The Bear’s Lair: Neutron bomb on Neutron Jack’s legacy

Fifty years ago, we all knew what home life would be like in the 21st Century – the Jetsons (admittedly set in 2062) showed us that it would include robot maids taking away the drudgery of cleaning, cooking and dishes. Yet somehow that future never arrived, or at least it hasn’t yet. I would suggest that GE’s concurrent decisions in the 1980s to bulk up its financial services arm and sharply reduce its research and development funding bear a great deal of responsibility for that. Thus GE CEO Jeff Immelt’s decision last week to divest most of GE Capital may lead us back to the Promised Land of a Jetsons world.

As of fifty years ago, GE was the largest manufacturer of all kinds of consumer appliances, with a massive research and development operation aimed at dominating the company’s markets far into the future. Thus robot appliances were certainly on the menu of possible future GE products, though in 1965 the technology for such ventures was not there.

Nevertheless, there can be no question that in the 1980s and 1990s, with GE’s R&D operation behind them, its robot appliance businesses would have made the massive conceptual strides necessary, particularly in the application of control technology to mechanical operations, to produce GE household robots of a very high sophistication by 2015. Instead, in spite of the best efforts of the modestly sized iRobot Corporation with its Roomba line of robot vacuum cleaners, we are nowhere near the goal of relieving domestic drudgery.

The drastic reduction of GE’s research and development capability, and its foray into financial services, were largely the work of its 1981-2001 CEO “Neutron Jack” Welch, so called because of his ability to fire all the staff within a facility and leave its real estate available for successful and profitable redeployment.

Welch was named “Manager of the Century” by Fortune in 1999, but for an award relating to a period that contained Henry Ford, Alfred P. Sloan, the Watsons of IBM and Lee Iacocca it’s very difficult to see why. He focused his attention entirely on return on investment, divesting and acquiring businesses relying on this short-termist criterion with little thought as to their strategic relevance for GE’s long-term future. He claimed to judge businesses depending on whether they could be first or second in their category, but of course this was PR hype to justify his maneuvers. In reality his relentless acquisitions appear to have been driven by his own ego and short-term profit considerations rather than by any such relatively rational criterion.

His financial service acquisitions, above all, were relentlessly short-termist. GE Capital at no point became first or second in the financial services business, nor was it likely to do so, being matched against behemoths like Citigroup and J.P. Morgan Chase. GE Capital developed dominance in certain limited areas of business such as leasing, where it had a comparative advantage because of its sister companies’ businesses and GE’s low cost of capital as a AAA-rated credit (until 2008). However it was never able to acquire the market share to make mainstream consumer finance anything but a me-too business, while in terms of innovation it was always following the leaders in such areas as derivatives and risk management.

GE Capital also notoriously suffered from the problem of dependence on wholesale funding, so when in 2008 its commercial paper was impossible to roll over, Immelt was forced to undertake the classic last refuge of a crony capitalist and call Treasury Secretary Hank Paulson for a bailout. Thus the theory that GE’s balance sheet would bail out GE Capital was proved to be bunk, and the unit (other than its function as a GE sales finance vehicle) was proved to be superfluous. It is extraordinary that it has taken over six years for Immelt to realize this, but I suppose in his own defense he could claim that prices available for junk financial assets are now higher than they have been since the 2008 crash or are ever likely to be again.

The central flaws in Welch’s approach to GE were demonstrated in his 1986 acquisition of RCA, with its subsidiaries NBC and Kidder Peabody. NBC was indeed in first place amongst broadcast networks briefly in the 1985-86 season before Welch bought it, a fact that no doubt featured prominently in the GE binders recommending the acquisition, but it quickly dropped back to its accustomed third place under GE ownership, since GE was culturally a poor fit with the prima-donnas of TV-land.

In any case, and much more crucially, broadcast networks were just beginning a drastic decline in their market share of TV viewership, losing ground first to cable channels and in the longer run to Internet video. A truly capable management, alive to long-term developments in the industry in which they were about to invest, would have spotted this highly adverse long-term trend, the beginnings of which were already apparent. However Welch’s people counted only the beans, and appear to have been incapable of this type of coherent strategic thought.

As for Kidder Peabody, that had not been No.1 or 2 in its industry since at latest the 1929 crash. As with NBC, long-term trends were decimating the independent Wall Street brokers, which were nowhere near large enough to play a significant role in the globalized financial sector. Essentially, an independent broker such as Kidders had the same problems as a London merchant bank, only without the same level of integrity.

It is notable that Kidders ran into the same trading problem in 1993 with Joseph Jett that Barings was to run into with Nick Leeson two years later, and with the same result: its exit from the business. You may however think that the ground-glass-chewing Welch and the Harvard MBA Mike Carpenter who he had running Kidders had far less excuse to be deluded by a junior trader than did the languid, beautifully-mannered aristocrats who ran Barings. At least Barings gave you a damn good lunch when you visited them, whereas visitors to Welch’s headquarters no doubt left with indigestion.

Regrettably, GE’s bad habits did not all end with Welch’s expensive departure. The company had got into trouble with crony capitalism back in 1960, when several of its top executives were jailed for price fixing. However a much more egregious example occurred in December 2007, when its lobbyists persuaded Congress to outlaw the incandescent lightbulb, albeit over a period of years.

GE presumably believed at that time that mandating impossible energy standards for the incandescent lightbulb would force consumers into CFL lightbulbs, in which it had available production capacity and a potentially dominant market position, thus hugely increasing revenues and profits in its lightbulb activities. However the CFL lightbulb, apart from being several times the price of an incandescent lightbulb, was a thoroughly inferior product. It claimed a much longer lifespan than the incandescent lightbulb, but frequent manufacturing defects shortened its average lifespan far below that claimed. Its light was considerably dimmer than that rated, and came on very slowly, leaving the owner in near-darkness for half a minute or so.

Most important, it contained significant amounts of toxic mercury. This wasn’t a real danger in itself (we used to drink the stuff in school chemistry lab, back when Men were Men and Teenage Boys were Teenage Boys.) However it laid householders open to harassment by environmentalist local authority officials, who could impose lengthy rigmaroles for CFL lightbulbs’ disposal, and impose fines or worse on those with better things to do than comply with them.

GE’s 2007 cronyism has not benefited it, because technical advance, the free market’s solution to all problems, has come to the aid of householders wanting a lightbulb that combated global warming, gave an adequate light and above all, didn’t need changing so often – in the form of today’s LED bulbs, now costing around $20. With a rated lifespan of 25,000 hours (doubtless overstated, but we won’t know for several years unless it is VERY overstated) they almost remove the problem of frequent lightbulb changing, a real annoyance for the middle-aged and un-athletic with the majority of their light sockets in the ceiling.

Had GE refrained from using its political clout in 2007, and worked on LED technology instead of pushing the inferior CFL product, it would today be dominating a business with much higher initial sales (albeit relatively little repeat business.) Instead younger, nimbler companies have gained substantial market shares in LED lightbulbs, and it is by no means clear that GE can win back its old dominance.

There is a huge gap in today’s corporate ecosystem, for a large manufacturing and engineering company that does not reward its management for endlessly playing capital markets games with the company’s assets and for focusing on short term blips in the share price instead of long-term value maximization. The missing company would have a world class R&D operation, like GE’s before Welch, or Bell Labs (which invented the transistor), or IBM’s under the Watsons (where Benoit Mandelbrot existed happily and productively for 35 years) – or indeed like Xerox’s PARC labs of the 1970s (which invented the mouse and the basics of Windows). Obviously placing the lab 3,000 miles from headquarters was asking for trouble, since Xerox failed to benefit much from PARC, but radically downsizing the R&D operation, as Welch did in the 1980s and as Ginni Rometty appears to be doing now at IBM, is a huge long-term mistake.

Maybe GE, as a corporation, has learned its lesson. In which case, I trust we can look forward, within the next decade or so, to some really useful and life-enhancing household robots!

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)