Editor's note: Emerson Electric, based in St. Louis, Missouri, stands out for two reasons. Founded more than 100 years ago, it has parlayed expertise in technology and engineering to accrue consecutive annual increases in earnings per share and dividends per share. And bucking the trend of CEO turnover, the company has been helmed by only three chief executives in the past forty-plus years. As a successful business that has changed with the times, it maintains a stable of brands from industrial automation to climate technologies, operates 245 manufacturing locations worldwide, and in 2004 demonstrated return on equity of over 18 percent. But Emerson has endured tough times, too.
In the early 1980s, it was caught off-guard when its formula for cost reduction was upended by foreign competitors who could manufacture higher-quality products for much less money. In the following excerpt from the new book Performance without Compromise: How Emerson Consistently Achieves Winning Results (HBS Press), Davis Dyer and former CEO Charles F. Knight, who led Emerson from 1973 to 2000, explain what went wrong and how the company struggled to forge ahead in a new business climate.
Becoming a best cost producer in the 1980s
Emerson's focus on cost reduction, in combination with other components of the management process, enabled us to deliver consistently high profit margins until the early 1980s. At the same time we encountered selective instances of competitors located in low-cost countries offering comparable performance and quality but at much lower prices. Three incidents stand out.
In the first, in the early 1980s, we lost overnight a substantial, longstanding business in hermetic motors to a Brazilian competitor. We had been shipping millions of these motors every year from our modern, efficient plant in Oxford, Mississippi, to Whirlpool, which then incorporated them into home refrigerator compressors at its plant in Indiana. Whirlpool also bought assembled compressors from Tecumseh that likewise contained our hermetic motors.
This was a great business for us and had been for many years. One day, though, we got some bad news: Whirlpool notified us that it would no longer need our hermetic motors. Indeed, it planned to close its U.S. compressor plant and to cease buying compressors from Tecumseh. Whirlpool had found a Brazilian supplier that could meet all its needs, including new government-mandated higher efficiency levels, at prices far below those it was accustomed to paying in the United States.
There was no appealing the decision, but we wanted to understand what had happened. Al Suter, then head of our motor division, flew to Brazil to gather the facts. What he found was eye opening. The Brazilian producer had licensed state-of-the-art technology from Europe, and its engineers and managers were well trained and highly competent. So were the factory workers. The facility itself was as modern and efficient as any of ours. Because of much lower labor costs and favorable steel and cast iron prices in Brazil, the producer could deliver assembled compressors to customers in the United States at prices 30 percent below the U.S.-manufactured price.
Together, these incidents showed us the error of our ways. |
Whirlpool's decision hit hard. Not only did we lose big, longstanding business, but we were also forced to close our hermetic motors operation in Oxford. We lost hundreds of hourly jobs, and a significant number of salaried jobs, at both the plant and in the division headquarters in St. Louis. We determined that such an experience would never happen again. We also learned two lessons: First, we could no longer take for granted that we were cost leaders in our markets; and second, we would have to keep a close eye on foreign competitors and realign our cost structure, as required, in time to prevent the complete loss of other product lines.
We soon had the opportunity to apply these lessons. This time it was an Asian supplier of temperature controls for small appliances like coffeemakers, which offered our OEM (original equipment manufacturer) customers 20 percent lower prices on selected models. Therm-O-Disc (T-O-D), the Emerson division that made these controls, couldn't match the lower price, which was below its cost. At the same time, T-O-D managers realized that if their low-cost foreign competitor gained access to American customers in these limited lines, the competitors would quickly broaden their product offering to include all of T-O-D's models. This meant that we would lose another significant business along with as many as two thousand hourly and salaried jobs in the United States. T-O-D offered a smaller price reduction on all its models, which in total matched the Asian rival in limited lines; our customers stayed with us, albeit at a lower profit margin. T-O-D then developed a plan to realign its cost structure to restore the original profit level and prepare to meet further price competition.
T-O-D started a Mexican operation, which lowered costs to the point that it not only regained profit margin but also was able to increase exports to Europe. The net impact on U.S. employment was a loss of approximately three hundred jobs, whereas our actions saved seventeen hundred jobs.
As if we needed it, a third incident in the early 1980s drove these lessons home. Again, the trigger was a communication from one of our major motors customers, which showed us a letter from one of its suppliers. Ironically, the supplier was our Japanese partner, and it had written to apologize for a defect rate of 80 parts per million units in the motors it had shipped. That level was about ten times better than we had ever achieved in our best American plant. And here was another supplierthankfully, not a competitorwith quality much better than ours apologizing to our customer and offering to make amends!
Together, these incidents showed us the error of our ways. Although we cut operating costs every year and customers rarely complained about quality, the competitive benchmarks were changing to reflect new standards: best-in-the-world, and not best-in-the-United States. In running our business, we were making the wrong comparisonnamely, comparing ourselves to ourselves. What mattered to customers, however, was not how little our prices were increasing but rather what the alternatives were. With the global economy reaching a new state of maturity, our customers suddenly had attractive alternatives.
In the early 1980s, then, we realized that global competition had arrived in a limited number of product lines, and we projected that it would soon spread to the rest of our businesses. We would soon be under much greater price pressure than ever before. With falling prices, moreover, traditional cost reductions would not close the annual gap between available price increases and inflation. We could achieve productivity improvements faster through new management techniques and equipment, but not fast enough to meet our targets for profitability. We would have to do something different.
We responded to rising global competition in the 1980s by defining a new Best Cost Producer Strategy. The idea was to not compete exclusively on price but rather on valuethe optimum combination of products, services, and pricingas perceived by our customers: best cost, not lowest cost.
Higher quality not only met competitive requirements but also became another way to reduce costs. |
The Best Cost Producer strategy originally consisted of six points (see "Emerson's Best Cost Producer Strategy: 1980s") that mingled old and new management policies and principles at Emerson. We maintained our traditional emphasis on formalized cost-reduction programs, effective communications, and ongoing capital expenditures. However, we stopped using ourselves as a benchmark and focused instead on the best-in-class competitors, wherever they happened to be.
For example, we set dramatically higher standards for quality, as defined by our customers, to reach the highest standard in the world. Achieving this new standard required that we make significant changes in manufacturing management, factory organization, and other areas of our business. We adopted statistical quality control methods and just-in-time inventory management, which required that we provide additional training for factory personnel and renegotiate terms and modify relationships with some suppliers and customers. As we improved quality to meet customer requirements in terms of reject rates, we realized that our increased costsour investment in quality improvementwere more than offset by reductions in internal scrap and rework as well as fewer returns from customers. Higher quality not only met competitive requirements but also became another way to reduce costs.
To implement the enhanced quality improvement programs throughout the company, we appointed a corporate officer to lead the change. D. Seals, formerly president of our In-Sink-Erator division, agreed to take on this assignment. He operated with minimal staff and worked with division management on setting targets, providing training, and monitoring results.
The hardest part of implementing the quality improvement program was convincing people that investing in quality actually reduced costs over time. Most managers believed that building in quality created an added cost. This was a communications challenge that we eventually overcame through demonstration and persistence. Another big issue was getting our managers to stop comparing their current and projected performance to their historical performance. We needed them to compare themselves to their toughest competitors, and that also took a change in mind set.
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Emerson's Best Cost Producer Strategy: 1980s
by Charles F. Knight with Davis Dyer
- Commitment to total quality and customer satisfaction
- Knowledge of the competition and the basis on which it competes
- Focused manufacturing strategy competing on process as well as product design
- Effective employee communications and involvement
- Formalized cost-reduction programs in good times and bad
- Commitment to support the strategy through capital expenditures