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Manufacturing Leaders Discuss State of Economy

Wed April 15, 2009 - Northeast Edition
Giles Lambertson

The recession of 2009 has construction industry manufacturers fine-tuning their business plans to ensure that when the economy bounces back, sales of their product lines will rebound as well.

Three manufacturing executives who accepted a request by Construction Equipment Guide (CEG) for a question-and-answer exercise, are, of course, keenly interested in the impact of the Obama administration’s infrastructure stimulus policy. Generally, they hope that it will boost construction activity and sales, though cash flow problems in the interim are difficult and tax policies seem problematic.

They acknowledge that some operational theories about the benefits of a global economy are being tested in this worldwide downturn. As Terex Corp. Chairman and CEO Ron DeFeo noted, because the world’s economies are closely joined for good or ill, economic struggles on other continents actually “exacerbated the recessionary effects we were feeling” in the United States.

The company officials also touch on the subject of “bellwether machines,” that is, pieces of equipment in product lines that are sensitive to marketplace fluctuations, giving early warning of economic changes ahead.

Joining DeFeo in answering the questions submitted by CEG editors are Don Johnson of Caterpillar Inc.’s Business Intelligence Group and Goran Lindgren, president and CEO of Volvo Construction Equipment North America Inc.

CEG: The economic cycle periodically produces recessions. Even so, companies sometimes do not prepare for them and suffer more dire consequences than they otherwise might. In its long-term planning, how does your company anticipate and prepare for cyclical downturns?

DeFeo: Construction equipment manufacturing is a cyclical business, but what we saw in 2008 was really a tale of two years. It was as if a light switch had been turned off some time in the third quarter. Our businesses did not anticipate the quick onset or severity of the downturn, for the most part, and we had to make rather dramatic manufacturing shutdowns to compensate.

To answer your question directly, we do many things to be flexible as a manufacturer, such as employing temporary workers and outsourcing components. We are not very vertically integrated. As one notable example, we buy engines as opposed to making them ourselves. However, it is our emphasis on lean manufacturing that serves us best in good times and bad.

Johnson: For several years, we have had trough-planning exercises in which business units develop plans as to how they would react to a recession. We have also spent time trying to identify factors that would suggest a downturn is developing.

Lindgren: We began seeing signs in late 2007 of some of the troubles ahead, and, in turn, began working to reduce our cost structure to suit lower, reduced, demands. The early [2007] downturn actually helped us when the major financial crisis hit in that we were ahead of the crisis, so to speak.

CEG: According to Census Bureau data, U.S. construction spending sagged in January. Unsurprisingly, Federal Reserve districts reported manufacturers of construction related equipment and material fell sharply in January and February. When does your crystal ball tell you that domestic and global manufacturing production of construction equipment will begin to rise again?

Johnson: We are currently monitoring home prices and credit spreads as potential indicators of improvement. Up to now, these factors remain negative.

Lindgren: There are so many variables in the equation. We are prepared to see this slide through 2009, but we, of course, hope for an earlier recovery. We also believe that the market will pick up first in rental, then parts and service on machines going back to work, followed by rental/sales conversions and finally new machine sales.

DeFeo: It is hard to handicap because our crystal ball is not that precise. Many observers expect this slowdown to continue through much of 2009 before we start to see recovery. Some people may think that view is optimistic, but we do know that recovery is inevitable.

CEG: Is there a global marketplace — China, for example — where your product line has not felt the drag of this worldwide recession?

Lindgren: No … it has taken China a bit longer to feel the effects of this recession than other parts of the world, but we are feeling the “drag” throughout the Volvo Construction Equipment business world.

DeFeo: We have felt this slowdown worldwide. Our larger cranes maintained a good backlog in the last quarter of 2008 and the outlook is positive for at least the first part of the year. Others have suggested — and we agree — that we may see recovery first in China due to the large infusion of direct infrastructure spending.

Johnson: The downturn is worldwide. However, developing economies appear to be holding up better than the major developed economies — United States, Europe and Japan.

CEG: Some construction equipment lines presumably are more vulnerable to the vagaries of economic forces. Is there a piece of equipment in your line-up that seems to weather downturns the best? Conversely, is there a piece that is a bellwether of economic health?

DeFeo: We first saw signs of the downturn in product lines that directly support the residential construction market, such as concrete mixer trucks. We have products that stretch across the economic cycle, so the cranes business is typically stronger later in the economic cycle. Maybe another company with fewer product offerings operating in one part of the economic cycle can point to one product that is a bellwether for them, but I don’t believe we have such a product.

Johnson: Products extensively purchased by governments, such as motorgraders, tend to be less volatile. Products used extensively in residential construction and mining tend to be more volatile.

Lindgren: Not really … the economic downturn has hit the construction equipment pretty much across the board — residential, industry and commercial construction, road building, mining, infrastructure projects — all, both private and governmental and municipal. This happened in the industry, however, on a segment-by-segment basis, you might say, with different segments being affected at different times, in different cycles. In the long run, this affected our entire range of equipment.

CEG: Among the lessons learned from both economic surges and sags have there been any that directly influenced product development? That is, has a piece of machinery in your experience been introduced or modified in response to contractors’ experiences during hard times?

Johnson: We view assessing customer needs and responding to them as an ongoing process. I am not aware of any products in which recessions led to a need to modify a product.

Lindgren: Not specifically for the market downturn — Volvo has always been ahead of the game when it comes to fuel economy for its entire range of machines, and that will prove to be of tremendous benefit to contractors as they — and we — weather this storm.

DeFeo: We try to be responsive to our customers’ feedback on our equipment and as a company have never believed in introducing new features for their sake alone. Instead, we concentrate on providing maximum return on their investment through maximum equipment up-time, ease of repair, and the like. Those things will always serve our customers well. I can’t say that I know of a case where an economic dip, per se, has led to a specific modification.

CEG: Current economic stimulus legislative efforts in this country and elsewhere are designed to stem and reverse the slowdown. Have the efforts aided the manufacturing sector in any way, other than to eventually spur more purchases of equipment by contractors with new contracts?

Lindgren: The economic stimulus programs now being introduced to the United States hopefully will benefit every sector of the economy and construction equipment will see its share of revitalization of the entire market. We must, of course, see a strengthening of our banks and a broad reopening of credit lines.

DeFeo: We hope to see some positive effect of the Economic Recovery stimulus package on equipment purchases in the U.S. and elsewhere, but that spending will only partly offset the effects of the worldwide economic downturn. You also have to remember that only a portion of that spending is going toward the so-called “shovel-ready” projects at the state and municipal levels.

At Terex, we take a longer-term view and have been actively encouraging policymakers to think of infrastructure investment as being essential to a nation’s economic prosperity. If you look at projects from the Erie Canal to the U.S. Interstate Highway system, key undertakings served to make the country much more economically competitive.

Alongside such organizations as the American Chamber of Commerce, the American Road & Transportation Builders Association and the American Society of Civil Engineers, we are advocating for thoughtful, strategic investment in carefully planned infrastructure projects in surface transportation, energy, ports and waterways, and other areas that will truly benefit our economy for the long term.

Johnson: We see little evidence that these packages have impacted sales but probably not enough time has passed for such benefits to emerge. In general, such spending is likely to offset some of the declines in private construction activity. So total construction likely will still decline.

CEG: Is there, in your view, a more effective way — tax or depreciation schedules, for example — for government to help construction equipment manufacturers remain viable during an economic slump?

DeFeo: The bonus depreciation and expanded asset expensing opportunities contained in the American Recovery and Reinvestment Act should help stimulate demand for new equipment. However, these provisions only address the demand side of the current challenge.

A key issue facing the industry is maintaining adequate cash flow given the state of the credit markets. Several possible income tax incentives that would improve cash flow are refundable income tax credits, extending the carry back period for income tax losses to allow companies to recover taxes paid in prior profitable years, and expanding the availability of the domestic production activities deduction by eliminating the taxable income limitation.

While these incentives help in the short term, they do not address the fundamental anti-competitive nature of the U.S. tax code. Many U.S. equipment manufacturers compete globally against other multi-nationals. The U.S. tax code should promote worldwide expansion of U.S. companies and facilitate international growth.

Increasingly, legislative proposals are focused on taxing the international operations of U.S. companies. Such proposals are unique in the G-20 group. In the past year alone, the U.K. and Japan have decided not to tax the income generated by foreign subsidiaries of companies located in these countries.

Johnson: The idea of investing in infrastructure is appealing. Such spending can soften the economic downturn and help improve the quality of infrastructure, which has deteriorated due to insufficient past investment.

Lindgren: The Bonus Depreciation plan has been of great assistance to contractors.

CEG: Do you foresee consolidation of the industry during this recession, with some smaller manufacturers of equipment surviving by becoming a division of a larger company?

Johnson: We have no comment on this question.

Lindgren: There is always a chance of consolidation of companies through mergers, acquisition, the development of partnerships. It is not unlikely in the present economic environment.

DeFeo: This is certainly possible, as we’ve seen this in previous down cycles. Beyond that, it would not be appropriate for me to speculate.

CEG: From your experience in the industry, do you foresee this recession becoming a significantly larger economic sag than was endured by the industry in the 1970s and 1980s?

Lindgren: In scale, yes, since our industry has become a global one and the effects are very, very far-reaching and since the economic “sag” has touched so many sectors of our society.

DeFeo: I certainly hope not. From a macroeconomic standpoint, we have a U.S. administration that’s working hard to prevent the worst possible recession, as are officials in many other countries, as well. I actually believe that the industry may be better situated to weather this storm and to recover more quickly than in previous cases. It is still going to be painful, however, and we can’t kid ourselves about that.

Johnson: This recession is on track to be the worst for the world economy in the postwar period.

CEG: Does a global economy mitigate a recession or, quite the opposite, does it speedily export a recession around the world from its starting place? Wasn’t the advent of a multitude of markets around the globe supposed to give some protection against “local” economic dips? What has been your company’s experience?

DeFeo: The thinking until very recently has been that having multiple global markets would mitigate the effects of recession. We generally shared that outlook and it seemed to work for a while. However, what we’ve seen with the quick unraveling of our financial institutions due to the meltdown of mortgage-backed derivatives was unprecedented. And our global economies are inextricably linked. So, that factor immediately exacerbated the recessionary effects we were feeling.

Let me just conclude by saying that all the manufacturers are facing considerable challenges in this global recession. At Terex, we have taken dramatic actions to meet the downturn in demand and to position ourselves for the inevitable recovery. This has been a difficult, but necessary process. We are very optimistic about our industry.

Johnson: This recession engulfed so many countries since many adopted similar economy policies at about the same time. In particular, many developed economies raised interest rates to deal with inflation concerns at about the same time. Similar policies produced similar results.

Lindgren: Even as global as we are, we all thought that our world was “de-coupled.” We felt that “protection” against “local economic dips.” But we were wrong in this regard; this current economic situation, again, has touched the entire global society and everyone is in the downturn. CEG

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