Last week, General Electric cut its dividend in half. This was big news for investors because GE was one of the original companies in the NYSE and has been a reliable revenue generator. The news caused GE‘s stock price to sharply drop and now its new Chairman, John Flannery is firing half of its board of directors.
GE was forced to cut its dividend because, as a recent article in CNN Money points out:
“this giant company no longer generates enough money to pay for investments in the business and dividends for shareholders. The [cash] crunch has been years in the making, but only recently has Wall Street come to grips with how bad it is.”
How did Wall Street miss that the bellwether company had been faltering for 16 years? And why couldn’t GE change its behavior quickly enough to keep the money flowing?
The answer to both questions lies in three widely-touted and widely-accepted “strengths” of GE that emerged from the Jack Welch years (1981 to 2001) but which, going forward, were in fact profound weaknesses.
Jack Welch, GE’s CEO from 1981 to 2001, famously declared that GE would only stay in markets where it held the #1 or #2 market share. Wall Street and the business press have long accepted the wisdom of this approach, under the thinking that only the largest competitors can achieve the economies of scale required to put smaller competitors out of business.
The problem with trying to #1 or #2 in any given market is that the entire concept of market share depends upon how you define the market, which is always arbitrary. Is it total sales of a product category? If so, what do you include in that product category and what do you omit? Do you segment that category by revenue, profit, geography or unit sales?
Because market definitions are arbitrary, corporate investment decisions based on them tend to reflect not whether the company can make money with a certain product or service but instead internal turf wars over which definition of the market is valid.
Politically-based market definition (and the consequent attempt to be #1 or #2 in an arbitrarily-defined market) tends to blind a company to what’s really going on until it’s too late to do anything about it.
2. Growth Through Acquisition
Conventional wisdom is that the easiest way to become #1 or #2 in a “market” is to buy your way into it. However, if your definition of the “market” is skewed or obsolete, such acquisitions are doomed to failure.
For example, GE apparently defines the “power generation” business as the burning of fossil fuels. This is not, by itself, irrational since in the U.S. most power is generated through the burning of fossil fuels. However, that definition of power generation misses what’s really going on, which is the rapid growth (worldwide but not the U.S., alas) of renewable energy.
Based upon its obsolete market definition, in 2015 GE purchased Alstrom, a company that made turbines for coal-burning power plants, for a record breaking (for GE) $9.5 billion. This was a spectacularly dumb investment, as CNN money pointed out:
“For GE, the deal represented a doubling down on fossil fuels, even as renewable sources of energy, like solar, were gaining popularity. Not surprisingly, GE admitted this week that Alstom has been a major disappointment, and that its power business is in shambles.”
Even when acquisitions aren’t based upon flawed market definitions, they’re damned difficult to pull off. According to the Harvard Business Review between 70% and 90% of all mergers and acquisitions fail. Unless a company is superb at absorbing other corporate cultures (and GE by all accounts wasn’t and isn’t), a “growth through acquisition” strategy is really stupid.
Welch and GE were also famous–and widely praised by Wall Street and the business press–for its implementation of “stack-ranking”–a management philosophy that you can consistently improve overall performance by firing the “bottom 10%” of the managers and employees in the company.
I put “bottom 10%” in quotes because, as with market share, there are “x” number of ways to measure managers. Because of this, implementing this management philosophy (aka “stack-ranking”) involves political turf wars to determine the metrics by which the “bottom” is determined.
Regardless of metrics, stack-ranking is a morale disaster. At Microsoft, for example, it drove managers and executives to sacrifice valuable team members to meet arbitrary firing quotas. Similarly, at Amazon, stack-ranking encouraged employees to secretly rat each other out, much like citizens in communist dictatorships.
While Forbes in 2012 held up GE as the exception to the rule that stack-ranking sucks, it’s highly likely that the harshness of the practice was one reason, perhaps the primary reason, that GE was so lousy at M&A. Much of what you buy with an acquisition is talent and talented people can find a job elsewhere when confronted with a Machiavellian culture.
In short, while Jack Welch may have fueled GE’s rapid growth at the end of the 20th century, the culture he created contained the seeds of its own decline.