GE's Fall, From Hubris Of Neutron Jack To Now, Is Warning To Conglomerates, Including Today's Big Tech
GE is by no means the last of the T-Rexes waiting to be put out to grass.
It is a warning not only to industrial era dinosaurs, but also the rising Tech Godzillas.
The announcement by GE (formerly General Electric), an industrial era behemoth, that it will split into three companies in order to save itself from oblivion is yet another wake-up call for conglomerates the world over. Their heyday is over.
GE’s three businesses will be aviation, healthcare and energy, though the actual spinoffs and demergers may take three or four years to execute. For a company that was started by inventor Thomas Edison and taken to the pinnacle of glory by its iconic CEO Jack Welch (“Neutron Jack”), who reigned for 20 years till 2001, it is surprising that it learned few lessons from what was happening all around it.
Throughout the tenure of Welch, even as other conglomerates were breaking up (AT&T) or being broken up (for anti-trust reasons), he took the company in the opposite direction, adding unrelated businesses ranging from finance to media and appliances. It was left to his hapless successors, from Jeffrey Immelt, who succeeded him, to the current CEO Lawrence Culp, to reverse the process. The delay in arriving at this Eureka moment has helped the company destroy several hundred billion dollars of investor wealth (Read more about GE’s past follies here, here and here, though some of it may be paywalled).
“By creating three industry-leading, global public companies, each can benefit from greater focus, tailored capital allocation, and strategic flexibility to drive long-term growth and value for customers, investors, and employees,” Culp said in a statement, adding: “I think as we’ve seen in so many instances outside of GE over the last decade, spinning good business heightens focus and accountability.”
The question is: if this was known for more than a decade, what took GE so long to do the right thing? Hubris? An unwillingness to admit it was wrong all along?
Before we get into details, let us sum up what needs to be coded into every corporate DNA, and this includes today’s high-flying Big Tech (Amazon, Apple, Facebook, Microsoft, Google), three of which have crossed $2 trillion in valuations and could hit $3 trillion.
First, conglomerates cannot ultimately deliver. While they may continue to exist in some form or the other, the resultant lack of focus and inability to allocate capital correctly by understanding risks correctly will ultimately either force them to split, or deliver sub-optimal returns to shareholders.
Second, no CEO or visionary founder can endlessly deliver returns far above normal. This does not mean leadership does not matter (it does), but success depends on many more factors, including the sector you are in, the business cycles you have to face, and the kind of disruption you will encounter from competitors who don’t initially look like competitors (example: camera companies versus smartphone companies). Jack Welch delivered high returns during his tenure primarily because he was in the right businesses in the right place. Once these conditions changed, his successors were left to clean up his mess. Now, they will preside over GE’s dissolution.
Third, too much cash from current operations leads to misallocation of capital, since they burn a hole in a company’s pockets, prompting its directors and CEO to take more risks in newer businesses. This happened in GE at the time of Neutron Jack, and it is happening right now in Big Tech. They too are not immune from conglomerate thinking – or insulated from their failures. America’s trustbusters would be doing them a favour by breaking them up before they can commit hara kiri. Over the next decade, their demerged progeny will collectively be valued at more than the mother ships, even assuming some of them fail in the process.
The historical reasons why businesses preferred to become conglomerates are the following:
#1: Stability. Conglomerates are like diversified mutual funds. They bring revenue stability and reduce overall risks, thus allowing a company to survive business cycles and adverse developments.
#2: Ability to angel fund new ideas. When businesses were largely controlled by families (which is the case even now in India), conglomerates allowed the cash-generating parts of the main business to fund the capital requirements of new businesses which some of the scions in a family may want to start. Getting families to stay together means helping some of its members to launch out on their own, and cushion their fall when needed.
#3: Tax efficiency. In countries with wayward and multi-point product tax systems (which was the case in India before the advent of the goods and services tax or GST), housing upstream and downstream units under the same company helped limit the overall incidence of indirect taxes. Reliance is a textbook case, where it made everything from oil to petrochemicals to petro-products to textiles under one roof till recently. But after GST, when taxes are being rationalised, it no longer matters if Reliance is an exploration company, a refining company, a petrochemicals complex a telecom company or a retailer. The savings on duties are no longer enough to outweigh the benefits of focus and strategy. Not surprisingly, Reliance is rapidly separating its oil-to-chemicals (O2C), telecom and retail businesses. The ultimate logic is demerger, with the rump Reliance becoming a holding company with lower valuations.
Today, in the age of “superabundant capital” (to use a Bain & Co term), it is entirely possible for any good business to attract capital from venture capitalists and other wealthy investors. Thus, the need for conglomerates to generate cash-flows to fund new businesses is even lower than before.
Next, since the global investor base is so large, companies which can’t focus on specific businesses will get lower valuations than peers with better focus. A conglomerate or multi-business enterprise will always be valued at a discount to the sum of its parts.
Even companies with focus – say, an Infosys or a Tata Consultancy Services (TCS) – will need to better utilise capital surpluses. When India did not have good coders, it made sense for Infosys and TCS to build huge campuses and hostel/hospitality infrastructure, not to speak of glitzy corporate offices to attract, upskill and house new talent and impress customers. Today, these investments may well be a drag on these companies. They would be more agile if they sold off parts of their campuses to other businesses, and improved returns on capital employed. Neither Infy nor TCS needs to run hotels and coding schools; they can do so by investing in companies that can do this with more focus and efficiency.
In fact, this is exactly what their customers are doing. From DaimlerChrysler to Vanguard, with whom Infosys announced a partnership, and Deutsche Bank and Pramerica in the case of TCS, software development deals now include the transfer of employees from customers to service providers. Isn’t this what Infosys and TCS should also be doing in non-core areas of costs in order to boost capital efficiencies?
GE is by no means the last of the T-Rexes waiting to be put out to grass. Many more exist, especially in the tech field, which is currently surplussing lots of cash. One becomes a conglomerate primarily because there is too much cash gurgling through the till. It makes CEOs believe that they can get away with anything, that they have the Midas touch. But the cash can gurgle down the drain just as fast if capital is misallocated, as GE found out to its cost. It is a warning not only to industrial era dinosaurs, but also the rising Tech Godzillas.
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