CATERPILLAR: A TEST OF U.S. TRADE POLICY : Heavy-Equipment Maker Gains the Edge Against Japan’s Giant Komatsu as Dollar Falls Against Yen

Here in this modest, oft-stereotyped city by the Illinois River, there’s a new pastime--dollar watching.

No matter what other image Peoria conjures up, this is simply a bedrock, blue-collar company town, with its fortunes tied inextricably to the corporation that overshadows all others here--Caterpillar.

And right now, it’s hard to find an American firm with more to gain than Caterpillar from the recent dramatic decline in the value of the dollar--and the simultaneous run-up in the Japanese yen.

For years, Caterpillar, the nation’s biggest construction equipment maker, has been locked in a global, one-on-one struggle with a single Japanese giant--Komatsu Ltd.

That competition has forced Caterpillar to slash costs, eliminate jobs and cut prices in order to hang on to its No. 1 position in the worldwide earth-moving equipment industry. To avoid getting swamped by cheap machines from Komatsu, Cat has not increased prices since 1981. At the same time, many of the smaller American and European equipment makers have quit the business after getting caught in the Cat-Komatsu cross fire, leaving the field open for the giants to battle.

But until recently, no matter what Cat did to remain competitive, the strong dollar kept battering its worldwide market share.

The weakness of the yen against the American currency over the last few years gave Komatsu a huge cost advantage. It produced its equipment in Japan with parts and labor paid for with cheap yen and then exploited the yen’s weakness by keeping prices low overseas. That edge helped Komatsu steal sales away from Cat around the world--and in the United States.

Traditionally one of the nation’s premier exporters of manufactured goods, Caterpillar suddenly found its foreign markets shrinking just as it was being severely tested at home. The results were plain to see on Cat’s bottom line--combined losses of $953 million from 1982 through 1984.

But since the yen has appreciated nearly 40% against the dollar over the last few months, the ground rules for Caterpillar’s fight against Komatsu have suddenly changed--in Cat’s favor.

And now, the outcome of its one-on-one competition with Komatsu could provide a clear test of the Reagan Administration’s currency-based trade policy.

The Administration, seeking to ease pressures for import quotas and other restrictions, has moved with other Western powers to intervene in the currency markets; although the dollar has gained some ground against the yen, it is still far weaker than it was before the central bankers acted last fall.

The idea behind the Reagan Administration’s currency strategy is to create a more balanced relationship among the dollar, yen and other major currencies, and thus enhance American corporations’ ability to compete on a worldwide basis.

But if that strategy doesn’t play in Peoria--if a relatively strong American manufacturer such as Caterpillar can’t beat back the Japanese now--the Reagan Administration may have to think twice about whether it can rely on currency intervention as the centerpiece of its trade policy.

The Cat-Komatsu competition “is not a bad proxy for judging the impact the dollar is having on trade with Japan,” observes Lee Morgan, a former Caterpillar chairman and now a leading business spokesman on U.S.-Japan

No Evident Impact

Caterpillar executives believe that they will begin to reap the benefits from the stronger yen within the next few months. But so far, it has been difficult to see any impact at all.

The Japanese have not been eager to give back all of their hard-won gains. And, like their counterparts in other American industries, Caterpillar officials say they have yet to see much evidence that the yen’s appreciation has curtailed Japan’s ability to compete.

“I don’t think we can say we’ve actually seen a situation where we’ve made a sale that otherwise we would not have made” because of more favorable currency rates, says Caterpillar Chairman George Schaefer.

Komatsu has twice announced list-price hikes since the yen began to appreciate late last year, including a 13% across-the-board increase that went into effect April 1.

But, like other Japanese exporters, Komatsu has been stubbornly avoiding effective price increases since the yen began to appreciate in order to hang on to its foreign sales, according to Caterpillar executives. As a result, the real, or “transaction,” prices that Komatsu charges its customers have not risen at all, Caterpillar officials insist.

Despite denials by Komatsu executives, Caterpillar officials say that Komatsu is providing subsidies to its dealers so they can offer below-list prices to customers and is absorbing the extra currency-related costs.

Caterpillar believes that Komatsu has announced list-price hikes in an effort to lure Caterpillar into raising its real prices before Komatsu institutes price hikes of its own that stick.

“Maybe their strategy is to see how long they can ride this out, to protect the market share they’ve built up,” Schaefer speculates.

Won’t Raise Prices

But Caterpillar has so far refused to take the bait; Schaefer and other executives say they won’t raise their prices until Komatsu makes the first real move.

Komatsu officials say the only reason their price hikes haven’t taken hold is that their dealers are still stocked with lower-priced equipment shipped from the factory before the increases went into effect.

“Our full list-price increases will take effect gradually, as our old inventory runs out,” says Nobuo Murai, president of Komatsu America Corp., Komatsu’s Emeryville, Calif.-based American sales and distribution arm. “We are not offering any special dealer incentives. Eventually, our transaction prices will gradually increase.”

Still, Caterpillar officials believe they won’t have much longer to wait for that to happen. Donald Fites, Caterpillar’s executive vice president for marketing, predicts that Komatsu will be forced to raise its transaction prices 3% to 5% between now and December, giving Cat a little breathing room for the first time in years.

“Somewhere down the road, there has to be some movement (on Komatsu’s prices) if they are going to protect their margins or to prevent themselves from going into a loss situation,” adds Schaefer.

He estimates that the spread between Komatsu’s expenses and revenues has worsened by 20%; the nearly 40% run-up in the value of the yen has only been partially offset by a 15% to 20% reduction in what Komatsu pays for energy and imported parts that are now cheaper to buy in Japanese yen.

So, today it is Komatsu’s turn to watch its edge erode because of unfavorable exchange rates, and Komatsu executives say they are starting to worry more and more about their ability to remain competitive with Caterpillar.

They are especially concerned about the United States, where Komatsu, which has rapidly built up a 10% domestic market share since first introducing a full line of equipment here in 1984, had hoped to make big inroads over the next few years in Cat’s still dominant 50% U.S. share.

Fear Losing Share

“If they maintain their current prices, I think we will lose market share,” says Komatsu’s Murai. “I hope that they raise prices.”

But Caterpillar executives haven’t made up their minds on that point yet. Fites says that when Komatsu’s prices finally start to go up, Cat will be faced with “strategic options”--whether to raise its own prices to get bigger short-term profits or to hold the line on prices in order to regain market share previously lost to Komatsu.

Fites indicated that the company may use a combination of the two tactics; raising prices on certain product segments where Komatsu is weakest while keeping them frozen on equipment that goes head-to-head with the heart of Komatsu’s lineup.

“That is still being discussed,” Fites said. “But we won’t be faced with making that decision until after we see some actual transaction price increases from Komatsu.”

Still, Fites does tip his hand when he criticizes General Motors for exploiting the yen-related price hikes of the Japanese auto makers by immediately raising its own prices by nearly 3%.

“We have been surprised by some of the actions taken by Detroit,” Fites says, indicating that Caterpillar will show greater concern for market share when the time comes to react to Komatsu.

One reason Cat can now afford to be cautious on pricing is that, after slashing costs 22% since 1981 and reducing its worldwide payroll from a peak of 89,400 in 1979 to 54,064 today, the company has finally returned to profitability.

After posting earnings of $198 million in 1985--its first annual profit in four years--Caterpillar reported that its cost-cutting drive continued to pay off in the first quarter of 1986, when it earned $111 million, compared to a $70-million loss during the same period last year.

Analysts Urge Boost

Still, some industry analysts continue to urge Cat to take advantage of the opportunity to raise its long-depressed prices.

“Caterpillar has got to get its transaction prices up,” says Charles Bromley, a heavy-equipment analyst with Duff & Phelps in Chicago.

“The energy and mining markets, where it sells its most expensive equipment carrying the largest profit margins, have collapsed. So Cat has been mostly selling less expensive equipment in other markets, and its margins are low right now,” Bromley adds.

But while Cat and the analysts worry about Komatsu’s future in the U.S. market, the real threat from Komatsu remains overseas, where the Japanese company’s big inroads into Cat’s dominance have not yet been curtailed by the rising yen.

Murai says Komatsu’s share of the worldwide market, including Japan and the United States, is roughly 24%, compared to Caterpillar’s 40% to 45%.

Although Cat is still strong in Western Europe, where it has large manufacturing operations, Komatsu is already No. 1 in the Middle East and has been gaining strength in Latin America, Africa and Asia.

Fites says the yen’s new strength has not yet been of much help in those markets. He notes that Australia is the only foreign country where prices have been rising since the Japanese currency started to appreciate last year.

(Ironically, one way Caterpillar hopes to fight back overseas is to expand its 23-year-old Japanese joint venture with Mitsubishi Heavy Industries into the hydraulic excavator business, which is one of Komatsu’s strongest markets. But Schaefer admits that the yen may force Caterpillar to raise the prices on the Japanese-built equipment produced by the joint venture.)

Faces Strike Deadline

At the same time, Cat may not have much chance to enjoy the benefits of the weaker dollar even if Komatsu raises prices soon; it is facing a June 27 strike deadline by its 17,000 union workers in the United States.

After enduring a 205-day strike by the United Auto Workers in 1982 and 1983--the longest nationwide strike in the UAW’s history--Cat has taken a less aggressive bargaining stance this year, even while stockpiling equipment to hedge its bets.

But another long strike could give Komatsu a chance to expand its market share here despite the exchange rates.

Komatsu may do that even if there isn’t a strike against Cat. No matter what happens to the Japanese currency, Komatsu officials vow, they won’t sit idly by and let Caterpillar get the better of them for very long.

Murai notes that Komatsu will be slashing costs in Japan to cope with the rising yen, improve its service system so that customers won’t mind higher prices quite as much, and will also open its first American manufacturing plant in Tennessee in October or November.

With a U.S. plant, Komatsu will not have to import as many products from Japan and will thus be less vulnerable to the volatility of the currency markets. Murai is talking about increasing Komatsu’s 10% market share, not watching it diminish.

“We will be taking actions to counter the currency situation,” pledges Murai, “and I think our U.S. market share will still be 10%--at least--when all of this is over with.”