Case: Caterpillar and the Fluctuating Dollar
Case: Caterpillar and the Fluctuating Dollar
Caterpillar, one of the world's largest heavy-equipment manufacturers, has been beset by two major problems: competition from Komatsu Ltd. of Japan and a fluctuating U.S. dollar. The 30 percent strengthening of the dollar against the yen in 1989 and early 1990, as noted in Fig. 8.2, made Japanese goods less expensive in the United States and third-country markets, giving Komatsu a substantial competitive advantage, and in early 1990, for the second time since 1981, Caterpillar executives tried to plot a strategy on how to cope with the strong dollar.
Caterpillar concentrates in the worldwide production and sale of heavy equipment and engines. (See Map 8.2.) It manufactures products in wholly owned or affiliated plants In the United States, Brazil, Canada, France, the United Kingdom, Australia, Belgium, Indonesia, India, Italy, Japan, and Mexico. It also has contract manufacturers in the United States, Finland, Norway, South Korea, the United Kingdom, and Germany. Products are manufactured under license in eight countries, and parts warehouses and distribution facilities are located in the United States as well as in nine foreign locations. Parts and components are shipped worldwide for final assembly in combination with other parts and components manufactured or purchased locally.
The Dollar Prior to the 1980s As noted earlier in the chapter, the U.S. dollar operated under a fixed exchange-rate system until 1973. As Fig. 8.3 shows, the two dollar devaluations of 1971 and 1973 resulted in a dollar exchange rate that was considerably below that of the pre-1971 era. The effective exchange rate, which is the value of the dollar against its major trading partners weighted for the importance of trade with them, reached a low point in 1973 and again in late 1978 and early 1979.
Several reasons account for the weakening dollar in the 1970s. An overvalued dollar and relatively strong U.S. economy, especially in the late 1960s, led to a growth in imports, a weakening of exports, and a balance-of-trade deficit. This deficit was magnified by the rise in oil prices and a worldwide recession in the mid-1970s. As the world began to recover from the recession later in the 1970s, the U.S. economy rebounded quickly, leading to strong demand for imports and increasingly wider trade deficit.
However, the deficit began to turn around in 1978 and 1979 as the declining dollar finally began to take hold. In particular, there was a marked increase in the exports of U.S.-manufactured goods as foreign customers continued to purchase these products because of sustained economic growth abroad, especially in Western Europe and Japan.
The Dollar in the Early 1980s In 1980 the dollar began a substantial turnaround.
Higher U.S. interest rates attracted marginal capital from abroad. The trend continued in 1981 as a tight monetary policy resulted in higher interest rates and as the current account continued to improve. Several factors were credited for the strength: relatively low inflation in the United States, relatively high nominal interest rates, the perception of the United States as a safe haven from world crises, a strong U.S. stock market, and demand for dollars by multinational corporations.
The strong dollar had good points and bad points both domestically and abroad. It was hurting U.S. exporters but helping U.S. importers. Foreign exporters liked the strong dollar because it gave them cheaper access to the U.S. market and helped them to compete with U.S. companies abroad. On the other hand, the strong dollar was sapping many of the industrial
economies. The huge federal budget deficit in the United States kept interest rates high, which created a strong incentive for European investors to invest in the United States rather than in Europe. These capital inflows helped offset the trade deficit outflows, so the dollar stayed strong. However, high interest rates kept the European countries from lowering their interest rates to stimulate their weak economies. These countries feared that lower interest rates would force even more of their capital to the United States and thus strip their countries of capital needed for investment.
The developing countries had difficulties because their debt burdens were denominated largely in dollars. High interest rates increased the amount of interest that needed to be paid, and the strengthening dollar meant they had to come up with more of their own currencies to
purchase the dollars to pay off the debt. Both industrial and developing countries found that the strong dollar made raw materials imports (especially oil) more expensive.
Caterpillar's Problems During this period of the rising dollar, Caterpillar experienced severe competitive pressures. Traditionally, Caterpillar has relied extensively on U.S. export of components and products to service world markets. More than two thirds of Caterpillar's employees work at U.S. plants, and 81 percent of its assets are in the United States. Therefore, the strong dollar made it difficult for Caterpillar to compete. In addition, Komatsu was challenging Caterpillar seriously in the United States and other markets for market share due to the cost advantage and weak exchange rate which the Japan-based company enjoyed. By 1980,
Komatsu, with a 40 percent price advantage over Caterpillar, grabbed over 17 percent of all equipment sold. Komatsu increased its market share in the United States from 15 to 25 percent, largely at the expense of Caterpillar.
Another problem for Caterpillar was that some of its major markets were experiencing serious difficulty. Collapsing oil prices and soaring Third World debt made it difficult for Caterpillar to sell machinery to mining and energy-related projects, especially in developing countries.
To tackle these and other issues, Caterpillar embarked on a three-pronged strategy. The first prong was to lobby for a weaker dollar. Management pointed out in Caterpillar's 1985 Annual Report that they were hopeful that a weak dollar would "ultimately strengthen the competitiveness of U.S. exporters, cut the huge trade deficit, and reduce the protectionist fever which now infects Congress."
The second prong of Caterpillar's strategy was to cut costs. This was accomplished initially by closing plants and laying off workers. Employment was reduced 40 percent (35,000 workers) to a level of 53,000 workers. Factory space was reduced by one third through the closing of nine plants.
The third prong of the strategy, related to the strong dollar and the desire to cut costs, led Caterpillar to become involved in contract manufacturing and expanded production capability abroad. Contract manufacturing has given Caterpillar more flexibility in responding to swings in the economy. Caterpillar began producing abroad specifically to take advantage of the strong dollar, even though its changes were not as significant as those found in other U.S. companies. At the time, many independent distributors in the United States were buying Caterpillar products abroad at cheap prices, importing them into the United States, and undercutting Caterpillar in its own market. So management decided to have foreign manufacturers make Caterpillar-brand products and also to replace U.S. suppliers with foreign ones. Foreign production of Caterpillar's own products jumped from 19 percent in 1982 to 25 percent in early 1987; sourcing of parts overseas increased fourfold during the same time period.
The Weakening U.S. Dollar In the fall of 1985, however, the dollar began to weaken. As noted in Fig. 8.3, the fall was steep, but not uniform. Against some currencies, notably those of the Asian NICs (newly industrialized countries), the dollar remained fairly stable; against some of the OECD (Organization for Economic Cooperation and Development) countries, however, the fall was fairly pronounced. The major concerns seemed to be the continuing large U.S. trade deficit, concerns about possible trade protectionism in the United States, the large federal budget deficit, and strong pressures on several currencies in the European Monetary System, especially the German mark.
Although the dollar was falling, U.S. exports were not increasing dramatically, largely because of weakness in other industrial economies and the fact that foreign competitors were willing to absorb the difference in smaller profit margins. In addition, imports continued to climb due to the strong U.S. economy and the reluctance of importers to raise prices and thus lose market share. However, most experts were looking for a gradual improvement in the trade balance in 1988 as the weak dollar began to take hold.
The Dollar in the Late 1980s The problem is that the dollar began to strengthen again in 1989, especially against the Japanese yen, and Caterpillar was not ready. Many U.S. companies built more overseas factories, increased their purchases of Japanese parts and components, and used financial hedging strategies to lessen the impact of a fluctuating—especially strengthening—dollar. Overseas investments of U.S. companies increased 24 percent in 1988, 14 percent in 1989, and were expected to increase by 13 percent in 1990. Caterpillar, however, has basically remained an exporter, the second largest in the United States behind Boeing.
Because of this strong U.S. production strategy, Caterpillar has resorted to lobbying the government for help by demonstrating the significant advantage that Japanese companies have in the U.S. and abroad when the dollar is so strong. Although the Japanese government tried to shore up the yen in early 1990, the U.S. government was not trying hard to weaken the dollar due to other concerns. Caterpillar led the assault on the government in 1985, and that lobbying helped tilt the decision in late 1985 to drive the dollar down. Caterpillar management hoped that its lobbying efforts in 1990 would have a similar effect.
During the mid-1980s, Caterpillar decided to modernize its plants, so it established its Plant With A Future program, or PWAF. Although Caterpillar management eventually hopes to cut costs by 19 percent with the new modernization,
it will take several years, and the decline in the yen would be difficult to offset with productivity changes. Thus Komatsu has lots of room to discount prices and offer special bargains, whereas Caterpillar is really boxed in by the strong dollar. As pointed out by Caterpillar's chairman and CEO, "Our No. 1 competitor virtually got a 25 percent price increase without changing one yen on price.
Caterpillar, one of the world's largest heavy-equipment manufacturers, has been beset by two major problems: competition from Komatsu Ltd. of Japan and a fluctuating U.S. dollar. The 30 percent strengthening of the dollar against the yen in 1989 and early 1990, as noted in Fig. 8.2, made Japanese goods less expensive in the United States and third-country markets, giving Komatsu a substantial competitive advantage, and in early 1990, for the second time since 1981, Caterpillar executives tried to plot a strategy on how to cope with the strong dollar.
Caterpillar concentrates in the worldwide production and sale of heavy equipment and engines. (See Map 8.2.) It manufactures products in wholly owned or affiliated plants In the United States, Brazil, Canada, France, the United Kingdom, Australia, Belgium, Indonesia, India, Italy, Japan, and Mexico. It also has contract manufacturers in the United States, Finland, Norway, South Korea, the United Kingdom, and Germany. Products are manufactured under license in eight countries, and parts warehouses and distribution facilities are located in the United States as well as in nine foreign locations. Parts and components are shipped worldwide for final assembly in combination with other parts and components manufactured or purchased locally.
The Dollar Prior to the 1980s As noted earlier in the chapter, the U.S. dollar operated under a fixed exchange-rate system until 1973. As Fig. 8.3 shows, the two dollar devaluations of 1971 and 1973 resulted in a dollar exchange rate that was considerably below that of the pre-1971 era. The effective exchange rate, which is the value of the dollar against its major trading partners weighted for the importance of trade with them, reached a low point in 1973 and again in late 1978 and early 1979.
Several reasons account for the weakening dollar in the 1970s. An overvalued dollar and relatively strong U.S. economy, especially in the late 1960s, led to a growth in imports, a weakening of exports, and a balance-of-trade deficit. This deficit was magnified by the rise in oil prices and a worldwide recession in the mid-1970s. As the world began to recover from the recession later in the 1970s, the U.S. economy rebounded quickly, leading to strong demand for imports and increasingly wider trade deficit.
However, the deficit began to turn around in 1978 and 1979 as the declining dollar finally began to take hold. In particular, there was a marked increase in the exports of U.S.-manufactured goods as foreign customers continued to purchase these products because of sustained economic growth abroad, especially in Western Europe and Japan.
The Dollar in the Early 1980s In 1980 the dollar began a substantial turnaround.
Higher U.S. interest rates attracted marginal capital from abroad. The trend continued in 1981 as a tight monetary policy resulted in higher interest rates and as the current account continued to improve. Several factors were credited for the strength: relatively low inflation in the United States, relatively high nominal interest rates, the perception of the United States as a safe haven from world crises, a strong U.S. stock market, and demand for dollars by multinational corporations.
The strong dollar had good points and bad points both domestically and abroad. It was hurting U.S. exporters but helping U.S. importers. Foreign exporters liked the strong dollar because it gave them cheaper access to the U.S. market and helped them to compete with U.S. companies abroad. On the other hand, the strong dollar was sapping many of the industrial
economies. The huge federal budget deficit in the United States kept interest rates high, which created a strong incentive for European investors to invest in the United States rather than in Europe. These capital inflows helped offset the trade deficit outflows, so the dollar stayed strong. However, high interest rates kept the European countries from lowering their interest rates to stimulate their weak economies. These countries feared that lower interest rates would force even more of their capital to the United States and thus strip their countries of capital needed for investment.
The developing countries had difficulties because their debt burdens were denominated largely in dollars. High interest rates increased the amount of interest that needed to be paid, and the strengthening dollar meant they had to come up with more of their own currencies to
purchase the dollars to pay off the debt. Both industrial and developing countries found that the strong dollar made raw materials imports (especially oil) more expensive.
Caterpillar's Problems During this period of the rising dollar, Caterpillar experienced severe competitive pressures. Traditionally, Caterpillar has relied extensively on U.S. export of components and products to service world markets. More than two thirds of Caterpillar's employees work at U.S. plants, and 81 percent of its assets are in the United States. Therefore, the strong dollar made it difficult for Caterpillar to compete. In addition, Komatsu was challenging Caterpillar seriously in the United States and other markets for market share due to the cost advantage and weak exchange rate which the Japan-based company enjoyed. By 1980,
Komatsu, with a 40 percent price advantage over Caterpillar, grabbed over 17 percent of all equipment sold. Komatsu increased its market share in the United States from 15 to 25 percent, largely at the expense of Caterpillar.
Another problem for Caterpillar was that some of its major markets were experiencing serious difficulty. Collapsing oil prices and soaring Third World debt made it difficult for Caterpillar to sell machinery to mining and energy-related projects, especially in developing countries.
To tackle these and other issues, Caterpillar embarked on a three-pronged strategy. The first prong was to lobby for a weaker dollar. Management pointed out in Caterpillar's 1985 Annual Report that they were hopeful that a weak dollar would "ultimately strengthen the competitiveness of U.S. exporters, cut the huge trade deficit, and reduce the protectionist fever which now infects Congress."
The second prong of Caterpillar's strategy was to cut costs. This was accomplished initially by closing plants and laying off workers. Employment was reduced 40 percent (35,000 workers) to a level of 53,000 workers. Factory space was reduced by one third through the closing of nine plants.
The third prong of the strategy, related to the strong dollar and the desire to cut costs, led Caterpillar to become involved in contract manufacturing and expanded production capability abroad. Contract manufacturing has given Caterpillar more flexibility in responding to swings in the economy. Caterpillar began producing abroad specifically to take advantage of the strong dollar, even though its changes were not as significant as those found in other U.S. companies. At the time, many independent distributors in the United States were buying Caterpillar products abroad at cheap prices, importing them into the United States, and undercutting Caterpillar in its own market. So management decided to have foreign manufacturers make Caterpillar-brand products and also to replace U.S. suppliers with foreign ones. Foreign production of Caterpillar's own products jumped from 19 percent in 1982 to 25 percent in early 1987; sourcing of parts overseas increased fourfold during the same time period.
The Weakening U.S. Dollar In the fall of 1985, however, the dollar began to weaken. As noted in Fig. 8.3, the fall was steep, but not uniform. Against some currencies, notably those of the Asian NICs (newly industrialized countries), the dollar remained fairly stable; against some of the OECD (Organization for Economic Cooperation and Development) countries, however, the fall was fairly pronounced. The major concerns seemed to be the continuing large U.S. trade deficit, concerns about possible trade protectionism in the United States, the large federal budget deficit, and strong pressures on several currencies in the European Monetary System, especially the German mark.
Although the dollar was falling, U.S. exports were not increasing dramatically, largely because of weakness in other industrial economies and the fact that foreign competitors were willing to absorb the difference in smaller profit margins. In addition, imports continued to climb due to the strong U.S. economy and the reluctance of importers to raise prices and thus lose market share. However, most experts were looking for a gradual improvement in the trade balance in 1988 as the weak dollar began to take hold.
The Dollar in the Late 1980s The problem is that the dollar began to strengthen again in 1989, especially against the Japanese yen, and Caterpillar was not ready. Many U.S. companies built more overseas factories, increased their purchases of Japanese parts and components, and used financial hedging strategies to lessen the impact of a fluctuating—especially strengthening—dollar. Overseas investments of U.S. companies increased 24 percent in 1988, 14 percent in 1989, and were expected to increase by 13 percent in 1990. Caterpillar, however, has basically remained an exporter, the second largest in the United States behind Boeing.
Because of this strong U.S. production strategy, Caterpillar has resorted to lobbying the government for help by demonstrating the significant advantage that Japanese companies have in the U.S. and abroad when the dollar is so strong. Although the Japanese government tried to shore up the yen in early 1990, the U.S. government was not trying hard to weaken the dollar due to other concerns. Caterpillar led the assault on the government in 1985, and that lobbying helped tilt the decision in late 1985 to drive the dollar down. Caterpillar management hoped that its lobbying efforts in 1990 would have a similar effect.
During the mid-1980s, Caterpillar decided to modernize its plants, so it established its Plant With A Future program, or PWAF. Although Caterpillar management eventually hopes to cut costs by 19 percent with the new modernization,
it will take several years, and the decline in the yen would be difficult to offset with productivity changes. Thus Komatsu has lots of room to discount prices and offer special bargains, whereas Caterpillar is really boxed in by the strong dollar. As pointed out by Caterpillar's chairman and CEO, "Our No. 1 competitor virtually got a 25 percent price increase without changing one yen on price.
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