When we interviewed Pierre Leroy, president of John Deere’s Worldwide Construction & Forestry Division and John Deere Power Systems, the company’s solid third-quarter earnings statement had just come out.
In it, the company reported worldwide a 68 percent increase over 2002’s third-quarter worldwide net income, and credited the upsurge in part to higher volumes in construction and forestry equipment, where sales rose 29 percent for the quarter and 25 percent for the first nine months of 2003. As a result, the company expected construction and forestry equipment sales to be up 13 percent for the year (excluding Hitachi).
Pierre Leroy, who started with John Deere in 1976, has been in a position to see both feast and famine brought on by the business cycle swings inherent in the construction industry. “This industry is not for the faint of heart,” he says with a smile, but he’s not joking. “You have to have a long-term strategy you believe will be good for the customer and your business, then you have to hang on to it regardless of the short term consequences.”
We sat down with Leroy in his office in Moline, Illinois. “Three years ago, we did some market research that told us we were the best-kept secret in the construction business,” he says. “We’re making sure that’s no longer the case.” Here’s an update:
Q: Let’s look at your third-quarter earnings statement. To what do you attribute such dramatic increases over last year’s results?
A: To several things. First, our rental activity has increased. Rental was something we hadn’t expected to strengthen this year and it’s much stronger than what we had anticipated.
We’re also starting to see contractors now feeling more secure and ordering equipment.
The results did catch us by surprise, because we had been forecasting an industry that was flat or even down 5 percent. Now we’re saying we believe the industry will be up 5 to 10 percent.
Q: You said you were surprised on the rental side.
A: We started getting signals of this a few months ago when we saw rental utilization going up, which is one of the first signs that our equipment sales are going to start to increase.
We saw this with our dealer fleets and also with our equity position in rental company Sunstate Equipment.
But because of the experience we’ve had over the past several years, we were more pessimistic and thought it might just be a blip, especially since housing starts were forecasted to be a little weaker than the previous year. But then the drop in mortgages fueled the housing market. We were also concerned because some state and local governments looked like they were having problems matching the federal funds that were available.
Q: Did you also see an increase in your larger horsepower equipment?
A: Most definitely. I’m very pleased with our success with the new larger equipment we’ve been introducing, especially the 1050C dozer. I think the market had been looking for an alternative that performed, had good productivity and uptime and low operating costs. Once they tried us out and found out that our dozer was something special, we’ve seen a lot more dozer orders than we anticipated.
We’re also seeing strong sales throughout our product line. Whether it’s four-wheel-drive loaders or backhoes or even skid steers, we’re starting to see an increase. The forestry market is also starting to strengthen, at least in North America.
Q: It seems most manufacturers in this industry are facing challenges with their dealer organizations. What are some of your challenges and how are you addressing them? How is Nortrax, your investment in John Deere U.S. dealerships, working out?
A: As you say, having a strong, aligned – and I stress aligned – dealer organization is really a concern for most manufacturers. There are manufacturers out there that have strong dealer organizations but they’re not necessarily aligned, and by aligned, I mean not only with the manufacturer but with each other. That’s extremely important in providing consistent nationwide service.
One of the reasons we began Nortrax is that we were seeing some of our dealers wanting to get out of the business. And when they wanted to get out, they would stop doing the things that were important to us, especially in the area of product support. While selling our product is important, the most critical thing our dealers do is provide product support. As long as our dealers offer strong product support and as long as they are calling on customers, the product will sell.
Nortrax gives us the opportunity to really give dealers another option if they want to get out of the business. When we began Nortrax, of the first 14 acquisitions we made, 11 of them were underperforming dealers. In the time we’ve had them, that group of 11 dealers has gained significant market share, their product support departments are much stronger and the emphasis is again where we want it, on the quality of services we’re offering.
Nortrax is probably one of our most important strategies we have for creating a strong, aligned dealer organization. But it’s not the only strong aligned dealer we have. RDO Equipment, for example, covers us in several states and is aligned not only with us, but with other dealers, offering strong product support. Then there’s Brandt Tractor in Canada, covering all the provinces west of Ontario. Those are the kind of dealers we’re looking for.
Nortrax helps us in transforming dealers from underperforming to performing businesses.
In the future, we may sell off portions of the Nortrax territories to interested investors who will offer the product support we require. That’s one possibility. Another is that
Nortrax will continue to own the same percentage of our market potential as they currently have. What’s important, and the reason for this strategy, is to create strong, aligned dealers – dealers that cooperate with each other in serving our customers.
Q: What do you say to people who would compare Nortrax to company store experiments that have failed in the past?
A: Nortrax is not a company store strategy. We don’t try to instill our culture into Nortrax and we don’t try to put a bunch of Deere people in over the dealership. We’ve hired people from other dealerships who have experience and we have them run it like you would a dealership, not a company store.
I’ve told the president of Nortrax a number of times that I don’t want him to ever buy a product from us just because we’re offering it. I want him to buy it because it makes sense for the dealership and the customer and I want him to tell us when it doesn’t make sense.
It’s a very different strategy. It’s not a company store. We don’t load them up with inventory and we don’t tell them how to run their business. We understand that retail and wholesale are very different.
What Nortrax has given us, though, is a real appreciation for some of the problems our dealers face. It’s helped us to understand when and why some programs we’ve designed to help dealers aren’t doing the job. That to me is a real competitive advantage.
We’re getting a clear communication from Nortrax on what’s happening on the dealer side of the business. We’re also getting clear information from them in terms of pricing and what the competition is doing. There are times when all we hear are the horror stories and you get the feeling there is no price low enough. Nortrax gives us a more balanced feel and they allow us to react faster to what’s happening in the marketplace.
Q: Do you think the new 50-percent depreciation bonus will have an impact on new machine sales?
A: That’s something we’ve been asked a lot about, and we just don’t think it will have that strong of an impact, primarily because of the way contractors run their businesses now. They’re very concerned about their asset level, so they are only buying equipment when they need it, which is a different way of operating from before.
About two or three years ago, several large contractors sat in our board room and told us that they didn’t rent equipment because they liked to own it. But today those same contractors are telling us they rent equipment because it’s a more efficient use of their assets.
Q: In late 2001, Deere took on marketing responsibilities for Hitachi in North, Central and South America. How is this venture working for you, especially in light of the fact that this is the first time Deere is marketing to the mining industry?
A: We’ve had a joint venture with Hitachi since 1988 and we’ve enjoyed success in particularly the mid-size excavators, some of which we’ve manufactured together in Kernersville, North Carolina. The one problem was that we used to have two marketing organizations, one in Houston and one here in Moline.
By consolidating the two marketing organizations we are able to give Hitachi customers much better product support – they actually are getting better parts response times than they’ve ever experienced. We also are able to give Hitachi dealers better support.
As a result, we’ve been able to reduce the total marketing costs of the two companies, increase the profitability and at the same time, give the customer better parts and service – the things that are really important.
I also feel comfortable that we will continue to improve the pre-eminent position Hitachi has in mining excavators. We’re appointing stronger dealers, particularly in Chile and Mexico.
Q: Historically, Deere has not made the same inroads in overseas construction equipment markets as some of its competitors. Do you feel this needs to be addressed? If so, what are you doing in this area?
A: It’s something the analysts seem more concerned about than we are. First of all, we have to recognize the North American market is the most profitable market in all the world, and we are clearly No. 2 in North America by a wide margin. It’s important to have some sort of affiliation overseas because of the volume and volatility in the market and also to serve international customers. Our relationship with Hitachi is such that they take on the function of our master distributor in Asia and the Pacific.
We have recently appointed a dealer in China and we own 80 percent of a Chinese rental company. Internationally, we’ve been trying to move into markets where we can make money and provide the customer with something unique.
Europe is a tough market because there are so many manufacturers and it’s still such a fragmented industry. But our acquisition of Timberjack has given us a head start since they have a strong dealer organization there. We’re still looking at our options as to what exactly we want to do and how we want to play in the European market.
Our international presence doesn’t concern me as much as it does the analysts. We believe we’re doing it the right way, which is doing it very methodically. We don’t want to jump into Europe and then have to jump out.
Q: You’ve expanded your product lineup in the past few years through product agreements (artics from Bell Equipment; large dozers and crawler loaders from Liebherr). Are there more construction equipment acquisitions in your future, either through product-only agreements or entire companies?
A: We’re happy with what we have now. What’s ahead are improvements in some of the products we have, and those will occur whether we own the company or whether it’s a relationship as in the case of Liebherr. We feel we have a full product line and we’re satisfied with its breadth.
Our focus is really on our value proposition – by that I mean offering customers more value than they can get anywhere else. Some companies have a value proposition of ‘you can’t buy it anywhere for less.’ Others have a value proposition of ‘we’ve been around so long, and we’re so big, how can you not do business with us?’
Our value proposition for customers is Productivity, Uptime and Low daily operating costs. When you buy Deere, you get PUL. That’s what we’re working on. That’s being put in the design specifications of all our new products. We’re designing our products to improve PUL. That’s probably more important than any product expansion to us right now.
Q: Deere has taken a strong technology stance with its Internet-based Customer Personal Service program and DeereTrax machine management system. Early in 2003, however, you seemed to draw away from DeereTrax in favor of direct machine-to-Palm-Pilot downloads. What is your present stance on customer and machine technology?
A: Technology is extremely important to us and we plan to be a leader in technology, whether it’s technology we use to develop products, technology on equipment or technology we sell to a customer to help them run their business.
Part of the reason we pulled away from DeereTrax was that a vendor had a more cost effective solution than we did. We don’t need to own or be involved in creating the technology. What’s important is to be able to offer it to our customers.
With our relationship with Hitachi, we have a machine information center that offers all kinds of diagnostic information. As an example, it will store up to 10,000 hours of information on hydraulics, temperature and other machine functions. Our customers tell us it’s tremendous in allowing them to analyze their costs and figuring out where their problems are. That’s how we want to use technology.
Q: You assumed responsibility for John Deere Power Systems in 2000. What’s ahead for this division?
A: The engine business is an exciting one made even more exciting by government regulations. We have come out with a complete line that’s Tier 2, Stage 2 compliant. We’re already starting to work on Tier 3, Stage 3 engines with our customers. We have engines that are compliant with Tier 3, Stage 3 and we’ll be making some announcements in terms of the technology in a few months.
Besides that, we’re introducing a new line of 2.4- and 3-liter, four- and five-cylinder engines that will go down to 35 horsepower, which will give us a broader line. They’ll serve the commercial, agriculture and construction markets. They are roughly 100 kilos lighter, are 3 decibels quieter and more fuel efficient than any of our competitors out there. So we’re very excited about that.
Forty percent of our engine business goes to other manufacturers. For them, we have a big advantage since we’re able to offer the integration of engine and drive train. We also have an advantage since we’re focused strictly on the off-highway market.
My expectation is that our engine division will continue to grow its overall percentage in our product mix.
Q: What do you now know to be true about this industry?
A: First, it’s a dynamic business and the cyclical nature of the business is such that it’s really not for the faint of heart.
Second, it’s also extremely competitive. It’s competition that really helps you keep your edge and makes you better.
Thirdly, this business is about customers and sometimes I think we forget that. If we can make our customers more profitable than our competitors’ customers, we will be successful. And by making them more profitable, we create and develop long-term relationships.
One customer I talked to had one of our sales people calling on him, naturally trying to sell him more product. After we had talked about what was happening with his business, I told him, ‘I don’t think you ought to buy any product from us this year. It’s very important for you to get your asset base right. If you get your asset base right, that will make you a stronger customer, and that’s what we want to do.’ This is a business where you have to take a long-term view with your customers.