Why GE Doesn’t Deserve The Applause

I’m beginning to sketch out my next book and I can’t figure out how to position GE in it. Even though I’ve written some nice things about GE in prior articles and books, I have a confession to make. I’ve never completely understood the seeming success of GE’s business model, nor its titanic reputation in the business community.You see, GE violates what I and many other experts consider a fundamental tenet of competitive advantage: Companies that are focused on dominating one market, or just a few, select, synergistic markets will perform better than companies which have a presence in numerous and disparate markets. Conglomerates spread their resources and management attention too thin over diverse businesses that often require vastly different sets of customers, value propositions, competencies, infrastructures, technologies, and networks. Research has documented the frequency with which individual companies once buried in conglomerate portfolios performed significantly better once they were divested, a.k.a. liberated from the centralized, standardized, bureaucratic tentacles of corporate conglomerate headquarters. Bear with me on one more paragraph of “acadamese” and then I’ll deal with GE directly (or skip right to the next paragraph). The term “conglomerate discount” applies to the finding that highly diversified companies are, and should be, valued lower than less diversified companies. For example, writing in the International Journal of Theoretical and Applied Finance in 2006, Swiss professors Manuel Ammann and Michael Verhofen note that a conglomerate can be regarded as an investor’s option on a “portfolio of assets” (the companies bundled as one conglomerate package). By splitting up the conglomerate, they point out that the investor now receives a portfolio of “options on assets”; that is, the investor now has specific choices among a variety of assets that used to be part of a bundle but are now separated in the free market. Ammann and Verhofen demonstrate that for investors, the value of a free-market portfolio of options (your carefully determined choices among independent companies for investment purposes) is “always equal to or higher” than the value of simply giving you, the investor, an option on one bundled portfolio, like a conglomerate. Small wonder that conglomerates typically underperform the S & P 500.So both in terms of performance and investment, conglomerates are a lousy bet. And since GE is a conglomerate of widely diverse companies (more on this shortly), why is GE considered the paragon of management? Well, everyone immediately points to the fact that under Jack Welch’s 20 year reign (1981-2001), GE’s market cap grew from $14 billion to $410 billion. True, but why? I suggest that it was because of Welch’s enlightened and pigheaded commitment to downsizing big fat pockets of non-value adding personnel, divesting long-standing poorly performing business units, attacking the company’s history of paralyzing bureaucracy and complacency, violently shaking up a rigid top-down hierarchy, and forcing managers to be accountable to new, aggressive performance standards. The combination of Welch’s unique leadership skills, the wealth of low-hanging company fruit to pick, and the investment community’s embrace of the practice of “managing earnings” during the 1990’s—all led to healthy financials, a rock-star status for Welch, and enthusiastic, transfixed investors (and business writers). But everything’s changed. The low hanging fruit’s been picked, the markets have experienced constant disruption, “managing the earnings” is less tolerated, and global competition has intensified to the point that it’s much much harder to meet the famous Welch standard that every GE business be #1 or #2 in the industry. In fact, check out GE’s returns over the last 50 years and you’ll see that apart from the Welch years, the growth in stock returns has, on average, been modest. Under current CEO Jeff Immelt’s seven year tenure, GE’s stock has plummeted by 30%. I say that it’s all because GE is a conglomerate, and a conglomerate—especially an enormous global $170 billion conglomerate like GE--is much harder to steer towards sustained success in today’s economy, even for someone like Immelt who is arguably a very accomplished business leader. Now I’m sure that Immelt would vehemently object to my analysis. I understand from people who know him that he’s a genial guy, but the quickest way to tick him off to suggest that GE is a conglomerate. From his perspective, GE is something like an intimate union of synergistic teams operating under a common thread of culture and values. Come on, Jeff, cut the crap. GE’s own website cites its market presence in (alphabetical order) appliances, aviation, consumer electronics, energy, finance (individual and business), health care, lighting, media, entertainment, oil, gas, rail, security and water. (By the way, that list doesn’t include the recently divested insurance and plastics businesses). There are so many diverse products and services within that classification that GE has to list them within an “A to Z” list, and that’s just for starters on a general website. So spare me the noble rhetoric about synergy and common culture. GE is a bloody conglomerate! It’s a testament to Immelt and his management team that they’ve actually done a pretty good job of meeting growth and earnings projections while riding such a humongous multi-limbed beast. But the Street isn’t impressed, because investors seek future earnings and cash flow, and regardless of how good Immelt and his team are as leaders, they’re managing (uphill) a massive disparate structure trying to cope with massive disparate markets—and investors are rightfully skeptical. You know what I’d tell Immelt? “Shrink and grow, baby!” Focus on just a very few fast-growth future-oriented markets that you’re already in—like alternative energy, new paradigm aviation engines and personalized medicine—and dump everything else. Okay, keep GE Capital, but shrink it, and dump NBC, dump railroad, dump appliances, dump lightbulbs, just go down the list and keep only the (few) seeds of the future. Trim the company (rather, put it on a crash diet), clean up the balance sheet, liberate a ton of cash for new investment, and focus your leadership skills towards helping GE dominate a few select future-growth sectors with innovation, customization, and scale. What worked for Welch in the ‘80’s and ‘90’s won’t work today. I say: Jeff, if you de-conglomeratize GE, you’ll be a bigger hero than Welch. And, just in case you care, you’ll be a “super hero” in my next book.

The Value of Dominating Underserved Markets

If you want to win a quick bet, ask your friends which car rental company is the biggest in North America. If they say Hertz or Avis, you can smile and shake your head—and pocket your winnings. Then titillate them further and say that this company is the most profitable car rental company too. It’s Enterprise. What’s the secret? Well, first, a genuine institutional commitment to customer service--which yields an exceptional customer loyalty. (As rated by independent players like J.D. Powers and Market Matrix, Enterprise consistently receives the highest customer satisfaction scores in the industry). But the real competitive whammy is that the company’s commitment to service, and its extraordinary growth, has been wrapped around a unique business model. Rather than competing directly against huge powerhouses like Hertz or Avis in airports and hotels, Enterprise grew by building, and dominating, a previously underserved market—in this case the “home city” market. In hindsight, it seems brilliantly obvious how often we need a car in our own town or city—like when our car needs mechanical repair, or is in an accident (or stolen), or when out-of-town relatives come stay in our home and need a car for just a couple days in the middle of their holiday, or when an out-of-town business associate quickly needs a car for a few hours in the middle of the day in order to get to a couple appointments. At that point, a nearby Enterprise office (strategically located, there’s a branch office within 15 miles of 90% of the U.S. population) will send someone to pick you up, provide you with a genuinely positive concierge service, and then after you’re done with the car, drop you off. Enterprise still dominates this lucrative market, and what’s more, the growth of the brand’s customer loyalty became so profound that Enterprise was able to expand cautiously, but profitably, into the big competitors’ airport territory. I thought about Enterprise when I received a note from Bernard Rapoport describing his gala 90th birthday party in Washington D.C. earlier this year. I’ve written about “B” in a couple of my books. Remarkable fellow. Still very active in a variety of ventures, even after retiring ten years ago from the CEO position in the company he started over fifty years ago: American Income Life Insurance. American Income is a billion dollar insurance company has been rated by A.M. Best, one of the country's oldest and most respected insurance ratings company, as A+ (Superior) for overall Financial Strength. But I’ll bet you’ve never heard of American Income. That’s because it doesn’t compete directly against the high-profile behemoth insurance powerhouses across all markets. (Initially, it did, and got creamed before switching direction). The company’s successes are due to the fact that it focuses on providing specialized products and unique services for what used to be an underserved market: lower income working families, labor unions, credit unions, and some professional associations. “Labor” is American Income’s core market, and I remember when I first met “B”, he told me that every employee at American Income is a card-carrying union member—including himself! During his birthday speech, here’s how Bernard Rapoport described the origin of the American Income business model in the early 1950’s: “When I was in New York in the early days, the company wasn’t doing well; it wasn’t growing. I looked up at the skyline and saw all the skyscrapers that belonged to the large companies like Metropolitan Life, Prudential Life, Equitable life, etc. I shook myself and said, 'I can’t compete with those companies. They’re too big! What I’m going to do is I’m going to give the big companies 235 million Americans and I’m going to take 15 million Americans for American Income.' I went to the labor leaders and told them that we were going to be the union company. Everyone in our company would be a union member and from that point on we were exceedingly successful.” What’s the lesson that Enterprise and American Income have learned? Great customer service is a great idea, but its market and financial impacts are logarithmically expanded when that great service is applied to virgin nascent market spaces that you can ultimately dominate. So instead of rabidly competing with everyone else in the same arena for scraps of market share the way hungry dogs fight for a lone piece of meat, always look for those untapped, underserved, potentially lucrative markets—and then commit to doing whatever it takes to grow them, and “own” them.