Selling GE Capital Was Both a Brave and a Good Idea

5/5 - (1 vote)

Steven Moore for HBR

Imagine that you have a business with two business units. And for the sake of simplicity let’s say that business unit A is in financial services and all its offerings have an 80% ROI, and business unit B is in manufacturing and all its offerings earn a 20% ROI.

It turns out that unit A is only five years old and unit B is 100 years old. But in only five years, because of the accumulated 80% ROI rolling in year after year, unit A is already two-thirds as big as unit B in terms of profits.

Then, suppose we are in the month of December, and like every month of December, management meets to decide where to invest the budget for next year. Where do you think most of the money will go to? Obviously, to unit A, because it’s very hard to justify both internally and externally why you’re investing the next year in a suboptimal unit when you have another option that is far more profitable.

And then imagine that this kind of decision happens year after year. What you are imagining is a very, very simplified account of the strategic choices that have been facing the top management of General Electric for decades in relation to GE Capital.

Now, naturally, GE’s situation is far more sophisticated than this, involving many more variables, such things as strategic importance and competitors’ moves, and, of course, for each of its business units, the offerings all have different ROIs.

Companies deal with different levels of profitability in different divisions all the time. So what is different here? The answer is the balance. At this rate, in 10 years GE Capital will account for 55% of GE’s profits, and over time it can account for the lion’s share of GE’s profitability, which would put into question what GE is really about.

I believe that none of this has escaped the astute Jeff Immelt, who as he contemplates GE Capital must know that he has three options.

  1. Focus on GE Capital: I expect Immelt knows that if he gives free rein to GE Capital he will in all probability reach record performance, but of course he eventually will have to pass the baton to a new CEO sometime in the future, and he knows that GE is not only about performance but about leaving a sustainable enterprise that is well balanced to create progress for the next generation. If he focuses on GE Capital over the next 15 years, given the difference in ROI, more than 60 to 70% of revenues and well over 90% of the profits will probably come from that unit alone, creating a strong incentive to whoever comes next to shed everything but GE Capital because doing otherwise wouldn’t make economic sense.
  2. Do nothing: I suspect Immelt also knows that if he doesn’t do anything GE Capital will take over the entire focus of the company anyway, because of its ROI superiority. And this problem could escalate quickly because the GE Capital unit already accounts for two-thirds of GE’s profits at a time when interest rates have been at a historical low. Once interest rates start picking up GE Capital will become even more attractive inside GE. Immelt knows that the influence of GE Capital could end up de-naturalizing GE.
  3. Sell GE Capital: Selling GE Capital now has many advantages. Financial investors such as Blackstone know about the coming increase in interest rates plus capital is their business. GE can capture today a significant portion of that income and use this cash to fund a new period of expansionary growth and at the same time keep the share price up through a large share buyback program. In addition, GE Capital is not only the most profitable business unit but also the most volatile, and in the last financial crisis, that business unit alone imperiled, for the first time in decades, the sustainability of GE itself. By shedding GE’s most profitable business unit, Immelt can not only lower GE’s risk profile and borrow at cheaper rates but also, most important, level the resource allocation playing field for the other business units which would lead to a much more sustainable GE.

With this valiant effort, I believe Immelt is making a bold move to sidestep what might otherwise be considered the natural course of business events.

There is another top executive who once faced this dilemma, and who decided to focus on the more profitable business unit and sell off the old, less-profitable one. He had started with a business that distributed produce to which he had added an oil refinery unit. This was John D. Rockfeller, and that decision lead to Standard Oil. It is this kind of performance that Immelt is, with this move, deliberately choosing not to take, and not to be remembered for. And for a good reason, Standard Oil does not exist anymore. Immelt’s job is indeed about performance, but it is also about getting it without discounting the future. From that perspective, selling GE’s most profitable business unit to protect the sustainability of GE is part of the job. But if that doesn’t take courage, I don’t know what does.

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