The Bear’s Lair: Welch destroyed Sloan’s Century

Jack Welch, former GE Chairman (1981-2000) who died last week, was named “Manager of the Century” by Fortune magazine in 1999. Twenty years later, we can see clearly that the Manager of the 20th century was not Welch but Alfred P. Sloan, CEO and then Chairman of General Motors (1920-1963). Welch’s main achievement was destroying the management model that Sloan had built, causing GE’s subsequent near-collapse.

Sloan graduated from MIT, went into business with his father, and became President of Hyatt Roller Bearing in 1899, which grew through supplying to the automobile industry and was bought by the General Motors automobile conglomerate in 1916. GM, which had been put together by the entrepreneur William C. Durant through acquisition from 1908, had flirted with bankruptcy in 1910 and did so again in 1920, being rescued by an investment from Du Pont, which had grown rich from the explosives business in World War I. Pierre du Pont removed Durant and installed Sloan as President of GM.

When Sloan took over, GM was an unprofitable collection of medium sized automobile companies, together far smaller than Ford, which dominated the market. Sloan installed strict accounting disciplines and a divisional structure, which differentiated the up-market Cadillac from the aspirational Buick, the mid-market Oldsmobile, the sporty Pontiac and the mass-market Chevrolet. He then instituted the annual model change for each division, which made the GM products appear more attractive than Fords, at that time limited only to the Model T. He created General Motors Acceptance Corporation, which provided medium-term secured financing for GM products. By 1925, GM had achieved the #1 market share in the automobile industry, which it never lost, growing steadily and very profitably thereafter until it became the United States’ largest and most profitable company.

Sloan’s last action as GM President was to prepare for a massive boom in demand following World War II, contrary to predictions from Paul Samuelson and other Keynesian economists; he retired from GM’s Presidency in 1946, remaining Chairman until 1963. Sloan’s successor Engine Charlie Wilson told a Congressional Committee “What’s good for General Motors is good for America” while Wilson’s successor Harlow Curtice was Time’s Man of the Year in 1955, probably the apogee year of GM’s psychological dominance in American and global life. Sloan’s formula for a large corporation organized by product divisions, all controlled by a sophisticated accounting system, and managed for long-term profitability, would become the paradigm for U.S. business until the 1980s. In less skilled hands it would produce bloated and sleepy organizations, but it also increased U.S. prosperity to a previously unimaginable level in the 1945-73 period.

Welch, on the other hand, was much lauded during his reign at GE (and in his obituaries) for his “Neutron Jack” style of management – the reference being to the neutron bomb that left structures untouched but eliminated people. Welch inherited a company that was the United States’ most successful conglomerate, managed along the lines that Sloan had set half a century before. GE’s profits had more than doubled under Welch’s predecessor Reginald Jones (1972-81) in a period that saw not one but two deep recessions and ended at the bottom of the most serious recession since World War II. Jones’ GE was loosely focused around electrical and electronic engineering technologies, with a strong focus on research excellence and international markets, although GE had sold its mainframe computer business to Honeywell in 1970.

By 1981, stocks had declined by three quarters in real terms since 1966; as a result GE’s stock price was thoroughly undervalued, like most others. Thus, Welch’s much-touted achievement in increasing the company’s market value from $12 billion to $420 billion resulted from a roaring bull market (the S&P 500 Index would have increased to $232 billion over the same period), piling on leverage and some highly aggressive accounting.

Welch’s management methods were very different from the GE tradition. He took a ruthless approach to human resources, laying off some 80,000 of GE’s 400,000 employees in his first five years, and instituting a policy of firing everybody whose annual appraisals ranked their performance in the bottom 10% among their peers. Inevitably this made GE a much more political place to work, and crushed the loyalty of long-term individualist employees, focused on technology rather than short-term profits. If your boss thought you an oddball, you got zapped.

Welch aggressively entered the mergers and acquisitions markets, selling those businesses that did not rank #1 or #2 in their industry, and buying new businesses such as RCA and the investment bank Kidder Peabody that bore no relation to GE’s traditional business or research strengths (and Kidder Peabody ranked about #12 in its industry of investment banking). Through Welch’s strategy, GE lost all strategic focus; no longer was it primarily an engineering company primarily focused on the technologies involving electricity. With operations in entertainment and investment banking (albeit in declining sectors of both industries – neither Kidders nor RCA’s main subsidiary the NBC broadcast network represented the future) GE stood for nothing but short-term manipulation.

During Welch’s tenure, GE lost its research superiority, as cutting long-term research spending boosted short-term returns. In an era when one particular electricity-based technology, information and the Internet, was to become overwhelmingly important, this was criminally destructive to shareholders’ long-term interests. GE should have been a leader in the burgeoning “tech” sector, both in the late 1990s and today, but following Welch’s changes – crickets! Welch purported to focus on shareholder value, but his shenanigans served only to boost the short-term stock price and the values of the stock options granted to Welch and the other greedy men who now ran GE.

Of all Welch’s changes to GE, his move into financial services was the most disastrous. GE had always had a substantial financial services business, to assist sales of heavily electrical equipment, aero engines, etc., but it had no special expertise in finance that would enable it to compete successfully with the titans of commercial and investment banking. As a result, GE Capital, while large enough to dwarf the rest of the business and relying entirely on the industrial business to boost its credit rating and lower its capital cost, had no real comparative advantage outside the equipment finance in which it had always specialized (and which when expanded led to numerous conflicts of interest). Consequently, when the financial sector hit trouble, in 2008, GE discovered that even its industrial business was not sufficient to stem the losses arising in the dreck of its financial services portfolio. Given its size, GE should have been a leader in the financial services business, as in its other businesses, but it never had enough expertise in that business to avoid becoming super-sized roadkill.

Being determined to boost the stock price and the value of management’s options, Welch also resorted to dodgy accounting, especially during the late 1990s, when operations began to falter and other companies’ stock prices were soaring. In particular, GE stopped making annual contributions to its vast employees’ pension scheme in the late 1990s, after stock prices had risen, indeed making negative pensions contributions in some years. Needless to say, this was to cause severe problems for Welch’s successor after the market peaked in 2000. In other areas also, the company’s accounting became notably more aggressive, storing up trouble for the future.

Welch, ever the gentleman, shortly before his death awarded himself an A for management but an F for his choice of successor. That was grossly unfair. Jeff Immelt, Welch’s successor for 16 years, had some skills that were to prove highly valuable – notably excellent connections in government which were to prove life-saving for GE in 2008-09. He lacked the capability to manage the over-leveraged monster that Welch had created, but in truth it was wholly unmanageable, taking so long to die only because of its gigantic size and because, buried deep beneath the rotting carapace of the financial services business, there remained some vestiges of the magnificent engineering conglomerate that had been built up by Jones and his predecessors.

Welch’s reputation in 2000 was largely built on hype, and on the inability of Wall Street and media analysts to read financial statements properly. The decline and later collapse of GE after Welch’s departure is a tribute to his failings. Overall, far from being the best manager of the 20th Century, he was a precursor of the overleveraged, badly managed companies of the 21st Century, destroying many of the advances in management capability and corporate culture that Sloan had created.

Very large corporations have major disadvantages as a way of organizing economic activity and as places for ordinary employees to work. Welch’s depredations and the admiration they brought him have greatly worsened those disadvantages, as will become glaringly apparent in the next economic downturn.

(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.)