Shopoholic is the word for W. James Farrell. Since he became CEO of Illinois Tool Works Inc. (ITW
) in 1995, he has spent well over $6 billion to snap up more than 200 companies. The spree has helped ITW almost double its net income and sales. Profit hit a record of $958 million in 2000, on revenue of $10 billion. The manufacturer, based in Glenview, Ill., now operates in 43 countries and employs 55,300 people. And Farrell says his shopping list is longer than ever.
ITW's growth-by-acquisition strategy may sound familiar. But ITW isn't just another acquisitive GE wannabe. While General Electric Co. (GE
) and other big spenders insist on industry domination, ITW prefers to pick and choose opportunities where its scouts find them. Farrell directed ITW's largest takeover ever--the $3.2 billion acquisition of restaurant equipment maker Premark International Inc. in 1999--but more often than not, he simply follows the lead of his front-line business managers.
The 59-year-old Farrell also doesn't believe in slash-and-burn consolidation. Typically, business buyers merge new properties with similar units and lop off redundant back-office employees in order to cut payrolls and other costs. Not ITW. Instead, it routinely breaks up each acquisition into even smaller stand-alone units. That way, Farrell argues, the business managers stay close to their customers. He also gives these managers nearly complete autonomy, encouraging them to act like entrepreneurs. Today, ITW has roughly 600 separate businesses.
From the outside, the setup looks anything but efficient. But ITW's numbers prove that Farrell is on to something. On average, when ITW picks up a new company, it joins the fold with an operating margin of 9%. Within five years, that average margin jumps to 19%, besting most of its industry peers. Farrell's secret? In addition to decentralizing authority, the chairman and CEO instills what ITW calls the 80/20 process at each unit. What this means is focusing exclusively on the 20% of customers or products that provide 80% of sales, and methodically letting go of smaller buyers and lesser product lines.
Despite ITW's heft and history--the company started in 1912 as a gear shop--the conglomerate is hardly well-known. But its products are everywhere. ITW makes everything from the plastic labels on soda bottles to door handles on automobiles to kitchen countertops and even the decorative films that make Victoria's Secret lingerie shimmer. And its industrial clients buy ITW's nail guns, welders, paint sprayers, and the strapping for steel coils and construction materials.
Farrell recently sat down over coffee with correspondent Michael Arndt and mused on this hodgepodge of products.
You've got 600 companies or business units at this point--each with duplicate functions and personnel. But the trend in the business world is toward consolidation for the sake of efficiency or synergy. Why do it your way?
There are two reasons. One is weak-sounding. It is our genetic makeup. Since ITW was formed close to 90 years ago, we've been creating divisions within the company. It was the way the company got started. That is one reason why we think small. The second reason is--especially in the last 15 or 20 years--we have been doing our 80/20 analysis. This leads us to the conclusion that if you simplify things, you can do them much more efficiently than the common consolidation route allows. For example, a consolidation may bring two divisions together, ending up with one sales force instead of two. At ITW, we will stick with two leaner sales forces.
But what about the risk that you're duplicating work throughout the 600 units?
People say this is crazy: "You can't have 600 divisions... You'll have more overhead and duplication of costs..." The real test of this is to give you a report that adds everything up. Our annual report takes all 600 divisions and adds them up: Here's our sales total, here's our overhead costs. And our costs are lower than 75% of the companies out there. We're competitive in the marketplace. So run your consolidated model. It seems to me my decentralized costs are lower than your centralized costs.
Do each of these 600 division managers act as mini-CEOs?
Absolutely. We're very involved in their businesses. When one of their employees comes in and says: "I want to retire," their HR department figures out what their pension costs will be. They have their own payroll, their own receivables, their own general ledger, and their own balance sheet. We do an annual plan every year and we review their budget. But on a day-to-day basis, they do it. We trust these people immensely. If ITW lost that trust, then we'd have to start putting in people and systems to watch them. Then our costs would ratchet up, and you'd start to lose any entrepreneurial drive.
If you're acquiring 40 or 50 companies a year, you must be looking at 10 times that many?
Maybe just four or five times that many. We don't have a codified process because we don't start with numbers. We start with a product. We have to believe that the product will provide a lot of value to its customer base and can be improved on. When we looked at Premark and its food-equipment group, we saw products like commercial dishwashers. And as we talked to customers, we heard things like: "I don't like those commercial dishwashers. They take up a lot of room. And they consume a lot of labor." We're listening to that and we're getting bigger and bigger smiles on our faces--because those are all areas to improve. You don't like the fact that it's big, let's make the dishwasher smaller. You don't like the fact that it uses a lot of labor, let's reduce the labor. Now I can create new sales by creating new value.
When a company acquires another, often it will wipe out 10%, 20%, or 30% of the labor force as soon as possible. What do you do?
The same thing, but it takes five years to do it. All we know is we just acquired a company--but we aren't intimate with what everybody does and how they do it. So we spend time with the people in the company to do this 80/20 process. And a lot of this workforce reduction is retirements and attrition. So we don't have to go in and announce big layoffs. This is why we become an attractive acquirer to people selling their businesses. They know we don't go in and wildly disrupt the organization.
Have you ever bought a company with a 9% margin and then suddenly, it's 5% or even zero? Occasionally, there's a dud?
Real occasionally. I would say with this 80/20 process, in the last 15 years or so, I don't think we've screwed up once.
Do other companies ask for your advice on how do you do this?
All the time.
And do you see any other companies that can make it work?
No. It took us 10 years to develop this 80/20 process. And after we really got going on it, it took another five years to get our existing businesses thinking this way. It's a tough discipline. Intellectually, it's easy to understand. But it's very difficult to put into practice. The organization starts to fight with you from Day 1. They say: "You can't get rid of these products, because we have to sell a complete product line. And you can't cut factory output, because we need the volume to absorb our fixed costs." And on and on. You get arguments up the wazoo. When it gets tough, that's when most competitors give up on 80/20.
Everyone's worried about a recession. What are you seeing?
Nothing good. If you go back to the first quarter of 2000, our revenues in our core businesses grew by 8.5%, year over year. Second quarter, it was 4%. Third quarter was 1%. See a pattern developing? Fourth quarter was negative 2%. First and second quarter "01 were both down 7%. That's not a great trend. Are we at bottom? I have no idea. But I don't think the odds are good for a rebound soon.
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