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BusinessWeek
April 11, 2005
Getting Emerson Humming Again
By James Berges
Emerson Electric Co. had one of Corporate America's longest winning streaks. The St. Louis
manufacturer posted steadily higher earnings for an incredible 43 years in a row. Then, with the
collapse of the telecom industry and a drop in most of Emerson's other businesses, the streak
came to an abrupt end in 2001, with profits falling 27.5%.
The company wasn't down for long. Emerson, which makes everything from air-conditioner
compressors to computerized equipment that can run an oil refinery, increased revenues steadily
for the next three years. In the fiscal year that ended in September, 2004, sales were up 12%, to
$15.6 billion, an all-time high. Profits, which increased 15.5% last year, to $1.26 billion, still
haven't topped 2000's record of $1.42 billion. But they may in the current fiscal year. Despite
some worrisome signs here and there, Emerson says net income should climb 10% to 15% on a
sales increase of 9.5%.
The 125-year-old company is benefiting hugely from the rebound in U.S. capital spending and
from China's economic boom. But that's only half the story. Influenced by Toyota Motor Corp.'s
lean-manufacturing practices, Emerson execs have closed or sold 140 factories and cut head
count by 16,100, or 13%, since 2000. At the same time, the company has been outsourcing more
and more work to China, Mexico, and other low-wage countries.
James G. Berges, 57, is Emerson's president. A former engineer at General Electric Co., Berges
was hired at Emerson in 1976 as director of manufacturing planning and worked his way up to
the company's No. 2 post in 1999. Berges recently spoke with BusinessWeek Senior
Correspondent Michael Arndt. An edited transcript of their conversation follows:
Tell me about the economy.
I've seen our order data through January; they're actually pretty good in the U.S. But we think the
economy will slow down in the second half. The consumer is getting a little wobbly.
But we could get surprised. U.S. manufacturing companies, particularly oil and gas, are awash in
cash. As the cash piles up, you've got to do something. You could increase your dividend payout,
or you could invest in those productivity programs that you've back-burnered for the past couple
of years. So even if the consumer goes into a little funk, the capital-goods sector might stay good.
We think this will be sustainable for a while.
Is economic growth outside of the U.S. less promising?
We have seen a slowing, particularly in Europe. People just aren't spending money. We're heavily
focused on capital goods in Europe. You combine the very strong euro with the rigidity of the
workforce — your inability to lay people off when there's a downturn — and it's a difficult
environment to invest in. We're looking at a pretty much flat year.
I hate to say this, because we've got terrific German, French, and Italian companies and people,
but you hate to hire people in those countries because the cost is so enormous if you ever have to
take them out. As we have had attrition in Western Europe, we have just not replaced people. And
I've got to believe the same thing is going on with everyone else.
What about China — threat or opportunity?
Our growth in China has been terrific. We grew over 25% in China last year. Our sales reached
$1 billion. I'd say '05 will continue to be pretty strong for us. These guys have done a marvelous
job of managing the economy so far. I'd almost say we're on fire there.
Do you see your capital spending migrating toward China?
Sure. We like to build factories in the market where the sales are. But we can do business in
China for a fraction of the capital that we can do in the U.S.
There's a terrific base of suppliers who are very competitive. You go to China, and everywhere
there are people who are willing to take the risk to go down the street and rent a garage and buy a
screw machine and start a business. So we rely on them to invest the capital. We're putting more
capacity in Asia, but we're not spending massively more.
Are your facilities in China primarily for the Chinese market? Or are they used to build products
for export?
We do both there. We manufacture roughly $700 million worth of goods in China, and we import
about $300 million. But then we also export $300 million. We've got about a perfect balance of
trade there.
Given your increasing exposure, do you have any worries that China will slow down too
abruptly?
The biggest concern has to be currency. They are swimming in dollars. Because the yuan is
pegged to the dollar, they have to print yuan to convert all the dollars flooding into the country.
That increases the money supply and increases inflation and speculation.
The problem they've got is keeping the export engine going and not getting a bubble in the
economy and runaway inflation — and the whole thing comes down. For their own sake, they
probably need to let their currency appreciate.
How does Mexico fit in?
A couple of years ago people were starting to move from Mexico to China. I think that has
slowed down. First of all, just picking up and moving from Mexico to China doesn't really save
you a lot. Wages are lower in China, but they're marginally lower. Wages are $1.50 an hour in
Mexico and maybe 90 cents an hour in China. You wouldn't pick up and move just for that labor
differential. In fact, many times, freight costs and the inventory you have tied up on the water eat
up the difference. But you might move because you have that supply base in China. For whatever
reason, the Mexican economy never developed this support structure. Either way, you want to
spread your bets: You don't want all your investment in China, or in Mexico.
Emerson is probably a typical manufacturer when it comes to hiring. Your sales and profits are
climbing, but your payrolls are shrinking. Do you see manufacturing ever becoming a big hiring
machine again?
Probably not, to be realistic. You've got this combination of low-value jobs going to Asia, which
will continue, and productivity gains, which are so terrific.
I don't think people realize how much savings you can get when you're serious about lean
manufacturing. It has had a huge impact inside Emerson. Your productivity rates really go up,
and I don't mean 2% or 3%. We get jumps of 5% and 6%. You get rid of a lot of unproductive
jobs. I don't need an expediter or a scheduler or a forklift driver in a lean factory.
Raw-material costs have been rising. How do you deal with that?
We had the good fortune of having long-term contracts with most of our steel suppliers, and we
had hedged much of our other raw-materials needs. So when things started to run up, we had
some level of protection. We had time to go out and get some price increases.
It's easy to get increases in some markets. For instance, when you're selling spare parts one at a
time, there's a lot of price elasticity there; customers need these parts right away if their machines
are down. In this aftermarket space, we could raise prices 5% or 6%. But when you're selling to a
large original equipment manufacturer, it's harder. If we could get 1% or 2%, we'd be lucky.
But at some point, contracts expire and hedges come off, and now you're exposed to market
prices. In our first quarter ended in December and in our March quarter, our results do reflect
pressure on our margins. But we should look a lot better in our second half. We've locked in new
supply contracts, and we've negotiated new prices with customers.
Health-care costs are rising too.
They're going up double-digit. Like everybody, we try to defer that. One of the big things you do
is push some of it on employees. It's an unfortunate thing, but it's something we have to do to be
competitive. It's still a big issue for us.
Let me ask you about corporate governance and new regulations on Corporate America, such as
the Sarbanes-Oxley Act.
Sarbanes-Oxley is an opportunity for us to transfer money to accounting firms. That's all it is. The
thought that these guys would somehow be able to come in and find something in our financial
reporting process that was a reportable offense is laughable.
Under Section 404, your accounting firm, on top of the auditing work, has to run around and
make sure all your policies and procedures are being followed. What do they find? They find that
a guy in Oshkosh did the work but didn't initial the bottom of a piece of paper. To find that out,
we get to pay $2.2 million. That sure helped the shareholders. I find it offensive, to tell you the
truth.
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