& the Heavy Equipment Industry

1. & the Heavy Equipment Industry Julie Pham Jason Howard Robert Austin

2. Agenda • Background of Heavy Equipment Industry • Market Structure • Background of Caterpillar • Firm Conduct • Market Performance • Summary

3. Background of Heavy Equipment Industry • Expanding global population • Farming • Canals • Roadway systems • Railroads • Dams • 1859 - Suez Canal • Ferdinand de Lesseps backed by Napolean III • Steam power floating ladder dredge machines • 100 million cubic yards of material • 1880 – 1914 – Panama Canal • France w/ US finishing the job • 70 large steam shovels • 260 million cubic yards of material

4. Background of Heavy Equipment Industry (cont.) • World War I and II • Early companies in the industry • 1835 International Harvester – Reaper • 1837 Deere & Company – Steel Plow • 1844 J.I. Case – Thresher • 1847 Massey-Harris – Harvesting Equipment • 1861 Allis Chalmers - Flour Milling • 1903 Clark Equipment Company – Lift Truck • 1904 Holt Company – Caterpillar Tractor

5. Market Structure – Industry Concentration • 723 companies in Heavy Equipment industry. * • Herfindahl-Hirschman index of 50 largest companies. • 1020.03 * • Concentration Ratio * • 4 largest 49% • 8 largest 59.5% • 20 largest 72.6% • 50 largest 84.6% * 2002 data from the US Census Bureau http://www.census.gov/econ/census02/

6. Market Structure – Industry Concentration (cont.) * 2002 data from the US Census Bureau http://www.census.gov/econ/census02/

7. Market Structure – Product Differentiation • Vertical Differentiation • Long bidding process • Quality • Durability • Price • Functionality • Repair costs • Purchases not influenced by style or buying trends (Horizontal product differentiation) • Product Mix Table

8. Market Structure – Barriers to Entry • Industry barriers • Large capital investment • Customer loyalty • Economies of scale • Foreign market barriers • Product marking and labeling requirements (India and China) • Complicated tax and financial systems (China) • Foreign incentives to entry • Open General License system – allows 100% foreign direct investment (India) • Profits can be repatriated in 3 years (India) • 5 year tax break on infrastructure investment projects (India)

9. Market Structure – Technological Change • Competitive advantage – remote control trend • 15 years - Fleet of remote control machines * • Operated by single person • Detect problems, inform and provide options • Construction digs and mining • Remote control excavator and materials handler • Hundreds of yards away • Allowing operators to handle dangerous materials (radioactive waste, etc) * Construction Equipment magazine

10. Market Structure – Demand Growth and Decay • Boom in 1990’s (US Market) • New homes • Office parks and urban commercial buildings • Stadiums / sports arenas • Infrastructure projects • 1998 Transportation and Safety Act ($219 B, $175 B roads & bridges) • Construction Equipment noted on December 1, 1998, "the Highway Act is one reason the U.S. construction market will feel little pain from global financial cooling."

11. Market Structure – Demand Growth and Decay (cont.) • Asian financial crisis (late 1990’s) • Slowed pace of demand for heavy equipment • Housing, roads, offices • Russian collapse (late 1990’s) • Total Industry shipments fell • $24 B in 1998 to $22.5 B in 2000

12. Quiz Question #1 • How is the Herfindahl-Hirschman Index (HHI) calculated? • It is the sum of the squares of the market shares of every firm in the industry.

13. Background of Caterpillar • Formed in 1925 after a merger of 2 CA companies. • Both companies pioneered new technology that helped win WWI and WWII. • First expansion abroad in 1950. • Currently operates in 200+ countries. • Network: • 220 dealers (63 U.S.) • 100 manufacturing plants (42 U.S.) • Employs 85,000 worldwide.

14. Background of Caterpillar (cont.) • CAT (Caterpillar) is currently the largest producer of construction and mining equipment, turbines and engines. • Earthmoving – mining – construction – forestry – waste – paving – powerhouses for boats, trucks and ships • 1 of 30 companies tracked by D.J.I.A. • Fortune 100 company ranked #1 in the industry. • Over $30 B in assets with almost $3 B net revenues. • 50/50 split with sales in U.S. and worldwide. • Recently began offering financing and insurance.

15. Firm Conduct – Closer Look • 80 year old company with a history of growth. • Mission Statement, Code of Conduct, and economic sustainability form the core of the organization. • Uniform conduct worldwide to sustain image and brand. • Ensuring free competition – refusal to bribe or extort – maintain honest financial records – internal development – non-hostile workplaces – personal responsibility – community action • CAT mission statement. • “Customers First”

16. Firm Conduct – SWOT Analysis • Strengths • Changing culture in management • Weaknesses • CAT becomes less nimble the bigger they get. • Opportunities • Emerging markets abroad (see weakness) • Threats • Negative public image for industry

17. Firm Conduct – Products & Pricing • Economies of Scale from wide range of similar products. • Production costs are lower than competitors now… • Early 80’s union troubles • Additional overhead to improve image. • Premium included in price charged to consumer. • Tractor $30K example • CAT equipment is considered premium equipment. • Better name • Better construction and repair facilities

18. Firm Conduct – Products & Pricing(cont.)

19. Firm Conduct – Products & Pricing (cont.) • Market Competitors depend on business segment studied. • Engines – Cummins and Volvo • Mining & Construction – Komatsu and John Deere • Mitsubishi at one time, but no more. • Komatsu • Sold engines to Japanese military • Entered U.S. market in 1967 to challenge CAT • World’s largest bulldozer • Silicon chips and electrical switching equipment

20. Firm Conduct – Selling & Advertising • Ring Power distribution chain • Rental machinery • Repair facility • New orders are usually custom • Most CAT advertising money goes to image • In 2005, $3.2 B, over 10% of company revenues • CAT sale of D9 and D10 tractors to IDF • NASCAR sponsorship to connect with rural America.

21. Firm Conduct – Research & Development • Sustainability drive is central to R & D • In 2005, $1.1 B in R & D expenses • Fuel-efficient engines and technologies • ACERT diesel engine • Turbines powered from plant fumes • Solar turbines • 6 Sigma investment in management • Thus far each 6 Sigma investment has been an individual cost center, creating revenue.

22. Firm Conduct – CAT in the news • CAT acquisition in Progress Rail Services in May • Synergy with engine rebuilding section • Future engine sales • “Caterpillar Posts 38% Profit Rise, Raises Outlook on Strong Demand” • WSJ July 2006 • Raised yearly outlook for the second time • From $40 B in sales to $42 B • Plans to break $50 B by 2010

23. Quiz Questions #2 • Pick two major competitors of CAT. Komatsu Tonka John Deere Mitsubishi

24. Market Performance • Market Efficiency • US construction spending (private and public) $1.1 trillion • Orders for construction machinery up 19% in 2005 • 2005 SAFE Transportation ACT • $286.4 billion for building highways in US • Project Management • Most firms are implementing new software and technology to improve efficiency • Steady demand growth

25. Market Performance (cont.) • Factors affecting growing demand • Reconstruction Efforts from Natural Disasters • Population growth • GDP growth • Government Regulations- ie. SAFE Act.

26. Market Performance (cont.) • Areas lacking efficiency • Construction Equipment takes months to manufacture and sell. • Purchase approval for heavy equipment goes through many layers of management before the decision to buy because they cost between $50K to $200K. • Heavy Equipment depreciates quickly. • Project Management • “The average construction project suffers 150% overruns and completes more than 175% late.”

27. Market Performance (cont.) • What consumers look for • Reasonable Price • Productivity of the Equipment • Life Cycle Operating Costs • In-Service Performance • Aftermarket Service

28. Market Performance (cont.) • Progressive • Mergers and Acquisitions • Provide purchasing options for consumers • Equipment Rentals • Financing Options • Maintenance Services for equipment • 6 Sigma - Process Improvement

29. Market Performance (cont.) • Progressive (cont.) • Customer Focus- • Making equipment easier to use with latest technology • Reducing parts to equipment • E-Business • Consumers can view market info, company info, and details on equipment for purchase. • Build equipment and make purchases online • Facilities all around the world

30. Market Performance (cont.) • Employment • In the next 10 years, 58.4% of US jobs created will be construction related. (Bureau of Labor Statistics) • Construction industry employs over 6.9 million people each year. • Engineers and operators of heavy equipment make up over 400,000 jobs in the U.S.

31. Summary • Heavy Equipment industry is an oligopoly • Industry continues a trend of consolidation • CAT leads with 26% of the market share, is among the Fortune 100. • CAT has an expanded product line produced and sold in over 200 countries in the world. • Overall, construction equipment industry growth is steady. • Construction spending is projected to increase 3-4% annually.

32. Quiz Question #3 • The inception of the SAFE Transportation ACT (Safe, Accountable, Flexible, Efficient) by the gov’t provided $286.4 billion for US highway construction industry. What does this do to the heavy equipment demand curve? • Moves curve up • Moves curve down • Moves curve to the right • Turns curve over

33. Quiz Question #4 • What is an example of CAT innovation and sustainable environmental policies? • ACERT technology • Posting on MySpace • Dodgers winning the NL West • Remote control bulldozers