The Sun Sets on an Iconic American Company

By V.P. Nandakumar
 
The General Electric company (GE), one of the oldest and most well-known names in the corporate world that counts Thomas Alva Edison as one of its founders, is breaking up. On November 9, GE announced plans to split into three separate companies for its aviation, healthcare, and energy businesses. The news marks the end of an era.
 
GE was incorporated in 1892 after a merger between the Edison General Electric Company, a company founded in 1878 by Thomas Edison, and the Thomson-Houston Electric Company. The deal was arranged by the influential financier J.P. Morgan. At its peak in early 2001, the company’s stock was worth more than $500 billion making it one of the most valuable companies in the world at that time. It was a giant global conglomerate in the true sense of the term, involved in commercial and consumer finance, infrastructure (water treatment systems, energy delivery systems such as power grids), diesel locomotives, jet engines, consumer appliances (refrigerators, washing machines, cooking ranges etc.), lighting products, health care (mainly diagnostic and imaging products), and also, for good measure,  media and entertainment!
 
However, in recent years, the company has struggled, particularly after the global financial crisis of 2008 left its financial services division, GE Capital, reeling. What was once an iconic American company and a Wall Street favourite, became a flat-footed giant unable to respond to or adjust to changing realities. A company that was an original constituent of the Dow Jones Industrial Average when it was launched in 1896, found itself ejected from the index in June 2018. In a way, GE’s decline is the outcome of a broader shift in the economy of the United States, which has drifted away from heavy industry and moved towards services, such as technology, finance, and health care.
 
Snapshot of a company in decline
GE’s stock has underperformed the market since the crisis; Share price and index rebased, January 2009.

[Description: Chart, line chart Description automatically generated]
Source: https://www.ft.com/content/1ca38b2c-a9ce-4450-b156-a17a24e33976
 
Jack Welch, legendary CEO
 
No write up on General Electric can do without a mention of Jack Welch, its legendary CEO for 20 years from 1981 to 2001. Welch authored five bestselling books on leadership and inspired a generation of business leaders. During his tenure, the company was consistently ranked amongst the top companies in Fortune 500 list and its market value grew from $12 billion to $410 billion. For Welch, GE was not merely a manufacturing company but a "boundary-less" business, and GE became a training ground for a growing cadre of star managers. They were developed and moved from one business to another every few years for better career growth though exposure to a wide range of businesses.
 
Welch succeeded because he understood that growth is what moves Wall Street even as he realized that most of the “industrial” businesses GE was operating in had modest organic growth prospects. He therefore developed a strategy of acquisitions to grow earnings. He would look for performing businesses in a dominant position in industries where there were only three or four large players, which could be counted on to contribute to profit from day one. Once a company came into the GE fold, GE’s star managers would get down to work, in the quest to improve its workings for higher growth.
 
Singularly determined to overcome the odds by shaking up the bureaucratic culture he had inherited, Welch earned two titles, “manager of the century,” and “Neutron Jack”, the latter for cutting back tens of thousands of jobs while acquiring, restructuring, and selling businesses. The allusion is to the neutron bomb which leaves buildings intact but decimates the population.
 
Welch had a no-nonsense approach to profit. A GE business that wasn't the market leader in its segment was faced with three choices. The first was to work on the business and make it the leader. If not, it was either sold, or shut down. In his first two years as CEO, 71 businesses were sold.  Welch also transformed GE Capital, a division originally meant to finance client purchases of its aircraft engines and power turbines, into a financial services powerhouse involved in everything from subprime mortgages to insurance. Ironically, within a decade of his retirement, amid the global financial crisis of 2008, GE Capital would prove to be a weak link and the source of much of its troubles.
 
Lessons about corporate strategy from GE’s failure
 
Not surprisingly, the story of GE’s fall from grace has been widely discussed in the media. A much talked about book in this context was published in 2020 with the title, “Lights Out: Pride, Delusion, and the Fall of General Electric.” Authored by Thomas Gryta and Ted Mann who are both journalists with the Wall Street Journal, the book traces GE’s decline from the days of Welch onwards. Bill Gates, the founder of Microsoft, recently put out a short blog post about this book. He wrote about his key takeaways from the book and offered his own insights into what likely went wrong. (More about Gates’ thoughts shortly.)
 
For this article, I would like to draw attention to an August 2019 case study authored by Dr. James E. Schrager, professor at the University of Chicago’s Booth School of Business. The study is titled, “Three Strategy Lessons from GE’s Decline” and it explains what can happen to a conglomerate that fails to adapt quickly when its success wanes. Dr. Shrager is of the opinion that GE never stood much of a chance once Jack Welch retired as chairman and CEO in 2001. No, it was not due to poor luck or indifferent management, it’s just that Welch’s brilliant growth strategy had run its course and ceased to be relevant. Welch’s great mistake was to fail to plan for what happens when the golden goose stops laying.  According to Dr. Schrager, the story of GE holds three powerful lessons about corporate strategy, which I quote below verbatim:

1. All growth from any single market or technology will end. Companies that endure are those that plan for this reality.
2. If you are successful, many will copy your success. Companies that continue to prosper update and adapt their strategies.
3. Smart corporate strategies are flexible and nimble, enabling action rather than constraining it.Having laid out the strategic lessons, here is what Dr. Shrager recommends that current and future CEOs should take care of.

1. Plan the next big thing: When Jack Welch presided over GE, his long-term and short-term views were not very different. In his vision of the future, he expected GE to continue acquiring promising companies at reasonable prices, thereby delivering uninterrupted growth with profitability. But by the time Welch ceded control to Jeff Immelt in 2001, the world had become a different place. The story of Welch’s success had been shared widely and many other business leaders adopted the same strategy, making it less effective over time.  The lesson here is, no matter how big or successful you are today, no matter how much you dominate your sector, you must plan for a time when your current strategy no longer works. Change will always happen and so strategies must be renewed and revised. As Dr. Shrager puts it, “Corporate leaders need to ask themselves: What is the pipeline? What is driving growth? What are we going to run out of?”

2. Expect competition: As mentioned earlier, Welch had developed a strategy of acquisitions to grow the company rapidly. However, once other companies too began to copy the same strategy, and once private-equity players emerged in the 1990s with the ability to raise huge capital and obtain funding from banks to finance their acquisitions, all the good candidates suddenly had too many interested parties looking to takeover. The bidding wars that followed pushed prices higher and higher, increasing the risk factor in the acquisition. Buying the right companies at the right prices became harder and harder. The lesson here is that market conditions change, successful companies will attract competitors, and competitors will copy your successful strategies and may even improve upon it, to make it cheaper, faster, or smarter. A good business leader should expect and plan for such competition well in advance.  
 
3. Be nimble: Strategies are not meant to be etched in stone and held valid for all situations and times to come, nor should they become inflexible in ways that constrain action. Rather, strategies work best as frameworks for decision-making. The successful corporate strategies enable companies to change direction when things don’t go according to plan, and when unexpected opportunities arise too. 

Bill Gates on GE’s decline

In a blog post of June 2021, Bill Gates talks about his two big takeaways from the book, “Lights Out: Pride, Delusion, and the Fall of General Electric,” by Thomas Gryta and Ted Mann.

Firstly, GE’s fall is a textbook case of mismanagement of an excessively complex business. As Gates explains, what seemed like one of GE’s greatest strengths was one of its biggest weaknesses. For many years, investors loved GE’s stock because the GE management team always “made their numbers,” which is to say the company would report earnings per share much in line with what Wall Street analysts predicted. However, as it became clear later, the culture of meeting the market’s expectations at all costs gave rise to “success theatre” and “chasing earnings.” Gates quotes an example from the book about how GE would sometimes artificially boost quarterly profits by selling an asset (e.g., a diesel locomotive) to a friendly bank on the understanding that GE would buy back the asset later. In this way, problems were brushed under the carpet for the sake of presenting a bright picture. However, it also allowed small problems to grow into big problems before they came to the attention of top management.

Gates points out that in many companies, bad news travels very slowly while good news travels fast. He contrasts this with the culture at Microsoft where he tried hard to keep this tendency in check.  As an example, he says that if a team member sent him an email saying, “we just won a software design competition,” he would typically respond with, “Why am I hearing about this one? That’s not statistically representative. How many competitions did we lose?” Gates calls it “making bad news travel fast” all the time so that he would catch negative trends early enough for top management to take corrective measures.

Gates’ second key takeaway is that GE did not have the right managerial talent or systems to manage its wide range of complex and divergent businesses. The company liked to believe that its famous training systems made its managers more capable of avoiding the pitfalls that had brought down conglomerates in the past. The reality was not so simple as GE’s generalists often lacked in-depth knowledge about the industries they had to manage. Consequently, they were not always well-equipped to steer their way through the trends and upheavals in their industries. These limitations were severely exposed when it came to GE Capital, which almost collapsed during the global financial crisis of 2008. The failure happened because GE Capital was all along borrowing short at cheap rates (using the commercial paper route) and lending long at higher rates to boost profits. When the crisis broke, confidence in the financial system shattered overnight halting the flow of credit, and GE Capital had to be bailed out by Warren Buffet.
 
Success not guaranteed

Many conglomerates have split up in recent years based on the logic of enabling the more promising businesses to focus on the opportunities within their sector. Days after GE’s announcement, another big American company, Johnson & Johnson, announced plans to split into two parts, with its consumer business separating from its pharmaceutical and medical devices business.

However, the results of such splits are not always on expected lines. A recent New York Times article cites the examples of Siemens AG and Honeywell to show how splitting a conglomerate can be a mixed bag. Siemens AG announced the spinoff of its energy business in May 2020. Since then, its shares have risen 64%, bettering the S&P 500’s 56% gain over this period. Honeywell announced the spinoff of its home equipment business In October 2017 but the gain in the company’s shares since has been outpaced by gains in the S&P 500 (63% vs 83%).

Moreover, even after GE’s split, the three new stand-alone companies will still be reckoned as large companies in their own right. For example, the jet engine business earned a revenue of $22 billion last year. Reportedly, there are about 36,000 GE engines fitted on commercial airliners worldwide and another 26,000 engines on military aircraft. GE’s health care business recorded revenues of $17 billion last year and hospitals and clinics globally use 4 million of its imaging and other machines. The third company coming out of the split will hold GE’s energy and power business which manufactures wind turbines and gas-fuelled power generators. Astonishing as this may seem, GE’s power plants generate one-third of the world’s electricity today!

For some years now, GE has been trying to extricate itself from its troubles by cutting down on debt and bringing more focus to its businesses. Hopefully, the split into three companies will make them nimbler.
 
Published in Unique Times Magazine, December 2021
 
(V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd. Views are personal)