* * *
INC.: And the market developed the way you thought it would?
HATSOPOULOS: As it turned out in 1976, natural gas was rationed to the automobile companies. So, they started purchasing more efficient gas furnaces. For example, when General Motors asked us what we could do for them, I said we could give them metallurgical furnaces that are 50% more efficient. We had them available, and our competition didn't. So we increased our market share overnight.
Later we developed an altogether new energy-based venture known as cogeneration -- the simultaneous production of electrical and thermal energy from a single fuel source. So, my whole involvement with the energy program affected both our long- and short-term strategies. We structured the company in the '70s to pursue energy efficiency. Within seven years, the sales of the furnace division went from $5 million to $50 million.
* * *
INC.: You didn't feel that that was going to happen when you got into it?
HATSOPOULOS: Well, I didn't know what would happen. I knew that it would be a good activity for us if we were going to plan the long-term strategy of the company -- because energy was one of the technologies that we focused on.
* * *
INC.: It sounds as though that whole effort to understand energy efficiency, and the study that you participated in, was market research.
HATSOPOULOS: That's right -- but a different kind of market research. You see, I think that business in general, and particularly in the United States, is too short-term oriented. Remember the millions of dollars that were spent in developing the Edsel? The problem was that nobody could figure out how consumer tastes would change by the time the Edsel came out. The people who are doing market research have no tools for answering that question. They have no technique.
INC.: That may be, but what's the alternative?
HATSOPOULOS: In order to get that answer, you have to look for the broad trends. You have to get out there yourself because you know your market and your customers better than any market researcher. And you have to get involved in the kind of outside activities that will let you see these broad trends. That's what enabled me to see a future need for more efficient furnaces.
* * *
INC.: Sometime later you took an interest in economics. You were running a company, so I don't imagine you were at a loss for things to do.
HATSOPOULOS: I'd been curious about economics for a while, but my interest became more pronounced in the '70s. There were things going on with my business that didn't jibe. I couldn't figure out why American industry was so energy inefficient, and why Germany's was so much more efficient. The reason was simple: economics dictated that. Our energy prices were much lower. So energy efficiency is not just a matter of technology, it's a matter of economics.
* * *
INC.: Were you experiencing some difficulties in the marketplace?
HATSOPOULOS: No, our business was booming in the late '70s. It was just that some of our most advanced technology, which was very expensive, we could peddle only in Japan and not in the United States. The question was why? The cost of energy by that time was about the same in the United States and in Japan, so there must have been something else going on, and it must have been the cost of capital. That was my hypothesis.
Cost of capital, to a layman like I was then, simply meant interest rates. So you looked at interest rates, you found a little difference -- interest rates were a little lower in Japan in '79 than in the States, but that couldn't explain the whole thing. So I asked my friends at MIT and various economists: "Tell me where I can read about the cost of capital?" I was not satisfied with what I found in the literature. I read it all and said, "Well, I'll do the work myself." So I started in '81 making a major study on the cost of capital.
* * *
INC.: How did you go about it? Did you hire some people?
HATSOPOULOS: No, I didn't. I did it by myself. I read books. It took me about a year and a half to finish. I wanted somebody to check it out, so I called Larry Summers, who was an MIT professor [now at Harvard and a principal economic adviser to Democratic Presidential nominee Michael S. Dukakis]. He read the paper and came back and said, "A lot of errors, George. A lot of mistakes. You misunderstood things." And I said, "Well, tell me about them." We worked together for six months. That was the first study I made.
INC.: And what did you conclude?
HATSOPOULOS: Well, the first thing we concluded was that interest rates were a very poor measure of the cost of capital. Why? Because the sources of capital are more than just debt; there's equity, too. The cost of equity is influenced by several factors -- including tax rates for both corporations and individuals and the structure of the financial markets. Looking at both debt and equity, we determined that over the past 20 years, the cost of capital in the United States was three to four times higher than it was in other industrialized countries. The cost of equity has been around 8% aftertax; in Japan, it's been less than 2%.
* * *
INC.: That's a big difference. Did these numbers surprise people?
HATSOPOULOS: Yes, they did. Some of the ideas had been in minds of economists, but they weren't widely understood. And nobody had done the numbers. Policymakers were totally in the dark.
* * *
INC.: So what were the implications of all this?
HATSOPOULOS: Quite simply, it meant that a U.S. company was at a real disadvantage when it came to competing against foreign companies. Its capital cost more, so its products were less competitive. The U.S. company had two choices: either it raised prices and it lost market share, or it tried to cut corners with the risk of losing out later.
