Before taking the helm of Ingersoll-Rand in 1999, Herbert Henkel knew that, if the firm was to survive, its legacy in cyclical construction machinery would need to give way to a more diversified industrial focus. Henkel has made decent strides. The firm recently expanded its portfolio of products, completing a $10 billion acquisition of the air-conditioning systems firm Trane. With second-quarter earnings per share of 90 cents edging out expectations by a penny, analysts are optimistic on the stock. And this was all after a big stamp of approval by buy-side behemoth Berkshire Hathaway, which made a sizable stock purchase in 2006, bringing the total number of shares it owned to 5.6 million. But with the industrial sector choppy, Henkel knows the company can't rest on its laurels if it wants to keep customers and investors happy.

Q: What are your long-term expectations for the industrial sector?
A: We participate in refrigeration and transportation, and if you look at a long-term graph, we've had 4.5% growth for 20 to 30 years. In the short-term horizon, however, from peak to trough we've been down 60%. We have to deal with the marketplace changing. That's the real challenge—how to set cost structure and have enough capacity, so in the future we can be prepared. In today's global economy, there are lots of companies that can turn out products, but who is going to innovate and really meet customer expectations?

Q: Do you think industrials will continue to feel the sting of skyrocketing material costs for some time?
A: Our costs have gone up $600 million for the same amount of materials over the last four years. Copper, lead, oil—which for us has to do with plastics—have all gone up. But we think we're at the peak of [price increases in] raw materials. However, I don't look for any cost reductions, either. If there are, that's a plus to our profit. But we think costs [will remain where they are] at least into 2009.

Q: The firm mentioned in its last earnings call an unexpected rise in costs of $20 million more than originally planned. How do you absorb that?
A: Looking at our crystal ball based on outside world factors, our assumption for 2008 was that steel would come in at $700 to $800 a ton. Instead, it came in at $1,100 to $1,200 a ton. That was a $20 million drain on profits, and when you miss numbers by $20 million, you have to come up with price increases and productivity improvements. We've increased productivity by 2.5% to 3%, but we're now set to accomplish 4% to 5%, and you add that to price increases to increase margins.

Q: Can you turn around productivity improvements quickly enough to absorb unplanned costs?
A: You do what you can to change material content, maybe move to a lower cut, and still meet customers' needs. We also look at whether we can change the design around, and still build it in less time. That is significant, to have that engineering capability.

Q: What's ahead for Ingersoll-Rand? Should we expect less activity in the near term?
A: Obviously, with the recent Trane acquisition, we expect it will take us 12 to 18 months to integrate it. I don't expect any major portfolio moves in the short-term horizon. But this is an ongoing quest. And while our package is pretty good, we need more of a footprint in other countries. We don't have anything in Scandinavia, for example. So I see some geographic acquisitions.