Interview: Caterpillar's Ed Rapp on winning in China

After three years as Caterpillar’s Chief Financial Officer (CFO), group president Ed Rapp took up a new role at the start of this year with overall responsibility for the company’s ‘Construction Industries’ products.

Mr Rapp is one of five group presidents, along with chairman & CEO Doug Oberhelman, at Caterpillar’s helm and was appointed to the role in 2007, ahead of his move to CFO. Speaking to Mr Rapp, who’s career with Caterpillar dates back to 1979, it is clear the change of roles is one he relishes.

“I’m really looking forward to it,” he said. “I’ve worked in the construction business through the years. The move over to the CFO assignment was a fascinating one, especially when you go through a global financial crisis. It’s an experience everyone should have... Once!,” he laughed.

A key part of his job is to develop Caterpillar’s business in China. To “Win in China” is one of the company’s “Big 8” imperatives for 2011 – 2015, a series of goals that Caterpillar’s executive team believe will help it to deliver superior financial results and global leadership in the industry.

Indeed, the company’s ambitions for China were clear from its enormous display at November’s Bauma China exhibition in Shanghai. Taking up an entire hall at the show – more than 12,000 m2 – the company displayed some 50 machines from both the Cat stable and its Chinese subsidiary SEM.

And it is not just about products – the company’s strategy for China is about services such as machine financing, the remanufacture of components, high parts availability, handling used equipment, equipment rental by its dealers, and so on.

“Selling hydraulic excavators in China is very important, but building our dealers’ power systems base and mining business is also important. I think we’ll win in China by bringing that whole portfolio to bear. There are tremendous opportunities in China in power systems, for example,” said Mr Rapp.

He continued, “Some people have asked why you have an extensive display at Bauma China when the market is down in 2012. That display is not based on the opportunity here in 2013, it’s based on the opportunity here out to 2025.

“Urbanisation is occurring. The stated goal of the government is to further urbanise. That drives demand back to basic infrastructure. If you look at the twelfth five-year plan and statements from the new government, they are very focussed on improving standards of living and GDP per capita. As that happens, it will drive demand back for commodities and everything we do. We’re here for the long haul and really optimistic about what the possibilities might be.”

As well as selling machines under the globally recognised Cat brand in China, the company also owns Shandong Engineering Machinery (SEM), a Shandong Province-based wheeled loader manufacturer it acquired in 2008. Although it is a wholly-owned Caterpillar subsidiary, the machines SEM makes are very different to products with a Cat livery.

“We’ve acknowledged the fact that there are two primary customer segments,” explained Mr Rapp. “One is the ‘Lifecycle’ segment which I would traditionally view as the Caterpillar customer around the world. They are concerned about up-time, lowest owning and operating costs and really looking at the value of the equipment over the lifecycle. One thing these customers really understand is that availability drives their bottom line. Down-time just kills profitability, and it is the Cat brand that I think about with that customer segment and value proposition.

“But in China in particular, you have a segment that I would call ‘Utility,’ where the customer at this point in time isn’t as concerned about that value proposition and lifecycle approach. It’s more about initial price and up-time.

“So with the Cat brand we have a strong focus on that lifecycle approach, and we are developing the SEM brand around that utility segment.” But according to Mr Rapp, there is a growing understanding in China that the cost of a machine is about more than just the purchase price.

“One of the things with the customer meetings I’ve had at Bauma China, which have been concentrated on the cement industry, is that they’ve all about the lowest operating cost. They see the slowdown in China as an opportunity, because the smaller players are less efficient and they see potential for consolidation.

“But the SEM brand is also in case that utility segment stays around for a long time. It is an acknowledgement from us that we want to be there whatever way the market goes,” he said.

Putting the long-term outlook aside for a moment, the fact remains that after a decade or so of remarkable growth, especially in the stimulus spending-supported years of 2009 and 2010, the equipment market in China in 2011 and 2012 was a tough one. Sales of machinery were down in the region of -30% to -50% in 2012, depending on machine type.

“It’s painful when you go through it, but I think the slowdown in China in 2012 is a good thing,” said Mr Rapp. “China did the world a big favour with the way it stimulated coming out of the 2008/9 crisis. Not only did it drive growth in China, but it drove demand around the world for commodities, which helped emerging markets. But there’s no doubt that the market in China overheated. You had new players, new capacity and some commercial practices that weren’t healthy over the long term. The slowdown in 2012 brought all that to a head.”

“We would like to see consolidation to happen in the industry. We think it would be the good thing for China in the long-term, but it depends where the market goes.

“The government has talked about industry consolidation being an objective. They have pushed it in other sectors, and we think it will come to this industry, and we would welcome it.”

2013 improvement

The immediate outlook according to Mr Rapp is that conditions will get better in China over the next year or so, but as echoed elsewhere, he thinks development will be more measured and more targeted in future.

“Our base forecast is that we will see some improvement in 2013, compared to 2012. The government is trying to be very thoughtful about how they stimulate the economy now they’ve got inflation under control.

“If you think about it, what they’re doing is turning two dials. One is to drive up growth and provide opportunities for the population to urbanise. The other is to control inflation for those that have already urbanised. It is a delicate balance.

“When you get into the transition points – when they’re trying to control inflation or drive up growth – those transition points are a little bit rough. We saw that in 2005.

“So we’ve been to this movie before, but I think what we’ll see this time is a more thoughtful approach and more gradual growth, avoiding the overheating that happened in 2010 and 2011. That would be good for the industry and good for us.”

And as the industry in China grows and consolidates, Mr Rapp also expects it to change. One aspect of this is likely to be in environmental performance, with further cuts in exhaust gas emissions from construction equipment.

Mr Rapp said, “In every conversation with the government this week, the environment has been raised and I think the sensitivity to it is more than just window dressing. I think there is a legitimate concern, which plays into productivity, matched fleets, systems engineering and so on.

“One of the things we’d like to see is a faster transition to Tier 3 and Tier 4. They’ve done it on on-road, but they’re lagging on off-road. I think it’s part of the continuing development here that over time you’ll see it. I think the comments made by government point to that, which we absolutely welcome.”

And construction equipment buyers in China are also expected to develop more diverse tastes in construction machinery. One aspect of this is likely to be a move away from the 20 tonne class excavators that dominate the market today, to bigger and smaller machines, more suited to specific tasks. Compact equipment is an area where Mr Rapp sees an opportunity, for example.

“If you look at developing markets around the world there has been a significant lag between the use of core and large products and then the move to small machines. I think that transition in China is going to take place faster than it has in other areas.

“Africa and the Middle East took a long time until the backhoe market really grew. It was the same for skid steers. But if you look at the mini hydraulic excavator market in China it is growing at a fairly rapid pace. That means they’re making that transition from manual to mechanical labour in fairly short order.

“They may have a different tool of choice here in China – mini hydraulic excavators instead of backhoes and skid steers – but I think we’re going to the small machine business grow. Based on urbanisation rates that are equivalent to building a new Chicago every two months, I think you’re going to see that develop.”

Caterpillar wants to be around in China to capitalise on all of these opportunities. As Mr Rapp explained, the company’s presence dates back some 40 years.

“There’s a fascinating history here back to President Nixon’s visit here in 1972. He gave them a communication system, which was powered by Caterpillar generators. I think Caterpillar was part of the delegation that came on the visit following that. We set up sales offices here in the 1970s and licensing agreements in the 1980s and then went on to manufacture ourselves.

“We have 22 factories in China, four research & development centres and three logistics centres and Cat Finance with over US$ 1 billion of assets under management. But we are also putting a lot of time and effort into developing our local leaders.

“What you see at the show (Bauma China) is our full business model from products to services to solutions to technology. It looks nice, but it’s been 40 years of heavy lifting to get to this point. What I say to customers and government officials in China is that you need to consider us a national champion – we’ve been here 40 years and we have no intention of going anywhere,” he said.