Corporate Survivors : Bears Don’t Scare the Lean, Mean

Compared with what they have been through in the last decade, most American corporations regarded the stock market’s collapse as a mild tremor.

It did not bankrupt them, nor even threaten to. Indeed many companies rushed to buy their own stock in a show of confidence. No company took lightly the possibility that the crash may presage a recession, but major U.S. corporations are in such fit shape--so lean and mean, in the phrase they use--that they are confident of weathering all but the most severe economic downturn.

Theirs is the confidence of survivors. For U.S. corporations, more than the companies of any other nation, have been challenged in recent years to withstand fierce competition from foreign companies--most of the time with an artificially strong dollar putting extra weight in their saddle bags.

A Blowing Gale

At the same time, presenting perhaps a greater challenge, U.S. companies have been subject to a blowing gale in the financial markets--to corporate raiders threatening takeovers and jumpy shareholders forcing corporations into mergers or massive restructuring of their assets and managements.

Some of the nation’s biggest and most important companies--U.S. Steel, Gulf Oil, Texaco, RCA, Boeing and Goodyear Tire--have been takeover targets. And those that haven’t disappeared in mergers have sought shelter under state laws or a forced restructuring that usually has meant selling divisions or paying a premium to buy back stock from their own shareholders.

Restructuring has become universal. Companies that once stood for lifetime employment--Eastman Kodak, IBM, DuPont--have forced employees into early retirement. Once staid General Electric has become a whirling dervish, selling 200 businesses in the last six years and acquiring 300 others.

Two Big Questions

Two big questions: Why did the financial gales shake American business just when the challenge from foreign competition was greatest?

And have games the markets play, of takeover and restructure, leveraged buyout and repurchase, helped or hurt American competitiveness? First, both the financial and foreign pressures built up during a past that was deceptively prosperous. American companies rode high 20 years ago, expanding broadly into every kind of business; 1968 saw 6,000 mergers, almost twice the 1986 total. Managements behaved generously toward employees, too; wages rose more rapidly in the ‘60s than at any time since.

But most companies failed to anticipate the challenge from foreign competition. Most also failed to rapidly turn out new products, to keep up with changes in technology, or even to make a sufficient return on investment for their owner-shareholders. So when competition from Japan burst upon them at the end of the 1960s, many U.S. companies seemed simply to fade.

Change was inevitable. Foreign competition made great inroads in U.S. markets in the 1970s. And inflation made both investment returns and wage gains illusory.

So change came in the 1980s, as foreign competition, coupled with the demands of stock and bond investors, created a great winnowing fan, separating the weak from the strong, forcing companies to pare fat and focus their competitive efforts--and forcing U.S. workers to work harder for less money.

“It’s the way we run the country,” says Richard Bott, investment banker at First Boston Corp., who notes that Japan does the same thing, but differently. “The steel industry in Japan is going through the same shrinkage and reorganization we went through five years ago,” he says. “But there, the Ministry of International Trade and Industry and the Ministry of Finance govern the process, while here market forces are making industry competitive on a worldwide basis. It seems messier, but it gets results.”

An Understatement

Messy is an understatement. No one denies that the market forces Bott refers to have been accompanied by crimes and abuses: prominent investment figures profiting illegally from advance information about mergers, stock manipulation affecting the jobs and lives of employees, company managers protecting themselves with golden parachutes while leaving their employees stranded.

The allusion to Japan’s steel industry is especially ironic because steelworkers at discontinued mills in Japan were given temporary jobs in other divisions of diversified companies, while the pattern throughout U.S. industry was that employees earning paychecks one day were consigned to unemployment insurance the next. Retraining was inadequate, where it was available at all. Whole regions grew gaunt while others waxed fat.

Yet the results, despite the hardships, are undeniable.

In manufacturing, where the greatest changes in employment and industrial practices have occurred, productivity (output per person or unit of investment) has increased 4% a year in this decade.

Employment in manufacturing is rising again after years of cutbacks; 300,000 manufacturing jobs have been added since June--as total U.S. employment has continued to climb. And more jobs are opening up as U.S. exports increase--although the trade deficit, exaggerated by rising import prices, persists.

Moreover, profits of U.S. corporations are rising again, according to the Commerce Department--meaning real profits as measured by returns on the investments companies make in their plants and equipment. Those profits, which are essential if a business is to create jobs for the future, were in decline from the mid-1960s until 1983.

And as company profits rose again following 20 years of decline, so did returns to shareholders. “It was almost two decades of investor frustration,” says Carliss Baldwin, professor of finance at Harvard Business School. Baldwin cites figures from Ibbottson Associates--a Chicago organization that studies returns from all investments--showing that from 1963 to 1980, common stock investments earned a low average return of 2.49% after allowing for inflation.

But returns on stock investments in this decade, even taking into account the stock market crash, are once again at respectable levels, averaging roughly 10% a year, more than 6% after inflation.

So while the process needs reform, say government and financial experts, there’s no doubt of its necessity. What really has happened, they say, is that U.S. industry has reshaped itself to meet the requirements of a new global reality in commerce and finance--and it has done so with pressure and assistance from the financial markets.

The Goodyear Parable

Akron, Ohio, center of the rubber industry for over 150 years, illustrates both the reality of global competition and the power of the financial markets. It was here in the 1970s that Goodyear Tire & Rubber Co. responded to a challenge from abroad. It was here, too, that the same Goodyear in 1986 was forced to change its policies by a corporate raid conceived and financed from Wall Street.

The competitive challenge came from Michelin of France, which had introduced radial tires to European markets, and in the early ‘70s was making headway in the United States; some automobile manufacturers were going to give Michelins a try, Sears was considering a contract for Michelin to produce the radials under its name.

U.S. tire makers at the time made bias-belted tires which, ironically given the extensive U.S. road system, were better suited for rough or rural roads than for superhighways. Ignoring clear signs that the radials were making inroads, the American tire makers were reluctant to change. They had investment in bias-belted tire machinery and, moreover, radial tires lasted longer than the bias kind. Radials had the potential of changing the economics of the tire industry, and Firestone, Goodrich, U.S. Royal (later Uniroyal) and General Tire were slow to respond.

Change to Radials

But Charles J. Pilliod Jr., since retired and now U.S. ambassador to Mexico, became chairman of Goodyear in 1973 and immediately ordered the company to change to radials. Pilliod had trained overseas, working for the company in Latin America and in Europe, before coming home to Akron to assume the chief executive’s position. He had seen radial tires winning market acceptance everywhere, knew that Goodyear and the United States could not continue in isolation. So he ordered the shift to radials.

It was expensive. “My predecessor made a decision to invest hundreds of millions of dollars,” says Goodyear’s current chairman, Robert Mercer. “And if he hadn’t, we wouldn’t be here.”

Indeed, Goodyear’s American competitors, although still prominent in the U.S. market, are fading globally. Present rankings in the world tire industry are Goodyear first with 21%, Michelin second with 13% and Bridgestone of Japan tied with and about to pass Firestone at 9%.

And failing to compete globally means the companies are finished, because there is no longer any market to hide in. Michelin and Bridgestone both produce in the United States. And West Germany’s Continental Gummi recently came to Akron to buy General Tire’s operations.

This northern Ohio city, with a labor force of more than 300,000 and an unemployment rate uncomfortably above the national average, has felt the effect of corporate failure. Tire manufacturing left Akron gradually over the 1960s and ‘70s, for Alabama--now the leading tire making state--and elsewhere. But the headquarters and technical laboratories of the big rubber companies remained, until the companies themselves fell behind competitively. Now, Firestone’s headquarters have moved to Chicago, Uniroyal has merged into Goodrich and General has been bought by the Germans.

Only Goodyear remained competitive, and its big headquarters and technical center benefit Akron--with good jobs, taxes, charitable contributions and the availability of its skills for community service.

Yet while meeting the competitive threat, Goodyear recently faced a more complex challenge, on the financial front. Company management lost a bet it had made in 1982 when, seeking faster growth in sales and profits than it thought the tire business could provide, Goodyear diversified. It bought an oil and gas pipeline company named Celeron and began the construction of a pipeline from coastal oil fields in California to refineries in Texas. The Celeron investment, ultimately rising to $1.5 billion, was expensive and poorly timed.

Oil Prices Sank

The price of oil sank shortly after Goodyear bought Celeron, investments in the California-Texas line further depressed profits and in October, 1986, corporate raider Sir James Goldsmith--backed by more than $1 billion of financing from Merrill Lynch--bought 11% of Goodyear’s stock and announced he wanted to buy the rest.

Goodyear mounted a spirited political defense, with local government officials in every town where the company has a factory joining in a closed-circuit television hookup to lobby the U.S. Congress into taking action against this and all takeovers.

But it was Goodyear shareholders, and not Congress, who would decide the company’s fate--and investors were nervous. The takeover bid, at a higher price than Goodyear had ever sold for, attracted many stockholders to tender their shares. As Mercer recounts it, Wall Street speculators and Goldsmith held more than a third of Goodyear’s stock before anything like a takeover “fight” really began.

Rather than see the company go to the raider, Mercer accepted a restructuring which forced Goodyear to sell the pipeline company and other diversified businesses, and left it concentrated in the tire business--where it is expanding relentlessly at home and abroad.

It was a dramatic example, say Wall Street investment bankers, of shareholders telling managers to get back to basics. “American companies have to compete for capital,” says investment banker John S. Wadsworth Jr., a managing director of Morgan Stanley. “And those who can access the capital markets are those who have a high rate of return on shareholders equity. The rate of return for the companies making up the Standard & Poor’s 500 index is 12%, for IBM it’s 20%, Morgan Stanley is 28% and Goodyear is 8%.”

Therefore, says Wadsworth, the Harvard-educated son of a Cincinnati bakery company owner, “What corporate managers call Wall Street’s intervention is simply the global markets saying you guys are not running your companies well enough to compete for capital in the American system.”

Chairman Mercer, understandably, disagrees. Noting that Goldsmith made $94 million and Merrill Lynch $22 million when Goodyear repurchased their shares, Mercer calls the ostensible premise of the raid--to increase shareholder value--a distortion of American industry.

‘Many Constituencies’

“I have a job description that concerns itself with many constituencies, and our No. 1 constituency is not the shareholder--it’s the customer,” says Mercer, 63, a graduate of Yale who has served four decades at Goodyear. “If you don’t have the customer you can forget the shareholders and everybody else. You handle the customer first and then comes the shareholder. But equally with the shareholder comes our employees and the communities where we operate and the suppliers--the whole litany of interests.”

It’s the classic conflict of American business--the manager saying company responsibilities go beyond the “bottom line”; the financier saying a return to the owners must come first. But the conflict is more apparent than real, for both Mercer and Wadsworth agree that staying competitive--as Goodyear did with Pilliod’s hundreds of millions of dollars in investments in the 1970s, and as it’s doing now with the further hundreds of millions that Mercer is investing in tire facilities--serves customers, community, shareholders, all the interests.

Learning to Focus

Still, the suspicion remains widespread that fickle shareholders impose a handicap on U.S. companies in the battle against competition. Shares of Japanese companies, by contrast, tend to be concentrated among the firm’s suppliers, customers and banks, all of them in for the long term. That’s an idea that William Ouchi, UCLA management professor and author of “Theory Z” and other books on the corporation, finds appealing. To mitigate what he calls “this war for corporate control,” Ouchi favors creation of a permanent group of large shareholders to be responsible for the company.

One way or the other, it may be an idea whose time has come. Many states have passed laws to control corporate takeovers and major companies have sought to ensure their independence by restricting voting power in their stock. Other investment authorities favor setting a minimum period of, say, a year or two for pension fund investors to hold stocks.

That would achieve more stable ownership without restricting voting power, in the eyes of investment banker Felix Rohatyn, and former Labor Department pension commissioner Robert A. G. Monks. Stability of ownership is the goal of such ideas, not a security blanket for complacency.

There was outward stability, and no raider in sight, when venerable Eastman Kodak decided to change in 1984. But the threat of some kind of reaction from a dissatisfied investment community was implicit following years of decline. The company that once epitomized product development, and made its yellow box of film familiar worldwide, had fallen behind. Fuji Film, from Japan, even grabbed sponsorship of the 1984 Los Angeles Olympics away from Kodak.

Financially, too, Kodak was green around the gills, its return on investment falling to only 7.5% in 1983 from 23.7% a decade earlier. Wall Street, in the words of one security analyst, pronounced the company “dead in the water.”

And then it woke up. Management reorganized and shook up operations, and spent millions to reduce staff through early retirement bonuses. The reorganization took fully two years, but now Kodak’s financial results are recovering. More important, Kodak has stalled Fuji Film’s challenge in the United States, and is now gaining a bigger share of Fuji’s home market in Japan.

‘There’s No Secret’

“There’s no secret to beating the Japanese,” says Kodak vice chairman J. Philip Samper. “You win with cost-effectiveness and quality. We’ve made significant gains in both.”

The lower dollar is now helping U.S. companies compete at home and abroad, but factors like currency tend to help those who have already helped themselves. Ford Motor Co. is an outstanding case in point. Ford has come all the way back to competitive leadership from the brink of ruin at the beginning of the 1980s, but it has spent billions of dollars transforming its factories and its car lines--as well as closing 15 plants and reducing its work force by 63,000 people--to do it.

Another example, Caterpillar Inc., has spent heavily when times were bad to bring its plants to maximum efficiency. Cat is operating now with 17,000 fewer employees, but it has regained its dominance of the worldwide construction machinery business.

Those companies have made what Harvard Business School Prof. Alfred D. Chandler Jr., would approvingly call “the significant investment” to keep ahead technologically and to lead their markets. Chandler, 79, is the author of “Visible Hand,” a work that traced the development of the corporation from 1850s railroads to 1960s conglomerates, and a premier scholar of the American company.

It is important, says Chandler who is at work on a new book on international industry, that companies not get lost diversifying into other businesses, as he believes conglomerates did in the 1960s--”You think you can manage anything, but that’s not true”--and critical that they focus their investments on market leadership. “IBM in the 1960s invested in the 360 system and changed its industry,” Chandler points out, recalling the computer company’s make or break decision in 1963 and ’64 to develop a whole new series of computers in 18 months and hit the market with them all at once. The move put enormous strains on IBM--then a $4-billion sales company--but it worked, and established IBM’s dominance of the computer field, which continues to this day, when its annual revenues have grown to more than $50 billion.

Rewards for Research

In this decade, pharmaceutical companies have been notable for focusing their efforts. Squibb Corp. and Merck & Co. have concentrated on products in which they can lead world markets.

Over the last 20 years, Squibb, which was known as Squibb-Beech Nut until it sold the Life Savers business to Nabisco, has transformed itself from an unsuccessful conglomerate’s drug division into a world leader in pharmaceuticals. It did so with patience and focus, using the millions it got from the sale of Life Savers and other businesses such as Charles of the Ritz cosmetics, to fund research and development. “You need cash to build labs, to hire scientists, to give them time to think,” explains Squibb Chairman Richard Furlaud. But it pays off. Squibb now has one of the world’s leading drugs for high blood pressure and heart problems.

Merck, too, is a model of focus, spending almost 12% of its $5 billion in annual sales on research--but concentrating on those areas in which it can achieve a competitive edge. Upon hearing that a Japanese pharmaceutical company was ahead with an ulcer remedy, Merck shifted its efforts to other areas--ultimately producing its current breakthrough anti-cholesterol drugs. Was that a case of running from competition? No, explained Merck Chairman Roy Vagelos to Business Week, it was allocating capital to where Merck has a technological edge.

It is worth noting that Squibb and Merck spend heavily on research and development and yet are two of the most favored stock holdings for pension fund investors. In the bitter arguments sparked by the active merger market, it has been charged that U.S. companies were being forced to focus unwisely on quarterly earnings because the big investment funds penalize managers for taking the long view and investing in research and development.

Opposite True

But John Pound, Kenneth Lehn and Gregg Jarrell, a trio of present and past Securities and Exchange Commission economists, have studied the R & D expenditures of, and pension fund investments in, more than 300 firms. And they found the opposite to be true; institutional investors favored companies that spent more on research, not less.

The whole issue of competitiveness comes down to “picking your spots,” says General Electric Co. Chairman John F. Welch Jr. “You choose those industries where there is a chance to have the leading edge in technology, not just an industry where there is little innovation and the only edge is in labor saving.” Welch demonstrated that concept dramatically this year when he traded GE (and RCA’s) television set making business for medical electronics--where he thinks the company can lead internationally.

Welch has become the most controversial chief executive in American business for his headlong remaking of General Electric. He was accused of running from competition in selling the TV set business. Yet GE is winning market share in the global businesses in which Welch has chosen to compete, such product lines as aircraft engines, major household appliances (dishwashers, refrigerators), medical systems (computerized tomography and magnetic scanners) and engineered plastics. Markets for other product lines such as electrical turbines and locomotives are currently depressed, but GE is paring its costs, getting ready for business to turn up.

In any event, Welch was not the first to recognize that TV sets, in which U.S. industry lost the competitive battle long ago, were a dead end today. Chairman Robert Galvin of Motorola did the same thing in 1983 when he took his company out of Quasar TV sets. He did so, explained Galvin--whose father started the now-giant company in car radios in 1928--because of a conversation with one of Motorola’s customers, a television appliance dealer. “In televisions, the power is in the hands of the buyer,” the dealer told Galvin--meaning that with 40 different TV brands from many countries vying for the market, the producer like Motorola was at the mercy of too many forces.

So Galvin sold Quasar and concentrated instead on Motorola’s cellular telephone business--an extension of its mobile radio capabilities but a new technology--where it is the world leader today.

Money for Pioneers

If technology is the key to industrial leadership, money is the grease in its development. And it is the U.S. asset of fluid capital markets that has helped industry find money to develop technology, argues Commissioner Joseph Grundfest of the Securities and Exchange Commission. The markets, in this decade’s wave of mergers and acquisitions, have recycled capital, says Grundfest--producing $167 billion in profits for shareholders between 1981 and 1986, and providing money for the 1.5 million new companies that start up each year in the United States.

Grundfest’s point is that the money did not go into a desk drawer or under a mattress. It circulated, financing new companies that since 1980 have created more than 12 million jobs and pioneered technology, in older industries such as autos and steel as much as on the frontiers of electronics, biotechnology and computer science.

There has been no shortage of venture capital for companies in electronics and biotechnology; and public investment has come in a veritable flood for such standouts as Apple Computer, the biotech pioneer Genentech and the software leader Microsoft.

Will that pattern continue now that the stock market has fallen? The answer is almost certainly yes. A bear market is unlikely to stop U.S. companies, after all they’ve been through this decade.