GE and Its Naysayers
November 26 2009 by William E. Rothschild And Stephen M. Rothschild
Whether it is a football team, baseball team, business enterprise, Federal or state government or any other organization that’s not meeting the expectations of its key stakeholders, the immediate and favorite American response is to fire the leaders and get new ones. Americans expect their leaders to do what they say and, most of all, win—and if they fail, they want immediate change.
Jeff Immelt, GE’s CEO, has learned this fact of life over the past two years and has become the target of what he called in GE’s 2008 Annual Report, “naysayers.” Third quarter profits slumped 44 percent this year on revenues that were considerably lighter than last year’s, prompting critics to question Immelt . Several of the major stakeholder groups, with the exception of the board of directors, are calling for a change of leadership.
Concern by the naysayers is justified. GE stock collapsed in October 2007, dropping from nearly $42 per share to trade as low as $5 before beginning a slow increase. It has recently flirted with the $16 mark, but is still well below its 52-week high of $21.04.GE’s Triple A credit rating was lowered and dividends were reduced 75 percent. However, very few corporations have achieved the Triple A rating and many companies have cut dividends to strengthen their balance sheet.
Perhaps the impetus for concern comes from the apparent surprise of GE management at their financial instability caused by the sudden financial downturn. GE’s team didn’t meet the high expectations it had created and promised to meet. So, it is logical to question whether GE’s leadership can do the job. To answer this question we must examine the key factors that caused GE’s financial instability.
The first factor is the unrealistic double-digit growth expectation that Immelt inherited. For over 10 years under Jack Welch’s leadership, GE’s price earnings multiple rose to 60 times earnings, over three times its historical average. Investors valued the company based on this trend continuing. Unfortunately, in the first quarter of 2008, GE missed its promised earnings numbers and shocked Wall Street, weakening its credibility and destabilizing GE’s stock price.
The second factor was the continued reliance on the success of Financial Services, which had become the principle growth driver and focus of the company. Welch did try, but failed to acquire Honeywell, which would have enhanced its manufacturing and system businesses and allowed it to diversify. When this did not happen GE’s business portfolio became too dependent on financial services, which heightened risk.
The third factor was poor timing in transitioning the business. To reduce risk and drive higher profitability from other business segments, Immelt had to make changes and new investments, but continued to depend on financial services. One of the first steps Immelt took was to make significant global investments in research and development. He also focused on global revenue growth, which would provide a foundation for increased profitability from other segments. Even though he took steps to reduce the company’s dependence on Financial Services, time was not on his side. GE Capital continued to take risks and company earnings depended on its ability to make deals and sell assets. With the confluence of economic events and a poor risk assessment, GE became unstable and was forced to seek an emergency investment from Warren Buffett. Obviously, there was a lack of internal auditing and strategy review because the company has has been surprised several times and paid $50million to settle a Securities Exchange Commission fraud charge.
In short, these factors led to GE’s missed financial results. Clearly, Jeff Immelt and his team, like many others, did not see the drastic economic downturn and the significant impact it would have on the company. While GE was weaker, the company was still highly profitable, issued dividends and invested in new high growth segments.
Jeff Immelt has been working to chart a new course for GE to get back to expected profit levels. One of the reasons that GE has prospered and grown over its 127 year history is that the leaders have adapted to changes, admitted mistakes and taken actions to move the company in the right direction. We believe that Jeff Immelt and his team exemplify these traditional leadership characteristics that made GE so successful.
Immelt’s Game Plan
Let’s review some of the key actions Immelt has taken to chart a new course:
Restoring GE’s technological innovation: Since Immelt took over, he has invested heavily in restoring GE’s technological strengths and innovation capability. Prior to Immelt, GE focused on the financial sector and made limited investments in R&D and manufacturing. Significant investments are being made in new and upgraded research centers in
Positioning the company in many growth areas: Immelt has focused heavily on infrastructure businesses such as healthcare, transportation, power generation, water and solar, as well as aircraft engines, that will benefit from the billions of dollars being globally invested in these industries. GE has been awarded large systems contracts in
Continuous pruning and surgery: Another reason GE has been successful over the last 127 years is management’s willingness to continually make objective assessments of its portfolio and divest any unattractive segments. Immelt continued to execute this GE portfolio strategy. For example, Immelt was willing to sell the plastics business at the right time and get a premium price, even though he previously held managerial positions in the business. He also has exited the insurance businesses and has now put the “security businesses” on the block. Using proper market timing and patience, Immelt has obtained premium prices for these businesses.
Reducing dependence on and refocusing financial services: Unfortunately, Immelt has been slow in reducing the company’s dependence on GE Capital and even permitted it to grow too big and take too much risk. Trying to gradually refocus the company, while meeting short-term financial expectations, proved to be poorly timed. GE Capital’s overnight failures forced him to more aggressively prune these services and refocus it on being a financing arm that would help sell GE products and systems and reduce its role as a commodities and financial services company. Timing is key and the portfolio must be skillfully pruned and sold at high—not low—prices.
Taking strong public positions to assure GE controls its own destiny: Another GE success factor has been leadership’s willingness to take public stands at the risk of being politically incorrect. In the 1930s, Gerard Swope played a major role in the New Deal as the architect of Social Security and National Recovery Act; both were highly controversial but vital to the
Willing to sacrifice personal wealth for good of company and personally invest in GE : GE leaders have been unselfish and totally committed to the company and its success. Their salaries and incentives have been competitive, but not excessive. Jeff Immelt refused to accept his $12 million bonus. He purchased millions of dollars of GE stock when it was declining to demonstrate that he was committed and believed profitability would rise again. This level of integrity is critical to a successful leader and is in sharp contrast to the many CEOs who get paid huge compensation even when their companies fail.
Getting the timing right: Though GE missed its 2008 earnings, Immelt has made the necessary changes to spur growth. He has made the right investments, divested nonstrategic businesses and strengthened the auditing staff, which had been downsized before he took over. GE’s portfolio is becoming stronger and simpler, as well as more transparent to investors. Many of the major issues have been addressed, but since the company is so large and the environment so dynamic, it will take time to get the desired results.
The Replacement Answer
So what would a new team do differently? If you are a “naysayer” and are not satisfied with the situation, you may believe that replacing Immelt and installing a new team is the right answer. So, let’s examine the attractiveness of this option and determine if the company would be better off.
First, there are internal candidates that can do the job; GE prides itself on having a very comprehensive succession planning system. This new internal team would have the benefit of knowing parts of GE, but since the company is so large, global and diversified none of them would have the same knowledge as the current team and it would take time for them to evaluate the entire portfolio and make the key strategic decisions. The same would be true if you brought in one of the GE alumni, who have had both GE experience and success in leading another major company.
The second option is to bring in an outside superstar, an individual with no GE experience. In this case, the individual would have to start from scratch and learn the entire company from the ground up or else just repeat what they know and what has enabled them to succeed.
Regardless of which type of new leadership team were hired, they would all need time. First, they must hire their own staff and determine which of the current GE management and professionals should be kept. Second, they must do a comprehensive, complex business portfolio analysis. Lastly, they must build confidence with all the key stakeholders and try and convert the naysayers, while retaining the key talent already on board.
Immelt is on the right track… so why change?
Changing the management team is always an option, but it is clear it will not improve GE’s profitability any faster. The naysayers may view a change in leadership as better, but it will be a short-lived exuberance. Immelt and his team are already adapting to change and have positioned GE to be more profitable, predictable and successful; it just takes time.
But if, despite Immelt’s best efforts, he fails to deliver the desired results, the next option to consider is the very dramatic step of splitting GE into three—or even four—companies. The current negotiations with Comcast to merge with NBC/Universal to form a new company may be the first step in this process.
Bill Rothschild is CEO of Rothschild Strategies Unlimited LLC and author of “The Secret to GE’s Success” which is in six languages. Steve Rothschild is CEO of EnableDoc LLC, a new venture to mobilize healthcare information and is the co-author of “Putting It All Together- The Process toBecome A Successful Strategic Leader”. Both Bill and Steve have contributed to Chief Executive in the past.