Lincoln electric venturing abroad case study

Competitive And Strategic Analysis

Harvard Business School 9-398-095 Rev. April 22, 1998

Research Associate Jamie O'Connell prepared this case under the supervision of Professor Christopher A. Bartlett as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright © 1998 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

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Lincoln Electric: Venturing Abroad

Returning late to his half-finished lunch of rice and stir-fried vegetables, Michael Gillespie, president for the Asia region of The Lincoln Electric Company, reviewed his plans to expand the company’s production base in his area. Although this venerable U.S.-based manufacturer of welding machinery and consumables had sold products throughout Asia for decades, these had been produced at plants in Australia, the United States, and Europe. Anthony Massaro, Lincoln’s new CEO and—like Gillespie—a newcomer to the company, had encouraged the Asia president to develop plans to open welding consumables factories in several Asian countries. Such facilities would enable Lincoln to take advantage of low labor costs and avoid trade barriers.

Specifically, Gillespie now turned his attention to plans for Indonesia. He faced several sets of choices. The first concerned whether to build a factory in Indonesia at all, given the particular political and economic conditions in that country, the nature of the market for welding products, and the competitive situation. If he decided this in the affirmative, he would need to choose whether to enter the market through a wholly-owned factory or a joint venture. Finally, Gillespie wondered whether the planned operation should adopt Lincoln Electric’s famous incentive system, credited with rapid, steady increases in productivity in the company’s flagship plant in Cleveland, Ohio. Although no immediate deadline loomed for these decisions, he would be asked to discuss his plans at the September 1996 meeting between Massaro and the presidents of Lincoln’s five worldwide regions, scheduled for the following Monday in Cleveland.

Lincoln in the United States 1

Founded by John C. Lincoln in 1895 in Cleveland to manufacture electric motors and generators, Lincoln Electric introduced its first machine for arc welding in 1911. The company eventually became the world leader in sales of welding equipment and supplies (such as welding electrodes). (Exhibit 1 gives more detail on welding technology and Lincoln’s products.) James F. Lincoln, John’s younger brother, joined in 1907 and complemented his older brother’s flair for technical innovation with a proficiency in management and administration. The company remained closely held by the family and employees until 1995, when a new share issue put 40% of its equity into the hands of the general public. These new shares acquired voting rights in the year 2005.

1 This section draws on The Lincoln Electric Company (HBS No. 376-028) by Professor Norman Berg.

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Founding philosophy

James F. Lincoln’s independent ideas about human motivation formed the basis of Lincoln Electric’s management methods and incentive compensation system. At the foundation of his philosophy was an unbounded faith in the individual and a belief in the equality of management and workers. He also believed that everyone could develop to his or her fullest potential through a system of proper incentives designed to encourage both competition and teamwork. In 1951 he wrote in his company-published monograph, Incentive Management:

There will always be greater growth of man under continued proper incentive. The profit that will result from such efficiency will be enormous… How, then, should the enormous extra profit resulting from incentive management be split? … If the worker does not get a proper share, he does not desire to develop himself or his skill… If the customer does not have part of the savings in lower prices, he will not buy the increased output… Management and ownership must get a part of the savings in larger savings and perhaps larger dividends… All those involved must be satisfied that they are properly recognized or they will not cooperate—and cooperation is essential to any and all successful application of incentives.

Incentive system

James F. Lincoln implemented his philosophy of “incentive management” through an unusual structure of compensation and benefits. He wrote, “There never will be enthusiasm for greater efficiency if the resulting profits are not properly distributed. If we continue to give it to the average stockholder, the worker will not cooperate.” The system had four key components: wages for most factory jobs based solely on piecework output; a year-end bonus that could equal or exceed an individual’s regular pay; guaranteed employment; and limited benefits.

Piecework Nearly all production workers—about half of Lincoln’s total U.S. workforce—received no base salary but were paid on the basis of the number of pieces they produced. A Time Study Department established piecework prices that stayed constant until production methods were changed. The prices enabled an employee working at what was judged to be a “normal” rate to earn, each hour, the average wage for manufacturing workers in the Cleveland area. (Rates were adjusted annually for local wage inflation.) Each worker also had to ensure his or her own quality, however, repairing any defects identified by quality control inspectors before being paid for the piece in question. But there was no limit on how much could be earned by those who worked faster or harder than the normal rate.

Annual bonus Since 1934 Lincoln had paid each worker a bonus at the end of each year based on his or her contribution to the company’s total performance. The U.S. Employee’s Handbook explained, “The bonus is not a gift and it does not happen automatically. The bonus is paid at the discretion of the Board of Directors of the Company. It is a sharing of the results of efficient operation and is based upon the contribution of each person to the overall success of the Company for that year.” Until the 1980s, the annual bonus averaged nearly as much as the total wages of those eligible: the average worker in an average year received a bonus that almost doubled his or her base pay. In the 1980s and 1990s higher base wages and competitive pressures reduced bonuses to 50% to 60% of base pay.

Nearly all Lincoln employees were eligible for a bonus, including office workers and managers whose regular compensation was not based on piecework. Each individual’s share of the bonus pool was determined by a semiannual “merit rating” that measured his or her performance compared to those of others in the same department or work group. The rating depended on four factors: output, ideas and cooperation, dependability, and quality. (Exhibit 2 explains these factors in further detail.) Each department received a pool of points for each factor that would allow employees

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in each department to average 25 points on each factor. Supervisors then allocated the points among individuals according to their relative performance. Merit ratings varied widely, with some workers receiving total ratings as low as 50 and some as high as 150. Each individual’s share of the bonus pool was determined entirely by the ratio of his or her points to the total awarded.

The combination of piecework and the annual bonus enabled Lincoln’s best employees to earn much more than their counterparts at other manufacturing companies. In 1995 the highest paid production worker at Lincoln’s U.S. operations received $131,000 in base pay and bonus, while the average employee received $51,911 in pay and bonus—82.8% above the Cleveland average for manufacturing workers.

Guaranteed employment James F. Lincoln saw guaranteed employment as an essential part of his system, writing: “Higher efficiency means fewer man-hours to do a job. If the worker loses his job more quickly, he will oppose higher efficiency.” He also believed that the costs of recruiting and training the highly motivated, creative workers who thrived in his system would outweigh any savings achieved by cutting the payroll during downturns. In 1958 he introduced the Guaranteed Continuous Employment Plan, which assured employment for at least 75% of the standard 40-hour week to every full-time employee who had been with the company at least three years. 2

James F. Lincoln’s successors agreed broadly with these views. When orders dropped, the company took advantage of falling materials prices to produce for inventory. If demand still did not pick up, management could cut hours to 30 per week and redeploy workers to maintenance and other tasks. During the deep recession of 1982, for example, production workers were retrained and sent out as salespeople, selling $10 million-worth of a new product in their first year alone. Such techniques had enabled Lincoln to avoid laying off a single employee in the United States, even one with less than three years’ experience, since 1948.

Limited benefits James F. Lincoln’s radical individualism also led him to minimize company-paid benefits under the rationale that fewer benefits enhanced profits and, thereby bonuses and worker compensation. While Lincoln employees received paid vacation, they had no paid holidays off, even Christmas. (They could, however, stay home on recognized holidays without their merit rating suffering.) Taking a day off for sickness also meant giving up a day’s pay. The company did not oppose benefits as such—it provided employees with access to a group health insurance policy if they paid the full premium—but it preferred to pay employees with higher cash wages and bonuses, rather than fixed benefits, to give them maximum choice.

Management style and culture

James Lincoln strove to erase hierarchical distinctions, and management’s approachable style combined with the system of rational incentives to build a spirit of cooperation between management and employees. The mutual respect was reinforced by the workers’ recognition that management worked as hard as they did, often putting in 60- to 70-hour weeks. Through its constant monitoring of the incentives and other work systems, Lincoln managers strove to build a sense of trust with the workforce. There were no reserved parking places in the company parking lot and executives ate in the same institutional cafeteria as janitors.

Open communication was regarded as essential, and management from the CEO down historically had spent hours of each work day on the shop floor. Furthermore, executives followed James Lincoln’s “open-door” policy toward all employees, encouraging them to bring suggestions for

2 Although there was very high turnover in the first three years of employment—and particularly in the first 12 months—overall, Lincoln’s turnover rate had historically been less than 1% compared to 4—5% for all manufacturing companies.

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improvement and complaints straight to the executive offices, which were located adjacent to the Cleveland plant. Since 1914, an Advisory Board of elected employee representatives had met twice a month with Lincoln’s top executives. It provided a forum in which employees could bring issues to top management’s attention, question company policies, and make suggestions for their improvement. Advisory Board representatives also communicated management’s perspectives to their fellow employees, and minutes of all meetings were posted on bulletin boards throughout the plant and discussed among employees.

The culture that resulted from Lincoln’s incentive program and unusual management style seemed to encourage individual employees to produce and innovate. For example, over the years, Lincoln’s engineers and operators had collaborated to modify most equipment to run at two to three times its original rate, and had even developed some proprietary machinery. Lester Hillier, a welder with 17 years’ experience at Lincoln, was a good example. In 1994 he told The New York Times, “I don’t work for Lincoln Electric—I work for myself. I’m an entrepreneur.” Hillier had put forward some 50 suggestions for cost reductions during the first half of 1994, about 30 of which management had accepted. Chief Financial Officer H. Jay Elliott gave his view of the atmosphere:

If I go down to the cafeteria, the guy in grubby clothes sitting next to me is just as proud of his job as the chairman in a suit—who’s sitting next to him! I think this is the best thing that piecework, the bonus system, guaranteed employment, and many employees’ participation in our stock purchase plan have created: a sense of ownership of the company from top to bottom.

Performance

Since 1911 Lincoln Electric executives and employees had attributed much of the company’s financial health to its innovative management style and, particularly, its incentive system. The company grew quickly, even as giants such as Westinghouse and General Electric entered the U.S. welding market. Although Lincoln maintained a significant cost advantage over its competitors, during World War II, a patriotic James Lincoln offered to share the company’s proprietary methods and equipment designs in order to boost industry productivity. Although its competitors’ costs were close to Lincoln’s in the immediate post-war period, company data showed Lincoln’s productivity per worker was increasing at twice the rate of benchmark manufacturing companies.

Eventually, Lincoln’s competitors began to wither in the face of the company’s high productivity growth, and by the 1980s the large companies had withdrawn from the market entirely. When Lincoln acquired British Oxygen’s US welding company, Airco, management was able to confirm that they had again outdistanced the competitors. In a similar facility, Lincoln was achieving three times the output with half the people. George Willis, Lincoln’s CEO in the late 1980s and early 1990s, summarized the company’s competitiveness this way: “We’re not a marketing company, we’re not an R&D company, and we’re not a service company. We’re a manufacturing company, and I believe that we are the best manufacturing company in the world.”

By 1995, Lincoln Electric estimated that it held 36% of the $1.5 billion U.S. market for welding equipment and supplies, making it the leading competitor in an otherwise fragmented industry. “It’s a simple strategy,” explained one manufacturing manager. “We strive for high productivity based on employee effort, continuous improvement in production processes, and seven-day-a-week utilization of equipment. By passing on cost savings to our customers, we generate very high demand that allows you to send everything you make straight out the door.”

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Lincoln Electric: Venturing Abroad 398-095

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Early Ventures Abroad

Canada

Lincoln started exporting from Cleveland early on, and in 1916 established a sales organization for electric motors in Toronto, Canada. In 1925, it opened a manufacturing plant there and produced the full line of Lincoln products, almost solely for the Canadian market, until the early 1990s. At that time, the advent of the North American Free Trade Agreement (NAFTA) led the U.S. and Toronto plants to specialize in different product lines.

The operation quickly adopted most of the U.S. incentive system, including an annual bonus starting in 1940 and piecework beginning in 1946. Like the U.S. company, Lincoln Canada did not pay piecework employees for sick leave. Holidays were paid, however, as required by Canadian law, and a guarantee of employment was never introduced. A senior executive who had spent most of his career with the subsidiary believed that piecework and the bonus had played a key role in motivating employees to high productivity. Executives’ open-door policy and the worker Advisory Council ensured communication among the subsidiary’s 200 employees. These workers, like the U.S. ones, resisted unionization, turning it down in a vote in the 1970s.

Australia

Lincoln continued gradually to expand its international manufacturing presence. In 1940, William Miskoe, a disciple of James Lincoln, moved from the United States to Australia to manage a plant Lincoln had opened in 1938. He introduced piecework for most production jobs and an annual bonus that usually amounted to between 25% and 35% of pre-bonus compensation. Although a commitment was never formalized, employees considered their jobs to be secure, and management cut employees’ hours during several recessions to avoid layoffs. Australia was one of the most highly unionized societies in the world, but Lincoln workers rebuffed organizing attempts on several occasions. A senior Lincoln Australia executive believed that Miskoe’s introduction of the incentive system when the operation had fewer than 100 employees had facilitated its initial acceptance; later hires embraced the system because their factory-floor colleagues liked it.

High Australian tariffs led Lincoln Australia to diversify into a nearly complete range of welding equipment and consumables. The company eventually began exporting to Asian countries, developing relationships with distributors and building the Lincoln brand-name.

France

In 1955, Lincoln responded to a request from the French government for U.S. manufacturing investment under the Marshall Plan and opened a factory that made welding consumables, and later, equipment. It sold its products throughout western Europe, along with ones made by Lincoln in the United States, through one of Lincoln’s U.S. distributors that also had rights to sell into Europe.

Expatriates from Cleveland helped implement the incentive system—including piecework, merit ratings, and a bonus that averaged 10% to 15% of pre-bonus compensation—in the late 1950s. A formal guaranteed employment policy was in effect from then until its repeal in the early 1970s. (Vacation, holiday, and sick pay were either mandated by law or by industry norms to which Lincoln adhered, varying the U.S. model.) Although Lincoln France had not studied its workers’ productivity, its executives believed that it had created a much greater enthusiasm for the work and commitment to the company than existed at other French companies. “There is no question in my mind that the incentive system is a major source of Lincoln France’s success. I am deeply convinced that it is essential to our competitiveness,” one remarked. From its founding through the late 1980s,

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398-095 Lincoln Electric: Venturing Abroad

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the subsidiary had just one unprofitable year, after the oil crisis of the early 1970s, and paid a bonus every year except that one.

Despite this international growth, the Cleveland factory accounted for approximately 85% of worldwide production and monopolized new product development through the late 1980s. The three foreign factories manufactured on a small scale for local and regional markets and relied on U.S. plants for a number of key parts. Corporate executives, based in Cleveland, paid them little attention, content with their healthy, if modest, financial contribution.

International Expansion, 1988-1994

Upon James Lincoln’s death in 1965, William Irrgang became the first non-family member to lead the company. Under Chairman Irrgang, however, Lincoln launched no new international ventures. Having fled Nazi Germany in the 1930s for the United States, Irrgang had a deep mistrust of all governments but that of his adopted country. This led him to turn down several oversees expansion proposals over the years, many from his President, George Willis.

Following Irrgang’s death in 1986, Willis became CEO and finally had the freedom to expand the company’s international manufacturing presence aggressively. He believed that a slowdown in U.S. market growth, as manufacturing’s share of the country’s economy continued to decline, would force Lincoln to find most future growth abroad. In the mid-1980s the importance of regional trade blocs, such as the European Community and the Andean Pact appeared to be increasing. The new chairman felt that his company needed manufacturing facilities inside each major bloc to ensure that external trade barriers did not render it uncompetitive with local producers. The European Community’s (EC’s) planned elimination of internal tariffs in 1992 was a source of particular interest.

Believing that the opportunity for immediate market presence made acquisitions more attractive than new “greenfield” factories, between 1988 and 1992 Willis acquired plants in nine countries. Finding no appropriate acquisition candidates, he also built new ones in Japan and Venezuela. In anticipation of European market integration in 1992, prices of many target acquisitions had been bid up to record level. As a result, Lincoln incurred long-term debt for the first time in its history. (Exhibit 3 lists the locations of Lincoln factories as of 1986 and 1992.)

Managing the new subsidiaries

After years of domestic focus under Irrgang’s leadership, Lincoln’s corporate headquarters contained no managers with substantial international experience. As a result, Willis retained the existing managers of most of the acquired companies to take advantage of their local knowledge, but directed them to implement Lincoln’s incentive and manufacturing systems. To help them, he sent out U.S. managers who knew the system in Cleveland, and also linked overseas supervisors and foremen with mentors among their U.S. counterparts. Beyond this, however, corporate headquarters largely left the new subsidiaries to manage on their own.

Most of Lincoln’s acquisitions were unionized, and at each relations between management and labor historically had been less cordial than at Lincoln. Corporate executives felt that this would change with time. William Miskoe, the former Lincoln Australia chief, who had become corporate senior vice president for international sales, told a reporter for Cleveland Enterprise:

[Workers in the acquisitions] have to learn to trust management, which is not something they are accustomed to doing. That means we have to be completely honest and not pull any punches. We give them the facts, and let them make their own decisions.

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Resistance from many quarters hindered the implementation of key elements of the incentive system, however. Many of the European managers and workers were philosophically opposed to piecework and seemed to value vacation time more highly than extra income from bonuses. Regulations presented additional obstacles: in Brazil any bonus paid for two consecutive years became a legal entitlement and in Germany piecework was illegal.

Financial trouble

In 1991, while internal reworking was still in progress, the new subsidiaries’ sales were hit hard by a severe recession in Europe and Japan. By 1992, nearly all of the newly acquired plants, plus France, were operating in the red. Nevertheless, corporate executives, still focused primarily on Cleveland, paid little attention. They remained optimistic that modified versions of the incentive system would eventually help most plants abroad achieve rapid productivity growth similar to Cleveland’s. Mexico had successfully implemented the system already and Willis told an interviewer that he expected the European operations to have some form of it in place within two years. Fred Stueber, the firm’s outside counsel and later its senior vice president and general counsel, recalled, “In 1992, Lincoln was in denial about the severity of the financial problems. They didn’t realize their full scale until 1993.”

When the 1992 results were reported in early 1993, the situation was plain: the new plants, especially those in Europe, were dragging the whole corporation down, and Lincoln Electric had lost money for the first time in its history. Despite strong performance in the United States, 1993 saw another loss. (Exhibit 4 shows net sales and profits for Lincoln’s operations by geography.) Recalled Stueber, “The company was almost in a death spiral: it had shareholders’ equity approaching $300 million, and had lost over $80 million in two years. It was hemorrhaging so severely in Europe that prospects were scary.” $217 million in long-term debt made the 1993 financial statements terrifying reading for Lincoln’s historically cautious board of directors. (Exhibit 5 shows Lincoln’s income statements and Exhibit 6 its balance sheets from 1987 through 1995.)

A new broom…

In 1992, company president Don Hastings was named CEO, in the middle of what he later called “the nightmare years.” His first move was to assemble an International Strategic Liaison Team to analyze the foreign operations and set attainable goals and performance guidelines for which local management would be held accountable. Despite its efforts, the team, comprised entirely of Cleveland-based managers, was unable to stanch the losses.

Recognizing that Lincoln lacked the expertise needed to handle the crisis, Hastings decided to look outside for executives with international experience. In April 1993, he hired Tony Massaro, former worldwide group president at Westinghouse Electric, as a consultant and brought him on permanently in August as director of international operations. Jay Elliott, former international vice president for finance at Goodyear Tire and Rubber Corporation, joined Lincoln in August as international chief financial officer to work closely with Massaro. The two were the first senior executives Lincoln had ever hired from outside the company. Hastings also added four heavyweight outsiders to the board of directors, including Edward E. Hood, Jr., former vice chairman of General Electric and Paul E. Lego, former chairman of Westinghouse.

Massaro’s first priority was to conduct an intensive examination of Lincoln’s new overseas subsidiaries. With Elliott’s help, he quickly identified several causes of the subsidiaries’ poor financial performance. First, they recognized that because most attention had been focused on the quality of the acquisition target’s manufacturing facilities, several of the newly acquired European companies had small market shares and weak sales organizations.

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Another problem was that fragmented production had kept costs high. Instead of concentrating manufacturing of each product in one factory to take advantage of the EC’s elimination of intra-European tariffs in 1992, each European factory had continued to manufacture a nearly full line of welding products. In the resulting Balkanized organization, many plants suffered from overcapacity and competed with each other. Ray Bender, a Cleveland veteran, appointed director of manufacturing for Europe, had realized upon arrival that rather than increase production—the classic Cleveland approach—he had to squeeze costs. “Managers ran operations like national fiefdoms,” Elliott noted, “and Lincoln lacked the confidence to bring them to heel. Headquarters let the subsidiaries do their own thing and never said ‘no.’”

In Venezuela and Brazil, Massaro and Elliott found different problems. There, the company had replaced inherited managers with former Lincoln distributors who were enthusiastic about Lincoln’s manufacturing and incentive systems but who had no manufacturing experience. Cleveland had given them little assistance, leaving them to succeed or fail on their own. “The Lincoln culture was so focused on individualism that corporate took a ‘sink or swim’ attitude with the subsidiaries,” commented Elliott.

The new executives’ analysis concluded that Lincoln’s lack of international experience had led management to believe that the new acquisitions and the greenfield in Japan would accept its unusual incentive systems and management style easily. Massaro remarked, “Part of the problem was that they tried to do things the Lincoln way everywhere, rather than adjust to local conditions.” With the benefit of hindsight, Hastings agreed:

We found that operating an international business calls for a lot more than just technological skill. And to be candid, in many cases we didn’t truly understand the cultures of those countries where we expanded. For example, we had an incentive program that was based on the belief that everybody in the world would be willing to work a little harder to enhance their lives and their families and their incomes. It was an erroneous assumption. 3

… Sweeps clean

With firm support from Hastings and the board of directors, Massaro and Elliott set about restructuring international operations to achieve profitability. Massaro explained,

The cleanup had two main stages. Some subsidiaries could not be saved and we had to shut these down. After that, we rationalized the product lines of the remaining plants in Europe and improved the sales force to increase volume.

The plants in Germany, Japan, Venezuela, and Brazil were judged too troubled to keep. In Germany, for example, sales costs were out of control, yet labor laws limited Lincoln’s flexibility to respond. Massaro noted that the plant’s militant union, IG Metall, was especially resistant to proposed changes, and the company ended up closing the subsidiary in 1994 at the cost of 464 jobs. Elsewhere in Europe, approximately 200 administrative and other non-production workers lost their jobs, leaving European operations’ overhead costs 20% below their 1993 level. Plant closings in Brazil, Venezuela, and Japan the same year eliminated another 120 positions.