cat_porter’s 5 forces going forward (revised final version) (1)

Running head: Porter’s 5 Forces: Caterpillar Inc. 1

Porter’s 5 Forces: Caterpillar Inc.

Eric Risi

Courtney Fenwick

Carl Schachter

Brendan McCauley

Florida Atlantic University

Porter’s 5 Forces: Caterpillar Inc. 2

Table of Contents

Title Page ........................................................................................................................................1

Table of Contents ...........................................................................................................................2

Abstract ...........................................................................................................................................3

Threat of New Entrants: Low .......................................................................................................4

Investment Costs ..............................................................................................................................4

Economies of Scale Available to Existing Firms ............................................................................5

Regulatory and Legal Restrictions ...................................................................................................5

Product Differentiation ....................................................................................................................6

Access to Suppliers and Distribution Channels ...............................................................................6

Retaliation by Established Products.................................................................................................7

Bargaining Power of Suppliers: Low ...........................................................................................8

Uniqueness of Input Supplied ..........................................................................................................8

Number and Size of Firms Supplying the Resources ......................................................................9

Competition from Other Industries and Cost of Alternative Sources ..............................................9

Bargaining Power of Buyers: Low .............................................................................................10

Number of Customers and Their Order Size .................................................................................10

Number of Firms Supplying CAT Products ..................................................................................11

The Threat of Integrating Backwards ............................................................................................12

The Cost of Switching ...................................................................................................................12

Threat of Substitutes....................................................................................................................12

Degree of Competitive Rivalry: Moderate ................................................................................15

Number of Competitors in the Market ...........................................................................................15

Market Size and Growth Prospects ................................................................................................15

Product Differentiation and Brand Loyalty ...................................................................................18

Power of Buyers and the Availability of Substitutes .....................................................................19

Capacity Utilization .......................................................................................................................19

Cost Structure of the Industry ........................................................................................................21

Exit Barriers ...................................................................................................................................22

Going Forward ...............................................................................................................................22

Bibliography .................................................................................................................................25

Appendix .......................................................................................................................................27


Abstract

This paper will examine Caterpillar Inc. (CAT) using Porter’s 5 Forces model as a guide.

The research will address the following areas of interest concerning Porter’s strategy when

assessing CAT’s place in its chosen industry and/or sector. Threat of New Entrants, Bargaining

Power of Suppliers, Bargaining Power of Buyers, Threat of Substitutes, and Degree of

Competitive Rivalry will be discussed in detail. CAT is large cap company tracked by the DJIA

index, operating in a mature and established industry. Having formed in 1925 when the C. L.

Best Tractor Company merged with Holt Manufacturing to form what is known today as CAT.

Since that time, CAT has become the industry leader in heavy industrial machinery

manufacturing. CAT has established a worldwide network for ancillary services such as

financing, parts, maintenance, and accessories.

Porter chose to focus on CAT in the 1980’s when he wrote his Five Generic Strategies

and outlined CAT’s success with product differentiation based on services surrounding the

product, instead of on the product itself. CAT has done this better than anyone else. With such

a mature industry within the U.S., CAT has sought out opportunities abroad in emerging markets

all over the globe and has been successful at penetrating every lucrative market it has found.

CAT faces many challenges in establishing itself in the South Pacific, India, China, and Africa.

The threat of new entrants into this mature industry is quite low due to the enormous costs

involved in establishing a global presence. Industry participation on CAT’s level requires years

of research, technology development, trial and error, and relationship building with suppliers and

customers to be competitive. Inversely, for an established company like CAT to exit the

industry, it would be financially devastating to the company and to any national economy in

which CAT operates. Concerning the heavy industrial machinery industry, CAT has three main

divisions within the company: construction and excavation, resources & mining, and engines &

power systems. CAT employs over one hundred thousand people worldwide and is a name

synonymous with quality, service, and support.


THREAT OF NEW ENTRANTS: LOW

CAT has several large competitors in the heavy industrial equipment business. However,

the threat of new entrants is low. “Achieving scale and winning orders from global companies is

unlikely from a new entrant, though possible as being proven by some Chinese construction

equipment manufacturers” (Anderson, 2012)1. Though it may be possible for new companies to

enter the heavy equipment and engineering industry, there are numerous barriers to entry for

smaller companies. While the high capital requirement remains the biggest hurdle, other factors

include; absolute cost advantages, economies of scale, government policies, brand/product

differentiation, access to distribution/suppliers, expected retaliation from existing firms, patents

and proprietary knowledge, and switching costs. (*Reference Graph 1 in the Appendix.)

Investment Cost

The significant initial capital investment required to enter the heavy industrial equipment

and engineering industries are significant impediments to new entrants. The need to produce

cutting edge and environmentally friendly machinery requires “manufacturers of heavy

equipment to continue to invest large amounts of capital in technological advancements like

automation, fuel-efficiency, and enhanced mechanical precision” (Brauns et. al, 2013)2.

The chart below shows Caterpillar’s (CAT) operating costs for 2013, ranging in the

billions of dollars.

OPERATING COSTS (in millions): 2013:

Cost of goods sold ................................................................ 40,727

Selling, general and administrative expenses ....................... 5,547

Research and development expenses ................................... 2,046

Interest expense of Financial Products ................................. 727

Goodwill impairment charge ……………………………… —

Other operating (income) expenses ……………………….. 981

Total operating costs ............................................................ 50,028

1 Anderson, M. (2012, November 20). Caterpillar Inc. (CAT). . Retrieved July 12, 2014, from

http://fisher.osu.edu/supplements/10/9160/11.20.12%20Matthew%20Anderson%20Final%20Analyst%20Report%20-% 20Caterpillar%20Inc.pdf 2 Brauns, J., Cosse, S., Gao, J., & Russell, S. (2013, April 23). Caterpillar Inc. (NYSE: CAT). . Retrieved July 12, 2014, from

http://tippie.uiowa.edu/krause/spring2013/cat_s13.pdf

http://fisher.osu.edu/supplements/10/9160/11.20.12%20Matthew%20Anderson%20Final%20Analyst%20Report%20-%25



Economies of Scale Available to Existing Firms

Large-scale infrastructure projects (i.e. mining, industrial, commercial, and residential

construction) requiring the use of heavy-equipment allow CAT to fully utilize economies of

scale. The magnitude of these projects has proven hard to reproduce by a new entrant from both

a time and cost efficiency standpoint. Over Caterpillar’s 80+ years in business, trial and error

have allowed the company to reach their Minimum Efficient Scale (MES). This is defined as

producing the least amount of a product while still taking advantage of the economy of scale on

their costs and supplies. Therefore, “the greater the difference between industry MES and entry

unit costs, the greater the barrier to entry. So industries with high MES deter entry of small, start-

up businesses” (Porter’s Five Forces, 2010)3. It is critical for CAT, “which generates some two-

thirds of its revenue outside of North America” (Munshi, 2013)4, to efficiently produce multiple

units to supply to various jobs at multiple sites.

Regulatory and Legal Restrictions

Government regulations focus heavily on environmental preservation. These include

legal restrictions on output emissions, energy consumption, and water management. As each

region varies in the amount of regulations enforced, “investments will depend on the local

Government coming out with a clear policy.” said Caterpillar India, China and Asian Country

Manager Kevin Thieneman (Caterpillar’s Concerns, 2011)5. In anticipation of such regulations,

CAT utilizes Environment, Health and Safety (EHS) Professionals to identify and mitigate such

risks.

CAT’s patents and proprietary knowledge have served as a key factor in keeping new

entrants out of the industry. “Only 20 to 30 percent of Caterpillar's worth is in the equipment

and factories that the company owns. The rest is intellectual capital” (Wiebusch, 2002)6. The

proprietary learning curve is huge for any company attempting to enter the industrial playing

field. Bill Berlinger, licensing manager for the Caterpillar corporate states that CAT has more

3 Porter's Five Forces: A Model For Industry Analysis. (2010, January 1). Porter's Five Forces. Retrieved July 12, 2014, from

http://www.quickmba.com/strategy/porter.shtml 4 Munshi, N. (2013, January 28). Caterpillar sees stronger China growth. . Retrieved July 12, 2014, from

http://search.proquest.com.ezproxy.fau.edu/docview/1282286776?pq-origsite=summon 5 Caterpillar's Concerns. (2001, January 1). . Retrieved July 12, 2014, from http://search.proquest.com.ezproxy.fau.edu/docview/837358715?pq-

origsite=summon 6 Wiebusch, B. (2002). Caterpillar opens its patent vaults. Design News, 57(11), 34. Retrieved from

http://ezproxy.fau.edu/login?url=http://search.proquest.com/docview/235261158?accountid=10902

http://www.quickmba.com/strategy/porter.shtml

http://search.proquest.com.ezproxy.fau.edu/docview/1282286776?pq-origsite=summon





than seven thousand patents. He further relates that CAT identifies and correlates every business

relationship on the grounds of intellectual property. Licensing new technology will drastically

reduce the time and expense needed to launch new products. (Wiebusch, 2002)7

Product Differentiation

Caterpillar is one of the most recognizable names among its industrial and mining

equipment peer group. Through strong marketing efforts CAT has become a name synonymous

with quality and service, which significantly lowers the threat of new entrants. Marketing

campaigns have played a major role in increasing awareness of their company on a global scale.

This has generated larger market share, lowered employee turnover, and increased customer

retention. Campaigns put on by the company “focus on the ‘need to define for the world what

Caterpillar does,’ says Tim Elder director of corporate affairs. Executives want to showcase

achievements such as giving people access to clean water or providing electricity for Zambian

schools to counter perceptions of an uncreative, ‘rust belt’ company” (Arbel, 2006)8.

Access to Suppliers and Distribution Channels

Access to distribution and supply channels, along with geographical positioning, are key

factors in Caterpillars success. Consequently, if it is difficult for new entrants to gain access to

these channels, the threat of entry is much lower. CAT’s primary distribution channels are

independent dealers. Its dealers are all independently owned and uniformly provide added value

in the form of financial services, remanufacturing services, logistical services, and leasing and

rental services to the end customer according to Enterprise Strategy (Enterprise strategy, 2010)9.

This allows CAT to focus solely on each dealer, thereby increasing the value of each product and

service that is provided. Enterprise Strategy further states that CAT’s lifelong relationship with

some customers provides information critical to the company’s ability to sustain continuous

growth. CAT’s dealer network is more valuable than the company itself and provides a

competitive advantage for CAT’s products and services (Enterprise strategy, 2010)10.

7 (Wiebusch, 2002). 8 Arbel, T. (2006). Caterpillar. Sales and Marketing Management, 158(8), 17. Retrieved from

http://ezproxy.fau.edu/login?url=http://search.proquest.com/docview/211867189?accountid=10902 9 Enterprise Strategy. (2010, January 1). . Retrieved July 12, 2014, from http://library.corporate-

ir.net/library/92/924/92466/items/171600/Enterprise%20Strategy%20Booklet.pdf 10 (Enterprise Strategy, 2010)


http://library.corporate-ir.net/library/92/924/92466/items/171600/enterprise%2520strategy%2520booklet.pdf



Through customer relationship management, CAT has been able to meet the needs of its

customers through expansion both horizontally and vertically. For example, Caterpillar provides

medium to high-speed diesel engines providing power for numerous types of vehicles such as

boats, trucks, ships, mining, and construction equipment. Enterprise states that CAT’s supply

chain is highly integrated and strategically positioned worldwide to provide value, flexibility,

and support unmatched by competitors. CAT has the lowest channel costs and best asset

utilization in the industry (Enterprise strategy, 2010)11.

Retaliation by Established Products

Should established competitors threaten Caterpillar, there are two options to retaliate.

The first option is price slashing on a temporary basis. This works due to economies of scale and

strong existing relationships. Secondly, a marketing campaign would be utilized to promote

their superior customer service and could prove to be extremely beneficial “as most products in

this industry are extremely capital intensive and require regular maintenance services over time”

(Brauns et. al, 2013)12.

For consumers switching from CAT, they must be willing to accept an extreme drop in

service and efficiency. Consumers may save on initial purchasing costs; however, they will lose

money in the long term from cost overruns due to repairs and maintenance. The advantages of

financing or renting used equipment must be considered. Caterpillar has achieved economies of

scale in production. They have enhanced their value proposition through an established

worldwide network of customer service and support. To replicate the same product value, the

initial cost of capital would be astronomically high, forcing new entrants to overcharge for the

same service. From a global industrial standpoint, “the weakening of the U.S. dollar makes

prices for Caterpillar products more attractive to overseas customers. The shift in exchange rates

gives Caterpillar an advantage over large, foreign-based competitors such as Komatsu”

(Caterpillar Inc., 2011)13.

11 (Enterprise Strategy, 2010) 12 Brauns, J., Cosse, S., Gao, J., & Russell, S. (2013, April 23). Caterpillar Inc. (NYSE: CAT). . Retrieved July 12, 2014, from

http://tippie.uiowa.edu/krause/spring2013/cat_s13.pdf 13 Caterpillar Inc. (2011, 01). Better Investing, 60, 20-22. Retrieved from





Exit barriers in the Heavy Equipment and Engineering industry are proportionately

inverse in relationship to the extreme initial capital investment required to enter the heavy

industrial machinery business. Asset specificity, as Porter defines, is the extent to which the

firm's assets can be utilized to produce a different product (Porters Five Forces, 2010)14.

Caterpillar requires highly specialized technology, plants, and equipment. Potential entrants are

reluctant to commit to acquiring specialized assets that are highly illiquid if the venture were to

fail. As seen in graph 2 in the Appendix, the break-even point for capital investment is not

realized until long after the research and development stages. A large amount of capital is

needed to produce heavy-equipment industrial machinery. It is for this reason that Caterpillar

must remain highly competitive against current threats.

BARGAINING POWER OF SUPPLIERS: LOW

Caterpillar (CAT) is recognized as the leader in industrial equipment manufacturing. The

company is split into three industrial sectors: construction & excavation, resources & mining,

and engines & power systems. In order to spur equipment sales and rentals, CAT has also created

CAT Financial for consumer financing needs when dealing directly with suppliers. To continue

to be recognized as the global leader in its industry, CAT must focus on the functionality of its

supply chain and the continued development of supplier relations. CAT will be able to determine

exactly how much bargaining power the supplier based on examining factors such as; the

uniqueness of the input supplied, competition for supply input, and impacts of supplier size and

costs of switching to alternative sources.

Uniqueness of Input Supplied

Due to the ease of access to raw materials, CAT’s suppliers do not pose much risk

through attempts to increase their bargaining power. In the event of increased costs by a lone

supplier, CAT would have no issue finding a replacement. CAT’s supplier bargaining power is

relatively low as CAT produces its own equipment and parts. This allows the company to save a

substantial amount of money in the long term. This type of operation allows CAT to be both

vertically and horizontally integrated.

14 Porter's Five Forces: A Model For Industry Analysis. (2010, January 1). Porter's Five Forces. Retrieved July 12, 2014, from




Another negative effect which impacts the supplier’s bargaining power is the reliance on

a high volume of product produced. CAT retails its products to dealers, which sell them to

construction and mining businesses. If dealer sales to mining and construction companies

decrease, CAT’s volume to their dealers will be reduced. When a producer like CAT threatens to

cut production volumes of equipment, the supplier’s potential profit is negatively affected as the

incentive to produce new lines of product will be decreased.

Number and Size of Firms Supplying the Resources

From a competitive standpoint, CAT’s market placement in various sectors is protected

due to the high expenses associated with entry. CAT’s three main competitor’s for market share

(John Deere, Komatsu, and Kubota) may offer similar products at a cheaper price, but aren’t able

to meet the level of quality CAT provides to larger consumers and entities like corporations and

governments. CAT is able to deliver on their promise of quality and efficiency to consumers by

constantly supporting their supply chain workflows. With competitors constantly searching for

new differentiation strategies that produce competitive advantages within the market place, CAT

must continue to reinforce established strengths. The recent development of the “new order-to-

delivery organization” will align production elements with consumer demand. This continues to

bolster CAT’s added value differentiation that makes them attractive to buyers. These procedures

add value toward CAT’s ancillary services that consumers would lose if they chose to work with

competitors.

Competition from Other Industries and Cost of Alternative Sources

CAT has become vertically integrated through the manufacturing of parts, accessories,

power systems, and by providing ancillary services. By streamlining its supply chain and

utilizing trusted sources for raw materials, CAT has effectively reduced its dependency on

suppliers and removed their ability to affect CAT’s bottom line. The global recession has

resulted in surpluses of raw materials world-wide which is beneficial to CAT by providing easy

access to the materials it needs to produce the goods and services it sells. “CAT has been actively

cutting its supplier base from a peak of 10,000 to below 5,000 as of 2012” (Anderson, 2012)15.

This reduced dependency on suppliers allows CAT to maximize its vertical in relation to the

15 (Anderson, 2012)


value proposition it provides for its consumers. A secure supply chain helps remove uncertainties

in the production process, builds consumer confidence, and insulates CAT from minor price

fluctuations in the global commodities.

BARGAINING POWER OF BUYERS: LOW

Within the heavy equipment manufacturing industry that CAT services, influential

consumers consistently attempt to search for the lowest cost with the highest value and quality.

Consequently, CAT experiences reduced sales margins for its goods in the marketplace. The

various aspects that influence consumer bargaining power are the extent of customer orders,

number of customers, amount of alternative suppliers, threat of backward integration, and the

cost of switching products.

Number of Customers and Their Order Size

Over the past year CAT’s global sales in mining equipment have been on a steady

decrease that is associated with the falling price of raw materials utilized for production. This

increases the power of the buyer as CAT would have to compete in a price war within its peer

group. “In that environment, the buyer searches for readily available substitute materials that will

help keep supplier prices under control” (Johnson, 1987)16. CAT will need to increase their

product quality under lower margins to stay ahead of global competition. Dowlatshahi states that

a more competitive environment leads to more stress between buyers and suppliers. Multiple

supplier relationships are used by the buyer to push prices down and to further ensure supply

chain continuity. (Dowlatshahi, 1999)17

In the face of lower commodity prices various mining companies have cut spending and

decreased equipment purchases. This trend has spread to CAT’s markets across the Asia-Pacific,

Africa, Europe, the Middle East, Latin and North American regions. The biggest concern facing

CAT is the uncertainty of demand within their mining and construction divisions. CAT’s dealers

most likely will not increase their direct purchases of construction products as demand has

slacked in correlation with the global recession. CAT’s global consumers are large in scale and

16 Johnson, G. "Manufacturer-Retailer Relations: the Shifting Balance of Power." Business Strategy and Retailing. New York: John Wiley & Sons (1987): 47-51. 17 Dowlatshahi, S. (1999). Bargaining power in buyer-supplier relationships. Production and Inventory Management Journal, 40(1), 27-35. Retrieved from http://ezproxy.fau.edu/login?url=http://search.proquest.com/docview/199953472?accountid=10902



traditionally hold a lower level of bargaining power. CAT retains leverage as they possess the

technology for heavy machinery, the spare capacity to produce it, and the ability to meet the

mining industry’s needs when demand increases. Trefis.com finds that mining companies work

new machines harder than older ones due to fewer breakdowns and repair costs than older

models. This helps the bottom line initially, but eventually new parts will need to be purchased

to prevent excessive downtime. Sales of parts and service of equipment will lend to the mining

sectors recovery (Caterpillars Lower End, 2014)18. With the rising costs of raw materials such as

coal, CAT will realize a greater amount of construction equipment orders from their mining

consumers. Their market share should grow proportionately as a result.

Number of Firms Supplying CAT Products

CAT sells its machinery and power systems in partnership with independently owned and

operated dealerships to meet consumer demand. Over time the acquisition, demand, and use of

industrial machinery has changed globally. Forbes relates that CAT’s distribution network was

originally for traditional customers, but has facilitated expansion through new customer

development. Rentals, operation across multiple territories, and marine clients operating on

global scales are forcing added cohesion between CAT and its service network. Dealer functions

are changing to meet the demands of the dynamic business environment (Catepillar Intensifies

Focus, 2014)19.

CAT is working with its network of distributors in response to the ever-changing

macroeconomic landscape associated with decreasing global sales. CAT has developed a

proposal called “Across the Table” in an effort to reduce inadequacies for large businesses that

deal with multiple CAT dealers in various countries. Additionally, a global rental business plan

is being discussed in response to changing demand of its bigger niche consumers. These types of

initiatives will enable CAT to stay ahead of competing firms that are smaller in nature.

18 Caterpillar’s Lower End User Sales Point to a Tough Second Quarter. (2014, June 27). Retrieved , from http://www.trefis.com/stock/cat/articles/244854/caterpillars-lower-end-user-sales-point-to-a-tough-second-quarter/2014-06-27 19 Caterpillar Intensifies Focus On Dealer Performance To Drive Results In A Tough Macro. (2014, March 11). Retrieved , from http://www.forbes.com/sites/greatspeculations/2014/03/11/caterpillar-intensifies-focus-on-dealer-performance-to-drive-results-in-a-tough-macro/

http://www.trefis.com/stock/cat/articles/244854/caterpillars-lower-end-user-sales-point-to-a-tough-second-quarter/2014-06-27

http://www.forbes.com/sites/greatspeculations/2014/03/11/caterpillar-intensifies-focus-on-dealer-performance-to-drive-results-in-a-tough-macro/



The Threat of Integrating Backwards

CAT’s vertical integration removes the consumer’s need to integrate backwards.

Historically CAT has purchased maintenance and repair businesses to hedge operational costs.

Commodity prices are relatively low for purchasing entities due to wholesale purchasing.

Demand for mining and construction equipment is currently dwindling. This gives rise to

massive surpluses in raw materials globally. Consequently, this leads to lower prices resulting in

smaller margins for mining companies who, in turn, purchase less equipment. To counter the

decrease in mining demand, CAT’s acquisition of Bucyrus International should effectively buoy

profits and keep the mining subdivision’s overall expenses lower in the short-run until demand

increases. CAT demonstrated its use of vertical integration by acquiring Bucyrus’s production

portfolio in 2010 along with current and on-going contracts. This means additional profits are

generated to minimize the mining subdivision’s overall costs.

The Cost of Switching

CAT’s consumers face a double-sided dilemma associated with the cost of switching

products. Though CAT’s competitors may offer products at lower prices, they don’t account for

the value proposition provided. CAT supplies its consumers with superior customer service

value through technical support, maintenance, and repair parts.

THREAT OF SUBSTITUTES: LOW

CAT’s threat of substitute products is relatively low due to the expensive price of entry

for potential new competition. For the consumer, the price of switching to an alternative is too

costly in terms of quality. This is due to CAT’s supply chain acquisitions from previous years,

which have made CAT substantially more competitive. For example, CAT’s acquisition of

Bucyrus International, in 2010, allowed CAT to provide products and services to a much larger

portion of the mining industry. Overall, CAT has the lowest channel costs in the industry

coupled with impressive asset utilization. This means CAT places great emphasis on

optimization, whether it is for a product or a method of service provision.

The current production portfolio of CAT ranges from engine construction to product

maintenance, and support. CAT has three predominant sources of revenue: construction &

excavation, resources & mining, and engines & power systems. Through these revenue streams,


CAT remains “locked-in” with the consumer for continued business through its ancillary

subdivisions. In doing so, CAT generates a strong relationship with the consumer, increasing

client retention and relationship management. Utilizing this methodology creates a strong sense

of consumer “loyalty” from the company’s point of view.

In addition to being the most convenient option for “all-in-one” service provision, the

consumer benefits from a “one-stop-shop” when looking for alternatives. Through several of

CAT’s previous acquisitions, the cost of service provision remains relatively low in comparison

to other industry competitors. CAT’s service method effectively creates a barrier to prevent new

entrants from competing due to the relatively expensive nature of the industry.

CAT’s threat of substitutes remains relatively low, due to the specialized nature of the

consumer’s needs. CAT’s optimization strategy has created multi-purpose equipment, which

mitigates and possibly eliminates the need for an alternative product. “Its objective is to identify,

track and mitigate anything that would prevent Caterpillar from achieving its long-term, strategic

objectives” (Driscoll, Torok, Walker, 2011)20. In doing so, CAT has generated an increase in

demand for its equipment by minimizing the client’s overhead costs. Therefore, CAT’s

equipment is clearly an efficient and cost effective substitute for manual labor.

The “going concern” for CAT’s foreseeable future should be to maintain their

optimization policies throughout its extensive product and service portfolio. “We argue that

attention needs to be directed to the ways in which “problems” and “solutions” are mutually and

reciprocally formed” (Miller & O'Leary, 2002)21. By utilizing their strategy of horizontal

integration, CAT eliminates additional consumer needs, pertaining to outside service vendors,

should an issue arise. CAT should remain the industry leader for the foreseeable future,

permitted they continue to utilize their optimization strategies. Their product range for industry

solutions is listed in the following table.

20 Driscoll, M., Torok, R., & Walker, P. (2011, November). The strategic advantage of ERM: integrating strategic planning with ERM at

Caterpillar. Risk Management, 58(9), 26+. Retrieved

fromhttp://go.galegroup.com/ps/i.do?id=GALE%7CA272432537&v=2.1&u=gale15691&it=r&p=AONE&sw=w&asid=f808937e7b4a61fab8f1aa

c71deb9b71 21 Miller, P., & O'Leary, T. (2002). Rethinking the Factory: Caterpillar Inc. Cultural Values, 6(1/2), 91-117. doi:10.1080/1362517022019766

fromhttp://go.galegroup.com/ps/i.do?id=GALE%7CA272432537&v=2.1&u=gale15691&it=r&p=AONE&sw=w&asid=f808937e7b4a61fab8f1aac71deb9b71



Table-1: Industry Solutions

Agriculture & Construction Landscaping Paving

Demolition & Scrap Marine Pipeline

Electric Power Generation Mining Power Plants

Forestry OEM Solutions Railway

Governmental & Defense Oil & Gas Technology & Solutions

Governmental / Local & State Trucking Waste

For industries such as construction and agriculture, large equipment is essential. CAT

systems minimize utility and labor expenses while simultaneously maintaining output

consistency. CAT has strategically placed itself within the “Industrials” sector by delivering

consistent quality, products and services that potentially overlap, rendering substitutes

incomparable. “The project has improved product availability, reducing the mean time for orders

with identified customers by 20 percent and reducing the standard deviation of product

availability for all orders by 50 percent” (Keene, Alberti, Henby, Brohinsky, & Tayur, 2006)22.

Another contributing factor for the low threat level regarding substitutes would be the continued

use of CAT’s products and services from previous successful contracts. CAT’s historical success

rate continues to generate recurring business, due to the fact that, “by-contract-clients” are highly

satisfied with CAT’s performance and the final result.

Additionally, CAT's customer service subdivision handles maintenance and repair

requests from the consumer while simultaneously providing rapid and efficient communication

between the appropriate departments. If CAT continues to follow through with their slogan

“Earthmoving solutions for today's challenges” and their service motto “24 Hours Part Service

Anywhere in the world or Caterpillar Pays” they should have no issue with retaining established

business. Overall, this architecture allows for easy communication amongst the parties involved,

leaving CAT as the "one-stop-shop" for leasing, purchases, and product maintenance.

22 Keene, S., Alberti, D., Henby, G., Brohinsky, A. J., & Tayur, S. (2006). Caterpillar's building construction products division

improves and stabilizes product availability. Interfaces, 36(4), 283-295,379-380. Retrieved from




DEGREE OF COMPETITIVE RIVALRY: MODERATE

The Caterpillar Company (CAT) is a well-established, large market cap ($68.8B),

manufacturing and heavy equipment company operating in a mature industry. Established in the

1920’s, CAT is an experienced company which is both horizontally and vertically integrated.

CAT has had time to establish a world-wide service network and develop a solid brand with a

reputation for quality over its 80+ years in operation. CAT has become the quintessential leader

in the construction, mining, and heavy machinery market. Ranked first globally for heavy

equipment manufacturing, Cat has both horizontally and vertically integrated itself throughout

several sectors and industries. Mining, engines, and construction are their main revenue streams,

but CAT operates in many ancillary industries such as defense, electric power generation, and

marine oil and gas to name a few. To determine the degree of competitive rivalry to CAT in the

industrials sector, several key factors must be closely examined. Factors such as competition,

market size, product differentiation, and substitutes are major components of competitive rivalry.

Number of Competitors in the Market

CAT is the #1 manufacturer in the world for heavy machinery with few true competitors.

“However, intensity of competition may increase as Chinese construction equipment

manufacturers expand internationally and enter the global arena; namely Sany Heavy Industries

(China) and LiuGong (South Pacific)” (Anderson, 2012)23. Major global competition stems from

Deere &Co. ($32.2B), AB Volvo ($27.5B), Komatsu ($21.7B), CNH International ($12.6B), and

Joy Global Mining ($6B) according to Yahoo Finance, NASDQ.com, and Morningstar, 2014.

These companies influence CAT to a greater or lesser degree dependent upon the industrial

sector and geographic location.

Market Size and Growth Prospects

“CAT’s largest global competitors for construction and mining machinery are Komatsu,

Hitachi, Volvo Heavy Machinery, Sany Heavy for construction machinery and Joy Global for

mining machinery” (Anderson, 2012)24. “More than 70% of CAT’s sales occur outside of the

United States. The backlog at the end of 2011, 2010, and 2009 was approximately $29.8 billion,

23 (Anderson, 2012) 24 (Anderson, 2012)


$18.7 billion and $9.6 billion respectively” (Caterpillar Inc. 4Q, 2014)25. International sales are

expected to be higher in the heavy machinery market for Original Equipment Manufacturers

(OEM) which account for $123 billion dollars annually.

With construction, mining, and engines being CAT’s top revenue streams many

opportunities clearly exist abroad in developing countries. With the U.S. mired in a stagnant

market, the Asian South Pacific region has been a focal point for CAT’s expansion efforts.

India, China, Japan, and Thailand are top markets for expansion right now. The share of the

Asian Pacific Market relative to the global market cap for OEM’s is $60 billion.

25 Caterpillar Inc. 4Q Earnings Release Reports Full-Year 2013 Results, Including Record Operating Cash Flow. (2014, January 27). Retrieved

July 12, 2014, from http://s7d2.scene7.com/is/content/Caterpillar/C10085836

http://s7d2.scene7.com/is/content/caterpillar/c10085836


Anderson relates that China is the largest construction equipment using nation in the

world and the largest driver for construction equipment sales. CAT’s sales in China are only 5%

of its global sales. (Anderson, 2012)26

Domestically, congress passed the Highway and Infrastructure Bill of 2012 in the amount

of $105 billion; China announced a $158 billion dollar infrastructure bill of its own in September

of the same year. This helps illustrate the greater opportunity overseas for CAT. “The Bucyrus

mining company acquisition in 2010 has increased CAT’s revenues from the mining sector by

16.4% alone” (Anderson, 2012)27. Bucyrus international supplies mining equipment for

companies in Africa, Canada, Russia, and other nations across the south pacific.

Clearly more opportunity exists abroad than domestically for CAT. Another major source

of income that will continue to be lucrative in the years to come for CAT is its services and spare

parts. “Revenues fell 16 percent last year to hit $55.7 billion, and earnings fell 32 percent as

demand for mining equipment plummeted as companies cut spending. The sector accounts for at

least a third of Caterpillar's total business” (Caulderwood, 2014)28.

Ancillary income sources such as parts and maintenance will hedge against the global

recession and ensure a healthy net profit from those divisions. According to CAT’s 2014 10K,

the 4th Quarter, the financial services department accounted for a total revenue of $756 million

dollars (Catepillar Inc. 4Q, 2014)29. CAT also benefits from being a large cap company which

has allowed them to penetrate foreign markets more rapidly and with less resistance than other

U.S. based heavy equipment companies. Anderson found that the Asian Pacific market

represents the best expansion opportunity for CAT, but it is becoming increasingly competitive

as other major companies are beginning to penetrate the market. Asian Pacific region is

responsible for 48% of construction machinery sales for CAT (Anderson, 2012)30. Anderson

further relates that much of CAT’s growth is organic. CAT’s revenues are supported by high

margin aftermarket services which will sustain profits during downtimes and aid in slow sector

recovery. (Anderson, 2012)31

26 (Anderson, 2012) 27 (Anderson, 2012) 28 Caulderwood, K. (2014, April 23). Caterpillar Q1 2014 Earnings Preview: Modest Growth As Gains In Construction Offset Mining Slump.

International Business Times. Retrieved July 14, 2014, from http://www.ibtimes.com/caterpillar-q1-2014-earnings-preview-modest-growth-

gains-construction-offset-mining-slump-1574992 29 (Catepillar Inc. 4Q, 2014) 30 (Anderson, 2012) 31 (Anderson, 2012)

http://www.ibtimes.com/caterpillar-q1-2014-earnings-preview-modest-growth-gains-construction-offset-mining-slump-1574992



Product Differentiation and Brand Loyalty

Given the maturity of the industry and the competitive nature of the heavy industrial

machinery market, it is becoming even more difficult to differentiate a product based on the

machines themselves. Aspects of heavy machinery are standard across the board due to the

expensive nature of the item. Therefore, brand loyalty is not as prevalent as it once was during

the industry’s infancy and subsequent growth stage. When dealing with governments and large

corporations, the client will usually hire the most cost effective option and the company that can

best justify each expense, thus making economics the key driver of choice instead of loyalty.

The consumer must consider the value proposition of the different brands and how they best fit

the consumer’s needs when making a choice. This differentiation is an aspect of Porters generic

strategies, which CAT has excelled at. In the 80’s CAT set out to achieve differentiation through

services, not product features or pricing. They were the first to do this in their industry and have

set the standard for every other company who wants to be competitive. CAT offers services such

as financing, insurance, maintenance, replacement parts, a world-wide network of qualified

mechanics and technicians. They further raised the bar by selling used equipment, renting

equipment, and selling accessories.

Through the strategic placement of supply distribution warehouses and mechanics all

over the world, CAT has a one day response time to any issue that could arise and keeps the

heavy machinery it sells operating at its peak capacity. Providing service and support to ensure

maximum machine operational capacity is of paramount importance to consumers. “CAT dealers

stock over 80% of parts needed and are able to fulfill around 98% of needs within 24 hours”

(Anderson, 2012)32. The leap forward in service has set CAT apart from every other competitor

since its inception and has left corporations like Deere & Co. scrambling to catch up. No

company has been able to come close to the level of service offered by CAT’s world-wide

network. When bidding on contracts in foreign nations the major obstacle is overcoming an

intrinsic instinct to go with a domestic company. Due to CAT’s amazing service and support,

they have been able to penetrate every lucrative market in the world.

32 (Anderson, 2012)


Power of Buyers and the Availability of Substitutes

Due to the highly expensive nature of the heavy industrial machinery sector, buyers tend

to have plenty of money to spend, but not many options to choose from. There are only a few

companies globally that can provide the necessary heavy equipment for excavation, mining,

construction, etc… “Globally, CAT’s customers are generally large and have buying power, but

the technology required to meet customers’ needs’ can only be met by a limited number of

heavy machinery manufacturers” (Anderson, 2012)33. Consequently, this leads to a low threat of

available substitutes. It could be suggested that the use of manual labor would be a substitute for

CAT’s products, but this alternative is costly, inefficient, and time consuming. Avoiding costly

manual labor was the very reason for the inception of heavy machinery. CAT has successfully

established itself as the top quality product in the heavy industrial machinery sector and is highly

regarded as more expensive than some alternatives, but well worth the cost.

Capacity Utilization

Capacity Utilization is defined as a metric used to measure the rate at which potential

output levels are being met or used. Displayed as a percentage, capacity utilization levels give

insight into the overall slack that is in the economy or a firm at a given point in time. If a

company is running at a 70% capacity utilization rate, it has room to increase production up to a

100% utilization rate without incurring the expensive costs of building a new plant or

facility according to investopedia.com. This metric shows how much room there is for

competition to enter the market based on amount of production currently being utilized by an

industry. Global Industrial Capacity Utilization stood at 78.1% in 2013 (Capacity Utilization,

2014)34.

33 (Anderson, 2012) 34 Capacity Utilization: Total Industry. (2014, June 14). - FRED. Retrieved July 14, 2014, from

http://research.stlouisfed.org/fred2/series/TCU/



*Graph above35

Many factors influence overall production and capacity utilization in an industry. From

the table above, metal mining capacity is down in comparison to other aspects of that sector.

This is due to large reductions in the cost of metals and raw materials because of slow downs of

production and construction globally. The wide availability of these resources currently sitting

on the market as surplus further discourages full mining capacity utilization. To CAT’s benefit,

any threat of new entrants to the industry are kept extremely low due to the high cost of the

equipment produced and the massive amount of capital it takes to get a business of that

magnitude up and running. Clearly the demand for these goods and resources are lagging and

CAT has the ability to ramp up production and fill the void as soon as demand returns. “Current

Capacity utilization is up to 79.1% so far in 2014” according to The Federal Reserve Bank of St.

Louis (Capacity Utilization, 2014)36.

Problems of low capacity utilization

Higher fixed costs per unit mean reduced profitability

Spare capacity can portray a negative image

Staff can become bored and demoralized during slow times

Fear of job loss

35 Graph Sourced from http://stks.co/bpmj 36 (Capacity Utilization, 2014)

http://stks.co/bpmj


Benefits of low capacity utilization

Low capacity utilization is undesirable in the long term as the higher unit costs will make it

difficult to compete. However, possible short term benefits include:

A firm may have more time for maintenance and repairs and for staff training, to

prepare for an upturn in trade

There may be less stress and more time for employees to train and achieve

certifications

The firm can better cope with new order loads

Firms in expanding markets have low utilization while they build their shares in

emerging markets.

(Capacity Utilisation, 2014)37

Cost Structure of the Industry

The cost structure refers to the expenses a company must consider when manufacturing

products or providing services. There are many such costs to consider, transactional,

sunk, marginal, and fixed costs are all key aspects. The cost structure of the firm is the ratio of

fixed costs to variable costs. A weak cost structure means CAT’s costs are higher than their

competitors. CAT’s cost structure is quite high for the industry. That expense is going to

establish differentiation from the competition through adding value to the business from the

buyer’s perspective, mainly from a services standpoint. The service, parts, and accessories

divisions of CAT, which set it apart from other company in the industry, do generate substantial

income.

The cost of establishing and maintaining a world-wide network for parts and maintenance

are significant, however. This will result in lower margins and/or a higher price point for the

company’s goods and services. CAT uses several methods to help stream line its cost structure

and minimize the impact of the extra expenses it incurs to add value to its products. Marketing

& Product Support Division (MPSD), activity-based costing (ABC), and activity-based

management (ABM) are methodologies CAT utilizes to maintain affordability to its dealers and

other business units within its vast network. MPSD’s strict plans required a flexible cost

structure to remove the waste. MPSD applied ABC and 6 Sigma to its largest office processes

37 Capacity Utilisation. (2014, January 1). Capacity Utilisation. Retrieved July 14, 2014, from

http://www.tutor2u.net/business/production/capacity-utilisation.htm

http://www.investorwords.com/2948/marginal_cost.html

http://www.investorwords.com/1992/fixed_cost.html

http://www.investorwords.com/4041/ratio.html

http://www.investorwords.com/5221/variable_cost.html


and services division to cut waste as well as increase efficiency. Vice Chairman and CEO of

CAT, Doug Oberhelman, states that CAT’s response to the ’08-’09 recession has been to change

the structure of CAT by reducing wasteful divisions and the number of managers. He further

states that complacency is the enemy and leadership within CAT must be accountable,

responsive, decisive, and significant. (Caterpillar Streamlines Corporate, 2014)38

*Reference graph 3 in the appendix.

Exit Barriers

In economics, barriers to exit are impediments to a firm that wants to leave a particular

market or industrial sector. These impediments are often time consuming, costly, and can restrict

a firm’s ability to exit so that it may be forced to continue operations, even if at a loss. Due to

extremely high asset valuations and cost structure for the industry, the barriers to exit are

immense for CAT financially. With highly illiquid assets, CAT, its bondholders, and its investors

would only receive 10-20% of the total value of the company. An exit from any sector would

take an inordinate amount of time as well as an extreme loss of capital.

Going Forward

According to Caterpillar’s 2014 Quarterly Financial Results, macro-economic and

political uncertainties are expected to decrease global GDP expansion. The mining industry is

anticipated to decline further, lowering the sales figures and capacity utilization for mining

equipment from its peak in 2012. Inversely, the construction industry’s utilization of heavy

machinery is expected to rise, increasing sales, parts, and maintenance revenues. Overseas,

uncertainty in China leaves CAT to guestimate projected sales and performance as “Chinese

leaders are in the midst of transitioning the world’s second largest economy to a longer-term,

more sustainable growth model while maintaining social stability” (Caterpillar Inc. 4Q, 2014)39.

CAT’s leaders however seem optimistic in comparison to competition so long as they remain

38 Caterpillar Streamlines Corporate Structure; Greater Emphasis on Agility, Cost Management and Meeting Customer Needs

Company reduces number of officers; Chief Financial Officer and General Counsel to report directly to Chairman and CEO. (2014, May 5). Caterpillar Streamlines Corporate Structure; Greater Emphasis on Agility, Cost Management and Meeting Customer.... Retrieved July 14, 2014, from http://www.prnewswire.com/news-releases/caterpillar-streamlines-corporate-structure-greater-emphasis-on-agility-cost-management-and-meeting-customer-needs-92902534.html 39 Caterpillar Inc. 4Q Earnings Release Reports Full-Year 2013 Results, Including Record Operating Cash Flow. (2014, January 27). Retrieved

July 12, 2014, from http://s7d2.scene7.com/is/content/Caterpillar/C10085836

http://www.prnewswire.com/news-releases/caterpillar-streamlines-corporate-structure-greater-emphasis-on-agility-cost-management-and-meeting-customer-needs-92902534.html




cautious of the negative affects of a declining mining industry where immediate actions may

need to be taken to increase revenue from that sector.

Going forward, the recommendation for CAT is to maintain its growth strategy in

emerging markets worldwide. In addition to CAT’s primary services (construction, mining,

power plants) a focus to improve ancillary services will help fortify their leadership position in

the heavy industrial machinery industry. These include improvements to infrastructure through

supply chain optimization and further streamlining of their internal processes. Financing, spare

parts, maintenance and repair, dealer networking, etc… will continue to hedge CATS’s revenues

against global downtrends. CAT has strategically laddered its contractual financial receivables

through 2018 to further hedge against global economic declines. Investors with an interest in

CAT should hold their current shares based upon CAT’s past performance and future potential.

Financial analysts note that even though intrinsic value and market value appear to be close, the

actual value of CAT’s worldwide network and ancillary services are not appropriately accounted

for. CAT’s presence in emerging markets, coupled with their 80+ years of R&D make its

intrinsic value much high than it appears initially. This helps to ensure that CAT still has much

upside left on its stock price in the future.


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Appendix:

GRAPH 1: (#6 - Dobbs, 2014)

GRAPH 2: (#3 - Chena, Keysb, 2009, May)


GRAPH 3: (Photo taken from Getting Lean and Mean at CATERPILLAR with ABM: By David

G. DeFreitas, CPA; John W. Gillett, CPA; Ross L. Fink; and Whitney Cox, CPA). Pg. 28)


GRAPH 4: Graph taken from:

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cat_porter’s 5 forces going forward (revised final version) (1)

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