I've long been a fan of GE. The only company to be on the Dow Jones Industrial Average for more than 100 years. A company that has transitioned through countless businesses, willing to get into and out of many opportunities in order to find ways to keep growing. Buried deep in the heart of this company's operating principles are tools which keep it from becoming too Locked-in. The constant 360 degree evaluations, the demand for results, the willingness to disagree, the acceptance of Disruptions, the investments in White Space. These have done GE well for years, allowing the company to evolve its Identity, Strategy and Tactics.
But recently, GE has been more disappointing. The stock crashed to $6/share earlier in 2009. And now Forbes reports "Accounting Tricks Catch Up With GE". One of the misguided tools of Defend & Extend Managers is using financial machinations – in effect generating profits out of thin air by playing with the accounting rules rather than making and selling something. I talk this through at length in "Create Marketplace Disruption" (FT Press, 2008) because for the CEO of a publicly traded company, it's an easy route to take. By playing with the accounting a business looks better, allowing the CEO to do more of the same instead of more deeply investigating market shifts that jeopardize the future.
I was deeply disappointed to read where GE allowed this to happen. They counted as revenue, and profit, sales of locomotives to financial institutions – rather than end users. And the use of derivatives at GE was an outright D&E practice to try making money on financial investments that weren't so good. I've decried the use of derivatives loudly – even by Warren Buffett – in previous blogs because they are a tool designed to make weak financial practices look better. This isn't what made GE great, but apparently these were the tools of "modern management" current executives used to prop up sales and profits – instead of focusing on the business. And now the SEC has forced GE to pay a fine for its actions.
Investors, employees and vendors need to be very wary of this. It could mark a sea-change in GE. For years, top executives made their mark by developing new businesses that were attuned to shifting markets. Jet engines and NBC are just a couple of huge businesses GE entered as a result of recognizing shifting markets and the huge opportunity being created. And GE has always been quick to pull the trigger on selling a business when a market shift meant the growth was starting to slow.
But now we can see that GE has used financial machinations to make some businesses look better. These kind of D&E actions are telltales of a company slipping from Phoenix Principle actions – which help you grow – into a company that could stall. And growth stalls are deadly. Only 7% of stalled companies every consistently grow at a mere 2% ever again.
So far, we know that these actions have hurt GE pretty badly. Firstly, there's the $50million fine. You may think this is chump change to GE – but it's money that didn't go into developing a new water filtration system, for example, which could make money down the road. Or invested into a new business plan that could turn into something big. Secondly, its use of financial instruments, including derivatives, and the SEC mark has dramatically eroded investor confidence. Like I said, over $150billion in market cap eroded (about 50%) in the last year alone – and that's after a recovery from $6 to nearly $15 per share (chart here).
High performing companies do NOT resort to D&E Management. It's a Siren's song, straight from Homer's travels, to lure the company ship onto the rocky shores. It seems so simple, and it is, to protect the existing business with financial adjustments that make it look better. But reality is that these poor returns indicate the market is shifting, and that action is needed to reconnect with the shifted marketplace. Whenever executives use D&E practices, including financial machinations (even legal ones) to make the business look better they are ignoring market shifts – which undermines the organization's ability to develop new scenarios, understand the impact of emerging competitors, disrupt old practices and develop White Space projects that can help the company move forward and meet market needs.
It was the willingness to resort to D&E Management that started GM on its long path to bankruptcy. Read "The Fall of GM: What Went Wrong and How To Avoid Its Mistakes" for more info on how easy it is to slip into a rut wiping out future returns.