“The Caterpillar Way: Lessons in Leadership, Growth, and Shareholder Value” by Craig Bouchard and James V. Koch is written like a business valuation case study.
Many business books unfold in a sequential fashion starting from the company’s founding and then ending in the present. Instead, this book attempts to answer the question why Caterpillar was able to have such a long run of stock price appreciation from the mid-'80s to the beginning of 2012. Caterpillar’s (CAT, Financial) stock price during that time grew from approximately mid-single digits to more than $100 per share.
The book starts by discussing why the authors chose to study Caterpillar instead of other Dow stocks. The authors have a 25-point checklist they call “The Bouchard-Koch Scale Efficiency Model.” Several factors in their model relate to operations, marketing, financial discipline, etc. The book then goes into more detail on a number of topics including operational excellence, global expansion, labor management and valuation.
On the topic of operational excellence, the book starts when Caterpillar was not operating efficiently in the 1980s. The company admits it had become bloated and arrogant. One reason is because Caterpillar’s organization was structured in a way where its processes were extremely bureaucratic. The company could not differentiate between profitable and unprofitable product lines. As a result, Caterpillar had to undergo a painful organizational restructuring from a centrally planned business where there were companywide departments (i.e., sales, marketing, etc.) to a structure where each division had its own profit and loss statement. As the re-org proved successful, the company continued along with other initiatives like lean manufacturing and six sigma initiatives. Lean manufacturing focuses on efficiency, and six sigma focuses on quality.
The book spends a lot of time discussing Caterpillar’s global expansion especially as it relates to China. It discusses how currency fluctuations had a great influence on Caterpillar’s sales versus its competitors like Komatsu. It paints China as a big emphasis for Caterpillar’s future, but it is also realistic about the business climate there. Throughout the book, the authors give “Insider’s Edge” snippets or lessons learned principles. One of my favorite Insider’s Edge quotes is about China:
“To conduct business successfully in China, one must become Chinese. This means many things, but here are a few concepts:
Operate at the scale of your Chinese competitors (small is usually a bad idea).
Understand the motivation of Chinese political leaders, which is first to feed the people.
Digest China’s five-year plan. Build into it because it really does provide a road map.
Make sure you have senior employees who are also senior members of the local Communist Party.
Develop an internal culture that understands and respects the Foreign Corrupt Practices Act.
Understand that your intellectual property could come under assault.”
Another example of the book’s detailed research involves a point the authors make that Caterpillar’s dealer network model may not be as successful in China. This is because in the U.S. when machinery breaks down, operators will buy a Caterpillar replacement part. In China, it’s common for operators to jerry-rig solutions instead of buying replacement parts. The discussion about China is a great cautionary lesson to investors and managers who want to extrapolate success in the U.S. onto other parts of the world. I think about companies like Tesla (TSLA, Financial) or Under Armour (UA, Financial), which are priced to perfection and are in the early stages of international expansion.
On the topic of labor, the book paints Caterpillar as brutally pragmatic but fair when it comes to dealing with its workers. Caterpillar has had several contentious standoffs with unions in its history, and it has an unbending principle that labor contracts must allow the company to remain globally competitive.The company insists that it must be allowed to relocate manufacturing plants should economic conditions dictate. If unions go on strike, Caterpillar has contingency plans for its nonunion laborers to be cross-trained and to work on the assembly lines including administrative and managerial personnel.
The authors argue that Caterpillar’s willingness to confront uncomfortable labor situations is a primary reason that the company fares much better than other manufacturing companies during tough economic times.
The last part of the book is dedicated to the authors valuing the company. They discuss what they like about the company, what they don’t like about the company, macroeconomic scenarios and valuation multiples. The authors believe Caterpillar has a competitive moat with its dealer network and its company DNA of operational excellence.
On the other hand, the authors question the timing and prices paid on some of Caterpillar’s acquisitions. They then provide bull, base and bear scenarios for Caterpillar’s valuation based on possible macroeconomic conditions and different multiples.
This book is highly informative and worthwhile. “The Caterpillar Way: Lessons in Leadership, Growth, and Shareholder Value” is recommended for value investors, business-minded and operations-focused individuals, as well as readers specifically interested in Caterpillar.
