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CEO INTERVIEW - Alexander Cutler of Eaton Corp.: Green Is Gold

CEO Sandy Cutler is no tree hugger, but he's positioned Eaton Corp. to profit from rising concerns about energy efficiency and environmental sustainability.

When alexander (SANDY) cutler succeeded Stephen Hardis as CEO of Cleveland-based Eaton Corp. in August 2000, the manufacturer of truck transmissions and other automotive parts had recently embarked on a bold plan to move into higher-margin, faster-growing products like aerospace components and hydraulic systems. Cutler, a Milwaukee native who joined the company in 1978 after it bought a rival run by his uncle, has accelerated that transformation. Since 2004 the 56-year-old has acquired more than 20 companies, including the power systems unit of France's Schneider Electric, which Eaton agreed to buy in June for $570 million. He also has pushed Eaton into making innovative, energy-conscious products, such as a hybrid drive system that aims to reduce carbon emissions by 40 percent and is being road tested by both United Parcel Service and FedEx Corp.

Cutler has faced his share of obstacles, notably the recession that coincided with the dot-com bust and the September 11, 2001, terrorist attacks. Revenues plunged $1 billion in 2001, sending profits down by 41 percent, to $346 million. Soon after becoming CEO, Cutler slashed about 12,000 jobs -- one fifth of the company's workforce. More recently, the passage this year of more-stringent federal emissions standards for heavy-duty trucks dealt a blow to Eaton's highly cyclical business making parts for those vehicles.

Today, however, Eaton is far less reliant on auto-related businesses. More than 70 percent of its $12.4 billion in annual revenues comes from its fluid and electric power systems businesses, which help in the construction of fuel-efficient airplanes and buildings. These divisions enjoy fatter margins and higher growth rates than do the auto-dependent businesses. As a whole, the company is benefiting from concern over dwindling energy supplies and global warming; even the vehicle-related businesses are geared toward reducing fuel consumption and greenhouse gas emissions.

Cutler -- a Dartmouth College Tuck School of Business MBA who ran track and played football while studying Far Eastern history as a Yale University undergraduate -- also has increased Eaton's presence in China, India and other emerging markets. During the second quarter, half of the company's revenues came from outside North America, a first in Eaton's 100-year history. As recently as 2002 the company pulled just 30 percent of sales from overseas. Its share price is up 50 percent in the past 12 months and 200 percent over five years.

In a recent interview with Institutional Investor Staff Writer Pierre Paulden, Cutler discussed his plan to increase annual sales to more than $18 billion by 2010 -- and explained why a mid-American auto-parts supplier became so environmentally conscious.

Institutional Investor: Are you an environmentalist?

Cutler: We're not approaching the business with an environmental agenda. I would say that our focus at Eaton has been more based on a primary set of values -- on doing business right. Within that is a sustainable business model, but to focus on that alone is not adequate. It does not recognize the cultural values of doing business right.

Would your company be making hybrid truck engines and other eco-friendly products if concerns about the environment weren't rising?

To understand the whole sustainability issue, you need to go to the basis of what Eaton is. We are involved in the management of electrical, fluid and mechanical power. Our base of business is helping our customers utilize power efficiently. It's become stylish to talk about eco-friendly initiatives or being environmentally friendly, but that is the core of our technology and how we help our customers. A number of these technologies are not the result of one or two years of focus. They've taken decades of research and application to develop.

How do your products help companies save energy?

We've been engineering higher-pressure hydraulic systems that allow airplanes to be made significantly lighter, thereby increasing fuel efficiency and reducing emissions. We took one metric ton out of the weight of Airbus's A380 airplane, for example. Another technology is called a parallel hybrid. That lets vehicles like refuse trucks, which are driving 25 feet between stops, use stored hydraulic power instead of their diesel engines. It took many years of research to understand how you get different power trains to work together to save fuel and significantly reduce emissions.

You've said that you oppose the Kyoto Protocol to reduce carbon emissions. How do you square that position with Eaton's making such green-friendly products?

Kyoto was a flawed execution of a good concept. Kyoto did not include developing nations, and it encouraged people to migrate processes that did not meet its standards into countries where the accord did not apply. Also, it was not a GDP-adjusted process, which meant that countries that grow very slowly have an easier time complying than those with high positive GDP. Without adjusting for that, you are not really going to get the combination of a sustainable business model and growth that enables residents of a country to have a quality of life. It's not the objectives of Kyoto that opponents objected to. It was, "Let's be sure you don't have a flawed piece of legislation or initiative and then celebrate it as being something which would have a positive influence."

Is U.S. regulation of carbon emissions inevitable?

What form should it take?

I don't know if it's inevitable. That's as much a political question as an economic one. All companies really need to be working on the issue of sustainability, and it needs to be much more of an integral part of the business model rather than a program that gets pasted on the back end. There are very positive moves from the Business Roundtable [a lobbying group for big-company CEOs] to undertake voluntary programs aimed at significantly reducing emissions. We have adopted those same goals and said we are going to reduce greenhouse gas emissions by 18 percent by 2012. Those kinds of programs, where people are really delving in and working, may provide the backbone if legislation is enacted.

Does adopting sustainable practices put you at a disadvantage in certain emerging markets where not everyone plays by those rules?

We honestly don't see a conflict there. We don't believe in regional or situational ethics. Our strong belief is, if you have superior business practices, you attract the best people to your franchise, they make the right decisions and you get great business results. I've always heard people say they cannot compete in this or that region because they need to lower their ethics to be successful. We say we won't go into those regions to compete. We've been very successful around the world maintaining the highest ethics in terms of doing business right, and that includes having a sustainable business model. We were recognized in China last year for our new facilities, where we put in place world-class water treatment facilities. Could we have done something less? We could have, but that did not cross our mind because that is not our standard for doing business.

Why is Eaton growing so quickly outside the U.S.?

In places such as China, India and parts of Eastern Europe, economies are developing and countries are beginning to mechanize and nationalize their economies -- and most of the products we make are involved in infrastructure. We continue to be very bullish on growth in those places. By 2010 we want our Asia-Pacific business to have grown from $1 billion to $2.5 billion. This is one of the few areas of the world where the major market-share positions are not well-established over a long period.

How do higher fuel prices affect Eaton?

Higher fuel prices can be a deterrent on an economy. But what's been remarkable is that we've gone from $30-a-barrel oil to more than $70 a barrel, and the U.S. and world economies are still growing. There has been enormous resiliency to fuel costs. What's changed is people are more conscious of ways of reducing fuel usage. Industries are finding ways to reduce or find alternative fuel systems. The big impact for us is that companies are thinking about utilizing new technologies.

Isn't weakness in the heavy-truck market still a problem?

The market has slowed down, but that's not economically driven. It's driven by new diesel emission standards that went into effect January 1. Historically, in years when the heavy-duty truck market shrank, Eaton's overall profit would decline. This year will be the first time in Eaton's history that the heavy-duty market will decline and our profits will go up. That's really been the culmination of a strategy laid out in 2000 for how we would change the mix and performance of the company.