A Discussion with Finning's CEO -

Michael T. Waites
(Source: Teaching Note for Finning International Inc.: Management Systems in 2009; copyright 2010,
Richard Ivey School of Business Foundation)

We've got different businesses and, depending on the nature of these businesses and geographic needs,
we're focusing on different targets. For example, at one end of the equipment sales business we've got
the large and core machines, the 20-ton excavators. On the other hand, the United Kingdom is a mature
market, and it uses 100-ton trucks, not 240-ton trucks.

In terms of the rental business, it's a commodity business that is also a service business. In Hewden, less
than half of the rental fleet is Caterpillar equipment. In rental, you want to minimize the parts and
service component. The rental business has two goals: it will run at zero free cash flow in 2009, and it's
got to earn at least the cost of capital. Each unit, each CAT rental store, is held to the same metrics.
Within the rental business, if you're running it well and with those two goals in mind, there are two key
metrics to monitor: price versus planned price, and financial or asset utilization. These are the
management metrics that support zero free cash flow. And as for equipment additions, cash can be
generated from sales of old equipment and from rentals. We're going to be self-funding our fleet. To be
able to do this, we need to have utilization about 45 per cent.

In our general construction business, what we've said is that we're going to target inventory turns of six
to eight times. The other metric is an EBIT margin number, though that is not finalized. We have to
manage our SG&A margins tightly. If we have gross margins of eight per cent to 10 per cent, and we
need to end up with four per cent in EBIT, that means our SG&A needs to be in the three per cent to
four per cent range. This means that our sales force coverage, retail locations, marketing and support all
have to add up to around three per cent of revenue.

In mining, the two key metrics are an EBIT margin number and market share. We have a 75 per cent
share across large units. The industry calls this PINS - percentage of industry numbered stock. The big
metric is an EBIT margin from product support profitability. We're monitoring how well we're tracking
the machines, how are we pulling them in for service, our service productivity, and market share. We're
tracking the percentage of new machines sales that were sold with product service contracts.

As more machines are rebuilt, Finning becomes more of a remanufacturing operation. We have a
Centre of Excellence in Collacut, in Red Deer, and what we're doing there is new equipment preparation.
Caterpillar gives us a small amount of money to prepare our machines, and the best place to prepare
them was in Red Deer. (We pulled machine preparation out of the oil sands where we were not
efficient.) When a truck is rebuilt, it is sold for two-thirds of the price of a new truck.

What we do when the economy slows down is to generate cash as a dealer because we're not ordering
as much inventory. We don't need precautionary stock so we would generate cash. A lot of focus is on
execution capability. What we said is that when things slow down, we'll fund only what is strategic. And
there are three strategic things: budgets and targets; short-term incentive programs; and operating
leverage.

We try to set up our budgets and targets by first understanding structurally the nature of our business
and the risks that surround it. We set pretax targets for capital employed, backed into an operating
income number, and this tells us what we should be looking for. In the United Kingdom, a mature
market with small to mid-sized machines, the expectations are less than in South America, where there
is big growth, high risk, and a commensurate return on risk. In the United Kingdom, the return on
capital might be 12.5 per cent; in South America, it may be 25 per cent we're looking for.

It's tougher to deal with the cycle in terms of short-term incentive programs. The way we do this is by
tweaking the personal objective component - the POC. We recognize outstanding managers'
performance in the POC. The POC includes "building leadership teams", "managing key stakeholder
relationships". The POC gives us latitude to award upside potential.

Something else we watch closely is operating leverage. If you have $100 million in incremental revenue,
how much of this do you get to the EBIT line? If not very much, if only five per cent or 10 per cent, we'd
come down hard on you. But, on the other hand, if you get to no revenue growth in a tough market
with aggressive competitors, but the bottom line increases, you'd get rewarded for that.

We don't reset targets partway through the year because it can be dangerous; it might send a message
that it is OK to negotiate for and meet a reset target. Good managers reset adverse reactions, not dollar
for dollar, but they'd remind us how much we're off plan. On the other hand, if targets are too low and
managers ride a wave, we could go back to looking at operating leverage and on individual components.
We could say, look, your revenue is higher at 10 per cent, but you did not do a good job getting it to the
bottom line. So the POC allows us to use short-term incentives to dial up or dial down bonuses,
depending on how managers perform.

In 2008, for a country or executive president of Finning, 45 per cent of total compensation was variable.
This means that if a country manager earned $500,000 in total compensation, the short-term incentive
portion should be 45 per cent of that.

The short-term incentive plan was calculated on a 45-point scale. The short-term incentive is broken out
as follows:

EPS/EBIT number worth 17 out of 45 points;

ROE or pre-tax return on capital worth 15 points;
Safety worth 7 points; and
POC worth 5-10 points.

This year, we'll have not bad earnings year, but we're substantially out. We won't pay out for anyone
other than in South America, but our ROE is quite good.

Other things to note: On the safety component, it's based on lost time incidences. We had a goal of 0.60
for 2,000 hours and we came in at 0.35. But we've had three fatalities, two in Canada and one in South
America. When a fatality occurs, the executive team in that country - the country president, finance
director, HR officer, and the head of the unit where the fatality occurred - has their safety component
automatically go to zero. This would not affect a divisional head in Canada because that person would
not be part of the executive team. We do this because incentives have a direct influence on what gets
prioritized and what does not. We don't want a CFO declining to invest in safety initiatives in order to
pare down a capital budget.

Nine-tenths of strategy is execution. We will execute differently and have leadership and metrics in
place. That's the real key to our strategy.