ITW's Formula for Innovation

Illinois Tool Works might seem like an unlikely innovation incubator. The 93-year-old company manufactures a hodgepodge of mundane products, from automotive components and industrial fasteners to zip-strip closures for plastic bags and laminates for flooring and countertops. Its R&D outlays, moreover, come to just 1% of sales, a miserly budget for even a bulk commodities producer. Yet ITW (ITW) routinely finishes among the Top 100 patent recipients in the U.S. every year, ranking 66th in 2004 with 301 new awards and 468 applications.

Among its newest inventions: A heater for automobile seats made by printing conductive ink onto a thin, flexible plastic film. Nissan Motor (NSANY) will offer this product, which costs only half as much to make as today's toaster-coil devices, in the 2006 model of its Infiniti G35 this winter.


  ITW owes its outsize achievements to an unorthodox business model. Like many old-line outfits, ITW gets most of its growth from acquisitions. It has averaged 28 deals a year over the last decade. But management doesn't merge new units into old ones as most companies do in order to reduce payroll and other expenses. Instead, it retains them as freestanding entities to maintain their entrepreneurial drive and keep them close to their customers. Today, the $11.7 billion conglomerate operates through 665 separate businesses, each with its own P&L statement.

The company also follows an 80/20 strategy, based on the so-called Pareto principle first suggested by management thinker Joseph Juran. With 80% of sales and profits typically coming from just 20% of customers, ITW identified this top tier and lavishes attention on it -- including custom-designed products -- to maximize the return from ITW's personnel and assets.

In August, David Speer, a 27-year company veteran, took over as chief executive. Speer, 54, worked his way up through ITW's construction operations after earning a Bachelor's degree in industrial engineering from Iowa State University in 1973 and an MBA from Northwestern University's Kellogg School of Management in 1977. Sitting in a bare-bones conference room at ITW's headquarters in Glenview, Ill., a suburb of Chicago, Speer talked recently with BusinessWeek Senior Correspondent Michael Arndt. An edited transcript follows:

Let's start out by talking about ITW's decentralized nature. Most big companies focus on consolidation to achieve economies of scale and so-called synergies. You seem to go to the opposite extreme.

Our business model clearly is the antithesis of scale. To begin with, our organizations tend to be small and lean. If I were to look at combining several units, the real cost savings we would wring out would be relatively modest, and the lack of focus we would end up with by consolidating would be tremendous.

This speaks to our 80/20 approach. At many other companies, you would find a disproportionate amount of resources being spent on that 80% of activity that creates only 20% of financial results because everything is judged the same -- all customers, all products, all orders, all markets. When you start scaling things up and putting them together, it becomes harder to get at the underlying data, and the 80/20 proposition is lost fairly quickly.

There's also a greater participation by the employees in running those smaller, more tightly focused units. And that leads to a much greater intimacy with the customer. If you're listening to your customers and what their needs are, you're in a much better position to react than if you're managing much larger businesses that are more concerned about economies of scale.

How does this play out practically at ITW?

A good example is our new seat heater. We started out by looking at warranty costs from the original equipment manufacturers, or OEMs, a few years ago. We discovered there was a big issue with seat heaters. They often stop working, and to fix them, you generally have to remove the seat from the car.

We didn't have any seat heaters at the time, but we had this heating element we had developed almost 20 years ago for the side mirrors on your car. So some of our engineers said: What if we put this into a seat? They went through a lot of iterations because this is a different application. In a seat, this has to flex regularly. This has to fit contours, not like a flat piece of film behind a mirror.

The benefit to the customer -- you, sitting in the seat -- is you can adjust the control any way you want, and it will self-regulate the temperature automatically through the resistance in the circuit. The major advantage to the OEM is that the heater can be serviced without pulling the seat out of the car. And because it's an electrical item as opposed to an electrical-mechanical assembly, it's much simpler in design. We're excited about this because it's a patented, proprietary item that adds value and allows us to get a little more money.

Does the 80/20 approach have productivity payoffs, too?

We dedicate production lines and resources to high-volume products. Those lines run only the three or four products, if that's the case, which represent the 80% of that business. We're able to make fewer changeovers with these lines, which enables us to increase the life of tooling on those lines.

Longer runs are more efficient. We're generally able, by physically linking machines, to eliminate work in process and storage areas, which means a smaller footprint. And, of course, all of the material handling and the indirect costs are reduced.

That doesn't mean we don't pay attention to the 80% that create only 20% of the value. It just means you have to look at managing those separately.

I would bet that China and India are big growth markets for ITW. How are you expanding in these markets?

We operate with the basic philosophy that we want to produce where we sell. If I'm going to sell a product in China, I want to produce it in China. If I want to produce locally, then I have to be able to compete locally and make a decent return.

Rarely do we ever get into a geographic market through acquisitions. We like to get our feet on the ground and assess the market and the opportunities with our own local management team first.

Today, we have 21 businesses in China. Only one of those has been an acquisition, and that started out as a joint venture. Now, we've looked at a number of acquisitions in China, but frankly what's available today -- [often] remnants of state-owned enterprises -- isn't particularly attractive. And in many cases, they want to do joint ventures and not sell outright. In our view, the market is not right yet for us for acquisitions.

In India, we have 11 businesses. Two of those started out as joint ventures that are now wholly owned. I think the opportunity for acquisitions in India will be quite good going forward.

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