1. During the two decades following WWII, Caterpillar management focused on an aggressive growth strategy aimed at anchoring its position as a leading producer of construction machinery on a global scale. This strategy was directed by four underlying policies.
(Exhibit 1) Caterpillar’s goal in competing in a global market was to seek new markets and increase its revenues. High R&D and high capital intensity of Caterpillar’s business, and homogenous customer needs favored the adoption of an aggregation strategy.Caterpillar had recognized that due to its industry focus and worldwide product standardization policies, there were significant potential savings through economies of scale and scope to be exploited by international expansion. Caterpillar’s cost and quality advantage would allow it to enjoy a leading position in the new markets that it entered and prevent local firms from growing into potential competitors. Initially, Caterpillar adapted an export strategy to supply its foreign markets.However, high tariffs and shortage of foreign exchange during this period made it very difficult for Caterpillar to fully penetrate many international markets through this strategy.
Starting in 1950, Caterpillar changed its market entry mode from one that only relied on exports from the US, to building wholly owned plants in its international target markets. In 1964, non-US plants accounted for 15% of Caterpillar’s production capacity. Caterpillar ensured to maintain direct ownership of wholesale marketing and warehousing activities in those markets.This would allow it to stay a tuned to customer needs, provide better customer service, and protect the reputation of its brand.
In 1960 Caterpillar management decided to enter the Japanese construction machinery market, which was worth $300-$350 million. Caterpillar knew that a major presence in the Japanese market was essential to its pre-emptive market occupation policy. However, due to high tariffs and foreign exchange rationing it was almost impossible for Caterpillar to serve the Japanese market with US exports. This caused Caterpillar to have to produce its products in Japan.
Caterpillar was not interested in licensing its technology to local producers. The inferior production quality of Japanese heavy machinery manufacturers caused Caterpillar to be fearful of negative effects on its brands and leakage of its intellectual property. Further, government regulations prevented Caterpillar from establishing a fully owned manufacturing facility in Japan. Caterpillar’s management recognized that the best plan of action to penetrate the Japanese market was to create a JV with a partner with “local know-how”.In 1962 Caterpillar established a joint venture with Shin Mitsubishi Heavy Industries (MHI) called Caterpillar Mitsubishi Ltd (CML).
Through this JV arrangement, CML produced a range of Caterpillar branded products, which Caterpillar deemed suitable for the Japanese market. This control over the product mix was in line with Caterpillar’s industry focus strategy. Also, since the machinery produced by the JV used the same design and technology as any other Caterpillar product, Caterpillar’s goal of worldwide product standardization was satisfied.CML allowed Caterpillar to enter a market with huge potential. However, through the licensing of its products, the sharing of all patents and process improvements developed by CML, presence of 30-40 Caterpillar advisors at the CML factories, and training of JV staff in Caterpillar’s US facilities, Caterpillar provided MHI with the tools to develop into a world class competitor. This goes completely against the pre-emptive market occupation strategy adapted by Caterpillar management.
Also, it is unclear if Caterpillar maintained direct ownership of wholesale marketing and regional warehousing activities.CML agreement seems to clash with Caterpillar’s direct market presence strategy. * This answer does not comment on the financial returns and focuses on more qualitative aspects of success or failure for Caterpillar as it relates to CML. Financial returns are discussed in question 4. 2.
*Caterpillar’s strategic goal after WWII was to aggressively expand and become one of the leading producers of construction machinery on a global stage. Caterpillar’s strategic goal for creating CML was to gain access to the Japanese and Far East markets, which top management viewed as key in becoming a top global competitor.Access to this market would have been impossible due to government regulations and other non-market factors such as outcry from local producers and protectionist groups. By partnering with MHI, Caterpillar gained a partner that allowed it to navigate the non-market factors in Japan and gain access to the regional market, thus fulfilling its strategic goal of global expansion. In selecting a partner, Caterpillar was looking for a Japanese company that shared its cultural values, its conservative approach to business, and its management style.
MHI, under the eadership of Mr. Makita, demonstrated such shared valued. MHI had expertise in metal work, development of large scale machinery, and had access to plant capacity. This overlap in technology and capabilities increased the absorption capacity between the two partners. Further, the similarities in organizational size, operations, and culture made MHI a good fit for Caterpillar. Since MHI had no previous experience in development of construction machinery, it would be dependent on Caterpillar’s design, engineering, and manufacturing capabilities.
MHI leadership was eager to assist in knowledge sharing, thus creating high bandwidth knowledge transfer channels between the two companies. The strict structure of the JV and the quality MHI as a partner made it so that potential problems such as leakage, free-riding, and hold-up were avoided. In terms of quality of partner, CML was a success for Caterpillar. Finally, CML should be evaluated based on how well it fits with Caterpillar’s four underlying policies for global expansion. Expansion to the Japanese market was seen as essential to Caterpillar’s preemptive market occupation strategy.
However, by partnering with MHI and sharing its internal capabilities, Caterpillar gave MHI the ability to improve its processes, gain expertise, and develop into a world class competitor. MHI could exit the JV agreement and start its own line of heavy machinery. Caterpillar gained the ability to enforce its industry focus strategy by retaining control over the product line produced by CML. This way Caterpillar could remain focused on its core business.
However, this steadfast avoidance to change its CML product line became a source of tension between the two partners.Also, by ensuring that only Caterpillar designed and branded machinery were produced by the CML, Caterpillar furthered its worldwide product standardization policy. CML actually became a supplier of parts to Caterpillar’s US manufacturing facilities. It is somewhat unclear if Caterpillar retained control over wholesale marketing and warehousing activities through the JV agreement. Caterpillar had to sacrifice many of its four underlying principles to enter the Japanese market. But since both parties seem committed to the JV for the long-term, there should be little negative impact to Caterpillar resulting from undermining its four policies.
. *The strategic objective of Mitsubishi in entering the CML agreement was to allow the company to enter the growing construction machinery market and compete with other domestic producers. The Japanese producer lacked the quality and design to compete with foreign producers. The JV agreement with Caterpillar provided MHI with access to Caterpillar’s designs, patents, and know-how through the 10 year license to CML. Further, any patents or process improvement developed by CML was shared by both companies.MHI’s employees working at CML could also sharpen their manufacturing and marketing skills by working with and learning from Caterpillar’s 30-40 advisors.
And finally, having JV employees trained at Caterpillar’s US facilities further enhanced knowledge sharing and knowledge spillover between the two companies. At the time of JV renegotiation in 1986, it is clear that the poor quality and design that plagued the Japanese producer is no longer an issue. * This answer does not analyze the financial returns and focuses on more qualitative aspects of success or failure for MHI as it relates to CML.Financial returns are discussed in question 4. By 1980, CML sales had reached $885 million, making it the second largest producer of construction machinery in Japan. From 1973-1980 CML’s sales growth and average return on equity were superior to its largest rival.
However, this advantage disappeared during the next 6 years as the company experienced declining sales and profitability, partly due to its limited product offering and royalty payments to Caterpillar. Despite the concisions made by MHI in the original JV negotiations, it seems that the company has achieved all of its strategic goals.The royalty payments, the limited product offering, and geographic market limitations imposed upon it were the price MHI had to pay to become a player in the Japanese construction equipment market. MHI was able to work with and learn from a global leader in construction machinery business, and build the capabilities to become a major player in its domestic market. Although the CML deal might not seem ideal now, it has provided many benefits to MHI and made it a strong domestic competitor.
4. There is a clear winner and loser when it comes to financial returns. By 1986, Caterpillar had managed to accumulate $1. 9 billion in returns from its investment in CML, as opposed to MHI who lost a total of $14.
5 million (Exhibit 2 & 3). The reason for this sizable difference is that Caterpillar’s returns were off the top-line and dividends, but MHIs returns were purely from dividends. CML was a new enterprise which required significant capital investment to generate thin margins and uncertain dividends. By Caterpillar taking 8% off of the top-line even less money flowed to the bottom-line, which in turn reduced the potential dividends (that were divided 50-50 between the two parent companies).It is necessary to negotiate a new division of CML returns between the two parent companies, as the current agreement is very much biased towards Caterpillar.
5. In order for CML to remain competitive with the other domestic producers, especially Komatsu, the cost structure of the JV needs to be addressed. One of the main causes of CML’s lower level of profitability (as compared to Komatsu especially during 1980-1986) was the 8% royalty payments to Caterpillar. The royalty payments were indeed necessary to compensate Caterpillar for the license to use its designs, processes, and brand at the time the JV was first formed.However, 18 years after the incorporation of CML, the JV must have developed new patents, designs, and improved processes that would have reduce its dependence on the original Caterpillar intellectual property. The 8% royalty payments need to be negotiated down to a level that is beneficial to both CML and Caterpillar.
As is, Caterpillar has no incentive in making the JV operations more efficient (by addressing its cost structure) as it receives 8% margin on all sales regardless of CML profitability. Also, this setup is very inequitable to MHI, which has lost a significant amount of money, while its partner has benefited greatly.Another cause of the negative profitability and declining sales for CML is the limitations on its product offering imposed by Caterpillar. According to the product charter, only those products deemed suitable (by Caterpillar) for the Japanese and Far East markets were manufactured by CML. However, since Caterpillar also has the ability to export products from its international facilities to Japan and Far East markets, it cannot make an impartial decision when it comes to expanding the product charter.Caterpillar has no incentive to expand the product charter to include other suitable products, as it can produce and market those products itself and avoid splitting the profits with MHI.
Caterpillar has a conflict of interest when it comes to making decisions regarding product offerings. This is a situation where there is significant competitive overlap between the two partners; the two parent companies need to find a way to increase the shared benefit through a more inclusive decision making process.Related to the product offering issue is the matter of production and sale of hydraulic excavators. In 1986, hydraulic excavators were the major growth segment in the stagnant construction machinery market. Both MHI and Caterpillar produced excavators, however, they could not come to a mutually beneficial agreement to expand the CML product charter to include these products.
In this case, MHI possessed the superior design and needed Caterpillar’s global network to sell on a worldwide basis (an ironic turn of the table as compared to the original JV negotiations).The two parent companies need to negotiate an expanded product charter that includes hydraulic excavators. The design of the excavators could be a mix of the best characteristics of MHI and Caterpillar’s designs. Through this compromise, Caterpillar would gain access to the Japanese excavator market which accounted for approximately 50% of global unit sales and MHI could access the international excavator market.
Exhibit 1: Caterpillar’s Four Underlying Policies Strategy| Description|Industry Focus | Caterpillar management chose to focus on its current industry by only producing heavy machinery and engines; the management team refused to diversification beyond these areas. | Pre-emptive Market Occupation | Caterpillar management team decided that the company should compete in all international market segments for its products, mainly to prevent local producers from evolving into world-class competitors. | Worldwide Product Standardization| Caterpillar management team also aimed to standardize its products and use interchangeable components in its production process.This approach allowed Caterpillar to enjoy opportunities for achieving greater economies of scale in its manufacturing process, more flexible sourcing arrangements among its production facilities, and more cost effective servicing of equipment in the field. | Direct Market Presence policy| Caterpillar management ensured to maintain direct ownership of wholesale marketing and regional warehousing activities, giving it more control over marketing and servicing efforts, and keeping it at a close proximity to its end-users.
| Exhibit 2: Caterpillar Cash Flows Exhibit 3: MHI Cash Flows
