A NEW WAY TO WAKE UP A GIANT . Alcoa CEO Paul O'Neill is fomenting revolution in an old company by putting safety first and sticking to his knitting. Could this be a model for U.S. basic industry?
By Thomas A. Stewart REPORTER ASSOCIATE Wilton Woods

(FORTUNE Magazine) – HOW DO YOU take a mature company in a highly cyclical industry and give it a dunking in the Fountain of Youth? In the 1970s and 1980s corporate alchemists chanted the following incantation: Kill your commodity business, move to the high end, send the M&A wizards out to nab some high-growth businesses, and emerge so different that, in time, you change your name -- say, from American Can to Primerica, or from U.S. Steel to USX. To which the 102-year-old Aluminum Co. of America has said, in effect, go jump in the smelter. Under Paul O'Neill, the first outsider ever to run Alcoa, the world's largest aluminum company is undergoing nothing less than an industrial revolution. O'Neill's goal: to transform Alcoa's traditional culture while simultaneously refocusing the company on its traditional business. If he succeeds, his bold program could provide a model for how America's basic industries can thrive in the 1990s. The early returns are encouraging. Alcoa's combined profits for 1988 and 1989 were more than double the total of the eight previous years. At the same time the company has managed to complete a six-year, $1-billion-plus modernization of its factories, increase its R&D budget by 50%, and cut long- term debt by 58%. True, these gleaming results were achieved during one of this notoriously cyclical industry's most robust booms. But O'Neill's goal is to ensure that his company rides out the bad times with equal aplomb. ''An enterprise shouldn't get beaten around by external things,'' he insists. ''If you calculate it right, you should be able to stick with your plans through thick and thin.'' For a corporation used to issuing a standing order for bottles of red ink in previous troughs, that's a heady ambition. Says Ronald Hoffman, group vice president for packaging and a 36-year Alcoa veteran: ''Before Paul got here, we'd say to ourselves, 'Damn -- another recession. Back to breakeven, the stock in the pits, and we can't do a thing about it.' But not anymore.'' O'Neill, 54, joined Alcoa in 1987 after spending much of his professional life working as a government civil servant -- an off-beat career track for the CEO of a major U.S. corporation. He remains close to old friends in Washington; he was on the short list to be George Bush's Defense Secretary and has often visited the President at the White House and Camp David. O'Neill's strategic vision is equally unusual. While it encompasses the hard realities of prices and profits, the heart of the revolution he has fostered is in the ''soft issues'' -- nonfinancial concerns like safety and teamwork. Plenty of other executives may speak the same language. Few pursue these goals with such intensity or hold in their heads a philosophy of corporate governance that so seamlessly weaves together ideas about quality, pricing, capital spending, people management, even dividend policy. WHEN O'NEILL arrived at Alcoa's Pittsburgh headquarters at six-thirty on a June morning, he carried in his briefcase a sheet of paper on which he had written what he hoped would be the keys to his new company's second century. High on it was the word ''quality.'' No surprise, that. Nor were his admonitions to himself to review all contracts with customers and to rate Alcoa's competitive position product by product. But how about this: The top item on O'Neill's agenda was safety. Safety? It seemed a curious choice. Alcoa, with the industry's best safety record, was cutting injuries by nearly 50% every five years. (The current rate is 1.8 per 200,000 manhours.) But before his first day was out O'Neill had told Alcoa's safety director, Charles DiMascio, that the only goal he would accept was zero. Says O'Neill: ''The wish to be injury-free isn't something people can debate, so it was a good place to drive a stake into the ground.'' It was also ''bigger than that,'' O'Neill notes, as he does before answering many a question. By focusing on safety, Alcoa's new boss unlocked the whole tool chest associated with total quality management. Says O'Neill: ''You can't get safety unless you really understand your processes.'' Safety and quality have grown so intertwined that Thomas Carter, Alcoa's vice president for quality, says he can no longer tell where one leaves off and the other begins. For example, workers who take shortcuts -- a major cause of accidents -- may be pinpointing an inefficient process or inadequate tool. By putting safety first, O'Neill also encouraged employees to develop a larger view of their jobs and to start thinking more like managers. Alcoa's safety program features a cadre of specially trained workers who stop by a fellow's station and watch him for up to an hour. Afterward, observer and worker discuss any deviations from procedures. To keep the talk unthreatening, names are stripped out before bosses see the data and the observer's comments. Says William Pritchett, the union member who heads the safety drive at Alcoa's beverage-can sheet factory near Knoxville, Tennessee: ''Involvement by hourly workers is the key. We have a brother's-keeper attitude.'' Alcoa had caught the quality bug before -- employees still talk about the time in 1984 when the company left a perfect roll of Japanese-made sheet on the floor of its plant in Warrick, Indiana, for workers to ogle. But O'Neill made it a raging fever. One of his first moves was to order top executives away from their desks for a grueling 28 days of quality seminars that included field trips to paragons such as Xerox and Florida Power & Light. Like his obsession with safety, this emphasis on quality delivered unintended -- but not unexpected -- bonuses. These include lower costs, savings from reduced inventories equal to half the cost of Alcoa's modernization drive, and an increase in capacity of almost 50%. Speaking with the enthusiasm of the salesman he once was, arch-Alcoan Ron Hoffman boasts that the company now makes beverage-can sheet within a tolerance of 0.0002 inches -- ''and we think we can cut that in half.'' Today Alcoa ships sheet to five Japanese canmakers and has U.S. rivals playing catch-up. Aluminum remains one of the most capital-intensive industries in the world. But under O'Neill, even budget forms for capital expenditures reflect the new religion. Rather than first answer what sort of returns an investment could generate, managers must reply to nonfinancial questions like ''How many hours out of 24 are you currently running your process in control and within capability?'' -- qualityspeak for ''Is your output predictable and does it meet customer specifications?'' Managers must then show how new spending would improve those results. All these initiatives require teamwork or, as O'Neill says, ''the right kind of relationships between people.'' Alcoa has had plenty of experience with the wrong kind. A few years ago, according to President C. Fred Fetterolf, labor relations were so bitter that disputes erupted almost weekly. ''Hatred,'' Fetterolf now says, is not too strong a word for what he and his boss feel about corporate class distinctions, and ''obliterate'' describes what they want to do to them. AS A START, O'Neill scotched his company limo and driver. He is also striving to give workers greater responsibility. More than 100 hourly workers / at Alcoa's Tennessee factory have jobs that traditionally were considered management -- many in safety, but others in teams all through the plant. Overall, John Murphy, who heads the negotiating committee for Alcoa's biggest union -- the Aluminum, Brick, and Glass Workers -- sees ''a tremendous change in the attitude of employees and a completely different management attitude.'' To reinforce that change, O'Neill has introduced a compensation plan that puts workers, shareholders, and executives on more common ground. Under a new profit-sharing program, U.S. employees in the aluminum operations now divide up 17% of any return on assets above 6% -- an average of $1,500 per person in 1989. Meanwhile, senior management's base pay has been frozen. Future increases in earnings depend on meeting performance-based goals, including nonfinancial ones like targets for safety and energy conservation. And in a novel dividend policy, Alcoa shareholders have been promised a fixed dividend of only 40 cents a quarter; but if things go well, they get an end-of-the-year kicker equal to 30% of profits above $6 a share. (Last year that amounted to an extra $1.12.) These ideas, O'Neill maintains, are of a piece with his efforts in safety, quality, and capital spending. Hourly workers should not have to depend on variable compensation for their standard of living. But they also should not be cut out of the rewards when their efforts pay off big. Says O'Neill: ''This begins to knit together the philosophical notion that we're all in this together.'' Nothing unravels that notion faster than big layoffs. During the 1982 recession Alcoa laid off about one in seven hourly workers. When the next downturn hits, however, O'Neill believes the company can get through it without retrenching. ''Cost is one blade of a scissors,'' he says. ''You can't think of it in the absence of the value you're creating. You can't chop your way to happiness. You shouldn't have costs in good times, especially people- related costs, that you're not prepared to carry in bad times.'' And if you calculate those costs wrong? ''Get a new leader.'' Alcoa's leader is the son of an Army sergeant whose postings took his family from St. Louis -- where Paul was born -- to Illinois, Hawaii, New Mexico, and California. At 19, O'Neill married Nancy Jo Wolfe, dropped out of college, and landed an engineering job with Morrison Knudsen in Alaska. With his wallet thickened, he returned to Fresno State College and graduated in 1960. The next year he hired on with the federal government while taking courses that led to a master's in public administration in 1966. O'Neill started as an analyst in the Veterans Administration. One of his tasks: to fend off ax-wielding examiners from what is now the Office of Management and Budget (OMB). As the story is told by James T. Lynn, former OMB director and now CEO of Aetna Life & Casualty, one examiner retreated to the office and told his boss: ''I just met a fellow over at the VA and -- wow! -- he sure doesn't taste like tomato juice.'' OMB quickly hired O'Neill. HE WAS THE highest-ranking civil servant in OMB when President Gerald Ford tapped him for a political appointment as the agency's deputy director, under Lynn. When Jimmy Carter moved into the White House, O'Neill joined International Paper's staff as a vice president with strategic planning responsibilities. He later took over the packaging division, the company's biggest. In 1985 he was named president and put on the board. Like Alcoa, International Paper in the 1980s was a cyclical company whose plants needed huge capital infusions to compete with Japanese and other rivals. According to IP's former chief financial officer Richard Harris, O'Neill quickly became the consensus builder on the eight-member top management committee. The role came naturally. Says Donald Rumsfeld, President Ford's chief of staff, former CEO of G.D. Searle, and an O'Neill friend: ''In government you learn to lead not by command but by persuasion -- and you learn early on to deal with multiple audiences and groups.'' O'Neill also got a reputation as a long-term thinker, says Rosalie Wolf, a financial analyst who reported to him at IP and now works at Bankers Trust. That's not a garden-variety discipline in cyclical businesses where, as Wolf says, ''the market is tough on you at the bottom even if you do things right, and rewards you at the top even if you do things wrong.'' Among those who watched his rise was IP board member W. H. Krome George, retired CEO of Alcoa. It was George who encouraged Alcoa's board to hire O'Neill when it grew disenchanted with his predecessor, Charles Parry. Though Parry had signed off on the big plant modernization program and begun fattening the R&D budget, he rattled the company -- and the board -- in 1985 by predicting that Alcoa would get half its sales from nonaluminum products in ten years. UNDER O'NEILL, the company has pursued a far more modest diversification strategy. It has adroitly followed the bottle-cap market into plastics (it will be the biggest supplier of both aluminum and plastic closures this year) and, with a 1988 acquisition, has added vinyl to its house-siding line. At Alcoa's 2,000-acre lab near Pittsburgh, researchers are designing machine tools to cut the cost of manufacturing new advanced materials for the aerospace industry. Says Alcoa President Fred Fetterolf: ''I tell our aluminum people, 'You make sure not one damn pound of composites gets onto an airplane.' And I tell the guys in composites, 'Make sure that any pound put on is ours.' '' But aluminum is where Alcoa is coming from -- and where it's going. Under O'Neill, Alcoans have rekindled the zeal of the company's early years, when traveling salesmen were under orders to turn off the road at every smokestack, grab the factory manager, and convert him to their miracle metal. With world demand rising only 3% a year, the company is eager to open big new markets in food cans and automobiles (see box). Aluminum has 97% of the U.S. beer and soda can business, but it claims less than 9% of food cans. The industry has been unable to make a food can rigid enough and cheap enough to beat steel. Aluminum beverage cans are literally held up by their carbonated contents. The No. 2 U.S. aluminum company, Reynolds Metals, makes fruit juice cans using a shot of nitrogen to give the rigidity that bubbles do in Coke or Bud. Food cans -- except shallow ones for things like cat food -- had the industry stumped. With new alloys, a ribbed can wall, and a patented electrocoating process, Alcoa thinks it has the problem licked. Its research partners, Central States Can and Silgan Containers, will soon open a 100,000-square-foot plant in Iowa City able to make 300 million cans a year -- enough to increase U.S. aluminum food can production by 12%. While maintaining the cannonade on its old steelmaking rivals, Alcoa picked a new fight in January, opening a San Diego factory that takes it into the esoteric business of electronic packages. These are ceramics made from alumina -- produced in refining bauxite into aluminum -- and baked into wafers an inch square and only a few thousandths of an inch thick. In a computer, they act like transformers to amplify and send on information coded on a microchip. The market, already worth several billion dollars annually, is growing at 20% to 30% a year. Alcoa aims to grab a billion-dollar share by 1995. That means taking on two formidable Japanese foes, Kyocera and NGK. Though that challenge has already sent GE and 3M to the showers, Alcoa thinks it can succeed because the business -- exotic as it seems -- actually builds on its heritage. As with microchips themselves, profit in electronic packaging comes from yield -- the percentage of wafers that leave the oven having shrunk evenly, without cracking. The Japanese have more experience in the kitchen, but Edward Graddy of Alcoa Labs thinks his outfit can make a better dough: ''We know more about alumina than anyone.'' In the most bullish scenario, new markets could boost growth in world demand for aluminum to more than 11% a year by 1998. But it seems increasingly likely that the industry will endure a nasty recession first. Housing starts and car sales -- two big markets for Alcoa -- are in the dumps, and energy, whose price has been surging, is 30% of the cost of aluminum smelting. Primary aluminum prices dropped to 63 cents a pound early this year before rebounding to about 90 cents. Not surprisingly, Alcoa's profits fell too. Even so, if aluminum prices don't plummet again, the company will likely end up achieving its third-best year in history. The reason? Significantly lower costs. Says Clarence Morrison, an aluminum industry analyst with Prudential- Bache: ''This is the first time Alcoa is coming to the end of a business cycle with lower costs than it had at the beginning.'' Even if the economy slides further, O'Neill vows to deliver no less than a 10% return on equity and to average 15% throughout the next business cycle. Alcoa could do still more to reduce the cyclicality of its business. While it rules the area that has the biggest markups -- alumina making -- it has kept a step or two away from consumers themselves. Unlike rival Reynolds Metals, Alcoa makes can sheet but not cans and, in a decision O'Neill says he might have overruled, quit making aluminum foil long ago, in 1975. (''My own mother used to take a box of our foil and call it Reynolds Wrap,'' explains Fred Fetterolf.) About the only place a consumer sees Alcoa's logo is on its 2,400 recycling centers. The company's biggest challenge is international. Aluminum demand is growing fastest in Europe and the Pacific Rim. But of the world's major producers, only Alcan Aluminium, ironically spun off from Alcoa in 1928 because management wanted to focus on the U.S. market, can truly call itself global. ! As the auto, aerospace, and soft drink industries become more globalized, O'Neill has put high priority on expanding aluminum fabrication overseas. In late September, Alcoa announced a joint venture with Kobe Steel, a leading Japanese metals company. The fifty-fifty partners will put up $75 million in equity to build a factory that will roll Alcoa ingot into can sheet for the Asian market, where only one out of three beverage cans is aluminum -- a far cry from the metal's 32-to-1 dominance in the U.S. They will also develop new ways to use aluminum in automobiles. ''It's a start,'' says O'Neill. But Alcoa would be 50% bigger if its world market share matched its U.S. position. Getting there will require major moves in Europe too. The hard part will be to manage this expansion without upsetting the profitable balance that has kept Alcoa and the aluminum industry running at nearly 100% of capacity for the past three years. But by O'Neill's lights, while that's an important problem it's essentially a ''transitory'' one. ''When I look ahead,'' he says, ''I think about companies that are winners in the sense that they endure for decades and centuries, not just some ten- year wonder.'' This is one corporate revolutionary who has only begun to fight.