BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Innovation Factory: How Parker Hannifin Pumps Out Breakthrough Products

Following
This article is more than 8 years old.

This story appears in the May 3, 2015 issue of Forbes. Subscribe

Twenty miles from Parker Hannifin's monolithic headquarters in Cleveland, Craig Maxwell darts from room to room in the company's newly opened "hacker space," unable to hide a grin. Sparks spit into the air as one engineer builds a trash truck that operates entirely by a hydraulic system and a battery-powered motor. One room over, another engineer opens up an explosion-proof chamber where he conducts experiments key to building faster pumps for the oil and gas industry. Across the hall a 30-year-old shows off a functioning exoskeleton that allows paralyzed people to walk.

It's not the scene you would expect inside Parker, the faceless $13 billion industrial giant known (by people in the business, if few others) for making parts that go into trucks, cars, airplanes and tractors. And that's exactly the way Maxwell, the company's engineering boss, planned it. When he first sketched designs for this space in a job interview 13 years ago, he told Parker's top executives that if they wanted radical innovation, they had to create something completely different from Parker's stolid headquarters or greasy factories. After more than a decade of pleading with efficiency-first bosses, Maxwell officially opened the place in January, and he can't help but smile at its doodle-covered walls and orange-colored kitchen--markers of his latest victory in a long, trying battle to create an internal startup scene at Parker, complete with breakthrough products, angel investors, venture capitalists, twenty something entrepreneurs and the potential for multimillion-dollar exits.

"You wonder why so many big companies just cease to exist," says Maxwell, 56, talking over the buzz of machines shaping prototypes. "It has something to do with taking the hill versus holding the hill. And when you're mature and successful, you're on top of the hill. And so now it becomes a defensive kind of posture."

Just ask companies like Kodak, which invented digital photography, then stuck to film for too long and ended up in bankruptcy--while Instagram, Facebook, Pinterest and Snapchat took over the Internet. Or RadioShack, which built a company around selling high-tech gizmos yet somehow missed the transition to e-commerce.

"For big companies to thrive and succeed, they need to be innovative--they all know it, but nobody has really cracked the code yet," says Bill Aulet, the managing director of MIT's entrepreneurship center. "That's why this whole thing with Parker Hannifin is so interesting, because you never would have thought that a $13 billion conservative company, in an old-line business, would be the one to solve it."

But, Aulet adds, Parker isn't quite there yet. The exoskeleton is still going through the FDA approval process, and the new trash truck is nowhere near ready for the road. Parker admits that only about one-quarter of its 142 divisions are hitting their innovation-based growth targets today. Over the last five years Parker's gross profit margins, which should theoretically soar if the company is churning out breakthrough innovations its competitors can't easily replicate, have barely ticked up, from 21% to 23%. And its total sales have grown at a rate of just 5% per year if you take out the effects of acquisitions and currency--rate changes.

Watch: Walking once again, thanks to a robot

Unless those metrics improve, investors will continue to view Parker as just another boring old industrial company, no matter how much it brags about its new toys. Parker's stock has produced a compound annual return of 15% since 2010, on par with the S&P 500 and the S&P 500 Industrials Index. "I don't know of any financial analyst who incorporates any of this into their financial model," says Eli Lustgarten, an analyst at research firm Longbow Securities. "They've got technology worth shouting about, but you have to bring expectations within a realistic framework."

Still, the company's top brass is counting on Maxwell. "He has laid a foundation; he has laid processes," says Tom Williams, a 12-year Parker vet who took over as CEO in January. " He has laid a vision for how we should be structured."

LAST JUNE CRAIG MAXWELL sat in an auditorium flanked by the most important executives at Parker Hannifin. To his left was Don Washkewicz, the 64-year-old CEO who had joined the company straight out of college and would retire from the top job within a year. To his right sat Williams, the gray haired operating officer, next in line to take over as chief executive. Maxwell trained his eyes on a string of nervous engineers, who had flown in from all over the world for this meeting. They got one short presentation to show off their inventions, which in many cases had required years of work, then faced an assault of questions from the executives. Who else is making this sort of thing? Why aren't the margins on it higher? Why should we invest?

It was a scene straight out of the ABC hit Shark Tank --but with bigger stakes. Parker spends $410 million a year on research and development, and Maxwell controls a $20 million fund to feed employees' wildest ideas. One group presented a simple way to streamline operations for oilfield service companies like Halliburton. So-called frac balls are used to plug up a section of pipe and increase water pressure during fracking. Traditionally these companies had to go back into the ground to drill out the balls and reopen the pipe. Parker's engineers created frac balls that dissolve, saving time--and money. Parker ramped up production and expects to be selling more than $50 million of dissolving frac balls in five years.

An earlier version of the hydraulic trash truck, which cuts fuel costs by 30% to 50% for sanitation trucks, city buses and delivery vans, also came out of the competition. FedEx and UPS drivers are already behind the wheel, experimenting with the vehicles. Even with the decline in gas prices, Parker expects to take in $ 200 million a year from the product by 2020. Numbers like that earn investments, along with star status for the inventors who come up with the concepts. "Turns out engineers aren't just geeky," Maxwell says. "They're actually quite competitive."

But Maxwell knows not all big ideas will come from inside. He found the technology for the exoskeleton that allows paralyzed people to walk in a research lab at Vanderbilt University four years ago. He hired one of the Ph.D. students working on the suit, Ryan Farris; licensed an early prototype; and launched a "startup" to independently develop the concept within Parker Hannifin. In 2014 Farris made the F ORBES 30 Under 30 list of young innovators, and Parker expects to start selling his product late this year. Four other companies have popped up around the world with rival designs, but Parker's product is lightweight and can break apart to fit into a carry-on suitcase. Parker predicts its exoskeleton and future spinoffs--think super powered factory workers and superhuman soldiers--will carve out a $500 million share of a $2.5 billion market by 2020.

Given that Parker has invested only $25 million or so in the exoskeleton so far, the appeal of Maxwell's in-house incubator is easy to see. Maxwell took a chance buying the initial license with his fund. When that gamble proved worthwhile, one of the company's seven branches jumped in to get a piece of the action, putting its own money behind the project and teaming up with Maxwell--just as one venture capitalist might team up with another. "It's the same model," Maxwell says. "I'm the angel investor that has a different risk profile than the operating group president."

LONG BEFORE PARKER HANNIFIN was forgotten as an industrial dinosaur, it was a scrappy young startup with big ideas. In 1918, 33-year-old Arthur L. Parker invented a braking system for heavy vehicles, put a patent on it and started a business. Ten years later he had expanded into airplanes and earned a reputation for extremely reliable products. Charles Lindbergh specifically requested Parker parts for the Spirit of St. Louis. Business took off during World War II, when the U.S. Air Force bought more valves and fluid connectors from Parker than any other company. But when Arthur Parker passed away in 1945, much of his company's entrepreneurial spirit died, too. Over the next six decades Parker clung to its innovative roots--designing parts for NASA's first moon landing in 1969 and making the control equipment behind the bite of the great white in the 1975 blockbuster Jaws. But mostly Parker grew by following the guidebook for corporate expansion, swallowing hundreds of smaller competitors, spreading into markets all over the world and maintaining a ruthless focus on earnings over innovation.

Maxwell joined Parker in 1996, leaving a rival company in Connecticut to take a midlevel managerial job at a Parker division in California that made automotive filtration systems for companies like Ford, John Deere and Caterpillar. Early on he embodied the conservative corporate ethos. Dressed in shirt and tie, he says, he scolded any employee he caught surfing the burgeoning Internet, telling his workers to stop wasting time. When they showed him how they could do research through AltaVista, a precursor to Google, he reversed course. Maxwell began embracing the free wheeling California spirit but injected it with a dose of East Coast rigor, pushing his team to come up with newer, more sophisticated products. The division had been selling filters for $3 apiece, but under Maxwell's leadership it built an entire fuel system that sold for more than $100, got Ford to put it in its new F-250 diesel pickup and boosted sales an average of 18% a year over six years.

That caught the attention of top management, which invited Maxwell to interview for Parker's head engineering job in 2002. Figuring he had little chance at the position, given that he had no advanced degree or corporate managerial experience, he stood up in the middle of his interview with then-CEO Washkewicz and told him Parker had been doing it all wrong. He grabbed a marker and started drawing out a plan for a separate space that would incubate internal startups. He got the job, but his request for hacker space was flatly rejected. Instead his startups had to rent space in greasy factories from other divisions.

Undeterred, Maxwell set about redefining research and development. Engineers at Parker had always had some free time to work on pet projects, but Maxwell set up a new career track for mad-scientist types who didn't want to become managers--and gave them the freedom to decide how best to spend their days. "Google talks a lot about what we've been doing for a long time," Maxwell says. "Twenty percent of the time you've got to do expense reports and budgets and all that, but really the other 80% of the time, especially in this profession, it's really up to you to figure it out."

THAT DOESN'T MEAN IT'S all playtime. Parker meticulously tracks its inventions and the engineers who work on them. Maxwell insists sales from inventions at each division must grow by 4% a year. Tweaks to old products don't count. There are 1,700 R&D projects going on at any given time across the company, and Maxwell can see them all, thanks to software he and his team spent three years developing. He can click on any of Parker's 142 divisions around the world and see all of its projects, laid out on a chart by their riskiness and potential to make money. High--risk, high--reward projects stay in the pipeline. But if an engineer is working on a risky invention with little upside, Maxwell's deputies will reassign the engineer to a more worthwhile project. All inventions are entered into statistical models that predict how much they will help the division grow in each of the next ten years. If the fluid systems division, for example, has several innovations coming out over the next two years but no big projects after that, Maxwell will give them a ring. Or if the water purification division predicted huge growth the last few years but hasn't delivered, its engineering boss should start searching for a new job.

What makes Maxwell unique is that he simultaneously manages to be a cheerleader for entrepreneurial wackiness and also a traditional corporate suit. "He is a very good fit for Parker Hannifin," says Aulet, the MIT professor who met Maxwell when he came to campus to participate in a weeklong startup boot camp alongside hoodie-wearing 20-year-olds. "You need someone who kind of has a dual passport, can play the old white conservative guy from the Midwest but also can walk into a startup and understand what they're doing and be ready to rock 'n' roll with them."

Maxwell's most radical idea: He wants to give employees an ownership stake in the products they invent, which means Parker could eventually cut multimillion-dollar checks to its most inventive engineers. For his internal entrepreneurs Maxwell wants to eliminate the company's traditional bonus, based on the return on net assets, and instead give them equity stakes of, say, 20% in their projects. Parker would own the other 80%, and if the idea proved successful and turned into a meaningful business, the company could then buy the remaining 20% and cut the " founders " massive checks. If the costs overrun, the company could put more money into the project, diluting the founders' stakes and reducing their eventual payouts.

"There is no doubt that if it's proven successful it will be carried out elsewhere," says Lustgarten, the analyst. "By doing that sort of model you also have the ability to attract entrepreneurs into your business, which you wouldn't be able to do if you wanted to bring them into a corporate structure. It has the ability to change the game."

CEO Williams says he is open to the idea, but he and Maxwell still have to hash out a key detail: how Parker would value the startup in the absence of an external liquidity event. Publicly traded Israeli exoskeleton competitor ReWalk has never reported a profit, is currently losing $22 million a year, has only $4 million in annual sales and is valued at $150 million on the open market. Forget valuing it on a price-to-earnings ratio--ReWalk doesn't make money. Its price-to-sales ratio is 38.

Even if Williams were to value the exoskeleton and its spinoffs at Parker's paltry 1.3 price-to-sales ratio, the business could be worth $650 million in 2020 (assuming Parker's growth projections are correct), which would make the founders' 20% stake worth $130 million. It's the kind of math that makes your head spin.

"What you're describing sounds good in theory, but it might be hard in practicality," says Williams, who made $6 million last year from his perch in the executive suite. "Cutting billions of dollars of checks to people would not be appropriate."

For Maxwell, the fight goes on. Standing in his lab, sparks in the air and machines humming around him, he peers through a window at a hollowed--out space with concrete floors and tubing crisscrossing the ceiling--the site of the next breakthrough idea at Parker.

The company is now turning the pumps, valves and fittings it sells into Internet-connected devices. Parker acquired a $10 million business called Micro Thermo in 2010, bringing on technology that allows Parker to outfit refrigerators in convenience stores with sensors, which stream data online to show customers how efficiently their refrigerators are running at any given time. Supermarkets pay Parker to track whether their refrigerators are wasting energy or spoiling food. Maxwell is hosting a hackathon to conjure up more Internet of Things plays and will fund the best ones from each of the company's branches with $200,000 seed investments. "We're right at the cusp now," says Maxwell, gazing at all of the projects going on around him. "I hope that I outgrow this building pretty quickly."

Follow me on Twitter or LinkedInCheck out some of my other work hereSend me a secure tip