of many Third World Nations to finance massive construction projects--which led to a global boom in demand for heavy earthmoving equipment. Caterpillar benefited from this development. By 1982, however, it became apparent that the commercial banks had lent too much money to risky and unproductive investments, and the governments of several countries (including Mexico, Brazil, and Argentina) threatened to suspend debt payments. The International Monetary Fund stepped in and arranged for new loans to indebted Third World countries, on the condition that they adopt deflationary macroeconomic policies. For Cat, the party was over; orders for heavy earthmoving equipment dried up almost overnight, and those that were placed went to the lowest bidder, which often was Komatsu. As a result of these factors, Caterpillar was in deep trouble by late 1982. The company responded quickly and between 1982 and 1985 cut costs by more than 20 percent. This was achieved by a 40 percent reduction in work force, the closure of nine plants, and a $1.8 billion investment in flexible manufacturing technologies designed to boost quality and lower cost. The company also pressed the government to lower the value of the dollar on foreign exchange markets. By 1984, Cat was a leading voice among US exporters trying to get the Reagan administration to intervene in the foreign exchange market. Things began to go Caterpillar's way in early 1985. Prompted by Cat and other exporters, representatives of the US government met with representatives of Japan, Germany, France, and Great Britain at the Plaza Hotel in New York. In the resulting communiqué--known as the Plaza Accord--the five governments acknowledged that the dollar was overvalued and pledged to take actions that would drive down its price on the foreign exchange market. The central bank of each country intervened in the foreign exchange market, selling dollars and buying other currencies (including its own). The dollar had already begun to fall in early 1985 in response to a string of record US trade deficits. The Plaza Accord accelerated this trend, and over the next three years the dollar fell back to its 1980 level. The effect for Caterpillar was almost immediate. Like any major exporter, Caterpillar had its own foreign exchange unit. Suspecting that an adjustment in the dollar would come soon, Cat had increased its holdings of foreign currencies in early 1985, using the strong dollar to purchase them. As the dollar fell, the company was able to convert these currencies back into dollars for a healthy profit. In 1985, Cat had pretax profits of $32 million; without foreign exchange gains of $89 million, it would have lost money. In 1986, foreign exchange gains of $100 million accounted for nearly two-thirds of its pretax profits of $159 million. More significant for Cat's long-term position, the fall in the dollar against the yen and Caterpillar's cost-cutting efforts by 1988 had helped to eradicate the 40 percent cost advantage that Komatsu had enjoyed over Caterpillar four years earlier. After trying to hold its prices down, Komatsu had to raise its prices that year by 18 percent, while Cat was able to hold its price increase to 3 percent. With the terms of trade no longer handicapping Caterpillar, the company regained some of its lost market share. By 1989, it reportedly held 47 percent of the world market for heavy earthmoving equipment, up from a low of 40 percent three years earlier, while Komatsu's share had slipped to below 20 percent. R. S. Eckley, "Caterpillar's Ordeal: Foreign Competition in Capital Goods," Business Horizons, March - April 1989, pp. 80 - 86; H. S. Byrne, "Track of the Cat: Caterpillar Is Bulldozing Its Way Back to Higher Profits," Barron's, April 6, 1987, pp. 13, 70 - 71; R. Henkoff, "This Cat Is Acting like a Tiger," Fortune, December 19, 1988, pp. 71 - 76; and "Caterpillar and Komatsu," in Transnational Management: Text, Cases, and Readings in Cross-Border Management, ed. C. A. Bartlett and S. Ghosal (Homewood, IL: Richard D. Irwin, 1992). Case Discussion Questions
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