03 NOVEMBER 2018
GE’s leadership problem goes beyond its CEO
Just about a year ago, in August 2017, General Electric brought in John Flannery to help revive the company. In November, the new CEO said the company was streamlining its business. By July, GE was reporting progress on cutting costs, and at least one division, aviation, was continuing to soar.
Flannery, a 30-year veteran of GE, said he foresaw a "multiyear transformational journey" for the venerable company.
But if so, Flannery won’t be along on the ride. After a slim 14 months in the top job, Flannery was ousted last week and replaced by H. Lawrence Culp, Jr., the former longtime chief executive of Danaher who joined GE’s board in April.
The tenure of GE CEOs has typically been measured in decades rather than months, and Culp’s appointment marks the first time the company has brought in an outsider to be its leader. These factors make GE’s most recent turn of events a "total shocker," said Wharton management professor Michael Useem during a recent segment on the Knowledge@Wharton radio show on SiriusXM.
"It’s quite a bit of a change," added Useem, who is also director of Wharton’s Centre for Leadership and Change Management. "Company culture at GE has really been focused on developing leaders over the past 20 to 25 years, and so having an outsider come in really does mark how much change I think the board wants in terms of efficiency and speed on various strategic initiatives."
GE has been reinventing itself and shedding businesses, but according to reports, change has not come quickly enough for the board.
"I don’t think a lot of the time they disagreed necessarily with the decisions [Flannery made], but once the decisions were made, the pace of change wasn’t keeping up with their expectations," said Tim Hubbard, management professor at the University of Notre Dame’s Mendoza College of Business, also on the Knowledge@Wharton radio show.
And once again, GE - with its laggard stock price, balance sheet and cash-flow concerns and unclear place in a fast-changing business environment - is grasping for direction.
"What could anyone have done in a year?" asks Wharton emeritus management professor Marshall W. Meyer. Under prior leadership, GE overpaid for oil-field services company Baker Hughes and Alstom’s power business, overpaid for buybacks of GE shares, and exited financial services but kept long-term care liabilities, Meyer pointed out. GE’s stock price is currently trading at half of where it was a year ago, and the company has lost $175 billion in market value over the past 20 months. In June, GE was dropped from the Dow Jones Industrial Average after more than a century.
The story of GE, Meyer said, has become "a slow-motion train wreck."
‘You’ve got to make things happen’ - or else
According to Useem, recent events at GE echo a similar episode at Ford when that company brought up Mark Fields from the ranks as CEO, and less than three years later replaced him for the same stated reason: not being able to change the company quickly enough.
"Regardless of the people, if you’re in the corner office these days, with the rate of change in just about everything - think about digital disruption - you have to be a person who is agile, you’ve got to move, you’ve got to make things happen," said Useem. "Boards have become unhappy with people who don’t do that," similar to the stock market.
That GE went to an outsider for leadership, Useem said, suggests that the board "in its wisdom decided that it needed completely fresh eyes on the business to understand what they ought to keep, what they ought to dispose of."
Wall Street approves of the fresh-eyes approach, at least so far. GE’s wan stock price gained about 7% immediately after the announcement of Culp’s appointment as CEO and chairman. (Share prices gained 3% after the June 2017 announcement of Flannery to the post.) "That is actually an amazing percentage," said Useem. "Let’s round off GE’s market value at $100 billion and take 7% - we’re talking about $7 billion on the fact that a new CEO is coming in."
But many of the troubles at Boston-based GE were already established fact when Flannery took over: the $13.5 billion agreement to take over the power business of French company Alstom and the decision to jettison consumer finance company Synchrony Financial, among them.
GE’s woes are a "combination of bad luck and bad decisions," said Meyer. "Bad luck is being in a bunch of bad industries at a time they didn’t fare so well. Health care took a bit of a pause, transportation/locomotive took a dive, oil at the time when they bought Baker Hughes turned out to be a bad investment. On power generation, again, they buy Alstom and that is not such a good investment because the market changes. And you’ve got this monster firm that was an icon in the U.S. for years. Suddenly it’s in trouble, and given the size of the ship, it’s very hard to turn it [around]."
Was elevating an insider to CEO a bad idea? Did Flannery have personal relationships or sentimental attachments to parts of the company that made it difficult for him to render the tough decisions necessary to turn the company around?
"You’d have to be a real insider to know that," said Meyer. Still, "if you spend 30 years in an organisation, you are deeply steeped in it and its way of doing business. It worked for you, so as a consequence not only might you be loath to see the things you can see, but you also miss a lot of things because you take them for granted."
According to Useem, research on succession shows that "when companies are doing fine, go within. When companies, though, are in trouble, they need redirection … [and] looking to the outside is a good way to go."
While it’s not entirely clear why Flannery was ousted so soon, one likely possibility is that the board was surprised by the quality problems with turbines, liabilities from the long-term health insurance business, and the misses on the sales forecasts, said George S. Day, Wharton emeritus marketing professor and founder of the Mack Institute for Innovation Management.
"Boards don’t want to hear that the leaders missed the early warning signs," said Day. "Not that a board expects prescience. But they do rely on the leadership team to see sooner and act faster when there are early warning signs. That is only one possibility [for why they ousted Flannery], but I do think the board felt blindsided."
Now, the pressure on Culp will be to boost the operational effectiveness of the businesses GE decides to keep, said Hubbard. "I don’t think they want to keep having the same product issues they’ve been having lately - for example, in power - and at the same time, I expect them to accelerate the spinoffs and various divestitures. I think those two things will be very interesting to watch over the next few quarters."
As that happens, Useem said the role of the board is going to be critical. "They intervened here; they forced out a CEO, and that doesn’t happen very often. It’s a strong board. They’ve got several CEOs on it who can provide guidance and advice from their own personal experience, and they are hopefully going to be of counsel, to actually help Larry Culp speed time cycles up - to decide what ought to be spun off, to reposition, to re-argue what they stand for."
Notably, with Culp’s appointment, GE also named Thomas W. Horton as lead director. The former American Airlines chairman and chief executive oversaw the airline’s restructuring and eventual merger with US Airways.
Changes on the board, in fact, have been one under-noticed aspect of the ongoing change at GE, said Wharton management professor John R. Kimberly. "The board that acted so quickly on Flannery is a pale shadow of the board that was in place when Jeff Immelt left," Kimberly noted. "It turns out there are five holdovers from the old board and six new members. Eleven of the members there in 2016 are gone, so that’s a pretty wholesale and unusually large turnover at the governance level. What that does in terms of the dynamics of these kinds of things is really open up opportunities to think differently at the top of the company and to take actions which might be difficult to take for board members that are longer tenured."
For the many who work at GE, this latest set of developments is likely "gut-wrenching," Kimberly said. "There’s got to be the potential for a pretty significant exodus of people, and some of that will probably be good because it may be that the longer-tenured folks are part of the problem, and Culp will be needing a next generation of managers with a different mindset and maybe different skill set."
The only way is up
Culp arrives at GE with some advantages. Perhaps the write-downs are all behind the company now, and all the bad news is known and being dealt with.
"They are likely to cut the dividend [again] to strengthen the balance sheet," said Day. "That prospect has already taken the equity price down, so I think that’ll happen. And they’ll certainly get behind Culp."
Culp is widely admired for his track record at industrial conglomerate Danaher, based in Washington, D.C., where over 14 years he boosted revenue and market share five-fold. "I think the markets will give him a lot more latitude, and the board is going to give him all sorts of latitude because he is one of them. Given what they did to Flannery, they can’t turn around and be as impatient with him," said Day.
Still, he said: "He’s got a tough situation because he’s someone that builds businesses who now has a complex set of long-cycle businesses that will be hard to turn around. The aircraft engine business will keep doing well, and that’s going to help them enormously, and they have to turn around the power systems operations, and that’s going to take a long time. They are going to have to be patient, while Culp has to make sure he doesn’t surprise everyone the way Flannery did."
In announcing Culp’s appointment on October 1, GE cited the way he transformed Danaher from "an industrial manufacturer into a leading science and technology company." Under his watch, GE said, Danaher "executed a disciplined capital allocation approach, including a series of strategic acquisitions and dispositions, a focus on investing for high-impact organic growth and margin expansion, and delivering strong free cash flow to drive long-term shareholder value."
Useem said Culp’s success at Danaher - which, despite its more modest profile, resembles GE in some of its diversity of businesses - came through use of a particular management method. "Larry Culp was a great fan of the Toyota system in which there is continuous improvement, exacting focus on what you’re delivering, no fooling around at the top and in the ranks and insisting that everything be produced on time with quality. [Danaher] way out-performed the market over the years he was CEO, partly because of who he is, but maybe most importantly of all because of the system he brought there. I think we’re going to see a doubling down on quality, meaning process oversight, so everything you make goes out the door and it works, which is not a trivial problem. And also no quarter, no year shall be cheered as a success in and of itself: We’re going to look at the problems we still face. That is the whole Toyota continuous improvement emphasis."
Meyer said if it were up to him, he might offer the board some contrarian advice.
"There is knowledge, there are capabilities buried in that company that I’m sure they don’t even know about," he said. "I’d spend a lot of effort really trying to find out what you know and exploit that. Go do a really deep dive and figure out what you have that the competition doesn’t. You will be surprised what you will find."
Can a new GE remain a conglomerate? Should it?
GE will likely remain somewhat of a diversified firm, said Useem. "They want to keep aviation, power and energy. Those are not identical, although they have some commonalities. What Larry Culp … is going to be asked to do is to find synergy. What you find in the aviation research and development can somehow be kicked over to power. Or at least you’ve got great people coming up in aviation who might be moved over to power. If Larry Culp can do that, he can justify the fact that it’s still a modestly diversified company," which was the case at Danaher.
GE may not end up with the footprint it has had. But that doesn’t mean it has lost its place as one of the great American stories - or cautionary tales.
Said Useem: "We are all fascinated, almost riveted, by what’s happening there - certainly investors [are]. Anybody with a pension fund that is investing in any kind of index fund is in GE stock. We’re all fascinated by whether Mr. Culp can pull it off."
Source: Knowledge@Wharton is the online research and business analysis journal of the Wharton School of the University of Pennsylvania. Visit our web-site at: http://knowledge.wharton.upenn.edu.