This year, Johnson Controls begins a yearlong commemoration of its 125th anniversary. But the Milwaukee company probably won’t be celebrating one recent, bittersweet milestone: In 2009 its venerable Building Efficiency division, the original thermostat business, again became Johnson’s top revenue generator, supplanting the once-dynamic but lately beleaguered Automotive Experience unit, which sells everything from auto electronics to whole car seats.
Founded in 1885 by Wisconsin Natural Sciences professor Warren Johnson, who invented the thermostat, the company diversified into auto supplies in 1978, and by 1993 sales from that burgeoning business had eclipsed those from home and office controls. But with the decline of the U.S. auto industry, Automotive Experience’s revenue has dropped by one third since 2008.
Nonetheless, Johnson’s CEO and chairman, Stephen Roell, sees the company’s increased dependence on the Building Efficiency division as more of an opportunity than a liability. “It’s a business that thrives on energy efficiency,” Roell explains. “We expect Building Efficiency to be a larger portion of the pie as time evolves.”
At the same time, he is looking to foreign markets to grow the auto business. Johnson operates in 750 locations abroad and is already a market leader in China. The company’s smaller third prong — Power Solutions — manufactures 36 percent of all global lead-acid vehicle batteries and recently won contracts from BMW, Daimler and Ford Motor Co. to produce lithium-ion batteries for hybrid vehicles.
The fresh orders are welcome. In its fiscal 2009 (ended in September), earnings were cut by close to 25 percent, to $28.5 billion, and for the first time in 62 years, the company failed to achieve any sales growth. The Building Efficiency unit provided $12.5 billion in earnings; Automotive Experience, $12 billion; and Power Solutions, $4 billion. But Johnson did report a 15 percent year-over-year gain in fiscal first-quarter 2010 net sales, to $8.4 billion.
Roell, 60, was installed as CEO in 2007, following more than a decade as CFO. The Moline, Illinois, native, who has a BS in accounting from St. Ambrose University in Davenport, Iowa, and a certificate of management development from Northeastern University, joined Johnson in 1982 as an operations controller. Senior Writer Frances Denmark spoke with Roell recently about Johnson Controls’ changing auto business and its increasingly green initiatives.
Institutional Investor: How will your automotive unit return to profitability, given that more cars are now scrapped than produced in the U.S.?
Roell: The Automotive Experience business unit returned to profitability in our third quarter of fiscal 2009 and delivered increased profitability in the fourth quarter. This was based on a combination of restructuring and growth in emerging markets. We responded early and quickly to the economic environment we faced and resized our business for what we knew was going to be the operating mode for the next several years. We’ve significantly reduced our breakeven point.
Which is what for that business?
It is now 8.3 million units in North America and 14.3 million in Europe, considerably lower than what it was prior to the downturn and the cost reduction initiatives. Our automotive business had two quarters of losses in fiscal 2009 — the quarters ended December of ’08 and March of ’09. We were profitable overall in the third quarter. And all geographic regions of our business were profitable in the fourth quarter. It really was the benefit of that restructuring, because we didn’t get much volume help. At the same time, we have been profitable in China, and growth there has continued during this entire time frame.
How has Johnson Controls been able to penetrate the Chinese market?
We have a strong presence in China, with nearly 30 joint ventures to produce auto interiors for the Chinese market. Essentially, the joint venture structure is one where our partner is our customer. For example, a Chinese auto company called First Autoworks, known as FAW, is in a joint venture with Volkswagen in Changchun. We then have a joint venture with FAW to supply them with seats. We get a broadcast that actually tells us what color, what fabric, what kind of leather they want in the upcoming line in the next 12 hours. If you think about a seat, you can’t do it effectively from across the ocean. We don’t put a lot on the water. We don’t ship across borders very often.
How much of your Chinese business is controlled by Beijing?
The auto industry is a protected industry in China, so we have to operate through joint venture structures. The same isn’t true in our Building Efficiency or Power Solutions groups. They are all our employees and 100 percent Chinese nationals. And they’re global leaders for us. Many of them have been educated in the U.S. and are part of our global leadership team. That’s the model we are trying to evolve.
Where do you see growth in the auto industry?
The growth rates in emerging-markets countries are so strong that I think manufacturing will be localized to those markets. The strongest growth is not in North America, and it’s not in Western Europe.
What’s the future of hybrid-electric vehicles?
Hybrids are in a very infant stage right now. They could be as much as 15 to 30 percent of car production in another ten to 15 years. It’s hard to gauge. But the two biggest factors driving growth are going to be, at least in the early stages, government regulations and gasoline prices. We haven’t provided any guidance because of the early stage of the industry. At the end of the day, though, higher gas prices are what’s going to drive this industry.
Do you see hybrids as a growth area for your Power Solutions auto battery unit?
It’s going to take two things for any battery supplier to the hybrid industry to be successful and profitable: scale and standardization of technology. If all original equipment manufacturers supply their own or different technologies and there’s no standard, then the multitude of chemistries and systems and packages are going to make it very difficult. I think that most new technologies will become consolidated, and standards boards will come together because they realize that to be financially viable, that’s what has to happen.
Will competition from small firms trying to get into the lithium-ion battery market affect your business?
They’re going to need a sizable investment. We recently received a $299 million government grant to build a manufacturing facility for batteries in Holland, Michigan. That’s just the government’s grant, so we have to match that dollar for dollar, so it’s really a $600 million investment. The issue with start-ups is that when you begin talking about power for a vehicle that’s very similar to an engine, or a critical part of the transmission, you have to know the auto industry and you have to have a fairly robust development cycle and technology base. What happened early on was that a lot of people had an idea to do this. But when you have to supply a product that has a ten-year life — which is what the new batteries have to have — and they’re so integral to the whole drivetrain, I don’t think start-ups can succeed.
Johnson is retrofitting the Empire State Building to make it more energy-efficient. Will such projects drive growth in the Building Efficiency business?
The work that we are doing there will save 38 percent on energy costs and pay for itself in three years. We expect that we will see growth in helping our customers manage their energy costs as they improve their carbon footprints. We estimate our Building Efficiency business will grow annually at a double-digit pace. We’re not projecting that for the current year because of all the concerns about construction and the slowdown. But once this economy gets back on its feet, the energy efficiency focus will help us.
Where is Building Efficiency’s growth coming from today?
We’ve seen good bidding activity in orders around our energy-related projects, where we provide our customers with solutions to reduce their energy costs. We call that performance contracting, and it continues to grow, even in these economic conditions. We still see and expect to see good growth out of our international markets, with energy-type projects in Asia, Brazil and the Middle East showing strong double-digit growth. We’re probably going to be able to derive some growth from service — just rudimentary, truck-based service — and facilities management, which we do for Barclays [Bank] and Hewlett-Packard [Co.] here in the U.S. That business is doing fine. Customers turn to us as a means of providing a solution, and our people operate their facilities.
