Pedal to the Metal at Eaton

Hard-driving CEO Sandy Cutler reflects on regulatory burdens, overseas outsourcing, and the punitive Kyoto Protocol on climate change

When he was on Yale's track team 35 years ago, Alexander Cutler remembers running against Gerald Tinker and Frank Shorter -- and seeing their backs as they dashed across the finish line ahead of him. His consolation? Both went on to beat everyone else, too, as they won gold medals in the 1972 Olympics.

These days, Cutler, 53, is someone to catch. After five years as president and COO of Eaton Corp. (ETN ), Cutler moved up to chairman and CEO of the diversified manufacturer in 2000. He got off to a slow start, as sales and profits fell the next year. Since then, Eaton has outpaced most of its industrial rivals. Sales rose 22% in 2004, to a record $9.82 billion, while net income leaped 68%, to $648 million, also an all-time high.

Cutler promises to break both records in 2005, with Eaton's truck-components business leading the way. By not being limited to a single market, the Cleveland-based outfit usually has at least a couple of businesses that are growing, no matter where the economy is in its cycle. Meanwhile, its expanding operations in China and other fast-accelerating economies should help balance its historic base in the U.S.

Known as Sandy, Cutler sat down in his top-floor office in Eaton's 28-story headquarters recently to field questions from BusinessWeek Senior Correspondent Michael Arndt. Following are edited excerpts from their conversation.

Q: Let's start with the economy. How does the year look?


These are really very good times for manufacturers. During the second half of 2004, we saw the economy change from being powered by the consumer to the manufacturing side. I think you'll see that continue through 2005, '06, and '07.

Q: Is that realistic?


That wouldn't be a long expansion in the post-World War II economy. Automotive is slowing, but we are in are several sectors of the U.S. economy that are classic late-cycle businesses. Nonresidential construction is a good example. It has been pretty moribund through the last three years. We think in the second half of this year, you'll begin to see that pick up. Another large segment has been commercial aerospace. It has been in a terrible free fall for three-and-a-half years. You now are, in the last six months, beginning to see that move up again as well.

The other thing that is relatively unique right now is that the strength isn't restricted to the U.S. and one other region. We are seeing some of the highest worldwide GDP growth in 20 years. It's not just China. It's not just the U.S. We're seeing the economic expansion broaden out, and that's very good news.

Q: One of the downsides of this economic expansion has been an upsurge in raw material costs. What has been the impact at Eaton?


We went through almost a 20-year period where material inflation wasn't a big element. Now it is. We incurred about $140 million of increased metal costs in 2004, over 2003. We were able to offset, either through price increases or other cost reductions, about $70 million. So we had about $70 million of pressure in our results last year.

By the way, I think material costs have been a big reason why we've had such very low job growth. There are two input costs -- materials and people. When material costs went through the roof, people were saying, "We've got to do something." What else could they do? They could reduce their people costs. So there were tremendous restrictions, in terms of not hiring people or laying people off. We know that happened because that is exactly what we were doing.

Q: So when will manufacturing start hiring again?


I don't know that you're going to have enormous gains. It's not that manufacturing activity has gone down in the U.S. But it's like agriculture. You have many fewer people working in it, because the technologies are so advanced and the productivity increases are so enormous. It doesn't have to do with the American worker, that they're not productive, that they're too highly paid. It's the regulatory costs that are what really drive you over the edge. The system is really beginning to strangle manufacturing.

You get to the choice that says, "Would you rather have this legal system, or would you rather have more jobs?" They don't go together. It's cheaper today to put manufacturing jobs in Canada than in the U.S. We don't want sweatshops, but our environment must be at least as competitive as others.

Q: Can you give me a specific example of how regulation is hurting Eaton?


I can't give you a specific. But ask yourself how many European and Asian firms have come to the U.S. and found it prohibitively expensive.

The Kyoto Protocol on global warming would have made matters even worse. Signatories wanted to reduce emissions of greenhouse gases, but the reductions were not adjusted to GDP growth. They were a fixed amount. Not tough for Japan, which was shrinking. Not tough for Europe, which wasn't growing very fast. But if you're growing -- and this economy, except for China, has been the fastest-growing major economy recently -- that's very tough.

In addition, all of the developing nations were exempted. That meant all the dirty practices, if you will, would be moved to those countries, which really isn't a net plus for the world. You saw the tremendous angst about the Administration not signing it. But anyone who has really read that accord would understand that it wasn't what it was made out to be. It was very punitive for the U.S. economy.

Q: If the U.S. is such a tough place for business, why not put everything in China, Eastern Europe, or Brazil?


There are a couple of reasons. You could open a business in the Gobi Desert, and it may be very low cost in terms of getting it set up. But now you've got to have infrastructure, communications, availability of trained people, and you've got to be able to get the product flow back and forth.

One only has to think about the jam-ups that have occurred in ports over the last three years due to increased security. It takes days to clear these ports today. There are some advantages overseas, but it's not the simple equation many people make it out to be.

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