When one thinks of possible models for a company in the I-Cubed (information, innovation, intangibles) Economy, the inclination is to look at the high-tech or the “creative” sectors of the economy: electronics, software, advertising, etc. How about industrial components – specifically Illinois Tool Works? ITW is a company that is “a hodgepodge of mundane products, from automotive components and industrial fasteners to zip-strip closures for plastic bags and laminates for flooring and countertops.” That is how Business Week describes it in their profile of the company No Need For Economies Of Scale. It is also a company where “its research and development outlays come to just 1% of sales, a miserly budget for even a bulk-commodities producer.”
But, as Business Week points out, “ITW routinely finishes among the Top 100 patent recipients in the U.S. every year, ranking 66th last year, with 301 new awards and 468 applications.”
The secret? Entrepreneurship and attention to customization.
ITW owes its outsize achievements to its unorthodox business model. Like many old-line outfits, the company gets most of its growth from acquisitions; it has averaged 28 deals a year over the past decade. But management does not then merge the new units with old ones to reduce payroll and other expenses. Instead, it retains them as freestanding entities to maintain their entrepreneurial drive and keep them close to their customers. Today the $11.7 billion conglomerate operates through 665 separate businesses, each with its own profit and loss statement.
The company also practices something it calls an 80-20 philosophy. The term derives from the fact that 80% of sales and profits often come from just 20% of customers. Once this top tier has been identified, management then lavishes attention on it — including custom-designed products — to maximize the return from ITW’s personnel and assets.
As the CEO, David Speer, explains:
Our business model is the antithesis of scale. To begin with, our organizations tend to be small and lean. If I were to look at combining several units, the real cost savings we would wring out would be relatively modest. Smaller, more tightly focused units also have a greater entrepreneurial spirit; there’s greater participation by the employees in the business. That leads to greater intimacy with the customer and better understanding of new opportunities.
The antithesis of scale — what a great way of putting it.
However, Speer is not completely correct when he says that. ITW does get traditional economies of scale in its concentrated production that comes out of the 80-20 philosophy.
We take the 80-20 approach and dedicate production lines and resources to high-volume products. A line will run only those three or four products, if that’s the case, which represent the 80% of that business. We’re able to make fewer changeovers on these lines and can increase the life of the tooling. Runs that are much longer are more efficient. By physically linking machines, we’re often able to eliminate work in process and storage areas, which means a smaller footprint. And, of course, all the material handling and indirect costs are reduced. That doesn’t mean we don’t pay attention to the other 20% — we just manage them separately.
Customized production married to dedicated production. An interesting model for manufacturing in the I-Cubed Economy.
But, before you start touting this model as the savior of American manufacturing, with 21 businesses in China Speer is clear about the need to be in overseas markets.
We operate with the basic philosophy that we want to produce where we sell. If I’m going to sell a product in China, I want to produce it in China. If I want to produce locally, then I have to be able to compete locally and make a decent return.
It may not be the model of the globally competitive company that we normally think of. But ITW’s attention to local markets may be the way that American manufacturing can hold on to a portion of the ever-changing world market.