Price Advanced Topics in Operations Management 502 Case Study

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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
Lincoln Electric—Case Study
A. Executive Summary
Since its founding in 1895 with start-up funds of a mere $200, Lincoln Electric had
successfully grown its business into the global market leader (in the welding products industry)
with sales of $1.6 billion and net income of $122 million by 2005. However, management felt
that they could achieve greater results if thoughtful action was carried out and implemented.
Aggressive financial goals were drawn up, although it became clear that international
sales would need to increase if these goals were to be met. In fact, at present, only 60% of its
sales came from the domestic (North American) market space. Its stated goals included the
following: “sales growth at double the rate of growth in worldwide industrial production,
operating margins over 15%, earnings growth of 10% annually and return on equity exceeding
20%.”
Lincoln Electric’s chairman, president and CEO John M. Stropki faced some tough
choices as a result of these goals—some of which perhaps are not as obvious as they would
appear to be. But the overarching theme that Stropki has been tasked with solving is this—
“What is the ideal mix of solutions in which to expand the Lincoln Electric enterprise?”
Over the course of this case study write-up, I will accomplish the following:
1. Present a summary of the competitive landscape & industry that Lincoln Electric finds
itself within,
2. Provide a brief overview of Lincoln Electric, in order to gain a richer appreciation of its
business challenges and issues,
3. Identify the issues that Lincoln Electric faces and
4. Offer my recommendations as to the course of action that it should take.
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
We turn now to the first item on the agenda—a brief overview of the competitive
landscape.
B. Competitive Landscape
In a nutshell, the welding industry can be boiled down into two core offerings:
consumables and equipment. “Consumables” is a collective term for the wire electrodes (filler
metal) that is used to bond two separate metals together in a process called welding. Equipment
refers to the “power sources and related parts used to create the electric arc” that heats up the
consumables to their melting point, so that they can create an adhesive bond between metals.
In aggregate, between consumables (58%) and equipment (42%), the welding industry
was a $13 billion industry as of 2005. Common sense would imply that since the welding
industry is in the building of providing the tools and materials to build things, that its economic
growth and decline are directly tied to the global economic growth rate (3% in 2006). However
simply supply/demand economics would point out that in rapidly developing regions (China &
India for instance) the resulting economic growth rate could be much higher, if executed
properly.
In 2005 North America accounted for 23% of global sales followed by Europe (21%),
China (17%), Japan/Korea (16%), Southeast Asia (9%), Russia/Africa/Middle East (6%), Latin
America (5%) and India (3%).
Interestingly, the pan-Asian region (China, Japan/Korea,
Southeast Asia and India) accounts for a full 45% of global sales—22% more than the North
American market.
In marketing terminology the welding industry (collectively) would be referred to as
being in the growth stage. Why? It is a highly fragmented market space that is not dominated
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
by any one (or two or three) company. In fact, the leading six companies are only responsible
for 45% (approximately $5,820,000,000) of the global market—leaving a full 55% to the
thousands of smaller companies to snap up.
The following table & chart will showcase Lincoln’s five main competitors in a visually
simple to understand manner before we move on to an overview of Lincoln Electric.
Competitor
ESAB (Charter plc)
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Illinois Tool Works (ITW)
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Air Liquide
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Kobelco
Thermadyne Holding Corp.
Highlights (as of 2005):
$1.3 billion sales (primarily equipment)
#3 position in the U.S.
Market Leader:
o Europe, Brazil, Argentina and India
Agreed to be purchased by Lincoln Electric, which later
backed out of the deal due to antitrust and other misc. items.
$1.3 billion sales (consumables & equipment)
#2 position in the U.S., collectively
#1 position in the U.S., just equipment
Asian subsidiary produced its consumables in Taiwanese
and Chinese markets
$600 million sales (consumables & equipment)
Focused mainly on industrial gases
Strong welding presence in Europe
$550-600 million sales (primarily consumables)
Market leader in the Asia-Pacific region
Joint venture with Panasonic in China
$470 million sales (niche equipment)
U.S. focused
Constrained by narrow product line & excessive debt
Welding Industry Competitor Breakdown
12%
Lincoln Electric
10%
ESAB
ITW
Air Liquide
55%
10%
4%
4%
5%
Kobelco
THC
Other
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
C. Lincoln Electric: Overview
Almost since its founding Lincoln Electric has been a pioneer and innovator, whether the
item at hand was involved a technical item or in how it managed its human capital. Specifically
the case study mentions five arenas, which I will now discuss.
1. Human Resources and Incentive System—While the case does not mention whether
or not this is an enterprise-wide practice, it is safe to assume that its piecework pay system is
most likely only applied to its production facility workers. Piecework pay essentially means
that workers only are paid for what they produce—and furthermore, what they product
correctly. This pay structure allows for no holidays, sick days or similar comp time, as again,
workers are only paid when they produce. In this way, Lincoln is assured that it is not wasting
financial resources on an unproductive workforce.
While at first glance this may seem like a very unattractive pay system, it is balanced
(somewhat) by the payment of yearly bonuses from the company’s profits. In fact, these
bonuses (in America) averaged $23,000 in 1997 and accounted for a full 32% of “income before
interest, taxes and bonus, in 2005”. Merit bonuses were based on a rating comprised of equal
component parts (“quality, adaptability/flexibility, productivity, dependability/teamwork and
environmental health & safety”). Furthermore, its policy of “no lay-offs” was extremely
appealing to its workforce.
2. Technology Development—A full 2% of its sales revenue was directed towards
research and development (R & D). This investment has paid of handsomely for Lincoln, as it
was the market leader in product introductions, quality performance and as a result became
known as “The Welding Experts”. In order to help ensure that it was able to maintain its
technological leadership, Lincoln spent $20 million in 2001 to break ground on the new David
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
C. Lincoln Technology Center, which would house its R & D efforts. It is worth noting that in
2005, of its total sales, a full 50% of its equipment sales were from products that it had
introduced within the previous five years. Clearly, its investment was paying off. Lincoln’s
technologic leadership has allowed it to price many of its product offerings in the premiumpriced market space.
3. Product Mix—Lincoln has a wide product line and is in fact, one of the few welding
companies in the world to have this advantage. In fact, it often was able to differentiate itself
from its competitors by offering welding solutions (individual offerings packaged together in
order to offer customer value to solve their specific business requirements) instead of singleproduct offerings alone. It offered products from the consumer, Do-It-Yourself market (Lowes,
Home Depot, etc.) to industrial quality product offerings and solutions.
The case study also briefly mentions a total of five acquisitions, supply arrangements and
expansions that afforded it a wider product line, while producing synergies (between itself and
its acquired J.W. Harris Company).
4. Marketing—Lincoln’s highly trained sales force provided Lincoln a key competitive
advantage: “it could offer advice to its customers on how to use its welding equipment without
charging them directly for the advice”. It seems likely to Lincoln can afford to offer such a
service, as a direct result of it pricing many of its products in the premium market space—it
isn’t operating within thin profit margins.
In each of the 86 countries in which Lincoln conducts business its sales staff has a
“hands-on” approach to managing the customer/prospect relationship. From its initial advice to
the prospect, Lincoln sales team members have face-to-face meetings, conduct a thoughtful
analysis of their true business needs and how those needs match up with Lincoln’s products &
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
solutions. Additionally, the sales team member will forecast the ROI a prospect will earn if
Lincoln’s products & solutions are purchased. Further, Lincoln offered its Guaranteed Cost
Reduction program, which stated that the company “guaranteed that the [end] user would save
money in its manufacturing process when it utilized Lincoln’s products”. This provides Lincoln
with a massive competitive advantage.
5. Design and Production—R & D investment was pumped up beginning in 1997 and as
a result, Lincoln saw increased go-to-market offerings (30 new products) and a modernization
of the plant at its headquarters in Cleveland, Ohio.
Next, we turn to the identification of the issues suggested in the case, some of which may
seem surprising.
D. Identification of Issues
Lincoln Electric’s management team essentially faces three central decisions to make
within this case, with respect to increasing sales revenue & maintain its global market
leadership. They are as follows:
1. What lessons, if any, should Lincoln Electric takeaway from its experiences within the
Asian markets—specifically in Japan, South Korea and China? Furthermore, are these
lessons applicable to it making a decision with respect to the next question?
2. Should Lincoln Electric expand its enterprise and move into India? And if so, how?
Know this fact: Lincoln experienced its first “major international expansion” from
between 1986 and 1992. Essentially, this first expansion cycle examines 6 years. That’s it. It
bears repeating—6 years.
Between 1986 and 1992 the organization grew from five
manufacturing plants in four countries to 22 plants (and increase of 17) in 15 countries. That’s
nearly 3 new plants in each of the six years in question.
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
Also know this fact: acquisitions in Europe and Latin America (at a cost of $325 million)
suffered such large operating losses that the company was forced to borrow money in order to
pay yearly bonuses to its American workers. Recall that bonuses are also tied to performance—
globally the firm in 1992 had not performed. However, in America continued to do well, thus
management decided it was best not to panelize its workforce in that region. One item became
clear as a result of this debacle—the American company lack of true understanding of other
cultures and laws hindered its performance in those expansion regions. These failures led it to
halt its further global expansion ambitions.
By 1996, Anthony Massaro was brought in to turn the company around and in fact did
just that. And once more, Lincoln Electric turned to a global expansion strategy to meet its
aggressive sales targets. In fact, through a series of new facilities, acquisitions and joint
ventures, Lincoln Electric expanded 25 more times between 1996 and 2004 (over 3 each year
approximately). While I can appreciate Lincoln’s enthusiasm to exhibit a larger handprint
within the global market, I question whether these short-term gains are sustainable. Case in
point, when Massaro came on board, he shuttered operations in Japan, Venezuela, Germany and
Brazil that were deemed unprofitable. Furthermore, he shifted production priorities (some
would focus on consumables, while others would focus on equipment) and output when it was
discovered that some of the plants were competing against each other in numerous product
categories. While it was certainly within his right to do so, I can’t help but think that stronger
use of marketing research and cultural awareness & understanding would have resulted in more
productive facilities that would be profitable and still operating today. Owing to the fact that
60% of its sales come from the North American market—and that is not a high enough number
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
to achieve its aggressive revenue goals, Lincoln must explore other markets and/or expand
revenue within existing markets.
This leads our discussion to the first major issue of the case: What lessons, if any, should
Lincoln Electric takeaway from its experiences within the Asian markets—specifically in Japan,
South Korea and China? Furthermore, are these lessons applicable to it making a decision with
respect to the next question?
Lincoln viewed these markets are indicators of what it should expect within the Indian
market space, should it decide to enter it. Why they believed this, the case does not explicitly
mention, (unless you take into consideration that management viewed these three countries as
“advanced versions” of the Indian welding market—which I personally feel is a real stretch and
not based on anything but subjective feelings, as it is not backed with any correlation utilizing
quantitative statistics—or even qualitative variables within the case study) however, I suspect it
has more to do with being emerging markets (with respect to market share) rather than such
variables as being a growth market, culturally similar or other such things. With a population of
over 1 billion, yet was a country that accounted for only 3% of the global sales in the industry, it
would appear to be ripe for growth.
Japan—As a market, Japan tended to favor cutting edge technological equipment, yet
favored (high-quality) consumables at competitive prices. In effect, the Japanese are willing to
willing to pay a premium price for equipment but expect consumables to be priced mass market.
However, the market (for Lincoln) primarily involves niche products to a niche customer base.
Yet, Lincoln’s dealings with the Japanese market appear to be problematic at best. Its
distribution is very limited in the country (zero market access on the commodity-end). Further,
its sales staff has very little access to customers in order to demonstrate (and explain) the value
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
of the products and solutions. Recall that management has seen this as critical to not only its
success in selling the products, but also in charging a price premium. Considering that the
Japanese will pay a price premium when warranted, this appears to be a disconnect which
management needs to address.
Additionally, selling to the Japanese market segment is complicated by the fact that the
country has “two voltages and frequencies in use.” Lincoln’s equipment is not optimized to
work with one of the two voltages—and thus, the Japanese are reluctant to pay the premiumprice point that the company is selling its products at. This seems like a no brainer to me—
solve the problem so that equipment would work on either voltage (depending on which one of
two plugs are used) or get out of the market completely.
This sounds harsh, but Lincoln is burning through its brand equity every time it faces this
challenge. It furthers the image that Americans (and thus its company’s) are geocentric in their
worldview and lack even the most basic of understanding in the differences between countries
(let alone their business practices). In effect, Lincoln is providing a faulty product each and
every time a customer purchases a product and it is not optimized for that voltage.
Additionally, without access to its customer base, the salesforce is not afforded the luxury of
pairing the appropriate products and solutions to the specific requirements of that prospect.
They are flying blind. This needs to be fixed.
South Korea—In South Korea, Lincoln does not have production capabilities, but it
does have distribution through a local distributor that it has utilized for over 27 years. Recall
that Lincoln’s management viewed Japan, South Korea (and China) as “advanced versions” of
what to expect in the Indian market. If one had read the case carefully, clearly there is an
immediately disconnect here—How could India have both distribution channels (such as in
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
South Korea) and no distribution channels (such as in Japan)? This should raise a red flag, that
perhaps Lincoln’s management may be over-generalizing its assessment of these markets.
Buyers in the South Korean market segment were not very willing to purchase high-end
equipment—in contrast, the Japanese were. Again, this is a disconnect.
Finally, without a production plant in the South Korean domestic market, Lincoln has
been forced to ship its products from the Cleveland production facilities. The case is very clear
that it is preferably to have a local or regional production facility to produce its goods, because
they are (1) extremely heavy and (2) this weight increases its shipping costs. Logically, this
means that they either need to absorb the cost of this increased shipping, thus lowering profits
or they tack on the additional cost to the product, thus increasing the cost to the consumer—who
may decide that a competing product (made locally) is the better bargain for the value received.
It is anticipated that goods will be shipped from China when that facility is fully functional.
While this move would potentially reduce shipping charges, it would not reduce them entirely.
With this added expense, Lincoln faces an uphill battle in trying to justify its higher price points
to a South Korean market segment that is already reluctant to purchase high-end equipment.
China—As in other foreign regions, Lincoln stumbled as it sought to expand its global
market share. While it was able to secure manufacturing facilities in the communist country, it
found dealing with the government burdensome and complicated.
Further it was greatly
restrained by a lack of “competent” managers and a lack of distribution channels. As a result, it
found profitability to be difficult to achieve. I’m struggling to correlate the idea of not being
able to find “competent” managers in a country with over 1.3 billion people. It seems to me its
way of doing business did not necessarily gel with the Chinese workforce, and it may have
perhaps been better served to adjust its HR policies to meet the needs of the local market.
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
Attempting to overcome these challenges, it partnered with Kuang Tai (a Taiwan firm)
“because of its established production plant and distribution network, its ability to locate
experienced, bilingual operations managers, its reliability, its proven ability to deal effectively
with an extensive Chinese bureaucracy and the company’s concern with the complexities and
uncertainties of alternatively partnering with a state-owned enterprise.” In a nutshell, it wasn’t
prepared for the realities of conducting business in China and its operations (and profitability)
suffered as a result
However, the joint venture was not without its own challenges. Specifically, Lincoln did
not always agree with its partner on how to grow the business (volume vs. profits) and
management viewed working with a partner as time consuming and tedious.
Essentially,
without a joint venture strategic partner they were not succeeding in China and with one, they
were succeeding—and yet Lincoln still thought they knew best. Yet again, this is a clear
example of Lincoln not understanding the local market and trying to implement “the American
way” onto the global markets. This is faulty logic in my opinion. Instead, Lincoln should be
taking every opportunity to learn and grow from its strategic partner. Only then, will it be more
capable of attempting to fly solo in the future.
Next up is the issue of expanding into India. Should Lincoln Electric do it? With all of
its struggles and challenges in other foreign markets, one might wonder why management
wanted to add one more potential struggle before it got the rest of its portfolio in line. In any
event, Stropki and the rest of the management team are considering it and thus, so shall we.
Recall, in 2005, the Indian market represented only 3% of the global welding industry
market. That’s it. However, in that same year the population of the country was rapidly
approaching 1.1 billion. It is also a market of high growth, due to the rising education rates,
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
development and foreign investments stemming from less expensive labor and an extensive
high technology labor market. As the case states, “India is currently rebuilding its infrastructure
and therefore will need thousands of miles of new oil and gas pipelines.”
On paper (fiscally speaking), it’s an attractive market. With 6% annual GDP growth,
India has one of the fastest growing economies in the world. It’s a $415 million market. In
comparison, Latin America (collectively) is $601 million and Europe is $312 million. Sounds
great!
Here’s where it gets a bit dicey—while 56% of the Indian consumable sales were
generated by the prevailing large firms who brought their proprietary goods to market, the
remaining 44% were actually copycats that recreated the (more or less) “brand name” goods and
then undercut the price of the major companies. Anyone that has taken marketing 101 knows
that competing on price (generally) is not sustainable in the long run, however, these are smaller
firms undercutting on price. If one goes out of business, there are thousands more just waiting
to take its place when it does.
Surprise, surprise—Lincoln is not the first welding company to think that India could be
a great opportunity to generate revenue. In fact, there are already three major competitors
dominating the marketplace: Ador Welding ($50 million in sales, 2005), ESAB India ($50
million in sales, 2005) and EWAC Alloys ($30 million in sales, 2005).
Ador Welding has gained economies of scale by merging its production requirements to a
limited number of production facilities within the country. They also enjoy tax savings by
utilizing plans that reside within tax-free zones, created by the Indian government.
Recall that Lincoln previously sought to purchase ESAB, before eventually backing out
of the deal out of concern for antitrust reasons. However, India is, well India and not the United
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
States. I suspect that antitrust issues would be less of an issue if Lincoln sought to acquire just
this branch of the ESAB portfolio, though it may not be wise to do so. Why? ESAB India has
not been very profitability, even though it does have a sizable market share. While it did
manage an 18% operating margin in 2004, it appears to be the result of accounting manipulation
and one-time write-offs. ESAB India appears to have adequate distribution channels and a
production facility. But again, on the flip side, it is not a very profitable venture thus far.
Finally, EWAC Alloys is a $30 million generating joint venture between Messer and L &
T. The case does not provide much more detail than this.
E. Summary Recommendations
In this section, I will make my recommendations—in the order that I believe that they
should occur (due to importance).
1. Relevance of Japan, South Korea and China to the India Decision
a. To be blunt, I don’t find a large correlation between these three countries and
that of India. Japan and South Korea are industrial nations with significant
development and resources. China is a communist country, which is burdened
by its government maintaining involvement in all aspects of its society—
including industry.
b. Perhaps the greatest relevance (correlation) between the three—and thus the
takeaway for Lincoln’s management is that they truly need to understand a
country’s culture and business environment before entering the market space.
Some may say, “Well if Lincoln aligned itself with a strategic partner, it
wouldn’t have to worry about these issues—the partner would know what to do.”
This is an ignorant opinion. In fact, I would argue that a company would need
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
even more cultural understanding and knowledge when bringing on a partner,
because the two business entities would be just that—partners. In a way, it could
viewed as conducting due diligence on a new partner. You want to make sure
that it’s a good fit before its too late.
c. Management needs to diligently study what went wrong in Japan, South Korea
and China and make a concerted effort to correct those mistakes. For instance, in
Japan—fix the plugs so that the correct voltage can be used. In South Korea,
conduct marketing research to understand the consumer motivating buying
behaviors. Use this acquired knowledge to grow demand for high-end products.
Furthermore, it needs to gets its Chinese production facility in line, so that it will
be able to ship from there instead of the United States. South Koreans wish for
speedier service. This would allow it to happen. Finally in China, management
needs to pull back and listen to its strategic partner. Kuang Tai turned the
operation around—clearly it understands the Chinese market better than Lincoln
does. While management may feel that quality talent is difficult to find, it may
be looking in the wrong place—perhaps those at Kuang Tai are the right workers
for Lincoln. It may wish to consider acquiring Kuang Tai in the future, if the
partnership continues to be fruitful. The Chinese market is not to be ignored.
2. Expansion into India
a. Recall that through a series of new facilities, acquisitions and joint ventures,
Lincoln Electric expanded 25 more times between 1996 and 2004. Recall also
all of the challenges and issues that have risen from those expansion efforts. The
reality is that Lincoln did not learn its lesson from the troubles in the harsh
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Advanced Topics in Operations Management 502
Case Study: Lincoln Electric
1980s. It is merely repeating them on a grander scale. From a marketing
perspective, companies need to diligently select their target markets. Rarely, if
ever, is it wise to go for (nearly) all of them. Economies of scale would not be
realized on such a grand scale, efficiencies would be far and few between and
there is only so much human capital to deal with all of the issues that can and
will arise. Discounting Japan and South Korea for the moment, Lincoln has its
hands full with China. This massive country—both in size, population and
economic growth—is expected to be a major global superpower within a
generation. It would be unwise to let things stand as they are in that country.
Lincoln needs to quickly acclimate itself to the business realities in China or find
itself overtaken by competitors that can and will do such.
b. I know that I’m in the minority here, but I do not see the promise of India at this
time. From a domestic (US) perspective, India is a great source for cheaper
labor—assuming that those produced goods would be sent back to the US—
which they would not be. The case stated (and I stated earlier) that, “India is
currently rebuilding its infrastructure…” What I did not state earlier was who
said that. In fact, it was Stropki, the CEO of Lincoln Electric. He has offered no
quantitative data to back up his claims. The reality is that the majority of the
country is a ghetto and the vast majority of the country live in abject poverty. Its
government is not spending heavily on infrastructure reconstruction according to
new sources that I have read.
The same cannot be said for China—it’s
transforming itself into China 2.0 right this moment.
That is the smarter
investment at this time and the one that Lincoln should be concentrating upon.