Getting Emerson Humming Again

James Berges talks about the benefits of lean growth and the trap of higher costs

Emerson Electric Co. (EMR ) had one of Corporate America's longest winning streaks. The St. Louis manufacturer posted steadily higher earnings for an incredible 43 years in a row. Then, with the collapse of the telecom industry and a drop in most of Emerson's other businesses, the streak came to an abrupt end in 2001, with profits falling 27.5%.

The company wasn't down for long. Emerson, which makes everything from air-conditioner compressors to computerized equipment that can run an oil refinery, increased revenues steadily for the next three years. In the fiscal year that ended in September, 2004, sales were up 12%, to $15.6 billion, an all-time high. Profits, which increased 15.5% last year, to $1.26 billion, still haven't topped 2000's record of $1.42 billion. But they may in the current fiscal year. Despite some worrisome signs here and there, Emerson says net income should climb 10% to 15% on a sales increase of 9.5%.

The 125-year-old company is benefiting hugely from the rebound in U.S. capital spending and from China's economic boom. But that's only half the story. Influenced by Toyota Motor Corp.'s (TM ) lean-manufacturing practices, Emerson execs have closed or sold 140 factories and cut head count by 16,100, or 13%, since 2000. At the same time, the company has been outsourcing more and more work to China, Mexico, and other low-wage countries.

James G. Berges, 57, is Emerson's president. A former engineer at General Electric Co (GE )., Berges was hired at Emerson in 1976 as director of manufacturing planning and worked his way up to the company's No. 2 post in 1999. Berges recently spoke with BusinessWeek Senior Correspondent Michael Arndt. An edited transcript of their conversation follows:

Tell me about the economy.

I've seen our order data through January; they're actually pretty good in the U.S. But we think the economy will slow down in the second half. The consumer is getting a little wobbly.

But we could get surprised. U.S. manufacturing companies, particularly oil and gas, are awash in cash. As the cash piles up, you've got to do something. You could increase your dividend payout, or you could invest in those productivity programs that you've back-burnered for the past couple of years. So even if the consumer goes into a little funk, the capital-goods sector might stay good. We think this will be sustainable for a while.

Is economic growth outside of the U.S. less promising?

We have seen a slowing, particularly in Europe. People just aren't spending money. We're heavily focused on capital goods in Europe. You combine the very strong euro with the rigidity of the workforce -- your inability to lay people off when there's a downturn -- and it's a difficult environment to invest in. We're looking at a pretty much flat year.

I hate to say this, because we've got terrific German, French, and Italian companies and people, but you hate to hire people in those countries because the cost is so enormous if you ever have to take them out. As we have had attrition in Western Europe, we have just not replaced people. And I've got to believe the same thing is going on with everyone else.

What about China -- threat or opportunity?

Our growth in China has been terrific. We grew over 25% in China last year. Our sales reached $1 billion. I'd say '05 will continue to be pretty strong for us. These guys have done a marvelous job of managing the economy so far. I'd almost say we're on fire there.

Do you see your capital spending migrating toward China?

Sure. We like to build factories in the market where the sales are. But we can do business in China for a fraction of the capital that we can do in the U.S.

There's a terrific base of suppliers who are very competitive. You go to China, and everywhere there are people who are willing to take the risk to go down the street and rent a garage and buy a screw machine and start a business. So we rely on them to invest the capital. We're putting more capacity in Asia, but we're not spending massively more.

Are your facilities in China primarily for the Chinese market? Or are they used to build products for export?

We do both there. We manufacture roughly $700 million worth of goods in China, and we import about $300 million. But then we also export $300 million. We've got about a perfect balance of trade there.

Given your increasing exposure, do you have any worries that China will slow down too abruptly?

The biggest concern has to be currency. They are swimming in dollars. Because the yuan is pegged to the dollar, they have to print yuan to convert all the dollars flooding into the country. That increases the money supply and increases inflation and speculation.

The problem they've got is keeping the export engine going and not getting a bubble in the economy and runaway inflation -- and the whole thing comes down. For their own sake, they probably need to let their currency appreciate.

How does Mexico fit in?

A couple of years ago people were starting to move from Mexico to China. I think that has slowed down. First of all, just picking up and moving from Mexico to China doesn't really save you a lot. Wages are lower in China, but they're marginally lower. Wages are $1.50 an hour in Mexico and maybe 90 cents an hour in China. You wouldn't pick up and move just for that labor differential. In fact, many times, freight costs and the inventory you have tied up on the water eat up the difference. But you might move because you have that supply base in China. For whatever reason, the Mexican economy never developed this support structure. Either way, you want to spread your bets: You don't want all your investment in China, or in Mexico.

Emerson is probably a typical manufacturer when it comes to hiring. Your sales and profits are climbing, but your payrolls are shrinking. Do you see manufacturing ever becoming a big hiring machine again?

Probably not, to be realistic. You've got this combination of low-value jobs going to Asia, which will continue, and productivity gains, which are so terrific.

I don't think people realize how much savings you can get when you're serious about lean manufacturing. It has had a huge impact inside Emerson. Your productivity rates really go up, and I don't mean 2% or 3%. We get jumps of 5% and 6%. You get rid of a lot of unproductive jobs. I don't need an expediter or a scheduler or a forklift driver in a lean factory.

Raw-material costs have been rising. How do you deal with that?

We had the good fortune of having long-term contracts with most of our steel suppliers, and we had hedged much of our other raw-materials needs. So when things started to run up, we had some level of protection. We had time to go out and get some price increases.

It's easy to get increases in some markets. For instance, when you're selling spare parts one at a time, there's a lot of price elasticity there; customers need these parts right away if their machines are down. In this aftermarket space, we could raise prices 5% or 6%. But when you're selling to a large original equipment manufacturer, it's harder. If we could get 1% or 2%, we'd be lucky.

But at some point, contracts expire and hedges come off, and now you're exposed to market prices. In our first quarter ended in December and in our March quarter, our results do reflect pressure on our margins. But we should look a lot better in our second half. We've locked in new supply contracts, and we've negotiated new prices with customers.

Health-care costs are rising too.

They're going up double-digit. Like everybody, we try to defer that. One of the big things you do is push some of it on employees. It's an unfortunate thing, but it's something we have to do to be competitive. It's still a big issue for us.

Let me ask you about corporate governance and new regulations on Corporate America, such as the Sarbanes-Oxley Act.

Sarbanes-Oxley is an opportunity for us to transfer money to accounting firms. That's all it is. The thought that these guys would somehow be able to come in and find something in our financial reporting process that was a reportable offense is laughable.

Under Section 404, your accounting firm, on top of the auditing work, has to run around and make sure all your policies and procedures are being followed. What do they find? They find that a guy in Oshkosh did the work but didn't initial the bottom of a piece of paper. To find that out, we get to pay $2.2 million. That sure helped the shareholders. I find it offensive, to tell you the truth.

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