Reality check: Lessons from GE's overreach
In the September-October, 2017, issue of Harvard Business Review, GE chairman and former CEO Jeff Immelt wrote about how he remade the company. It was one of three features that “examined how GE undertook the massive task of transitioning from a classic conglomerate to a technology-driven company”. Four months later, GE’s new chairman and chief executive officer, John Flannery, announced a $10 billion loss. He quietly told analysts the US Securities and Exchange Commission was investigating the company’s insurance business, how it recognised revenue from long-term service agreements for the maintenance of power plants, jet engines and other industrial equipment, and that GE would take a $6.2 billion charge and provide $15 billion over seven years to pay for policy-holders living longer than expected.
For almost all of the 120-plus years since it was founded, GE has been one of America’s most admired corporations. In 2008, Warren Buffett liked it so much he loaned it $3 billion.
And it has never been shy about telling the world how it could make its unpopular conglomerate model work, selling its advice to companies worldwide.
In early June last year, GE’s board announced that Healthcare boss Flannery would replace Immelt as CEO. It was a strong message to those companies that looked to GE to show them how to manage in the new age of technology. GE still calls itself “a digital industrial company” that will use its position as an industrial internet giant “to generate consistent growth, high margins and high returns for investors”. But the issue wasn’t disruption or technology or both. Poor management decisions saw America’s Most Admired become America’s nearly bankrupt.
Ten years ago, GE’s stock was selling at around $US30 ($37). In January 2018, the price was $US16. Market cap was down $US250 billion and Warren Buffett has sold his remaining shares.
Jack Welch took GE into financial services in the 1980s and Immelt grew GE Capital into arguably the world’s largest shadow bank. It became one of America’s biggest mortgage insurers, had a portfolio of subprime mortgages, credit-card financing in Japan, a $74 billion US commercial lending and leasing business, and a $16 billion finance unit that lent money for private-equity buyouts. The finance division contributed more than 55 per cent of group profit. While for 100 years GE had been an industrial stock, in the early 2000s, Fortune classified it as a diversified financial. Of course, the value of being in the financial services business is that you can smoothe earnings.
When the crisis hit, GE shares hit $US7 and the government hit them with very strict controls. Immelt’s answer was to shrink the company and free capital to invest $US50 billion in share buybacks and $US20 billion in energy-related acquisitions.
The market rewards growth. Welch delivered it, Immelt didn’t. Activist investor Nelson Peltz, whose company Trian Partners bet $US2.5 billion on GE in 2015, said GE’s “great businesses were overwhelmed by the bad ones and the underlying defensive growth of GE’s core industrial business was obfuscated”.
The death knell sounded soon after Immelt’s HBR article appeared. Trian Partners chief investment officer, Ed Garden, was given a seat on GE’s board with an implicit promise to move faster on cost cuts.There are enough lessons in the demise of GE to keep HBR in case studies for decades. Hubris can kill. Welch managed to be king of the executive world with some humility and lots of performance. Under Immelt, GE executives turned it into an art form. Then there’s complacency. In 2007, GE’s return on equity was more than 19 per cent. The GE practice of smoothing earnings worked until the GFC stopped the financial services businesses generating cash to smooth profits. As Nicholas Heymann of Sterne Agee, quoted in Fortune, said: “Investors now understand that GE uses the last couple of weeks in the quarter to ‘fine-tune’ its financial service portfolios to ensure its earnings objectives are achieved. It turns out it really wasn’t miracle management systems or risk-control systems, or even innovative brilliance. It was the green curtain that allowed the magic to be consistently performed undetected.” Welch summed up all the lessons when he used to tell his executives: “Face reality as it is, not as it was or as you wish it were”.