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Why ITW is changing century-old habits2013-01-30 08:53:42

GLENVIEW, ILL. (Aug. 13, 2 p.m. ET) -- As Illinois Tool Works Inc. marks its 100th birthday, the manufacturing conglomerate is changing the habits of a lifetime.

Founded in 1912 when Byron Smith posted an ad seeking investment opportunities, Glenview-based ITW grew to nearly $18 billion in annual sales by gobbling hundreds of small companies in a decades-long buying spree. Rather than combine the properties in a centralized hierarchy, ITW oversees a sprawling confederacy of 800 autonomous units that make everything from welding torches to seat-belt buckles.

ITW requires only that its various enterprises hew to the “80/20” philosophy that lavishes attention on high-volume customers, the 20 percent who account for 80 percent of orders. For years, the system produced above-average margins and stock returns.

But as growth stalls in the sluggish post-recession economy, management is changing the formula. Amoeba-like expansion is out, replaced by a tighter focus on higher-growth markets. ITW will rely more on internal sales growth and less on acquisitions. Most significantly, the company is moving to a more-centralized structure likely to cut its number of business units by more than half.

“This is a big deal,” says Chicago-based analyst Robert McCarthy of Robert W. Baird & Co., who reckons the reorganization is the biggest change since ITW adopted the “80/20” system some 30 years ago.

It’s not a case of panicky managers overreacting to short-term setbacks by trying to fix a business model that isn’t broken. True, ITW sales have slowed while the premium on its share price has evaporated. After beating industry peers and the broader market for decades, ITW shares lagged both during the past three years. An activist shareholder is pressing for change.

But something more fundamental is happening. CEO David Speer seems to be facing the harsh reality that the company’s old ways won’t necessarily work in the future. In classic ITW style, Mr. Speer’s public comments soft-pedal the project as “business simplification” and “cultural nuance change.”

Don’t be fooled. It’s a major strategic and cultural shift intended to position the company for long-term success in markets that are becoming increasingly global and intensely competitive. And it’s just what ITW and many big manufacturers need to do to survive.

Low-priced competitors, many of them Chinese, are squeezing profits in a range of industrial niches, forcing the likes of ITW to zero in on markets where they have real competitive advantages.

ITW’s fragmented structure, with business units averaging only $30 million in annual sales, allowed it to respond quickly to changing market conditions and customer needs. But it didn’t capture the full economies of scale all those acquisitions could have generated. And it didn’t allow the company to bring its full resources to bear on the most promising opportunities.

In today’s economy, no company can afford to leave money on the table or scatter its investments like buckshot. Consolidating into fewer, larger business units with average sales of about $100 million should yield back-office savings and allow ITW to make bigger bets in markets with better profit and growth prospects. The company also plans to unload businesses with subpar growth potential.

Mr. Speer, who continues to work despite an unspecified medical condition, said in April that “the associated strategic benefits and savings from these initiatives will be significant,” but he won’t provide financial details until December.

Success is by no means certain. Driving change of such magnitude through a company as old and proud as ITW is painful. And there’s not a lot of fat to cut: ITW’s profit margins are nearly double industry norms. Jobs will be lost, and confusion will reign as the organization adapts to new ways.

And if the reorganization doesn’t rekindle growth, it could set the stage for a breakup of ITW, like those we’ve seen at other old-line companies.

Then again, so would sticking to ITW’s old ways.

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