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GE and the belief in management magic

This week, the diversified industrial colossus announced that it would break itself up into three specialized companies. What killed GE?

Our impressions of corporate decline and fall are skewed by flameouts like Enron Corp. in 2001, Lehman Brothers Holdings Inc. in 2008 or Theranos Inc. in 2018. Such spectacular implosions make it seem that companies go from glory to failure in the blink of an eye.

GE’s dissolution, though, points to another reality of corporate life and death. Often, failure—as Ernest Hemingway wrote in “The Sun Also Rises”—happens two ways: “gradually and then suddenly.”

GE’s corporate culture prided itself on elevating management to a kind of science. The dissolution of the company, however, points to a reality many executives don’t like to admit:

Management matters a lot, but it doesn’t matter as much as you think (especially if you are management).

Economic and business cycles are often more important to a company than what its managers do. And the struggle to undo what their predecessors did can saddle managers with so great a burden that they can’t accomplish what they otherwise might.

From the 1940s through the 1970s, conglomerates grew until they were all the rage. Holding companies like International Telephone & Telegraph Corp. and Gulf & Western Industries Inc. bundled dozens of businesses together in the belief that the whole is greater than the sum of its parts.

ITT popularized the idea that hundreds of elite managers at a conglomerate’s headquarters would provide expertise on accounting, shipping, recruitment, patents, inventory control, research and development.

Then, in the 1970s, investors stopped bidding up conglomerate stocks; ITT and its peers sputtered. Diversification was out. Specializing in a handful of core businesses was in. Many conglomerates broke themselves up to unlock the value that had gotten obscured by throwing disparate businesses together.

A similar wave seems to be breaking right now. Right after GE’s announcement this week, two other giants, Toshiba Corp. and Johnson & Johnson, said they would also split up into separate units focused on specific lines of business. (J&J isn’t a conglomerate in the traditional sense, though.)

GE, formed in 1892, managed to benefit first from the stock market’s love of conglomerates, then later by specializing in the central lines of business that would drive its growth for decades: consumer goods, energy and power, financial services, infrastructure and technology (including healthcare), and media.

The late Jack Welch, chief executive from 1981 to 2001, played it both ways, making nearly 1,000 acquisitions and other deals like a conglomerateur—but, like a focused specialist, ensuring that nearly all were in that handful of segments.

GE Capital, the company’s financial-services unit, boomed as interest rates fell for decades. The firm’s relentless wheeling-and-dealing in everything from railcars and residential mortgages to car loans in Thailand gushed profits.

Quarter after quarter, GE’s earnings rose in almost perfectly smooth progression. The result seemed to be almost unparalleled durability.

Like ITT and earlier conglomerates, GE prided itself on its rigorous training for managers. In 1956, it established a “leadership institute” in New York’s Hudson Valley where thousands of executives have immersed themselves in techniques to improve GE’s operations and strategy. Young rising stars rotated from one business to another and across locations world-wide.

By the early 2000s, the company was spending $1 billion a year on training. Not many problems seemed too hard to solve. “We can sit around a table on any set of issues and say ‘what do you think?’ and arrive at a ‘right answer’ on most of the important ones,” then-Chief Executive Jeff Immelt wrote in GE’s 2001 annual report.

For most of a century, the system seemed foolproof.

Business historian Leslie Hannah, analyzing the 100 companies that had the largest stock-market value in 1912, found that only 21% remained among the top 100 in 1995. Almost half had disappeared, while most of the survivors shrank.

GE hadn’t just survived, but thrived. Seventh-largest in 1912, it was No. 2 in 1995, exceeded only by Royal Dutch Shell PLC, the energy behemoth.

In the spring of 2000, even as internet stocks collapsed, GE’s market value went up, peaking at No. 1 among all U.S. stocks at nearly $550 billion. Even in early October 2008, GE was still the second largest, according to the Center for Research in Security Prices.

Then all hell broke loose. By late March 2009, GE’s market value had fallen to $105 billion from $214 billion as GE Capital melted under the heat of the excessive risks it had taken. With GE struggling to meet its financing needs, Warren Buffett’s Berkshire Hathaway Inc. invested $3 billion and the U.S. government guaranteed tens of billions in debt.

That meltdown was decades in the making. Nicholas Heymann, a former internal auditor at GE, now a securities analyst at William Blair & Co., has followed the company for nearly 40 years. He thinks GE’s troubles date back at least to 2000-01, when Mr. Welch delayed his retirement to reshape GE by taking over its rival conglomerate, Honeywell International Inc.

The $45 billion deal ultimately fell through. Honeywell remained independent, but GE had gone off course, says Mr. Heymann. The company had focused all its energies on a giant acquisition just as the economy sank into a severe recession. “When you fall behind like that, how do you catch up?” he asks. “You go long and go big.”

GE undertook a series of disastrous acquisitions, among them $14 billion for film and television assets and almost $10 billion for a biosciences firm.

The struggle to integrate some of those lumbering acquisitions, and sluggish growth elsewhere at the company, forced GE Capital to become ultra-aggressive. Management had no choice; smooth earnings growth had to come from somewhere when other parts of the company were faltering. GE Capital “could get higher returns only by shouldering more risk,” my colleagues Tom Gryta and Ted Mann wrote in their book “Lights Out: Pride, Delusion and the Fall of General Electric.”

Low interest rates and a long bull market made those risks seem latent—until the 2008-09 financial crisis hit and they burst to the surface. Suddenly investors were wary of backing an operation that relied too much on debt. GE Capital had to scale back, constricting the cash that had long helped prop up the parent company’s earnings.

GE has always had a robust risk and deal-evaluation process across its businesses, including GE Capital, says the company.

For much of its life, GE had been in the right place at the right time. Now it was in the wrong place at the wrong time—and management’s vaunted vision didn’t enable GE to see around corners. In 2015 the company paid $10 billion for the French power giant Alstom SA. In 2017, it sank $7 billion into a venture with Baker Hughes, an energy-services company. Starting in 2018, oil prices swooned, and GE sold most of its interest in the energy venture in 2019.

Decades of success had bred complacency. Rita McGrath is a management professor at Columbia Business School who studies corporate change and has consulted for GE. In the early 2000s, she says, a common attitude among the company’s managers was: “It doesn’t matter what we make; it’s how we manage.”

GE was betting that “management technology would always save them,” she says.

No management technology, however, can erase decades of bad decisions—or counteract irreversible changes in how business is done.

In the 1999 annual report, Jack Welch had written that the “E” in “GE” could stand for “E-Business” and that the drive to digitize gave GE “the transparency, excitement and buzz of a startup.” But a management system optimized for wringing out incremental efficiencies couldn’t make the leap from the Industrial Age to the Information Age.

In the early 2010s, GE pushed a big-data and analytics platform for the “industrial internet” that it called Predix, reportedly spending some $5 billion on it. That was much too little, much too late. In the meantime, Microsoft Corp., Amazon.com Inc. and others had grown into conglomerates for the new age, offering a suite of technology services much the way GE had long filled the basic needs of industry.

Likewise, GE’s $10 billion deal for Alstom in 2015 was based partly on the rationale that natural gas would remain a dominant fuel for power plants. Today, green energy is in fashion. GE itself is belatedly racing in that direction; one of its three spinoffs will focus on “affordable, reliable and sustainable energy,” Chief Executive Larry Culpsaid this week.

In today’s markets, exchange-traded funds have made diversification effortless. Most investors probably want CEOs to focus on a few businesses, not to offer a broad bundle of them that the investors could replicate themselves in an ETF at low cost and lower risk.

So industrial conglomerates are on the wane, at least for now. The myth that great management can always work miracles should be, too.

This story has been published from a wire agency feed without modifications to the text

 

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