The CEO of Rio Tinto on Managing in a Hypercyclical Industry

My appointment as chief executive of Rio Tinto, the Anglo-Australian metals and mining company, had a definite tropical flavor. I was on vacation with my wife in Singapore in January 2013 when I received an e-mail from Rio Tinto’s chairman, Jan du Plessis, asking me to travel immediately to London for an emergency board meeting. The chairman understood that I was away from home, so the e-mail told me to drop everything and “come as you are.” I had joined Rio Tinto in 1991 and had risen to lead the iron ore operation, the largest product group in the company. I’d also been on the board since 2009. So I knew enough about the 140-year-old firm’s culture to understand that if you want to be taken seriously, you don’t show up to a board meeting in a Hawaiian shirt. But I had few other options in my suitcase. So I frantically searched for a 24-hour tailor, had a suit made, and boarded a plane. Though I had earned a reputation for managing my product group with discipline and accountability, some were surprised when the board asked me to take over as chief executive. I was 63 at the time, a bit beyond the job profile in terms of age. In addition, Rio Tinto—which is the second-biggest mining company in the world, with a market cap of around $50 billion—did not have a reputation for removing chief executives. But the directors recognized that the company had lost its way. In the 2000s it had been caught up in one of the largest commodities booms in history, fueled primarily by China’s rapid development. Almost all the major mining companies made mistakes in the mad rush for growth; but at Rio Tinto the smart allocation of capital had traditionally been a strength, so our recklessness was particularly painful. We suffered multibillion-dollar write-downs of two of our boom-time acquisitions, and in 2012 the company reported a net loss for the first time in 25 years. We had been spending as if we had an open checkbook. Quite frankly, we were living beyond our means. I knew that had to change. Three Initiatives From a macro perspective, I took the helm at an interesting time. In the coming decades, hundreds of millions of people across the globe will move from rural to urban environments in search of a better life. They will rely on extracted minerals and metals for their smartphones, cars, buildings, and other comforts. International development cannot move forward without the mining industry. But I believe that our business will be even more competitive in the future. Sudden demand shifts and price fluctuations will become more frequent. Industries will be hypercyclical. Xi Jinping, the president of China, calls this “the new normal,” and everyone should be preparing for it. To ensure that Rio Tinto would succeed in such a turbulent environment, I needed to reconnect it with its core balance-sheet discipline and put it back on a path of measured, sustainable growth. Fiscal discipline and responsible risk management are sound business principles in any market environment—but they’re absolutely essential in a hypercyclical market, where prices have a tendency to soar and plummet. My chief financial officer, Chris Lynch, and I decided to focus on three initiatives: First, I would tighten up our investment decisions so that only the best projects received funding. Second, I would run the entire organization for cash—a highly unusual step for a company of our size and complexity—and elevate shareholder value above all else. Third, I would drive efficiency through the organization by cutting costs, exiting businesses, and rationalizing our workforce. But I would also continue to invest in innovation—pulling best practices from other industries and fully harnessing the efficiency gains made possible by new technology. Investment Checks and Balances This wasn’t the first time I stepped in to lead during times of hardship. My father, a former postmaster, and later a director of the commonwealth government in Australia, died when I was 15, so I had to manage the family finances from a young age. In the 1980s I led the team that overhauled the Australian division of General Motors, which at the time was struggling with huge debt, lost market share, and overcapacity. I learned more than just fortitude during my time in the automotive industry. (I also worked for Nissan.) I learned how to operate systems effectively, how to be truly competitive, how supply chains work, how to foster innovation, and that the customer (not the product) must always come first. My first meeting on the day I was appointed CEO was with the investment committee, which would decide whether and how to spend hundreds of millions—perhaps billions—of dollars. This committee was supposed to evaluate all projects, and it was signing off on almost everything at the time. But the subject matter experts—the people in the middle of our organization—were the ones who actually understood how things worked. They knew about geology and hydrology, geotech, marketing, financing, joint venture relationships, and so on. These vital managers were being passed over. I saw immediately that I needed to reinforce the system of checks and balances that had once been a core competency for Rio Tinto. The first thing I did was stop the upward flood of delegation. I wanted people who were closer to projects to make more decisions; the investment committee should act as a final safeguard, not the only one. And I decided to raise the hurdle for new investments—dramatically. During the boom years, almost every project with a positive net present value had been given the green light. We made a bold announcement: Only projects that met or exceeded an internal rate of return of 15% would move forward under my leadership. My thinking was: Good projects are always good projects. The problem with marginal projects is that people work to pull them over the line. They stretch assumptions. High prices during a bubble can hide a lot of sins, but when this bubble burst, we were left exposed. Chris and I felt that by setting an IRR of 15%, we could cull the marginal projects and focus on the good ones. So our spending on new projects went from $17.6 billion at our peak to $5 billion in 2015. Cash Doesn’t Lie I then turned to Rio Tinto’s accounting practices. For years before my appointment, the company was focused on earnings. I’m a believer in the adage that cash doesn’t lie. It’s either there or it’s not. God bless accountants, but there have been so many changes to accounting rules that earnings no longer track performance. I was told that managing for cash wasn’t possible for a business as large and complex as ours, but I held my ground. Drawing on my early experience with managing the family finances, I made a home economics analogy: If you find a hole in your roof, you move money around. You don’t buy a new suit, and you use the money you didn’t spend to fix the roof. At our annual meeting in 2015, a shareholder commented that cash was mentioned in the annual report 24 times. Now that is what I call success! I also decided to change how we issue forecasts, from quarterly to monthly. What we’d been doing before was the equivalent of driving while looking in the rearview mirror. The same naysayers claimed there were too many variables. I took them on again directly and went through various input costs line by line. We’re now forecasting monthly with a 5% margin of error, which is plenty accurate enough. A renewed emphasis on accountability requires more than a focus on the balance sheet. It requires that all 60,000 of Rio Tinto’s employees adopt an “owner’s mindset” in order to align their interests with those of our shareholders. Instilling that mindset at Rio Tinto was made easier by the fact that about 38% of our employees already own shares in the company. I’m quite clear with our people that shareholder returns are Rio Tinto’s number one focus. I’m sometimes asked why I don’t make safety or the environment number one. Safety is a top priority. It is widely acknowledged that a strong safety and sustainability record is essential to achieving returns. But I want our employees to know that it’s not embarrassing to say we’re here to make money. That is our purpose as a business! It sounds like a pretty simple cultural change, but for a huge company like Rio Tinto it required a major shift in thinking. Of course, like all mining companies, we are watched closely by NGOs, unions, and other stakeholders, who sometimes raise concerns about Rio Tinto’s environmental impact, the safety of its workers, its community relations, and other issues. We welcome their scrutiny for the same reason we foster a culture of protecting internal whistle-blowers. We can—and must—do better. At the same time, our safety record is the best it’s been in our 140-year history. We’ve reduced greenhouse gas emissions by 21% in the past five years. We’ve barely reduced our community spending around the world, even as we’ve made enormous cuts throughout the rest of the business. We’re always working to make mining safer, cleaner, and more sustainable. A Drive for Efficiency As I was instituting these changes, I met with two of our former chairmen to ask them about the historical context in which Rio Tinto had risen—to understand how and why the company’s accounting and capital expenditure procedures had been set up and to make sure that I was staying true to the principles underlying its run of success. These informal mentors gave me confidence that I was on the right track. I’ve had to make some difficult decisions in my drive for efficiency. We’ve substantially reduced our head count, including at corporate headquarters, where we cut the staff by more than half, and we’ve taken costs out of every aspect of the business. Many of these decisions were painful, but all were necessary. When I took over, our target was a $3 billion reduction in costs. We recently announced that we have hit $5.5 billion in savings, and we’re still going. Given the imperative to restore discipline to the business, I’ve had to be careful to continue investing in the innovations that will keep our long-term prospects bright. And I’m not shut off to inorganic growth opportunities. But what excites me most is using technology to increase our productivity. “Mine of the Future” I try to focus the senior leadership team on the wide world around us, to ensure that we are pulling best practices from outside mining. In 2005, when I was running the iron ore product group, I took my team on a U.S. road trip. We deliberately did not visit a single mining company. At Stanford we saw R&D programs for driverless tractors in farming. I knew from experience in the car industry what can be achieved with automation. Rio Tinto now has a “mine of the future” program that includes 66 driverless trucks that have moved some 400 million tons of material. Each truck weighs 350 tons and is the size of a house—the tires alone are more than six feet high. These trucks allow us to run the operation much more efficiently. In fact, our autonomous fleet outperformed the manned trucks by an average of 12%, primarily by eliminating required breaks, absenteeism, and shift changes. As they trundle back and forth from our mines, they are unmistakable harbingers of what the future holds. At Schlumberger we saw oil and gas platforms being remotely managed. Today we manage 15 iron ore mines, 1,700 kilometers of rail, four ports, three power stations, and various other facilities in real time from a remote operations center in Perth, Australia, which resembles an air traffic control center (except it’s much larger). The center helps us recruit talented people who might not want to live in remote mining areas. But more important, it helps us optimize operations. If we see a mine slowing down because of heavy rain, for example, we can increase production elsewhere, maintain the consistency of our iron ore blend, and keep the whole show running. We can analyze variations in plant and mine performance and tweak as necessary. We have captured the IP, and our competitors are now a decade behind us. Three years after my appointment, these changes are starting to bear fruit. We now have one of the strongest balance sheets in the sector. Crucially, we reduced our net debt from $22.1 billion in June 2013 to $12.5 billion in December 2014. Demand from China and other developing countries remains softer than in the recent past, but scale and efficiency allow us to compete as a low-cost producer, helping us sustain or even gain market share during periods of deflationary pressure. Our underlying earnings were the highest of any mining company’s for the six months leading up to June 30, 2015. Of course, you can’t actually turn around a company in just three years. A lot remains to be done. I think the big secret of my job is how completely the chief executive relies on his or her team. I don’t shovel in a mine. I don’t produce aluminum in a smelter. I sit at my desk, spend time across the business, and lead the company. My executive committee is composed of bright people who make decisions every day that create value for this business. Strong leadership extends right through to the teams on the ground. Rio Tinto provides the building blocks for the global economy. The materials we dig out of the earth have helped unleash untold value since the end of agrarianism, and they will continue to do so. My hope is that when I leave Rio Tinto, I will pass on an even stronger company to my successor.

The CEO of Rio Tinto on Managing in a Hypercyclical Industry

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