Caterpillar Enlists Suppliers in Targeting 25% Profit Margin

Mike Render, an engineer who has worked for Caterpillar Inc. since the 1970s, has spent the last three years trying to break with the company’s past.

Render suggested his employer partner with a supplier to design a component that cuts emissions, rather than dictate specifications and choose the cheapest vendor. His team ended up working with 12 counterparts from catalytic-converter manufacturer Tenneco Inc. at Caterpillar’s Mossville, Illinois, engine center, where they created a mock production line to work out kinks in the manufacturing process. Output of the component at a Tenneco plant in Nebraska cut Caterpillar’s costs on the item by 20 percent.

The collaboration is a cultural shift for Caterpillar, whose suppliers in the past have complained about a lack of consultation, said Stephen Volkmann, an analyst at Jefferies & Co. in New York.

“It was, ‘Give me what I want when I want it, and the rest is your issue to manage,’” said Volkmann, who doesn’t own Caterpillar stock and has a “buy” rating on the shares. “The big change in attitude is from the servant-master relationship to more of a team-type relationship.”

Tenneco Collaboration

Caterpillar, the largest maker of construction and mining equipment, expects the Tenneco collaboration to become a benchmark, says Chief Executive Officer Doug Oberhelman, who succeeded Jim Owens in July. It’s dramatically shrinking the number of suppliers to 6,000 from 9,000 and working more closely with 200 companies identified as critical to future growth.

Improving the supply chain is a key piece of Oberhelman’s strategy to pull 25 cents of profit from each new dollar of sales as demand in emerging markets surges. He plans to apply engineering and quality-control expertise from suppliers inside Caterpillar factories to build the company’s signature yellow- and-black machines more efficiently.

His efforts come at a time when Caterpillar shares have increased 41 percent this year, leading the Dow Jones Industrial Average for the first time since 1993. That year rising home construction helped the company become profitable after two years of losses.

Caterpillar gained $1.77 to $80.32 at 4:15 p.m. in New York Stock Exchange composite trading.

Caterpillar wasn’t prepared for the last increase in demand, from 2006 to 2008, and the mistake proved costly. Sales rose 24 percent in that period while profit was little changed as the company paid more for raw materials and faster delivery of parts from suppliers.

‘Better Playbook’

“In the next cycle, Caterpillar wants to have a better playbook,” Larry De Maria, an analyst for brokerage Sterne, Agee & Leach Inc. in New York, said in an interview Sept. 9. “It’s critical that they have wheels, tires, bearings and everything else, which is essential to maximizing returns to shareholders, return on capital and operating margins.”

Oberhelman says he’s targeting earnings of $8 to $10 a share in 2012 on sales of close to $60 billion. Caterpillar, based in Peoria, Illinois, has forecast profit this year of $3.15 to $3.85 a share on sales of $39 billion to $42 billion. The company will report third-quarter earnings results tomorrow.

“The supply chain and supplier collaboration is a big piece of our future profit pull-through plan,” Oberhelman, 57, said in an interview at Bloomberg News headquarters in New York.

“We are still a bit behind in our supply chain efficiency,” he said. “If we get that right, the profit pulls through pretty quickly.”

Dominant Position

Oberhelman appointed an outsider with a “deep background in supply chain collaboration” as his new chief procurement officer. Frank Crespo, who held that post at Honeywell International Inc., started work in August.

Caterpillar may not have needed to focus on collaborating with suppliers in the past because of its size and dominant position in the industry, said John Henke, president of Birmingham, Michigan-based Planning Perspectives Inc. Henke has advised manufacturers on supplier relationships for more than 20 years.

“Competition is going to be based on the supply chain, not an individual company,” said Henke, who has developed an index that quantifies buyer-supplier relations. “Toyota and Honda are good because of their supply chain and great supplier relations.”

Honda Motor Co. was the leader in Planning Perspectives’ ranking for supplier relations this year, followed by Toyota Motor Corp. and Ford Motor Co. General Motors Co. is in the lower half of the survey and Chrysler Group LLC has been the lowest ranked since 2008.

Engendering Trust

Henke said improving relations with suppliers entails communication and engendering trust that would spur vendors to give manufacturers their best technology.

Still, working closely with suppliers can present pitfalls. Boeing Co. in August postponed the first delivery of its 787 Dreamliner aircraft to early 2011 partly because of Rolls-Royce Group Plc’s inability to supply an engine for flight tests. Boeing is also working through quality issues in sections built by Finmeccanica SpA’s Alenia Aeronautica.

Caterpillar’s collaboration model isn’t “the absolute Japanese definition,” Oberhelman said. “It’s not the American automotive supplier collaboration, where it’s price cuts, costs down, and then you go bankrupt together. We are trying to find a spot in the middle.”

‘Rubik’s Cube’

Tenneco’s experience building parts that reduce emissions for the automotive industry has benefited Caterpillar, Render said. The partners reduced the complexity of the device they worked on. They made two versions of a part used to burn soot in the emission-reduction device for Caterpillar’s various machines, compared with the 43 versions made by Caterpillar just for truck engines in 2007.

“It’s a bit like playing a Rubik’s cube,” said Render, a Caterpillar product manager. “If we do this, what will happen? If we do that, what will happen? They helped with the innovation. Tenneco has given us a model to collaborate.”

The device Caterpillar and Lake Forest, Illinois-based Tenneco worked on to reduce diesel emissions, as required under federal law from next year, will be used in about 100 Caterpillar models including various types of excavators, backhoes, wheel loaders and bulldozers.

“When we come up with what we think is a pretty great technical innovation, the first guys we talk to are the guys at Caterpillar,” said Brent Bauer, 54, a senior vice president who oversees the project for Tenneco. “When you have everybody in the same room, there are some magical things that happen. We get great products. We optimize costs and we add speed.”

To contact the reporter on this story: Shruti Date Singh at ssingh28@bloomberg.net

To contact the editor responsible for this story: Simon Casey at scasey4@bloomberg.net.

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Photographer: Daniel Acker/Bloomberg

Caterpillar engineer Mike Render suggested his company partner with a supplier to design a component that cuts emissions, rather than dictate specifications and choose the cheapest vendor.

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Photographer: Daniel Acker/Bloomberg

Caterpillar engineer Mike Render suggested his company partner with a supplier to design a component that cuts emissions, rather than dictate specifications and choose the cheapest vendor. Close

Caterpillar engineer Mike Render suggested his company partner with a supplier to design a component that cuts... Read More

Photographer: Daniel Acker/Bloomberg

"When we come up with what we think is a pretty great technical innovation, the first guys we talk to are the guys at Caterpillar,” said Brent Bauer, a senior vice president who oversees the project for Tenneco. Close

"When we come up with what we think is a pretty great technical innovation, the first guys we talk to are the guys at... Read More

Photographer: Daniel Acker/Bloomberg

Render's team at Caterpillar worked with Bauer's team at Tenneco to create a mock production line to work out kinks in the manufacturing process of an emissions component. Moving the production to Tenneco's plant reduced costs by 20 percent for Caterpillar. Close

Render's team at Caterpillar worked with Bauer's team at Tenneco to create a mock production line to work out kinks... Read More

Photographer: Jin Lee/Bloomberg

Caterpillar expects the Tenneco collaboration to become a benchmark, says Chief Executive Doug Oberhelman, who succeeded Jim Owens in July. Close

Caterpillar expects the Tenneco collaboration to become a benchmark, says Chief Executive Doug Oberhelman, who... Read More

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