Abdullah Alarify BA 301. Pro.

Barker Final Term Paper Portland State University CATERPILLAR 6/4/2011

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Table of Contents
Executive Summary 2

Position

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Sense 5

Uncover

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Solve 13

Build 15

Achieve

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Bibliography 19

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1. Executive Summary
Heavy dependence of revenue from on non-US geographies like Latin America, Asia Pacific which are marred by the economical, ethical and legal challenges arising from diverse cultures and political pressures. The pot boiling issues may jeopardize the revenue expectation from the region. Concerns like rising interest rate due to high inflation in Latin America, India and other developing economies, monetary tightening in China and the recent Earthquake and tsunami in Japan. Caterpillar’s mission is to enable economic growth through infrastructure and energy development, and provide solutions that protect people and preserve the planet and this will ultimately suffer with the existing circumstances. A myriad of solutions that have been thought of like focusing on developed economies, shifting manufacturing to USA etc. aren’t feasible because of slow recovery in the region from recession and lack of trade agreements. The recommended solution to the problem is to customize the operations in various countries according to the current economic conditions and ethical challenges faced by Caterpillar. The initiative is to realign the corporate strategies for the key revenue drivers like China, Japan and Latin America by incorporating tactical economic and ethical changes. The human resource and sales department will play a key role in incrementing the strategy. Financial infusion of $5million would be required to drive sales by providing

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financing assistance to customers; monitoring progress on a weekly, monthly and quarterly basis.

Position About Caterpillar
For more than 85 years, Caterpillar Inc. has been making progress possible and driving positive and sustainable change on every continent. With 2010 sales and revenues of $42.588 billion, Caterpillar is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and dieselelectric locomotives. The company also is a leading services provider through Caterpillar Financial Services, Caterpillar Remanufacturing Services, Caterpillar Logistics Services and Progress Rail Service.

Caterpillar’s mission:
“Our mission is to enable economic growth through infrastructure and energy development, and provide solutions that protect people and preserve the planet.” (Caterpillar1)

Strategy:
“Our strategy is to provide work environments, products, services and solutions that make efficient use of the world’s natural resources and reduce unnecessary impacts on people, the environment and the economy. This means that we leverage resources, including technology and innovation” (Caterpillar1) Listed below are some of Caterpillar’s main stakeholders. • • Doug Oberhelman, CEO and Chairman Board of Directors

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• • • • • •

Group Presidents Vice Presidents Customers Shareholders Investors Competitors

Along with engaging to spearhead financial and strategic issues, Caterpillar also focuses on environmental and social issues. Caterpillar Inc. multi-functional research and development center in Wuxi, China was awarded Gold Certification for Leadership in Energy and Environmental Design (LEED). “This designation highlights Caterpillar's leadership in energy management, waste, material and water usage, promoting sustainable development and

innovation,"(Caterpillar1) In the wake of recent tragedy in Japan Caterpillar has pledged to provide up to $3 million in cash and machinery to support relief operations in Japan. Caterpillar Foundation, the company's philanthropic arm, will donate $1 million to the American Red Cross for disaster aid. Caterpillar Japan Ltd. will provide $1 million donations of construction equipment and engines to generate power. Caterpillar plant in Leicester and Desford in England achieved zero waste to landfill in 2010. Caterpillar Foundation also announced a donation of $1 million to Opportunity International in 2011 to fund "Banking on Africa" initiative, which will develop a network of banks to address the capital infrastructure needs of poor communities in

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Africa which align with its mission is to support programs that foster sustainable humanity (opportunity international2). Caterpillar Inc. recently adopted guidelines on corporate governance issues; these guidelines reflect the board’s commitment to oversee the effectiveness of policy and decision-making both at the board and management level, with a view to enhancing stockholder value over the long term. (Caterpillar, February 9, 20113)

Sense
As the global economy continued to improve, the demand for Caterpillar products saw an upward trend. Around the fourth quarter, Caterpillar witnessed an increase of 62% in sales and revenue as compared with the previous year (www.caterpillar.com 4). Year 2010 marred a good year for company in terms of increase in production, enhanced efficiency, higher operating cash flows, new capacities and products were added to expand the business and to set the course ahead for 2011. Company grew through acquisitions as well. Financial Products revenues decreased $135 million primarily due to integrated service businesses performed better throughout the business cycle as compared to new machines and engines even sales and revenues for 2010 showed an upward trend. However, new machines and engines, integrated service businesses formed a smaller part of the company sales and revenues than the previous year. These businesses represented about 40 percent of total company sales and revenues in 2010; the share was 13% lower as compared to 2009. One aspect that didn’t work in the companies favor was the currency which had a negative impact on sales of $14 million. (Inputs from CAT SEC filings)

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If we take an overview of the situation of Caterpillar, we can divide the issues into three segments problem faced in 2010, upcoming risk, and geographical concerns.

Problems
We did see an upward trend in earning however; improvements were partially offset by higher SG&A and R&D expenses and the negative impact of currency along with a couple of other factors: • SG&A and R&D expenses increased by $986 million primarily due to provisions for incentive pay and increased costs to support new product development programs, including those related to emissions requirements. There was an increase of about 20 percent in R&D expense. (Caterpillar, 2010, SEC earning release.) • Other income/expense was income of $130 million compared with income of $381 million in 2009.The decrease was because of unfavorable impact from currency gains and losses. Machinery and Engines currency hedging losses were near $50 million in 2010, which was down about 125% as compared to 2009. • • • An unfavorable product mix. Redundancy costs were $706 million in 2009. Higher tax expense, primarily from an unfavorable geographic mix of profits from a tax perspective. • Bridge financing costs of about $50 million related to the Bucyrus acquisition and some additional cost related to integration planning.

Risk
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In the course, ahead company may have to face new challenges like: • Most energy and metals prices have increased since early 2009; the company is expecting average prices to be higher in 2011 than in 2010. As per the forecast copper prices will hover around $4.25 per pound, West Texas Intermediate oil, $92 per barrel is expected to go even higher because of the Middle East unrest. • Higher commodity prices, particularly for oil, will result in an increase in inflation. In April, Caterpillar Inc. had the biggest decline in the Dow Jones Industrial Average, losing 2.9 percent. • Company is concerned that central banks in the developed economies like India, brazil which are reeling through very high inflation right now may begin tightening economic policies at an aggressive rate to curb inflation. • World economic recoveries have diverged, disrupting the consensus on economic policies that developed early in the financial crisis. Policy differences are creating trade and currency tensions and increase the potential for trade frictions like the case of China devaluing its currency. Figure 1.

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Geographical Concerns
Developed economies Developed economies responded slowly to economic downturns, and high unemployment remains a problem for the United States, Europe and Japan. Weak labor markets have impeded recoveries in housing, office and retail construction. There is a concern that central banks in the developed economies may begin tightening economic policies too quickly. Modest interest rate increases in both Australia and Canada, two of the stronger developed economies, quickly caused some weakness in construction indicators (Caterpillar1) • S&P downgraded its outlook on the United States credit rating to negative, as they are concerned about U.S. policymakers being able to address the long-term fiscal pressures. • U.S. housing starts increased 6 percent, resulting in the second worst year for housing since 1945. The weak job market held household formations at approximately half the long-term average. As a result, new home sales declined 15 percent. • Orders for U.S. nonresidential building construction dropped 15 percent, the third year of declines. Both office and industrial vacancy rates increased further, and selling prices for commercial properties declined. Africa and Middle East Oil-producing countries accounted for the largest part of the volume gain in Africa/Middle East. Oil prices rose 29 percent, production increased 1 percent, and the

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number of operating drill rigs expanded by 11 percent (CAT). However, political unrest, in Middle East and further spreading in Bahrain, Yemen, Libya possess a great threat to future growth in these countries. Developing Economies In response to the recession, developing economies had cut short-term interest rates. As their economic conditions improved they have increased rates from their recession lows, and a further increment is expected in 2011. China has been tightening policies, and this will account for much of the slowing. Latin America Latin American economies are expected to slow from approximately 5.5 percent growth in 2010 to 4.5 percent in 2011, largely the result of interest rate increases in Brazil and Chile

Key Area of Concern
Figure 2. Urgent Ethical, Mission Critical economical Not Urgent and Slow Economic

legal challenges faced in recovery in USA non-USA geographies. based

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Not Mission Critical

Higher Commodity price

Higher R&D cost

Heavy dependence of revenue from on non-US geographies like Latin America, Asia Pacific which are marred by the economical, ethical and legal challenges arising from diverse cultures and political pressures. Concerns like rising interest rate due to high inflation in Latin America, India and other developing economies, monetary tightening in China and the recent Earthquake and tsunami in Japan. The pot boiling issues may jeopardize the revenue expectation from the region.

Uncover
There is not a single source for the problem that Caterpillar faces. There are several variables that coexist that created this problem and the large impact that it has. Some are intertwined with each other and some could be a problem on their own, but they directly correlate to the problem at hand. A fishbone diagram (figure 2) was constructed to map the possible causes of the problem. Figure 3.

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Caterpillar India
Caterpillar Inc. is facing challenges in India in spite of good industry growth numbers because of the ambiguous policy on environmental issues basically the problem lays with the Environment Ministry. There has been significant political risk, as recently the local environment ministry has put mining licenses on hold for MNC’s like Posco and ArcelorMittal. (globeinfowire5). There are ample reports of illegal mining around various parts of the country and supplying equipment to such miners would be against the Mission and ethics of Caterpillar too. If India does not come out with objective standards on these issues and enforce them uniformly, it will have “serious negative consequences for India in the near future.” (Asia head, Caterpillar)

Caterpillar China

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The reason why China is critical for Caterpillar is that China is the world's largest market for construction excavators, wheel loaders and other earth-moving machinery. However recently the increasing level of hostility between China and USA over jobs, allegations of China devaluing its currency to sustain its low cost manufacturing industries and other economic and trade issues is “undermining Caterpillar's expansion strategy in China” (Oberhelman, Caterpillar). Currency war: The Fed’s $600 billion injection into the U.S. financial system has helped weaken the dollar 8.5 percent, which helped Caterpillar Inc. boosted foreign sales by about a third last year, has be highly criticized around the world by Germany, China and Brazil that the U.S. was starting a competitive devaluation of the dollar, hurting their economies. Brazil in order to curb the currency from appreciating has tripled a tax on foreign investors’ fixed-income purchases to 6 percent. China increased banks’ reserve requirements to lock up cash and cool inflation. Other concern include the ethical issues which Caterpillar stands for i.e. its endeavor to market, distribute or sell its products, in business environment that conform with international human rights and humanitarian standards however the same are highly exploited in China.

Caterpillar Japan
After the devastating earthquake and tsunami Caterpillar Inc. estimates that disruptions in its supply chain in Japan could sporadically affect the company's assembly plants elsewhere in the world. Caterpillar said its plants Sagami and Akashi, Japan, remain open, but production levels have varied from day to day.

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Caterpillar Latin America
Latin American economies are expected to slow from approximately 5.5 percent growth in 2010 to 4.5 percent in 2011, largely the result of interest rate increases in Brazil and Chile. Latin America is struggling to contain rising inflation, with policymakers trying hard to control the food prices and increasing foreign direct investment flowing into the capital market. Officials voiced concern over the inflation fight in Brazil, Peru and Chile. Interest rate increase is the only disposable measure in hand to control prices. After identifying the problems, the next logical step is to identify ways to resolve the issue faced by Caterpillar. Weighing the pros and cons on each possible solution will help us identify the best resolution. A couple of potential solutions are: • Simply ignore the ethical and political challenges and supply the equipment irrespective of their possible use. • • • Focus on developed economies like America for revenue growth Manufacture in USA for export purpose Develop customized solution to tackle ethical as well as financial issues in developing economies.

Solve Simply ignore the ethical and political challenges and supply the equipment:
It can cause litigation like alleged Caterpillar Inc.’s role in human rights violations in the Occupied Palestinian Territories in which a Caterpillar D9 bulldozer was directly

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involved in the death of U.S. citizen Rachel Corrie in March 2003. Reports say an Israeli soldier drove Cat supplied bulldozer over Rachel while she was protesting against a drive, which was demolishing, homes in the Gaza Strip. Corrie family had filed a lawsuit and the current trial underway in Haifa, Israel, “Rachel Corrie v. the State of Israel”. Such allegation and litigation against company can cause huge financial and reputation loss. Misuse of its equipments for carrying out illegal activities like unauthorized mining is not only against law but clearly against the stated mission of Caterpillars endeavor to protect people and environment.

Focus on developed economies like America
The United States used to lead the world on trade; post the sub-prime crisis the story is becoming alarming massive financial reforms are required. Economic recovery has been painfully slow. The U.S. tax code is another source of uncertainty. Profitability took a hit in 2010 due to massive healthcare and state pension reforms. Developed economies grew almost 2.5 percent in 2010, a rate of growth was not sufficient to push the economy and to foster much improvement in high rates of unemployment. Moreover there is a rising concern over central banks in the developed economies may begin tightening economic policies aggressively. Modest interest rate increases in both Australia and Canada, two of the stronger developed economies, quickly caused some weakness in construction indicators. So to narrow down the focus to developed economies will be counterproductive.

Manufacture in USA

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It is not only expensive with the rising commodities prices, lack free trade agreements with some of Caterpillar’s largest trading partners and key growth markets such as Brazil, China and India would make it all the way more expensive. Other countries have aggressively pursued trade agreements that leave U.S. exporters at a competitive disadvantage.

Develop customized solution to tackle ethical as well as financial issues in developing economies
The idea is to customize the operations in various countries according to the current economic conditions and ethical challenges faced by Caterpillar. The initiative is to realign the corporate strategies for the key revenue drivers like China, Japan, and Latin America etc. by incorporating tactical economic and ethical changes. Keeping in mind the potential of growth these markets can provide it is in the best interest of Caterpillar to focus on each market independently as the nature and scope of issues vary from country to country. Therefore, we would further elaborate on developing customized solutions as the recommended course of action.

Build
Following are the region wise customized solutions:

China

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People’s Bank of China raised a key lending rate by a quarter-point, in an effort to slow the economy and combat consumer prices that have been rising at an annual clip of more than 5 percent. It was China’s third such rate increase in four months. Beijing began allowing foreign companies to issue Yuan debt last year. Considering the tightening monetary policies and rising interest rates Caterpillar can look for alternate ways to provide financing for buyers in order to sustain sales like selling Yuan-denominated debt to finance activities in China. Caterpillar should also hedge through currency forwards to protect against currency valuing uncertainties in China. In China authoritarian rule has been the norm, media is strictly monitored and controlled, common criticisms are over areas such as human rights, environment, and labor standards The key to solve this problem is in designing policies, which can be implemented across countries where Caterpillar does business. Caterpillar should review and design policies to protect human rights along with civil, political, social, environmental, cultural and economic rights based on internationally recognized human rights standards.

Japan
Post the earthquake and tsunami, to restore the supply chain management to provide components to Caterpillar operations inside and outside of Japan, a contingency plan is the need of the hour. Caterpillar Inc. should closely monitor the situation in Japan and should the need arise they should look for alternative sources of suppliers for components produced by Japanese-based establishments.

India

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Caterpillar Inc. should be cautious of fresh investments into India and should wait for the local Government to come out with a clear policy on environmental issues. It is in the best interest of the organization to work along with Indian corporations which have established repute.

Latin America
Economic growth in Latin America will fall to 4.5 percent in 2011 from 6.1 percent in 2010 as inflation and rising interest rates curb expansion. (Institute of International Finance). Brazil raised its rate 50 basis points to 11.75 percent in March. Inflation could have a negative impact on the credit standing of banks, as it could hamper macroeconomic growth and potentially weaken the financial conditions of borrowers (S&P April, 2011). Subsidiary of Caterpillar in Latin America should enter into agreements with its dealers in Brazil, Peru and Chile and with banks and Non-Banking Finance Company's (NBFCs). As not all dealers can afford to tie up their funds in installment contracts, the collaboration agreements will give customers in Latin America new finance options for the purchase of Caterpillar machinery and power systems, which are being used to fuel growth and a wide range of development in the region and help CAT, sustain its revenue from the region. The idea is to offer competitive rates, security and liquidity.

Figure 4. Cost Benefit Analysis
Tangible Costs • • • Infusion of 5 million through Caterpillar financial services. Increase in Sales by 6%, an approx. increase in revenue of 9 million on y-o-y basis. Possible cost of law suits for causing imbalance in

Tangible Benefits Intangible Costs

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ecosystem due to illegal mining. • • Intangible Benefits • • Lost business due to customer’s financial incapacity to buy equipment. More customer satisfaction Improved company status Improved sales response time

Achieve
• To implement the ethical issues Caterpillar human resource department can take guidelines from The International Council on Human Rights Policy. • Caterpillar Financial services can tie-up with certain Sales finance companies to provide loans to small and medium enterprises and help them project finance for capital equipment and infrastructure by partially funding starting with a budget of 5 million for Latin America and India. It will also offer 0% financing on all Cat Work Tools. • Caterpillar will start by selling $150 million in Yuan bonds to provide financing for buyers of its heavy equipment in China. • To measure the effectiveness of loans provided to customers Caterpillar will pay close attention to inflationary trends, the effectiveness of policy measures, and any subsequent impact on the quality of loans. • To measure employee satisfaction a quarterly e-sat survey would be conducted. Any ethical issue reported needs to be addressed within a fortnight. • The new financing activities should lead to an increase in revenue by 6% on y-o-y basis. 19

Caterpillar financial division will set rates weekly to reflect current market conditions.

To begin with, Caterpillar should do a monthly analysis on the situation, once the conditions stabilized, and agreements have been set a quarterly review would be good.

Appendix 1

Appendix 2

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Bibliography "Caterpillar: Learn about our company." Caterpillar . Caterpillar Inc, n.d. Web. 25 May 2011. <http://www.cat.com/about-cat>.

“Opportunity International” Web 25 May 2011 <www.opportunity.org/about/strategic-partners/caterpillar/> “Caterpillar Inc Guidelines on Corporate Governance”, Feb 9, 2011; Web 26 May 2011 <http://www.caterpillar.com/cda/files/2499389/7/Guidelines+on+Corporate +Governance+Issues+(adopted+Feb+9,+2011).PDF> “Caterpillar Quarterly results”, Caterpillar Inc. Web 26 May 2011 <http://www.caterpillar.com/investors/financial-information/quarterlyresults>

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K. Giriprakash. “Caterpillar wants clarity on Environment policy” Web 26 May 2011 <http://globeinfowire.com/caterpillar-wants-clarity-on-environmentpolicy/> Caroline Salas and Catarina Saraiva, “Fed Answers Brazil-China-Germany Axis Over QE2 With US Growth”; Web 28 May 2011 <http://www.importsofasia.com/2011/04/03/fed-answers-brazil-chinagermany-axis-over-qe2-with-us-growth/> Oak Brook. “Businesses Successfully Meet Caterpillar Foundation's Corporate Giving Challenge for Opportunity International”. Feb 17, 2011 Web 28 May 2011 <http://www.csrwire.com/press_releases/31613-BusinessesSuccessfully-Meet-Caterpillar-Foundation-s-Corporate-Giving-Challengefor-Opportunity-International> P & O Cruises (2008). pp 26. Web 29 May 2011, <http://www.pocruises.com/pocruising/Home.aspx.> Linda, D. (2000). “Braking for Growth”; Web 29 May 2011 <http://www.echoinggreen.org/resource/orgdev/carr1.htm on 2nd February 2008> Canales, J., Kibble, B., and Terk, N. (2000): One step beyond strategic planning. Foundational news and Commentary, Vol.41. Web 29 May 2011 Hay, R. “Strategic management in non-profit organizations. Westport. Greenwood Press”. Web 30 May 2011 Lazear, E.“Performance and Productivity. Journal of Human Resource” Web 30 May 2011 Kim, C. “Management Strategies; Journal of Business Strategy”, Vol. 5(9): 89-100. Web 30 May 2011

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