Tag: Jack Welch

This was the house that Jack built

GE Logo

This week’s news that GE is to demerge into separate energy, healthcare and aviation businesses follows the disposal of GE Capital Aviation Services in March that finally completed the dismantling of GE Capital, finalises the implosion of the business led by Jack Welch between 1981 and 2001.

Shares in GE jumped by more that 10% on the news, suggesting that, even at this stage in the disaggregation of the conglomerate’s activities, owners of GE stock took the view that the corporate entity sitting above the various businesses was destroying over $10 billion in value. To this measure of the destruction of value by the corporate parent of the underlying businesses should be added the $7 billion paid in fees to Wall Street investment banks since 2000, of which $2.3 billion related to M&A advice and $3.3 billion to fees related to bonds (not unconnected to the parent company’s top executives about the corporate structure).

The FT staff’s covering story commented that “investors welcomed the move, which will make it easier for them to decide which of the businesses they want to back.”  We have moved a long way from the 1970s and 1980s approach to corporate strategy captured by the BCG 4 box matrix with its Stars, Dogs, Cash Cows and Problem Children and the idea that at a corporation could create value by shifting resources between the business in these quadrants.  Jack Welch’s GE, aided by McKinsey, used a 9 box matrix, but the essence was the same.

The FT’s Brooke Masters has written a first class piece reflecting on the conglomerate cycle.[1]  She cites the LSE’s Alexander Pepper: “It becomes the conventional wisdom conglomerates are no good and need to be broken up.  Then we end up with companies that are so specialised that somebody decides that there is merit in vertical and horizontal integration.  Ten years later you end up with a conglomerate”.  Brooke Masters further observes that “the conglomerate’s resurgent appeal lies in the normal ambition to improve couple with a hubristic assumption that good managers can manage anything.  Entering new business lines seems attractive new business lines seems attractive when competition rules prevent dominance in a single sector.  Cynics note that chief executive pay and influence expands with company size.”[2]

The Escondido Framework approach to the conglomerate is to think of the corporate centre as a business in itself, distinct from the portfolio of businesses that it manages.  Jack Welch’s GE was in the business of managing a portfolio of activities, allocating capital, buying and selling business according to a number of guiding principles (such as only buying or selling businesses that could demonstrate that they were number one or two – generally on the basis of market share – in their sector), and rolling out some common approaches (such as 6 Sigma quality) to management across the businesses it owns.  How businesses in the portfolio created value themselves for their stakeholders and wider society was incidental.  Jack Welch’s GE, the corporate centre of the corporation that bore the GE name, has long since failed to meet the test for an organisation to survive, that it should create value for those with whom it interacts above and beyond what is delivered by markets.

[1] FT 10th November 2021

[2] A number of these features apply equally in public sector organisations, not least in the NHS where I spend much of my professional time.

The dumbest idea in the world?

In an article in today’s FT Michael Skapinker describes how the debate around shareholder value is turning. He notes that Richard Lambert, his former boss now at the CBI, has suggested that the era “Jack Welch capitalism” – the elevation of shareholder value – was drawing to a close, but that the celebrated Jack had marked this himself last year when described shareholder value as “the dumbest idea in the world”, adding that “Shareholder value is a result, not a strategy … Your main constituencies are your employees, your customers and your products.”

Skapinker notes that Unilever’s chief executive, Paul Polman, has recently said the said same to the FT: “I do not work for the shareholder, to be honest; I work for the consumer, the customer. I discovered a long time ago that if I focus on … the long term to improve the lives of consumers and customers all over the world, the business results will come.”

Skapinker’s own observation on these comments, and what has been going wrong, are worth repeating in full:

“I am sure these leaders did not mean shareholders did not matter; rather that they were best served by businesses that performed well over the years. That meant selling goods and services to customers who were happy to come back, and employing staff committed enough to encourage them to do so. Doing that, and doing it profitably, would, over the years, be reflected in the share price.

“The problem has been the rise of shareholders who are not prepared to wait years, but who want a return now, so that they can sell their shares and repeat the trick elsewhere.”

He observes that the focus on shareholder value has resulted in the design of the executive remuneration packages that were designed to address the “agency problem” and to encourage them to do what was best for shareholders. However, any scheme designed to reward a manager will reflect the relatively short time horizon of the individual – unlikely to be in post for more than ten years and probably a great deal less, so in due course retired and on their way to satisfying Keynes’s “long-run” condition. In contrast, companies or, for that matter, their investors, particularly institutions like pension funds and life insurance companies have very long term, even unbounded, time horizons. It is also worth reflecting on the time that it can take to create a great corporation – building a Unilever, a GE, a McKinsey or BCG, one of the great universities, or even one of the sustainable technology companies (Microsoft is now 45 years old and Apple 44 years old), is a matter of generations.

The second issue that Skapinker refers to is interesting.  It is hard to see a moral argument for the promiscuous shareholder who trades shares on short term price movements having pre-eminence over the other constituencies (to use Jack Welch’s terminology). With well-developed equity markets, the investor has a far more fungible stake in the company than most employees, suppliers or customers. However, there are parallel issues to executive pay in the rewards in the fund management industry. Many fund management remuneration packages encourage short term trading rather than long term active engagement with investee companies. This is despite mounting evidence (probably best illustrated by the success of an even more iconic figure than Jack Welch – one Warren Buffet, sage of Omaha) for the superiority of long term investment strategies over playing short term market movements.

Skapinker completes his challenge to the primacy of shareholders by observing that “it is the customers who provide the revenue, the employees who produce the goods and services and society that tolerates the company’s presence. It is hard to reward one when the others suffer.”