(FORTUNE Magazine) – MEAD CORP., like many other U.S. companies, was sitting tight. It had not built a new paperboard plant since 1975. But a little over a year ago top executives met to reconsider. Their mills were operating at capacity, the economy was solid, and the dollar was back down to earth. With two years of research piled on the conference table, the executives finally said yes to a new $556 million project -- their first ever to rely heavily on the export market. ''It's a big-scale risk,'' says Thomas Johnson, president of Mead's coated-board division. ''But we're investing in a strategy to give us a foothold beyond our borders.'' Like Mead, many U.S. companies are opening their wallets after a long spell of caution. Last year business investment rose 9.5% to $487.2 billion after adjusting for inflation. Many CEOs insist that spending would have been even greater if the 1986 tax reforms had not eliminated investment tax credits and lengthened some depreciation. Though FORTUNE expects that real growth will slow to about 4% this year, capital spending will continue to be one of the strongest sectors in the economy. More than 46% of the 5,000 companies surveyed recently by Dun & Bradstreet plan to increase expenditures this year, up from 41% in 1988 and 33% in 1987. The remarkable thing about this surge is how different it is from earlier bursts of capital spending. American corporations are rethinking old assumptions about how to invest. The smartest are finding they can do more with less by managing their factories better and adding equipment rather than bricks and mortar. This point is overlooked by critics who complain that capital investment has been dangerously inadequate, and it helps to explain why manufacturing productivity has been rising faster than in any other postwar expansion. For many companies, overhauling factory management remains the first priority. As the Japanese have shown, old machinery can outperform new by a wide margin if the production system and the workers are well trained. Conversely, new equipment operated under archaic procedures may not boost productivity much, if at all. Executives are becoming more sophisticated about the budgeting process itself. They are challenging the mechanistic use of the venerable discounted cash-flow model and taking advice on what to buy from managers at all levels. Some are even listening to the people on the factory floor. Today's decisions also reflect lessons hard-learned during the torturous Eighties. In the classic boom-and-bust pattern of capital spending, many companies had overbuilt by the time the 1981 recession hit. Then came the high dollar and fierce competition from abroad. Though the operating rate for manufacturing, mining, and utilities is running at a smokestack-warming 84.4%, it is still below the 86.9% of 1978-80. And much of the tightness is concentrated in basic industries such as paper, now operating at 94.6% -- and, not incidentally, adding capacity vigorously. Many companies in other industries still have more plant than they need, and for some the problem is global. By most estimates world auto overcapacity stands at better than six million units -- enough to supply the entire U.S. market for more than half a year. Managers have to struggle with extraordinarily difficult questions, such as how long the aging world economic expansion will last, who will be helped and hurt by swings in exchange rates, whether increasingly leveraged companies can bear the extra debt new investments will require, and whether the market can absorb the huge additions to capacity that today's world-scale plants imply. Some of the toughest decisions face executives in basic industries. Quantum Chemical wrestled with a typical mix of late-1980s quandaries recently when it weighed whether to spend $450 million on a new ethylene plant. The chemical industry is on a roll, its plants operating at the highest rates since 1973. Most security analysts predict prices will be strong at least through 1989. But Quantum had just taken on $1.1 billion of debt in a leveraged recapitalization that paid every shareholder a $50 dividend. And like other makers of commodity products, Quantum also had the classic worry about what the competition would do. When times are good, they're good for everyone, and the companies all expand. ''They've tended to act in a lemminglike manner,'' says George Feiger, a partner at the McKinsey & Co. consulting firm. At least four other chemical companies, including Dow, are either adding new ethylene plants or considering them. A single plant can increase U.S. capacity 4%. Quantum CEO John Hoyt Stookey nevertheless took the plunge. Says he: ''Had our sole mission been to deliver cash now to the shareholder, we wouldn't be doing this, but we decided to balance it with growing our company.'' Quantum's strategy is to get there first. ''The first person is going to enjoy some very good times,'' says Stookey. ''The profits that get made during that period reduce the cost of the plant.'' He figures that for every day his plant is late in starting, Quantum will pass up at least $300,000 in earnings. The contractor, needless to say, will get a big incentive payment if it finishes on time. The question that remains for Stookey, and for managers in many other industries now adding capacity, is whether the rest of the lemmings will follow. The paper industry, for example, will increase outlays by 28% this year, a bigger jump than in any other; most major papermakers are building new plants. RECENT EXPERIENCE does seem to have taught many of these companies caution about going overboard. ''They've become much more aggressive stewards of their assets,'' says Feiger. ''They're more conscious of shareholders, raiders, and ) past mistakes.'' For example, Mead added two white-paper plants in 1982, but now won't start more than one big project at a time. Not all of those planned ethylene plants will necessarily be built; industry analysts think that at least one manufacturer is wavering. Nonetheless, some eventual overcapacity in basic industry is probably inevitable. Ford Motor offers a model for companies seeking to resist temptation. The auto star has been running at capacity for three years and could have spent to its heart's content on new factories and robots without exhausting its cash hoard, which now totals some $10 billion. Instead Ford was a tightwad, investing $16.6 billion from 1983 through 1987, less than half as much as General Motors spent, though Ford is three-quarters GM's size. Says treasurer David McCammon: ''Sure, we might have missed a few sales, but one of the reasons we've been so successful is that we didn't get carried away in capacity planning and add a lot of extra costs.'' Instead Ford made its existing plants better. Largely by developing a management system that emphasized teamwork and quality control, the company has lowered its breakeven point in North America by 40% since 1980, and has become the most efficient of the Big Three. Now Ford is ready to shell out. Capacity is stretched and many of its platforms, the basic foundations upon which cars are built, are aging. Over the next five years Ford plans to spend considerably more than it has in the past five years. Ford won't say how much, but Scott Merlis at Morgan Stanley estimates that spending will total about $29 billion. Ford doesn't want to add another statistic to the column of redundant plants, but it must update vehicles like the Escort, redesign engines, and modernize paint shops. ''The name of the game is to stay ahead,'' says McCammon. ''One reason we're being very aggressive is we know the competition is doing a lot.'' Ford also can expect to get its money's worth because it has already restructured factory operations. Equipment purchases account for 71% of today's capital spending. Partly that reflects prudence -- companies don't want to get caught again with idle plants. But it is also a natural outgrowth of efforts to overhaul factory management. A company that goes to just-in-time inventory, for example, may not need a new building for a long while. The system typically frees up at least a third of the space in existing plants while increasing output, leaving plenty of room for expansion. THE NEW machinery is often aimed at boosting productivity and making companies able to respond faster to customers' needs. The machine tool industry lagged badly on both counts during the 1980s and lost a lot of business to the Japanese and West Germans as a result. Its leaders are now taking advantage of strong sales to recoup. Cincinnati Milacron, the biggest U.S. producer, increased its capital budget 34% to $21.5 million in 1988 and will increase it again to $37.5 million in 1989. No new factories, of course. Says President Daniel Meyer: ''The new manufacturing approach is to improve quality and increase output with less floor space.'' Milacron plans to cut total manufacturing and design lead time dramatically with its new equipment. Getting a new product to market used to take three years; Milacron's goal is to do it in less than a year. One big obstacle to smart spending is the tendency of financial staffs to hew rigidly to quantitative analysis. The basic tool is the discounted cash- flow model, which estimates cash to be earned from a project in future years by figuring the probable costs and revenues. The projects that pass muster are those that meet the desired return on investment, the so-called hurdle rate. ''Models can be very important in adding insight and rigor,'' says Stewart Myers, an MIT professor and a leading expert in corporate finance. The danger is that the modelers may ignore benefits that are hard to quantify, such as quality improvements or reduced inventories. These may be vital to making the company competitive -- but nobody has told the number crunchers. ''When you talk to senior executives, they say they never kill projects on financial grounds alone,'' says Robert Kaplan, a professor of accounting at Harvard. ''But down at the plant level engineers don't propose projects unless the numbers are exactly right.'' And, of course, in any model the calculations are only as good as the input. If a manager is overly optimistic about a project or if he wants to please his enthusiastic boss, the numbers will turn out promising. Hurdle rates pose their own problems. Many companies have come to realize that a single corporate hurdle rate is a trap. Risky projects tend to look overly attractive because their putative returns are high. Safer projects yielding lower returns, by contrast, may appear much less attractive. Such deficiencies have led some critics to throw up their hands. ''Every capital budget model I've seen has been wrong,'' says Michael Porter, a professor of management at Harvard. ''You can never forecast the future.'' Warren Buffett, the shrewd chairman of Berkshire Hathaway, doesn't use models at all. ''It's a lot of game playing,'' he says. ''I tell our managers just to do what makes sense to improve the competitive position of their business.'' Executives who want to quantify but would like something more sophisticated may want to investigate the so-called option model that some companies are experimenting with (see box). BUT CORPORATIONS are learning that the old yardsticks can work well enough if they're informed by good judgment. Mead sets higher hurdle rates for divisions with riskier businesses. At Ford, says McCammon, ''some nonquantifiable factors are overriding -- to rattle off just a few: quality improvements, technological improvements, or sometimes even government regulations. They can be so important that we're willing to settle for a lower return.'' The secret to setting the right spending priorities is to get people to think strategically about them. For many companies it's no longer enough to know whether you need capacity for a new product or want to raise productivity. You have to focus clearly on your long-term goals, think about your global competitors, and consider how their costs and other competitive factors compare with yours. Says Kodak CEO Colby Chandler: ''The process should begin with strategy.'' Sounds obvious enough -- but it's all too rare. While top management may be thinking strategically, lieutenants involved in the mire of numerical forecasts and divisional politics often are not. ''A lot of capital projects get done by operating guys, largely free of strategic thinking,'' says Jon Weiner, a partner with McKinsey & Co. What's more, capital decisions often go through many wringers on the division level before approval by a capital budget committee. ''The capital spending and budget process frequently takes on a life of its own,'' says Porter. ''Projects get killed for the wrong reasons.'' Or approved. Companies like Kodak are pushing strategic thinking and spending authority down the ladder. Four years ago Kodak reorganized its large operating groups into narrower lines of business. Says Chandler: ''We did so partly to put planning in the hands of the people most involved in marketing, development, and manufacturing.'' Capital spending decisions, accordingly, originate at the business unit level and are based on the strategic goals of that operation. The unit manager's spending authority, says Chandler, ''has substantially increased.'' Projects outside the limits get approved by the office of the chairman, president, and vice chairman -- a more efficient process than the old system, where decisions trickled up through layers of middle management. Ford, too, has been pushing responsibility down. Until the early 1980s, any project costing more than $2 million had to go to the finance committee or board for approval. Now the president of each operation can approve capital projects that cost up to $20 million. Quantum's approach is to get as many ideas as it can from managers. During its recent bout of spending decisions, CEO Stookey asked division heads to write a list of projects they thought would help the company expand, regardless of cost. The ethylene plant was one; so was a research center, which Quantum is also planning to build. Only half joking, Stookey says, ''I'd like to install an 800 number to end-run the bureaucracy.'' Spending strategies are self-evident for some companies, especially high- technology outfits that must routinely bet on the future. Though the semiconductor industry is looking for a down year in 1989, Intel pushed capital spending from $350 million to $475 million in 1988 and will increase it to about $500 million this year. A good chunk of the budget is going toward building a plant that will design dime-size chips crammed with 20 times more capabilities than Intel's present chips. Says Robert Reed, the chief financial officer: ''You can't quantify a return on future technology. You just have to have faith and believe it will make lots of money and give you an edge.'' The Japanese do not pay a great deal of heed to fine payback calculations either -- and they pose what is probably the biggest challenge to U.S. companies' capital-spending habits. Japanese companies focus on one concept when making capital decisions: long-term strategy. Says Masaaki Morita, chairman of Sony Corp. of America and brother of Sony's worldwide chairman: ''We always insist on strategy. Manufacturing is a long-term project.'' Sony built its TV plant in San Diego 17 years ago not because of a strong dollar, but because it wanted to be closer to its customers. This year the company is pumping almost $100 million into expanding the plant. Like most Japanese companies, Sony's basic strategy is to gain market share. But American managers will be making a grave mistake if they set a similar goal without understanding just how the Japanese achieve it. ''We'll do whatever we must to make the best,'' says Morita. Japanese companies spend without reservation on continual refinements of their manufacturing processes, making their goods ever less expensive and better. They also invest in the people who run the machines. According to a study by Martin K. Starr, a Columbia University management professor, Japanese companies in the U.S. spend twice as much on training as U.S. companies. The Japanese don't throw money at their capital projects, but instead rely on the knowledge of plant managers and even workers to steer spending to the right ones. At Honda's U.S. factories, for example, groups of workers suggest the types of investments they believe will raise productivity. Says Scott Whitlock, senior vice president of Honda of America Manufacturing: ''By drawing on our collective intelligence, we maximize our use of cash.'' Americans are just beginning to employ collective intelligence as a force for improving operations on the factory floor. As they come to understand its full potential, capital spending could be the next beneficiary of the U.S. managerial revolution.

BOX: HOW TO PLAN YOUR SPENDING

1. Think strategically. Be sure the financial models reflect your long-term goals for market share and competitive advantage. 2. Give each division its own hurdle rate. A single corporate benchmark for return on investment can steer too much spending into risky projects. 3. Get a big wish list. Urge managers and employees to tell you what they need most to cut costs and raise quality. 4. Make sure you can use what you buy. Gee-whiz machinery wastes money if it's plugged into a creaky production system or operated by ill-trained workers.

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