Answer

1. Company’s Profile

Caterpillar Inc., uses the ticker name CAT on the New York Stock Exchange. CAT (2020) describes itself as a transnational business entity that operates in diverse industries, namely heavy construction equipment, financial products, and insurance services. The firm’s core competence is in designing, engineering, manufacturing and marketing its heavy equipment. Caterpillar further licenses work-wear and clothing manufacturers to use its brand on their clothing and boots. The company maintains a global presence through a well-connected and established network of dealers. Caterpillar holds the market leadership position as a leading and the largest manufacturer of heavy construction equipment with a market share of 54%. Because of its exemplary performance against rivals, Caterpillar has consistently been ranked among the best 100 companies in the Fortune 500 list. Caterpillar is a public corporation, thus floats its shares on the New York Stock Exchange under the ticker CAT. It operates in the heavy equipment industry. It was founded in 1925 in California, USA. Caterpillar is currently headquartered at Deerfield in Illinois. By 2018, the company had 101,500 employees and revenue of $54.7 billion.

1. Heavy Equipment Industry Economic Characteristics

The global heavy construction equipment, in which Caterpillar operates, was valued at $55.9 billion in 2016. It is expected that increased investment in construction projects and infrastructure will drive growth in the coming decade. The revenue projections for the industry are summarized in figure 1 below. As evident in the graphical representations, the rising demand for infrastructure and residential buildings in Fort, Austin, Dallas, and Seattle will boost the purchase of heavy construction equipment. CAT (2020) reports that the heavy construction equipment market is concentrated. Caterpillar holds the largest market share of 54% in the USA followed by Komatsu at 40% and the remaining 6% shared by other firms (check figure 2 below). Caterpillar has managed to attain this position because of its differentiated, quality, and reliable products. In addition, the industry has a small number of sellers which reduces the intensity of competition.

Figure 1: Projected Industry Revenue (GVR, 2020)

Figure 2: Industry Market Share (CAT, 2020)

1. Porters Five Forces Analysis of the Industry

Michael Porter designed the five forces model to evaluate five factors that significantly affect the profitability of firms in a given industry. These factors are evaluated as follows.

1. Threat of New Entrants

There is low threat of new entrants in the heavy construction equipment industry. This is attributed to the exorbitantly high capital investments required to invest in the industry. The raw materials and the final products are very expensive and thus, discourages many small firms from investing in the industry. Additionally, gaining market share from incumbents such as Caterpillar could be a challenge for most new entrants. It might take longer for these firms to break even. Other barriers to entry include lack of technological expertise and patents for construction technologies. The incumbents, especially Caterpillar, have an established brand name, which is a distinct competitive advantage in the heavy construction equipment industry. Because of these disadvantages, Caterpillar faces a low threat of new entrants. In the event that smaller rivals manage to enter the industry, they might be greatly disadvantaged because of the high switching costs among consumers. In addition, they may not access economies of scale, thus make lower profit margins. Alternatively, they will thrive in offering more specialized and differentiated products to focus customer segments. In such cases, Caterpillar can instigate price wars and devalue the firm after which it can either consider a merger or acquisition.

1. Rivalry among Existing Firms

Generally, the competitive rivalry is high (GVR, 2020). In the domestic market, there is low competition, while the international market poses intensive rivalry from countries such as China, Netherlands, and Japan. These countries have engineering expertise similar to Caterpillar’s. Rival brands include Terex, Volvo CE, Deere & Company, JCB, Liebherr, Yanmar, Hitachi, XCMG, Sany, and Komatsu, among others. As much as the company faces intensive competition in some countries, there is no competition in others. However, globalization is threatening the continued dominance of Caterpillar across all markets because the rival products are cheaper.

1. Threat of Substitutes

There is low threat of substitutes. The heavy nature of work done by the heavy construction equipment cannot be substituted by other machines. In most cases, crude tools could be used but they are less effective, thus taking more time. Nonetheless, mega projects value efficiency, thus will invest in the heavy construction equipment to ease work. These dynamics can be explained in terms of the high costs of switching from the heavy equipment to crude tools and vice versa. Low threat of substitution translates to increased profitability.

1. Buyer Power

Buyer power is low. According to Markman (2018), buyers are demanding and will want the best value proposition. A small customer base is more powerful compared to a large customer base. Customers with high bargaining power demand more offers and discounts. Caterpillar has many buyers, ranging from individuals to groups and organizations. Their customer base further includes government agencies and multinational construction firms. Given the large number of customers, and the limited number of reliable manufacturers of heavy construction equipment, buyer power is considerably reduced, thus making them price takers rather than setters.

1. Supplier Power

Suppliers provide components and raw materials required to manufacturer the heavy equipment. Supplier power is low because there are many suppliers. Additionally, Caterpillar’s manufacturing plants are located across different regions of the world depending on the concentration of suppliers. This strategy enables it to attract the best bargains from suppliers. According to Pope (2019) there are few dominant suppliers in the heavy equipment industry. Regardless, there is no single supplier who can exert immense pressure on Caterpillar’s supply chain. This translates to low bargaining power.

1. Caterpillar’s Strategies

According to Caterpillar’s website, the firm ensures its strategies align with its operating and execution model. Using this model and related strategies, the business has managed to achieve sustained competitive advantage and remain profitable. Its values include sustaining high levels of integrity, teamwork, excellence, commitment, and sustainability. Caterpillar works closely with stakeholders, especially the people, partners, and customers. The firm’s operational excellence is founded on safety, quality, lean manufacturing processes, and flexible yet competitive cost structures. A detailed analysis of the strategies shows that Caterpillar pursues the differentiation strategy since it produces high quality and differentiated products. However, lately, its rivals have copied its designs, thus demanding that the company invests more in research and development to create unique products. By pursuing differentiation, Caterpillar forfeits cost leadership and focus strategies. The cost leadership strategy is mostly adopted by Japanese and Chinese brands as a competitive advantage. The focus strategy is applied mostly by the small firms with specialized product offers.

Considering Ansoff’s growth matrix, Caterpillar pursues market penetration and market development. The company applies these intensive growth strategies depending on the nature of the market. According to Pope (2019), market penetration is the primary strategy used by Caterpillar across markets where it already has a significant presence. Market development is preferable for new markets, especially in Africa and Asia where the company establishes new presence in the markets it was previously not available. Caterpillar uses distributors and dealerships to realize both market development and market penetration.  Currently, the company is involved in less product development and diversification.

The competitive advantages available to Caterpillar include its effective implementation of a transnational strategy where it designs and manufacture’s heavy equipment using centralized manufacturing and identical components in a few large scale manufacturing facilities strategically located near suppliers. This competitiveness is realized from the use of the operating & execution model (CAT, 2019). Using this model, Caterpillar creates competitive advantage by allocating resources to profitable sections of the enterprise. This strategy allows the company to use its strengths to maximize profits. GVR, (2020) notes that even though rival brands such as Komatsu are cheaper, Caterpillar retains its value for a longer period, thus ensuring a favorable purchase for customers who might want to resell the equipment once the projects are completed. These strategies are very sustainable since they have helped the company improve product quality by 40% and reduced asset deployed by $3.3 billion.

Caterpillar’s products are targeted at broader consumer markets in the construction industry. Target customers rely on heavy construction equipment to ease construction projects. Caterpillar has not backward-integrated into the production of raw materials such as steel. The company has retained its focus on production of its own parts and spare parts for its equipment. In regard to diversification, Caterpillar is diversified its products, industries, and geographical markets. It operates in the heavy construction equipment industry, financial services, and insurance services industry. It is a transnational company, thus operates across different markets.

1. Quality of Financial Statements

Caterpillar maintains quality financial statements generated using the US Generally Accepted Accounting Principles (GAAP) as opposed to the International Financial Reporting Standards (IFRS). The company uses this reporting standard because it is recommended by independent auditors to be used by all public companies in the USA. GAAP is a combination of commonly accepted ways of reporting and recording accounting information and authoritative standards acceptable by policy boards. Given the uniformity in accounting standards across public organizations, the financial statements compared are considered comparable and reliable.

A key observation made over the past six years is that Caterpillar’s revenue has been fluctuating. The firm reported revenues of $55 billion in 2014, $47 billion in 2015 and $38 billion in 2016. The revenues increased to $45 billion in 2017 and $54 billion in 2018, and dropped slightly to $53 billion in 2019 (Macrotrends, 2020). Across this period, earnings per share were at their peak in 2018 and 2019 at $10.74 and $10.26 respectively.

1. Profitability and Risk

• Net operating profit after taxes (NOPAT)

NOPAT = (Net Income + tax + interest + non-operating gains/losses) x (1 – tax rate). A simplified form of this formula is income accrued from operations or operating income x (1 – tax rate). Operating income for 2019 was $8,290 billion while corporate tax rate for listed firms was 25% (Macrotrends, 2020). 

NOPAT = 8,290 x (1.0.25) = $ 6,218 billion

• Total net operating capital

Total Net Operating Capital = Net Operating Working Capital + Non-current Operating Assets

                                                          = $8,290 + (-478)

                                                          = $7,812

• We use these measures to calculate
• The operating profitability ratio (OP)

Its operating profitability ratio is 16.33%

• the return on invested capital (ROIC)

Return on equity (ROE)                 = 41.77%

Return on assets (ROA)                 = 7.77%               

1. Ratio Analysis

Profitability Ratios

Caterpillar’s Profitability Ratios (Stock Analysis, 2020)

The firms operating profit margin is 16.33%