GE’s Complete Leadership Failure

General Electric’s Chairman and CEO Jeffrey Immelt announced last week that his next big step as leader will be to sell off the company’s real estate assets and the balance of its financial services business.  This is a massive $300B asset sale.  It follows the very large spin-off of GE’s retail banking unit as Synchrony Financial in 2014, and the sale of NBC/Universal in 2013.  When it comes to shrinking a company, few CEOs have ever been as successful as Mr. Immelt!

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The money is not going into developing any new markets or new products.  It is not being used to finance growth of GE at all.  Rather, Mr. Immelt will immediately begin a massive $50B stock buyback program in order to prop up the stock price for investors.

Immelt GE WayWhen Mr. Immelt took the job of CEO GE sold for about $40/share.  Last week it was trading for about $25/share.  A decline of 37.5%.  During that same time period the Dow Jones Industrial Average, of which GE is the oldest component, rose from 9,600 to 17,900.  An increase of 86.5%.  This has been a very, very long period of quite unsatisfactory performance for Mr. Immelt.

Prior to Mr. Immelt GE was headed by Jack Welch.  During his tenure at the top of GE the company created more wealth for its investors than any company ever in the recorded history of U.S. publicly traded companies.  GE’s value increased 40-fold (4000%) from 1981 to 2001. He expanded GE into new businesses, often far removed from its industrial manufacturing roots, as market shifts created new opportunities for growing revenues and profits.  From what was mostly a diversified manufacturing company Mr. Welch lead GE into real estate as those assets increased in value, then media as advertising revenues skyrocketed and finally financial services as deregulation opened the market for the greatest returns in banking history.

Jack Welch was the Steve Jobs of his era.  Because he had the foresight to push GE into new markets, create new products and grow the company.  Growth that was so substantial it kept GE constantly in the news, and investors thrilled.

But Mr. Immelt – not so much.  During his tenure GE has not developed any new markets.  He has not led the company into any growth areas.  As the world of portable technology has exploded, making a fortune for Apple and Google investors, GE missed the entire movement into the Internet of Things.  Rather than develop new products building on new technologies in wifi, portability, mobility and social Mr. Immelt’s GE sold the appliance division to Electrolux and spent the $3.3B on stock buybacks.

Mr. Immelt’s tenure has been lacked by a complete lack of vision. Rather than looking ahead and preparing for market shifts, Immelt’s GE has reacted to market changes – usually for the poorer.  Unprepared for things going off-kilter in financial services, the company was rocked by the financial meltdown and was only saved by an infusion from Berkshire Hathaway.  Now it is exiting the business which generates nearly half its profits, claiming it doesn’t want to deal with regulations, rather than figuring out how to make it a more successful enterprise.  After accumulating massive real estate holdings, instead of selling them at the peak in the mid-2000s it is now exiting as fast as possible in a recovering economy – to let the fund managers capture gains from improving real estate.

GE is now repatriating some $36B in foreign profits, on which it will pay $6B in taxes.  Investors should realize this is happening at the strongest value of the dollar since Mr. Immelt took office.  If GE needed these funds, which have been in offshore currencies such as the Euro, it could have repatriated them anytime in the last 3 years and those funds would have been $50B instead of $36B!  To say the timing of this transaction could not have been poorer ….

The only thing into which Mr. Immelt has invested has been GE stock.  And even that has been a lousy spend, as the price has gone down rather than up!   Smart investors have realized that there is no growth in Immelt’s GE, and they have dumped the stock faster than he could buy it.  Mr. Immelt’s Harvard MBA gave him insight to financial engineering, but unfortunately not how to lead and grow a major corporation.  After 15 years Immelt will leave GE a much smaller, and as he said in the press release, “simpler” business.  Apparently it was too big and complicated for him to run.

In the GE statement Mr. Immelt states “This is a major step in our strategy to focus GE around its competitive advantage.”  Sorry Mr. Immelt, but that is not a strategy.  Identifying growing markets and technologies to create strong, high profit positions with long-term returns is a strategy.  Using vague MBA-esque language to hide what is an obvious effort at salvaging a collapsing stock price for another 2 years has nothing to do with strategy.  It is a financial tactic.

The Immelt era is the story of a GE which has reacted to events, rather than lead them.  Where Steve Jobs took a broken, floundering company and used vision to guide it to great wealth, and Jack Welch used vision to build one of the world’s most resilient and strong corporations, Jeffrey Immelt and his team were overtaken by events at almost every turn.  CEO Immelt took what was perhaps the leading corporation of the last century and will leave it in dire shape, lacking a plan for re-establishing its once great heritage.  It is a story of utterly failed leadership.

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Hostess’ Twinkie Defense Is a Failure

Hostess Brands filed for liquidation this week.  Management blamed its workforce for the failure.  That is straightforward scapegoating.

In 1978 Dan White killed San Francisco's mayor George Moscone and city supervisor Harvey Milk.  The press labeled his defense the "Twinkie Defense" because he claimed eating sugary junk food – like Twinkies – caused diminished capacity.  Amazingly the jury bought it, and convicted him of manslaughter instead of murder saying he really wasn't responsible for his own actions.  An outraged city rioted.

Nobody is rioting, but management's claim that unions caused Hostess failure is just as outrageous. 

Founded in 1930 as Interstate Bakeries Co. (IBC) the company did fine for years. But changing consumer tastes, including nutrition desires, changed how much Wonder Bread, Twinkies, HoHos and Honey Buns people would buy — and most especially affected the price – which was wholly unable to keep up with inflation. This trend was clear in the early 1980s, as prices were stagnant and margins kept declining due to higher costs for grain and petroleum to fuel the country's largest truck fleet delivering daily baked goods to grocers.

IBC kept focusing on operating improvements and better fleet optimization to control rising costs, but the company was unwilling to do anything about the product line.  To keep funding lower margins the company added debt, piling on $450M by 2004 when forced to file bankruptcy due to its inability to pay bills.  For 5 years financial engineers from consultancies and investment banks worked to find a way out of bankruptcy, and settled on adding even MORE debt, so that – perversely – in 2009 the renamed Hostess had $670M of debt – at least 2/3 the total asset value!

Since then, still trying to sell the same products, margins continued declining.  Hostess lost a combined $250M over the last 3 years. 

The obvious problem is leadership kept trying to sell the same products, using roughly the same business model, long, long, long after the products had become irrelevant.  "Demand was never an issue" a company spokesman said.  Yes, people bought Twinkies but NOT at a price which would cover costs (including debt service) and return a profit. 

In a last, desperate effort to keep the outdated model alive management decided the answer was another bankruptcy filing, and to take draconian cuts to wages and benefits.  This is tanatamount to management saying to those who sell wheat they expect to buy flour at 2/3 the market price – or to petroleum companies they expect to buy gasoline for $2.25/gallon.  Labor, like other suppliers, has a "market rate."  That management was unable to run a company which could pay the market rate for its labor is not the fault of the union.

By constantly trying to defend and extend its old business, leadership at Hostess killed the company.  But not realizing changing trends in foods made their products irrelevant – if not obsolete – and not changing Hostess leaders allowed margins to disintegrate.  Rather than developing new products which would be more marketable, priced for higher margin and provide growth that covered all costs Hostess leadership kept trying to financial engineer a solution to make their horse and buggy competitive with automobiles. 

And when they failed, management decided to scapegoat someone else.  Maybe eating too many Twinkies made the do it.  It's a Wonder the Ding Dongs running the company kept this Honey Bun alive by convincing HoHos to loan it money!  Blaming the unions is simply an inability of management to take responsibility for a complete failure to understand the marketplace, trends and the absolute requirement for new products.

We see this Twinkie Defense of businesses everywhere.  Sears has 23 consecutive quarters of declining same-store sales – but leadership blames everyone but themselves for not recognizing the shifting retail market and adjusting effectively. McDonald's returns to declining sales – a situation they were in 9 years ago – as the long-term trend to healthier eating in more stylish locations progresses; but the blame is not on management for missing the trend while constantly working to defend and extend the old business with actions like taking a slice of cheese off the 99cent burger.  Tribune completey misses the shift to on-line news as it tries to defend & extend its print business, but leadership, before and afater Mr. Zell invested, refuses to say they simply missed the trend and let competitors make Tribune obsolete and unable to cover costs. 

Businesses can adapt to trends.  It is possible to stop the never-ending chase for lower costs and better efficiency and instead invest in new products that meet emerging needs at higher margins.  Like the famous turnarounds at IBM and Apple, it is possible for leadership to change the company. 

But for too many leadership teams, it's a lot easier to blame it on the Twinkies.  Unfortunately, when that happens everyone loses.

 

Paid to fire! Why CEO compensation is all wrong


Since Craig Dubow took over as Gannett's CEO in 2005, Gannettblog reports that employment at the company has dropped from 52,600 to 32, 600.  So 20,000 employees, or nearly 1 in 3, have disappeared.

  • 2006 – 49,675 down 6%
  • 2007 – 46,100 down 7%
  • 2008 – 41,500 down 10%
  • 2009 – 35,000 down 16%
  • 2010 – 32,600 down 7%

Doesn't this look like dismantling the company? It is undoubtedly true that people are reading fewer newspapers than they did in 2000.  But that fact does not mean Gannett has to head toward the whirlpool of failure, slowly cutting itself into a less relevant organization.  There are a plethora of opportunities today – from creating a vital on-line news organization such as Huffington Post to moving into on-line news dissemination like Marketwatch.com to digital publishing like Amazon and its Kindle, to wholesale news distribution like the Apple iPad to on-line merchandising and ad distribution like Groupon, to —- well, let's just say that there are a lot of opportunities today to grow.  To it's credit, Gannett owns 51% of CareerBuilder.com (who's employees are all included in the above numbers).  But that one investment has been, as shown, insufficient to keep Gannett a vital, growing organization.  At this rate, when will Gannett have to stop printing those hotel newspapers?

Yet, the CEO was paid $4.7M in 2009, including a cash bonus of $1.45M for implementing cost cuts.  And that's what's quite wrong with CEO compensation America. And the problem, compensating CEOs for shrinking the company, has an enormous impact on American economic (and jobs) growth. 

It is NOT hard to cut jobs.  In fact, it is probably the easiest thing any executive can do.  CEOs can simply order across the board cuts, or they can hand out downsizing requirements by function or business line.  It's the one thing any executive can do that is guaranteed to give an improvement to the bottom line.  Any newly minted 20-something MBA can dissect a P&L and identify headcount reductions.  Anyone can fire salespeople, engineers, accountants or admins and declare that a victory.  There are lots of ways to cut headcount costs, and the immediate revenue impact is rarely obvious. So, why would we pay a bonus for such behavior? 

You can imagine the presentation the CEO gives the Board of Directors. "Our industry is doing poorly in this economy.  Revenues have declined.  But I moved quickly, and slashed xx,xxx jobs in order to save the P&L.  As a result we preserved earnings for the next 2 years.  Because of revenue declines our stock has been punished, so I recommend we take 50% (or more) of the cash saved from the headcount reductions and buy our own company stock in order to prop up the price/earnings multiple.  That way we can protect ourselves from raiders in the short term, and continue to report higher earnings per share next year (there will be fewer shares – so even if earnings wane we keep up EPS), despite the terrible industry conditions."

Oh, by the way, because the CEO's compensation is tied to profits and EPS, he is now entitled to a big, fat bonus for this behavior.  And, as Brenda Barnes did at Sara Lee, this can happen for several years in a row, leading to the company's collapse.  As the company becomes smaller and smaller, its overall value declines, even if the EPS remains protected, until some vulture – either another company, private equity firm or hedge fund-  buys the thing.  The investors lose as value goes nowhere, employees lose as bonuses, benefits, pay and jobs are slashed, and vendors lose as revenues decline and price concessions become merciless.  The community, state and nation lose as jobs and taxes disappear in the revenue decline. The only winner?  The CEO – and any other top executives who are compensated on profits and EPS.

When a company grows, compensating profits is not a bad thing.  But when a company isn't growing, well, as seen at Gannett, the incentives create perverse behavior.  CEOs take the easy, and personally rewarding route of cutting costs, escalating the downward spiral. Without growth, you got nothing.  So why isn't there a simple binary switch; if the CEO didn't grow revenues, the CEO doesn't get any bonus?  Regardless.

"What about industry conditions?" you might ask.  Well, isn't it the CEO's job to be foresightful about industry conditions and move the company into growth industries, rather than staying too long in poorly performing industries? CEOs aren't supposed to manage a slow death. Aren't they are supposed to lead vibrant, vital, growing companies that increase returns for investors, employees and suppliers?

"What about divestitures?  What if the CEO sold a business at a huge multiple making an enormous profit?" Good move!  Making the most of value is a good thing!  But, once the sale is complete, isn't the critical question "What are you going to do with that money now?"  If the CEO can't demonstrate the ability to invest in additional, replacement revenues that have a higher growth rate then shouldn't that money all be given to investors so they can invest it in something that will grow (rather than in buying company stock, for example, which just gets us back to the smaller company but higher EPS discussion above)?  CEOs aren't investment bankers, who earn a bonus based upon buying and selling assets at a profit.  Investment bankers can earn a bonus on transactions, but that's not the CEOs role, is it?  Isn't the CEO is chartered with building a growing, profitable company.

Look at the CEOs of the Dow Jones Industrial companies.  How many of them are compensated only if their company grows?  As growth in these companies has floundered the last decade, how many CEOs continued to receive multi-million dollar compensation payouts? 

If we want to grow the economy, we have to grow the companies in the economy.  And if we want to grow companies, we have to align compensation.  Rewarding shrinkage seems to have an obvious problem.

 

Value creating CEO – Steve Jobs, Innovation and Apple

$150billion.  That's a lot of money.  And that's how much shareholder value has increased at Apple since Steve Jobs returned as CEO.  Can you think of any other CEO that has aided shareholder wealth so much?  Do any of the cost cutting CEOs in manufacturing companies, financial services firms, or media companies see their share prices rising like Apple's? 

Fortune has declared this "The Decade of Steve" in its latest publication at Money.CNN.com.  Such over-the-top statements are by nature intended to sell magazines (or draw page hits).  But the writer makes the valid point that very few leaders impact their industry like Apple has the computer industry, under Jobs leadership (but not under other leaders.)  Yet, under his leadership Apple has also had a dramatic impact on the restructuring of two other industriesmusic and mobile phones/computing.  And a company Mr. Jobs founded, Pixar, had a major impact on restructuring the movie business (Pixar was sold to Disney, and has played a significant role in the value increase of that company.)  So with Mr. Jobs as leader, no less than 4 industries have been dramatically changed – and huge value created for shareholders.

No cost-cutting CEO, no "focus on the core" CEO, no "execution" CEO can claim to have made the kind of industry changes that have occurred through businesses led by Steve Jobs.  And none of those CEO profiles can say they have created the shareholder value Mr. Jobs has created.  Not even Bill Gates or Steve Ballmer can claim to have added any value this decade – as Microsoft's value is now less than it was when the millenia turned.  Despite the relative size difference between the market for PCs and Macs (about 10 to 1) today Apple has more cash and marketable securities than the entire value of the historically supply-chain driven Dell Corporation.

Mr. Jobs is constantly pushing his organization to focus on the future, about what the markets will want, rather than the past and what the company has made.  It was a decade ago that Apple created its "digital lifestyle" scenario of the future, which opened Apple's organization to being much more than Macs.  Jobs obsesses about competitors and forces his employees to do the same, to make sure Apple doesn't grow complacent  he pushes all products to have leading edge components.  Mr. Jobs embraces Disruption, doesn't fear seeing it in his company, doesn't mind it amongst his people, and works to create it in his markets.  And he makes sure Apple constantly keeps White Space projects open and working to see what works with customers – testing and trying new things all the time in the marketplace.

Following these practices, Apple pulled itself away from the Whirlpool and returned to the Rapids of Growth.  Almost bankrupt, it wasn't financial re-engineering that saved Apple it was launching new products that met emerging needs.  Apple showed any company can turn itself around if it follows the right steps.

As companies are struggling with value, people should look to Apple (and Google).  Value is not created by cost cutting and waiting for the recession to end.  Value is created by seeking innovations and creating an organization that can implement them. Especially Disruptive ones.  Whether he's the CEO of the decade or not I can't answer.  But saying he's one heck of a good role model for what leaders should be doing to create value in their companies is undoubtfully true.