Eaton's Distance Runner

How CEO Cutler is leaving the industrial conglomerate's rivals in the dust

When he was on Yale University's track team 35 years ago, Alexander M. Cutler remembers running against Gerald A. Tinker and Frank Shorter and seeing their backs as they dashed across the finish line. He was consoled when both beat everyone else, too -- each won gold medals in the '72 Olympics. "They were fast," Cutler recalls. "Really fast."

These days Cutler is someone to catch. After five years as president and chief operating officer of Eaton Corp. (ETN ), a diversified manufacturer that makes everything from engine components and electrical distribution gear to grips for golf clubs, Cutler moved up to chairman and chief executive in 2000. Admittedly, he got off to a slow start as the downturn in the industrial sector depressed sales and profits the next year. Since then, though, 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. Sales should rise by at least 12%, to $11 billion, with earnings up 20%, to $785 million, he says. Leading the way: Eaton's truck-components business, with sales up 16.5% or more.

The 53-year-old Cutler, known to everyone as Sandy, is an Eaton lifer. He started out in 1975 at Cutler-Hammer Inc., a motor-component maker then run by his uncle. He moved on to Eaton when it acquired the Milwaukee company in 1979. Seated in his office atop Eaton's 28-story headquarters in downtown Cleveland, Cutler discussed recent business developments with Senior Correspondent Michael Arndt.

Let's start with the economy. Viewing things from your vantage point, how does the year look?

These are really very good times for manufacturers. One watch-out is you now have material inflation around the world, but I don't think it will prove fatal. During the second half of 2004, we saw the economy change from being powered by the consumer to the manufacturing side. You'll see that continue through 2005, '06, and '07.

Is that realistic?

That would not be a long expansion in the post-World War II economy. Automotive is slowing, but we are in 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 a 3 1/2-year period. You now are, in the last six months, beginning to see that move up again as well.

The other thing that's unique right now is that the strength is not restricted to the U.S. and one or two other regions. We are seeing some of the highest worldwide gross domestic product growth in 20 years. It's not just China. We're seeing the economic expansion broaden out, and that's very good news.

One of the downsides of this economic expansion, of course, has been an upsurge in raw material costs. What impact has that had at Eaton?

We went through almost a 20-year period where materials 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 about $70 million, either through price increases or other cost reductions. So we had about $70 million of pressure in our results last year. We are estimating another $140 million in raw material cost increases this year. But through continuing pricing and productivity initiatives, we expect to recoup $155 million this year.

By the way, I think materials costs have been a big reason that we've had such very low job growth. There are two input costs: materials and people. When materials 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 when will manufacturing hire again?

I don't know that you're going to have enormous gains in hiring. 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.

Can you tell me in what other ways you feel handicapped as a U.S. manufacturer?

Health-care costs are enormously challenging. We can't stand this continuing escalation, where costs are rising at two times people's sales rates.

Education, energy, and taxes are problems as well. Ill-conceived environmental regulation is another. I tell you that 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 growth in gross domestic product. 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. Anyone who has really read that accord would understand that it was not what it was made out to be. It was very punitive for the U.S. economy.

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

There are a couple of reasons. You could set up a business in the Gobi desert of China, and it may be very low-cost in terms of getting it set up, but now you've got to have an infrastructure, communications, availability of trained people, and you've got to be able to get the product flow back and forth. There are some advantages overseas, but it is not the simple equation many people make it out to be.

What's the advantage to being a diversified manufacturer? A lot of people say you should just do one thing and do it the best.

The data actually say that isn't right. On the industrial side, the highest-performing companies are the diversified industrials. Why? Because they have the ability to move best practices from business to business, there are technology rub-offs, and you get extraordinary talent in management by having people exposed to these different challenges. We like the breadth. If you're going to create an enterprise capable of growth through the cycle, you'll need a business mix.

The dollar has declined markedly over the last couple of years. Has that had an impact on Eaton?

We tend to manufacture in our end markets, so we don't tend to get jacked back and forth by currency movement. We are in China with 12 different ventures, and they basically produce products for the Chinese market, across all of our major businesses.

Tell me about doing business in China.

You're coming from an economy where there is no history of intellectual property. But what the U.S. has to understand, because we get on our high horse on this point, is this: If you're in a state-run economy, all property, including intellectual property, belongs to everyone. People in the U.S. say that's not right. But whether you like it or not, that was their system. I think the U.S. is right to continue to pound on this. But it's going to be a very slow changeover.

Back when you were in college or just starting in the business world, did you ever think you'd be a CEO?

I always wanted the opportunity to run something, though I wasn't sure what "something" was. People end up in these jobs because of luck more than anything else; a lot of things have to happen at the right time. I can remember my dad. He was a managing partner at a law firm. I remember every night after dinner my father would go back to his library and work for a couple more hours. I kept thinking: "Gosh, I'm not sure I want a job like that." Oops, now I have one. But I enjoy what I'm doing. I'm lucky.

    Before it's here, it's on the Bloomberg Terminal.