As a Ph.D. economist and new CFO at the time, Dr. Owens recognized that the business unit structure could uncover cost problems only if transfer prices were negotiated from market benchmarks, “so the losses showed up where the cost problems were. And if you lose that discipline, you’ve lost it. I was thrilled that [Fites] took that very staunch position.”
It was no small feat to create reliable metrics that would give every division its own balance sheet and P&L. In June 1990, Mr. Fites went to the “unsung information heroes” (as one observer later called them) of the accounting division and asked how long it would take. They said they thought they could do it in three years. “I told them, ‘I want every one of these divisions to budget next year on the basis of their new balance sheets and come up with a P&L,’” Mr. Fites recalls. “And Bob Gallagher, who was our comptroller — the blood drained from his face. I thought he was going to faint right on the spot! But you know what? They did it. And they did it well. We hardly ever had to make any changes in the balance sheets or the P&Ls. That six months was probably one of the most incredible transitions that ever took place around here.”
Motivators on Target
“The great motivator,” says Don Fites, “was survival — survival of the company, your personal survival as an important player, survival of this product that you love and that you designed, the survival of your plant.” Nevertheless, Cat’s reorganization also involved an overhaul of the compensation plan. Before the reorganization, individual bonuses were based on overall corporate performance rather than business unit objectives. After the reorganization, an employee could make anywhere from 7 to 45 percent additional salary per year based on meeting business plan targets.
These incentives cascaded through the organization and helped the business units focus on tangible, measurable outcomes that line employees could affect. For example, John Pfeffer recalls a new concetration on meeting delivery commitments: “We supplied all these little components, and prime product plants just go berserk when you shut them down because you missed a shipping date. So our incentive plans were heavily skewed [toward meeting the shipping dates]. And what happened was, we started meeting [those shipping dates without] expediting stuff all the time.”
Mr. Schaefer (who remained on the Caterpillar board for several years after retiring) credits the compensation plan with generating buy-in for the change deep down in the organization. “We had a lot of trouble in the middle and lower ranks buying into these many changes. But when we told them, ‘If you get your revenue up by 10 percent, and you get your profit up by 20 percent, here’s the amount of bonus you earn,’ they bought into that in a hurry!”
The compensation committee of Caterpillar’s board set up a long-term incentive plan for top management, and short-term incentive plans for individual units. Under the short-term plans, managers in business units who outperform their ROA targets receive bonuses even if the company does not meet an overall target. But by far the larger incentive is provided by the long-term plan, under which Cat executives can earn bonuses when the company outperforms a peer group of about 15 other companies on ROA and profitability growth targets. Glen Barton believes that the incentive plan has “caused people to work together.”
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| Clockwise from top-left: Caterpillar's assembly plant in Mexico, mentioned in this article for its innovative resale of scrap steel; two views of the East Peoria, Ill., plant; Cat's hometown retail store in Peoria. |
