Japan Management Association Consultants

I am honored indeed to be here today. One reason is that this is such a distinguished group. Another is that, while no expert on Japan, I have been a long time student, and I have learned many of my best management lessons from Japan. Therefore it is a special pleasure to be asked to share with you my views on management of large organizations. I do understand that this is my assignment today, I think I have some ideas for you, and I will certainly share them with passion and conviction.

One thing we all learn as life progresses is that the lessons we have learned by doing, the solutions we have ourselves crafted through our trials and errors, are the lessons we know and believe in the most. And I have had an exhilarating career with one of the greatest companies in America, I have learned by doing, especially in the 1990s, and I am eager to share these lessons and views with you.

I really am a student of Japan, not in any formal sense but certainly by long time exposure. I came here first in 1968. These were the early years of the Japanese Miracle, and I was overcome with admiration. My intellectual understandings weren't great; I spoke none of your language and knew almost nothing of your culture, yet I was overcome.

My boss then was Jim Abegglen, Abe-san as I recall his Japanese friends called him, and I studied his short book, The Japanese Factory. He focused on lifetime employment, the social contract among company, employee and society, the role of government planning, and the benefits of low cost debt financing in building powerful competitors. These features were no doubt important in your economy's development, but there are other lessons I will talk about today, lessons that did not become clear to me and to much of American industry until the late 1980s: the lessons of quality and productivity, and the techniques underpinning them.

And I will state right at the outset my principal message in these remarks today: The adoption of these fundamentally Japanese developed techniques by American business over the last decade is the cause of the dramatic change in America's competitiveness internationally, from well back in the pack a decade ago to, by common consent, first today. I will also add a corollary lesson, that the willingness of the American society and government to maintain borders open to imports and a society open to change and new ideas, even in the face of short term adversity for American employees, is our nation's great strength. These are the reasons why we prospered from the Japanese challenge, why we gained in the long term even while we lost in the short term.

UTC is a good example of an American company open to change and benefiting from change just as the American economy and society has been open to and benefited from adversity and change.

UTC is America's 21st largest industrial company and 41st largest company overall. Our revenues last year exceeded $25 billion, and our market capitalization today is about $30 billion. You may recognize us more for our trademarks than for the parent company's name: Pratt & Whitney aircraft engines, and I am proud to note the maker of about half of the jet engines operating in Japan today, and the maker of all of the engines for your newest airplane in service, the Boeing 777; Otis Elevator Company, the world's largest elevator company and a significant competitor here in Japan; Carrier Corporation, also a world market leader, in both residential and commercial air conditioning and in commercial refrigeration; Sikorsky Aircraft, inventor of helicopters and the primary supplier to the U.S. Government for military applications; and Hamilton Standard, world market leader in aircraft engine controls, high power propellers, aircraft cabin pressure and temperature control systems, and maker also of all the space suits used by Americans in space, ever.

We are also one of the most international companies anywhere in the world, with 180,000 employees, 105,000 of them not American, located all over the world: 50,000 in Europe, 30,000 in Asia. In fact, the United Nations identifies only twenty companies worldwide with more than 100,000 employees outside of their home countries, and UTC is one of four American companies on this list. Nearly 60% of our sales are outside the United States, we have a product or presence in virtually every country in the world, and we have employees located in an astonishing 1,900 cities around the globe, twice as many as either Citibank or American Express. We are one of the few US companies to print its annual report in languages other than English, and I am pleased to have copies here today in Japanese.

But the reason you have asked me to address you today is to discuss change in this great company in the last decade. Perhaps captured best by a six times increase in our stock value since 1992, this has been a period of wrenching changes, changes that are transforming UTC in ways unimagined 10 years ago, changes that still have a long, long way to go.

We have a third fewer U.S. employees, 35,000 fewer than we had in 1991, and this has come entirely from productivity and not from shifting of manufacturing overseas or from outsourcing. We also build products with quality levels three times higher than before. Both achievements reflect what I call the process revolution, the incorporation of essentially Japanese developed methods, and I'll give you some examples in a few minutes. But they have also come from the unique functioning of the American securities markets, and these have themselves changed dramatically in the last decade.

Through their pension plans American companies control about 40% of all of the equity capital in the United States. These funds are relentlessly managed, with their managers competing against each other and shifting funds based on performance. These same fund managers are relentless in their appraisals of UTC's own performance, demanding that we exceed performance of peer companies, demanding that we implement changes as fast or faster than our peer companies. And UTC management's failure to implement these changes effectively and quickly would have consequences: changed management, or a company structure altered by merger or divestiture. In short, this is a harsh environment with demanding standards, but it is also a highly positive environment with benefits for Americans overall, huge benefits.

The essential point is that we will change or be changed. This is an important difference between Japanese and American societies today, and I believe we can say with some confidence that the American way may not be the easier way, but it certainly works.

We have also made some great changes and implemented some highly innovative and effective techniques and methodologies, most pioneered in Japan. The reason these techniques were developed here rather than in the U.S. was that American companies in the whole post war period, certainly through the late 1980s, have focused on products rather than processes. Supported substantially by our Government's leadership and funding, especially in the defense, space and health sciences areas, we have invented enormous amounts of intellectual property: semiconductors; digital communications; digital control; materials of all kinds, whether plastics or composites or the exotic metals found in jet engines; the Internet, and the amazing inventions and processes derived from the Internet, whose dimensions we are just now beginning to see; and drugs and medicines and medical procedures beyond counting. And any one of us could continue this list almost without limitation.

But American companies focused on products to the exclusion of process. Our prevailing production mentality was economies of scale and standardized products. But we failed to see how subtle changes in these processes could have truly dramatic results. And Japanese companies, in contrast, saw these subtle differences and exploited them to the hilt.

We treated setup times as fixed, and established lot sizes accordingly; Japanese methodology set out to eliminate setup times and costs. We drove the manufacturing process by push, relying on extremely complicated scheduling systems, where Japanese processes emphasized pull, or kanban, scheduling. We relied on end of line inspection, seeking to inspect quality in, whereas Japanese practice sought process control at each individual work station, working to a philosophy of never building bad product in the first place and, therefore, eliminating inspections entirely. And we treated our suppliers as adversaries, seeking to maximize our gains at their expense in a zero sum model, whereas Japanese process sought integration among suppliers and customers, generating value for both by doing things better together.

I'll share some specific examples of this process revolution and its impact on UTC. But first I would like to speak about the person who has had more to do with these changes than anyone else in our company, our Japanese advisor on quality methodologies, Yuzuru Ito. Ito-san in fact lives in our headquarters state of Connecticut and has for the last five years, after retiring from a distinguished career at Matsushita Electric eight years ago. His impact on our operations has been profound and pervasive. We are so fortunate to have him, as a consequence of our now 26 year old partnership with Matsushita Electric in the elevator business here in Japan. I might also note that I have chaired the board of Nippon Otis for more than a decade, and that much of my management philosophy has been formed in association with this Japanese venture. Komoto-san, Nippon Otis president for eight years and here today, is also one of my teachers, and a great teacher at that.

Ito-san teaches us to eliminate defective processes at the point of the processes themselves, and with the managers of the processes, who are in fact the individual production employees in charge. We routinely use Japanese techniques like QCPC and 5S. But the fundamental quality techniques are never to build bad product in the first place, and to recognize that we achieve this not with complicated inspection regimens or automated statistical process control, but instead by involving every single UTC employee, all 180,000 of us, ensuring that each does his job right the first time.

Ito-san's most basic teaching is therefore that quality methodologies need to be the essence of simplicity, and to involve every single employee. He also teaches us what I call relentless root cause, the device to eliminate defects in processes in the first place. He teaches us that a defect, any defect, is a gem or treasure because understanding the reason for the defect in the first place will in turn eliminate the defect forever.

Each year the UTC board of directors spends three days with senior management reviewing operations and strategies and plans for the years ahead. We had this session recently, and we shared our quality methodologies with these directors, as some of the fundamental forces shaping UTC. We also had, by chance, an excellent example. [Holds up card] This is a magnetically encoded key access card; we use them all the time in American hotel rooms because they are cost effective and can also be changed with each room occupant. But often they don't work: the wrong room number is encoded, or the magnetic encoding is affected by a nearby and unrelated magnetic source. Unfortunately, my key card was affected just this way. When I sought to have it fixed, the process so typical in America happened: First, I was told it was not the hotel's or the clerk's fault, it was mine; then I was given a substitute card with assurances that it would work. And the failed card was thrown away.

Why this illustrates our quality methodologies so well are first the principle that the failed card was a gem, and yet it was thrown away; and, second, that this gem should have triggered a process analysis and relentless root cause investigation. As our quality expert teaches, "nothing ever happens in isolation." And the third principle is that it is the work of every employee, every member of the organization, that causes perfect product, and therefore why quality education has to be persuasive to 180,000 people.

A second example of the process revolution is supplier integration and lead time compression. Common practice for years in your country, these changes are just starting in mine. A few months ago, we entered into what for us is a revolutionary set of commitments. We are supplying car interior modules, basically the entire instrument panel and wiring and steering column assembly, for about 500,000 General Motors vehicles annually, starting in 2002. The value per vehicle is about $800, and our manufacturing productive labor time is 28 minutes.

The notable fact for us is that the broadcast time, the time between when GM tells us they want car interior modules and establishes their specific characteristics, is only 120 minutes. We have 28 minutes to manufacture, 12 minutes to load the transport vehicle, 20 minutes transportation time, 20 minutes on arrival at the assembly plant, and 40 minutes slack. And the contract volumes are material, about $400 million per year.

We see the same kinds of time compression in everything we do; jet engines developed in half the time and at half the cost, helicopters built in well less than half the time required just a few years ago. We accomplish these gains not only with improvements in our own internal processes, but also with much tighter and collaborative relationships with many fewer suppliers. We told our investors a year and a half ago that we would achieve $750 million in savings annually for purchased UTC commodities and components within three years, and from one sixth the previous number of suppliers, and we are more than on track to achieve these goals.

My third example is in the category that I call corporate good citizenship. Our Government requires annual reporting of environmental impacts and employee health and safety. Remarkably, on the two basic measures of U.S. environmental impact, hazardous waste generation and chemical releases, we have reduced 83% and 90% from the levels in our company just 10 years ago. On the incidence or frequency of lost time injuries within our workforce, we have reduced by a factor of four. And the savings from these items, which we would do for good citizenship alone regardless of costs or savings, exceed $100 million annually now, and we recently set new goals of ten times further improvement.

The point of these examples, and there are countless more, is that gains in front of industrial companies today are truly limitless. The unflinching grasp of tough goals, and the confidence to achieve these, are all that are required. In the case of companies in America today, we are helped tremendously by the pressures and disciplines of markets, both commercial markets and securities markets. We obviously have demanding customers, and I mentioned earlier the pressure of our investors and security analysts. Let me tell you about one of the most significant changes UTC ever made to facilitate performance improvements.

When I was younger and a division manager in UTC, we always negotiated with the parent company our annual business plans and targets. Perhaps Japanese companies do the same. But because we were negotiating internally, sometimes we tried to hold back a little performance improvement, keep it in our pockets to compensate for the possibilities of unanticipated events. And because the parent company was itself a large financial entity, we never saw the impact of our own performance on the bottom line results of UTC as were reported to shareholders.

Beginning in the early 1990s, and along with the restructuring we undertook then, we reduced dramatically the size of the corporate office, both in number of employees and as a financial entity. We also aligned with our internal organizational structure the publicly reported results of UTC by its various business segments. And then we asked the division presidents to speak directly to our shareholders and analysts. Under the discipline of the financial markets, our division presidents stated their goals and, after some time, these goals began to add up to more than the expected improvements for UTC overall. The lesson in this experience is straightforward and powerful: We all need disciplines and pressures in our lives to improve ourselves, and to change ourselves, and experience shows that there have never been any better disciplines than competitive markets, ever.

The results of these change mentalities and disciplines have been powerful indeed for UTC. In 1992, our return on net assets was 8% and ranked 13th of the 13 companies most like us in the U.S. (which we identify as our peer companies). Last year, this return was 31% and ranked 3rd among the same 13 companies. In 1992, a share of our stock (adjusted for a subsequent split) was valued at $20; today it is valued at $120. And where the S&P 500 value increase over this period has been just less than three times (2.8), UTC's value increase has been six times.

The point is that disciplines work, market pressures work, open markets work, transparency of information and benchmark comparisons work. And in our case specifically, Japanese practices have been remarkable in their impact.

Notably, these performance improvements for UTC are by no means over. We face our future with confidence and project to investors returns half again improved on a ratio basis, from 9.5% operating income to revenues today, to 13-14% within a few years.

Japan is its own particular society and culture, and these lessons, so powerful for one American company, may not be applicable to your companies. But some of them may. Everyone always talks about the trade agenda in meetings like this, and I deliberately make no comment on this topic. But I do note that Japan remains closed along another dimension, inward foreign direct investment, with the cumulative total over all decades being only about $50 billion. This is less than a twentieth of the total for the United States and almost less than the inward flow to China in the single year 1997.

Japanese investors are also normally less confrontational and demanding than their American counterparts. And the translation of investor pressures into performance gains may not be as effective here, in part because segment reporting is less extensive in Japan. But I repeat my comment that segment reporting and its alignment to the internal organizational structure within UTC has had immense impact on our company.

I think it is fair to say there are dissatisfactions and concerns within Japan today over the performance of your economy and companies. Some of these concerns may even echo the experiences in the United States in the 1980s. The solutions are clear and entail for you, as for us, the willingness to promote change aggressively, the willingness to promote openness and competition, the willingness to submit to market disciplines. No country wishes Japan the best outcome more than the United States does. We have both taught each other so much over the phenomenal five decades since the 1940s. This is why I am glad to be here today, to share experiences together, and with the full confidence that we will benefit mutually. Thank you.