Among many business gurus, these truths are held to be self-evident: That U.S. manufacturing is on the wane, that outsourcing is the future, that “core competency” is in, and that diversification is out.
So how to explain the rock-steady performance of Illinois Tool Works Inc.?
ITW, the Glenview-based conglomeration of more than 700 mostly obscure widgetmakers, has been profiting handsomely for years precisely by making hay in the sorts of basic, hard-knuckle industries like auto parts and industrial products that are supposed to be declining or fleeing overseas.
On Thursday, Chairman and Chief Executive David Speer posted a 25 percent surge in second-quarter income and boosted his outlook for the year despite clear weakness in two of ITW’s key end markets–housing and automotive.
That ITW has been able to wring such performance from some of the economy’s least glamorous industries says as much about the value of conventional wisdom as it does about the power of good management.
“ITW doesn’t get enough credit,” said Chris Kotowicz, an analyst at A.G. Edwards & Sons in St. Louis. “Their operating profitability has been outstanding, especially given the businesses they’re in.”
As Speer explained it recently during a wide-ranging interview at the company’s spartan headquarters, his company’s success boils down to the unsung art of coaching and teaching, not management genius or top-level heroics. At 55, Speer has been at ITW for 28 years and took over about a year ago from longtime CEO Jim Farrell.
A large chunk of ITW’s growth each year comes from identifying and buying dozens of small to midsize companies, most of them under $100 million in revenue. The result is so many different business units making things like self-drilling screws, welding guns, industrial switches and anti-slip coatings that the ITW Web site doesn’t try to list them all. Instead, it provides a little search engine to help investors and customers track them down.
The main difference between ITW and other serial acquirers like Tyco International Ltd. is that the goal is not simply to get bigger by adding revenue. Rather, it is to generate above-average profit growth by “sucking up good companies and making them excellent ones,” as one prominent Chicago-based investment banker put it. Speer said one hurdle for a new acquisition is whether ITW believes it can produce a 15 percent to 16 percent after-tax return on the investment over five years.
“For every one deal we close, there are seven or eight more we don’t close,” he said.
ITW’s core competency is not a single set of products or services. It is a well-honed system for consistently creating those above-average returns across a wide array of businesses, both the ones it buys and the ones it already owns.
At the center of that system is something called the “ITW Toolbox,” a portable set of management disciplines that help the managers of acquired companies analyze their business in ways they might never have thought of. Unless management at an acquisition target will embrace the toolbox, ITW ends negotiations. It also will reject a company if management expects to pocket the money and ride off into the sunset.
“We have to have a management team that’s going to respond well to our processes,” Speer said, “because they’re the ones who transform their businesses. We don’t send people out from Glenview to make the changes. We basically expose them to the toolbox, show them how to use it and then put them to work applying it.”
That, of course, is much more complicated than it sounds.
The main tool in the box is a management discipline called 80-20. The theory is that 80 percent of the results are created by 20 percent of the activity.
“And you can fill in the blanks with customers, products, plants, people,” Speer said.
Applying 80-20 means gathering reams of data on the activity in question and analyzing it to discover what 20 percent of the effort generates 80 percent of the results. That way, management can concentrate on what’s most important and avoid being distracted by things that don’t generate much value.
Speer gives the example of the Hobart commercial dishwasher business in Ohio. When ITW bought it in 1999, Hobart was making 100 different models of dishwashers, a number ITW said was probably too many.
“How do you know it’s too many?” the Hobart managers complained. “You don’t know anything about dishwashers.”
This, Speer said, is a typical, and logical, response, if only because getting rid of products may mean abandoning some longtime customers. But when Hobart applied the 80-20 analysis it discovered that 80 percent of the dishwasher revenue came from just 14 models.
“So we said, `We’re not asking you to get out of anything. If you need 100 models, that’s great. But we’re gonna ask you to take these 14 and focus on them separately. Just tell me how to make 14 models really, really well.'”
Today, Hobart has about 50 dishwasher models, and Speer said margins are two-and-a-half times higher than they were in 1999. Revenue has grown by 20 percent annually. The defect rate has shrunk to less than half a percent, and the business is thriving in Ohio.
“We’re saying why don’t you get rid of the deadwood,” Speer said. “You’re going to shrink before you grow. We give you permission to shrink. That’s not a metric you’re going to hear from the financial buyers.”
John Brooklier, ITW’s vice president of investor relations, said he’s constantly asked how senior executives possibly can manage so many businesses.
Speer’s answer: They don’t. Their job is to ask the right questions, not provide all the answers. ITW counts on individual managers to understand their own markets and create their own opportunities with help from the toolbox.
“The reason we keep it from turning into chaos is that the businesses are self-contained,” Speer said. “The good news is they’re not relying on any burst of brilliance from Glenview.”
Speer recognizes that the game is his to lose. After he took over as CEO in August, the stock rose 24 percent, to a split-adjusted high of $53.54 a share in May, only to give most of it back since on jitters about the slowdown in residential construction and auto sales. Some analysts worry whether ITW can rely on the same formula for growth that is pushing it beyond $13 billion in revenue. Despite the strong earnings, the stock fell 1.3 percent Thursday to close at $43.71.
To maintain the pace, Speer is targeting acquisitions in the $100 million to $500 million range to augment the smaller ones. That means more risk and creating a management structure to find targets. He’s also prodding the existing businesses to penetrate high-growth markets in Asia and Eastern Europe and to innovate for the highest growth markets.
One example is welding. An 80-20 analysis in that business pointed managers toward the red-hot market for providing equipment to companies welding oil and gas pipelines in remote parts of China, India and Russia.
But after sending people into the field to watch the welders in action, ITW concluded it was selling them the wrong solution. If the company could create digital controls for welding machines powered by generators, it would make the tools easy to use and much more precise. Engineering went to work and came up with a digital control that boosted productivity more than 25 percent.
The key, Speer said, is the discipline to apply your best energy to the right customers.
“It’s easier to make intelligent decisions if you’ve got good data,” he said. “It’s that simple.”
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mdoneal@tribune.com
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PROFILE
Illinois Tool Works Inc.
Producer of fasteners, components and other equipment for a wide variety of products.
Founded: 1912
Headquarters: Glenview
Employees: 50,000
Business units: 700
2005 revenues: $12.92 billion
QUARTERLY NET INCOME
Scale in millions of dollars
Q2: $465.9 million
STOCK PRICE
Daily closes
Thursday’s close: $43.71
Sources: The company, Bloomberg
Chicago Tribune
