Parker Hannifin Corporation (NYSE:PH) is one of the great corporations of America. Founded in 1924 (after Arthur Parker’s first start-up in 1918 foundered due to a truck accident destroying all its inventory), it has remained an independent manufacturer of motion and control equipment. In other words, PH is an industrial company, in an age where Internet, IT and services businesses are supposed to have rendered such enterprises as dinosaurs frozen in the ice age on the US economic scene. PH must not have been properly notified of their impending doom. Consider the statistics since 2001:
- Stock Price – trading in the $30-$40 range in 2001, the price is now penetrating the $90 mark
- Revenue – just topping the $5b mark in 2001, analysts estimate $10.5b for 2007
- Profits – in 2002 PH achieving a profit of $130M: in 2007 analysts estimate profit will be closing on $800m
- Fortune 500 Ranking – in 2001 PH was ranked 330, in 2007 it is ranked 266
In fact by any ranking, PH has been a star performer, even when compared to non-industrial companies.
Management must be congratulated on this stellar performance. In a front page, headline Wall Street Journal article of March 27, 2007 “Changing the Formula – Seeking Perfect Prices, CEO Tears up the Rules” Timothy Aeppel writes that the secret of success lay in the three part strategy pursued by the PH CEO – first adopt “lean” manufacturing, overhaul parts purchasing, and the “last – and most crucial element – he targeted was pricing.”
Pricing at PH had been a cookbook approach, where the company used a simple ‘cost-plus’ formula, the standard still among 60% of industrial America according to Thomas Nagle a pricing consultant at the Monitor Group (as quoted by Aeppel.)
In the article, Aeppel attributes the foresight of the PH CEO, a PH ‘lifer’, in understanding that different parts manufactured by PH delivered different levels of value to PH customers, and in differing environments of competition. This resulted in a decision to review every single one of the many hundreds of thousands of items manufactured by PH for the appropriate pricing point. It took several years, but the results added $200m to the bottom line, and one of the major contributing factors to the success enjoyed by PH.
The change, as detailed by Aeppel, was brutal. Years of standard practices had to be re-modeled, and both employees and customers needed to understand the reasons for and the value of the changes. Ultimately, under a thoughtful process of governance, the company achieved its signal success.
Most instructively, Aeppel writes “To his surprise, Mr. Washkewicz (the CEO of PH) discovered that computer programs for calculating prices, adopted in the 1990s, were part of the problem…”
The story of PH has a happy ending because its far-seeing CEO was sufficiently focused to determine the root cause of the stagnant return on equity that the company had been experiencing up to the point that he assumed the helm. Unsurprisingly (to those of us in the business rules practice), the problem turned out to be the fault of automation, where sub-optimal business rules had been buried in code.
We have often observed the phenomenon of automated solutions creating de facto, settled business practices when rules are implemented by one generation of managers and inherited by another. The policies leading to the business practice (as embedded in the business rules and process of the existing automation solution) become lost to an incomplete record of history, and the business continues on autopilot following its own (or an entire industry’s) arcane practices. Even when management begins to question the reasons and policies behind practices, it finds it is unable to discover the roots of the practice in its computer systems because the business rules are so deeply buried in technical expressions of computer code.
COTS (Commercial off the Shelf Systems) are often equally dysfunctional in this regard. Access to business rules in these systems are very complex and frequently not even understood by the vendors themselves!
The inertia arising from years of practice that PH had to overcome was complicated by the computer systems (many of them COTS) less than ten years of age, not considered as the oldest of legacy systems today. Unless modern systems separate business rules from code, expose those business rules, enable management access to those business rules, and facilitate the challenging of those rules, then those systems are simply creating strategic strait jackets for future generations of managers. The Parker Hannifin story is both inspiring and sobering.
