Ready for an Upturn. Not Ready to Spend.
By LOUIS UCHITELLE
June 23, 2002
LEVELAND -- ALEXANDER M. CUTLER worked his way up through three recessions. Unlike many chief executives, he has learned to thrive in downturns, and has made his reputation that way at the Eaton Corporation, the giant manufacturer based here. This downturn, however, has been different.
"The recession we've been through," Mr. Cutler said, "was as steep as anything we've seen since 1981 and 1982," which stands as the worst since World War II. "Everybody keeps comparing what just happened to the mild '90-'91 recession. That totally misses it."
National statistics are signaling recovery now, but Mr. Cutler worries that the data are too upbeat. While the Bush administration and many forecasters see a revival under way, he sees only "mild indications" of the beginning of an upturn. It will not be truly recognizable at Eaton, he said, until the fall. Even then, his managers will have incentives to be tightfisted and to shun the risk of overexpansion because the bust has been so painful.
"Any company that has been through the trauma of laying off people," Mr. Cutler said, referring to the 19 plants and 12,000 jobs — 20 percent of the work force — that Eaton has eliminated in the last 18 months, "is going to be cautious about adding that incremental person or investment dollar back until you are really sure that you have a stream of new orders coming in."
That reluctance, shared by chief executives across manufacturing, could become self-fulfilling, weakening the economy for many months. By cutting capital spending, the nation's manufacturers helped bring on the recession. Now their determination to squeeze as much production as possible from scaled-back plants and shrunken work forces is shaping the recovery. Instead of a rapid decline followed by rapid rebound, the recession is being followed by a slow rebound.
Eaton makes hydraulic and electrical devices as well as truck and auto components in 109 American factories and 100 more abroad. It is still in the decline stage, and so are many of its customers. Because Eaton sells components to other producers, its difficulties reflect manufacturing as a whole. The nation's manufacturers, in turn, have enough leverage through spending and hiring to speed up a recovery.
"Manufacturing dragged the economy into recession," said Sung Won Sohn, chief economist at Wells Fargo. "And now it has the leeway, more than any other sector, to pull the economy back up."
But if gradual economic growth is the nation's lot, the productivity gains at companies like Eaton may result in a more efficient, more profitable corporate sector — or, in a future stretch of hard times, in companies that will not have to pull back so drastically when revenue is falling and profits are squeezed. That is Eaton's goal today.
"Restructuring on the fly," Mr. Cutler called the solution. While Eaton is further along in the process than most manufacturers, he said, it is still finding ways to produce more with a reduced work force and restricted investment.
Mr. Cutler presents himself as a chief executive who cuts costs ethically. At 51, he still has the square-faced youthfulness of a varsity football player and pole vaulter. He was both at Yale and the Loomis Chaffee prep school in Windsor, Conn., where his parents sent him from their home in Milwaukee. In an interview in his living-room-size office here, near a framed photograph of his wife, Sarah, on horseback, Mr. Cutler extracts from the story of his 24 years as an Eaton executive the managerial qualities that he views as essential for chief executives.
The main ones seem to be these: the ability to absorb new information quickly and to act on it without second-guessing. In his career, that has meant a lot of downsizing, without looking back. Many critics of downsizing point to it as a huge source of job insecurity and even alienation. Corporate America nevertheless has adopted the practice as an essential tool in achieving productivity and cost control. And in this context, Mr. Cutler has developed what he describes as a procedure for laying off workers as painlessly as possible.
"We try to give as much advance warning as we can, and we try to talk people through the process as we're developing information," he said. Benefits to those laid off are generous, he said: a year's pay for workers with at least 25 years' service, at least three months' pay for short-termers and company-paid health insurance for the severance period.
"I think our employees understand it," he said, "and as a result, when we have had to go through a contraction, we've been very fortunate that we have not suffered employee sabotage, people leaving before we can get a job done."
Slimming Down
In Mr. Cutler's eyes, the Eaton plant in Asheville, N.C., is a fine illustration of the company's gains in efficiency. The plant is a collection of unionized operations from the North that over the last 35 years were moved to the South and became nonunion. The median wage at Asheville is $14.54 an hour, high for the city but $8 to $10 an hour less than it would be in a Northern city, said Richard A. Stinson, vice president of Eaton's power distribution division.
From this plant, acquired from Westinghouse in 1994, come control boxes and panels, similar in function to residential fuse boxes but far larger and more technologically advanced. Customers — say, a manufacturer or a hospital — use them to bring power from the street and distribute it in-house. The plant's payroll, at 701 employees in 1999, when sales were $146 million, has been cut to 574. Sales in May ran at an annual rate of $125 million.
"We have gotten much more aggressive about laying off nonperformers," Mr. Stinson said.
In addition, mandatory, unpaid furloughs lasting up to 28 days have reduced the hours of the remaining employees by the equivalent of 78 workers. When the rebound finally comes, Mr. Stinson explains, production and sales can rise even higher than the 1999 level without the need to increase staffing. Ending the furloughs would be enough to expand capacity by 40 percent without any capital investment, he said.
If Eaton's sales are hurting, competitors have lost even more sales, some to Eaton, Mr. Cutler says — an assertion he makes for all of Eaton's products. In today's zero-growth marketplace, he said, the battle in manufacturing is over market share.
During a tour of the plant, Charles L. Haltiwanger, the plant manager, points out the "process improvements" that he says have helped lock in the new capacity. Instead of assigning individuals to assemble entire cable boxes, for example, the work is being shifted to a more efficient assembly line. A design modification has also helped.
Elsewhere, plastic bins filled with bronze bolts, washers and nuts are lined up within reach of a worker who uses them to secure the metal panels of huge control boxes. The worker, Irvin Ball, says that in the past, the bins were scattered, forcing him to walk to get what he needed. "We used to bolt together six or seven of these structures in a shift," Mr. Ball said. "Now we are up to 15 to 16."
Many customers now enter orders via computer, requiring less labor for Eaton. Previously, faxes and mail were more the norm. The efficiencies have pushed down costs at Asheville faster than prices have fallen, or at least as fast, a phenomenon that also shows up in the Commerce Department's national measures of the economy for the last two quarters. That downward spread produced the first spurt in corporate profits since the fall of 2000.
For Eaton, just holding the line on prices is considered an achievement, and at Asheville, price increases come only by adding bells and whistles to the electrical controls, Mr. Haltiwanger said, just as automakers charge extra for sliding sunroofs.
"We can charge more for load shedders and for diagnostic devices," he said, speaking of add-ons for large pieces of equipment. "In today's market, we can get a 10 percent premium for faster cycle time," or weeks between order and delivery. "And tomorrow," he added, "when sales come back and demand is greater, the premium for faster cycle time will be 30 to 40 percent."
At a far end of the plant, a new laser-beam device, the only significant recent capital expenditure, cuts steel sheets into parts of various shapes. Metal stamping, however, is not what Mr. Cutler describes as a core competency — not a means of adding much value, or price, to a product. That would seem to make Asheville's metal stamping a candidate for outsourcing, although Eaton is not planning that now.
Across Eaton, outsourcing has been a means to reduce what Mr. Cutler calls its capital intensity. The company has outsourced transmission plates, metal housings, castings and distribution operations to contractors in the United States or abroad — and Eaton's capital spending has fallen to $275 million, or 4.5 percent of net sales revenue, from $500 million, or 6 percent, in 1999.
The new goal, even in the next boom, is to hold down capital spending to 4 percent of net sales revenue. Eaton, meanwhile, is paying down debt, retiring $663 million over the last five quarters, so that when the moment comes, Mr. Cutler said, Eaton will have "the financial capacity to invest" again.
"You will see capital spending come back," he said, "but with a lag."
The Lessons of Hard Times
The trauma that has made Mr. Cutler so cautious — "the dark side of the bubble," as he puts it — was abrupt and precipitous. Emotion and awe edge into his voice when he recounts the events that were already coming at Eaton when he took over in August 2000 as chairman and chief executive. During his first 16 months, $1 billion disappeared from $8.3 billion in annual sales revenue, cutting net income by more than half.
The damage spread across all of Eaton's divisions, and net sales revenue is still falling, although only at half the 15 percent rate of last year. Shipments will not begin to turn up significantly until late this year, Mr. Cutler says. Not since the Rust Belt crisis of the 1980's has Eaton had such an experience. Then, the company shrank by one-third, and while the "resizing" is less drastic now, he said, it is much swifter and steadier.
"Some people will say, `Gee, that's tough; that's insensitive,' " he said. "My view of it is that attentiveness to month-to-month and year-to-year productivity gains is really a tremendous focus in the economy."
His management tactics were shaped during a difficult stretch for American industry. In 1975, having just earned an M.B.A. at Dartmouth's Amos Tuck School, Mr. Cutler returned to Milwaukee and went to work for Cutler-Hammer, an electrical equipment maker. His great-grandfather had founded the company, and an uncle still ran it as chairman, although it had been taken public decades earlier.
Eaton in the 1970's was a Cleveland-based maker of truck transmissions, clutches and auto components, and in its first big fling at diversification, it acquired Cutler-Hammer in 1978. Mr. Cutler came with the package. By the early 1980's, during a recession, he found himself managing an Eaton electrical parts factory in Atlanta. The plant's major customer, an air-conditioner manufacturer, bought 60 percent of its output and was unhappy.
"We were going to lose that customer within three months after I got there," Mr. Cutler said. "That was the challenge."
The customer stayed, satisfied with Mr. Cutler's improvements — or, more to the point, his operating style. Glossing over details, Mr. Cutler talked about speed and decisiveness as the qualities that served him in Atlanta and still do. "You've got two choices," he said. "You can get on with it, or you can stew about it. And you might as well get on with it."
Getting on with it meant the decision in January 2001 — five months after Mr. Cutler became chairman — to close 19 factories and eliminate 12,000 jobs, mostly in the United States. That reduced the work force to 27,000 in the United States and 20,000 abroad. He acted soon after the Federal Reserve decided that the economy was sinking and began to slash rates.
Even while majoring in history and economics at Yale, Mr. Cutler had shown a preference for getting on with things. Rather than delve profoundly into the forces that shaped the United States, whose basic history he knew from prep school, he studied Japan. "I think you can study the same subject forever and you are going to learn the last 4 percent of it, and that is not of that much interest to me," he said of American history. "It's learning the new things that matters."
It was a quality that helped to lift Mr. Cutler to the posts of president and chief operating officer. He held those jobs from 1995 to 2000, while Stephen R. Hardis was chairman and chief executive. As Mr. Hardis, who retired at 65, describes their relationship, Mr. Hardis was the conceptualizer who put together a series of acquisitions and divestitures that completed Eaton's diversification, while Mr. Cutler was the doer who integrated the acquisitions and strengthened central management.
When the downsizing began, the task fell to Mr. Cutler. "I know I could not have done the cost-cutting," Mr. Hardis said. "He is much better at it."
Reading Signs of Change
To Mr. Cutler, the new economy never existed separately from the old. In their enthusiasm, high-technology companies drew in old-line manufacturers like Eaton and everyone overexpanded together. Consider electric generators for auxiliary power, popular products among the flourishing dot-coms, which they used as backup in their well-appointed offices and plants. Eaton makes circuit breakers and other components for generators, and to meet the demand in the late 1990's, it expanded production at two factories.
When the bubble burst, "we had to cut way back," Mr. Cutler said, adding that Eaton will not easily bring back those two assembly lines.
For all his reluctance today to embrace the optimistic talk of an upturn, Mr. Cutler missed the first signals of the recession. In July 1999, he was still 13 months away from taking over at Eaton, but as chief operating officer he was very much in charge of daily operations, and he made an appearance at a golf outing for truck dealers. At dinner, he asked the dealer sitting next to him how things were going and learned for the first time that prices for used tractor-trailers had begun to fall sharply.
"I can remember talking to people about what he said," Mr. Cutler recalled. "And people said: `He's crazy. He does not know what he is talking about.' "
The booming new-truck market was still six months away from reacting to the pressure of declining freight and overproduction. Net sales revenue across Eaton's product lines was still climbing toward $8.3 billion in 2000, and the payroll had swollen to 59,000 from 41,000 in 1995. Times seemed good, and Eaton's chief economist, James Miel, assured Mr. Cutler that they were. "Our interpretation was too sunny," Mr. Miel said, "and Cutler soon sensed it."
Now the antennas are out for the upturn. "There is a lot of goofy economics out there," Mr. Cutler said. "One of the best places to find out whether the economy is up or down is to hop into a private car in New York or Chicago and ask the limousine driver how business is."
It is not good.
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