A hard act to follow

THINGS at last seem to be going Jeffrey Immelt’s way. On June 23rd General Electric, the huge American multinational he runs, was declared the winner in a battle for the energy businesses of Alstom, a French engineering group. GE snatched Alstom from the jaws of Siemens, its German archrival, which had been encouraged by the French government to make an alternative offer, and which had enlisted the help of another of GE’s main competitors, Mitsubishi Heavy Industries of Japan.

Mr Immelt’s charm offensive, including meetings with France’s president, François Hollande, and an appearance before the National Assembly, paid off. But to win official blessing he had to agree to a messy deal in which GE will get all of Alstom’s gas-turbines and most of its steam-turbines business but will end up in three joint ventures with Alstom in making wind- and hydropower generators, power-grid equipment and steam turbines for nuclear-power stations. GE also had to agree to sell its rail-signalling business to Alstom. And the meddlesome French government will become a shareholder in Alstom (see article), and thus in the joint ventures.

Having been criticised for overpaying in past acquisitions, Mr Immelt (pictured, right) insisted that the $16.9 billion valuation he had put on the businesses in his first proposal would not be increased. In fact, because of Alstom’s continuing stakes in the joint ventures, GE is in effect buying control of them for around $13.2 billion.

Mr Immelt had surprised investors and some of his own executives by pursuing Alstom in the first place, having apparently sworn off takeovers of this size. He did so because the deal allows him to make a leap in executing his most important strategic goal, to transform GE from a misfiring finance-heavy conglomerate into a more focused maker of industrial equipment.

To meet this objective GE is also shrinking its finance business. If all goes well later this year with the initial public offering of Synchrony Financial, as its credit-card business is now known, GE will be on track to earn less than 25% of its profits from finance in 2016, down from 45% in 2013.

Investors have been pressing for such a change in GE’s portfolio of businesses since the firm’s brush with disaster in the 2008 financial crisis, so its progress in shifting away from finance while building its industrial side bodes well for GE’s share price. However, despite its recovery in recent years, the price is half the peak reached under Mr Immelt’s predecessor, Jack Welch (see chart), and down by a third since Mr Immelt took over in 2001—whereas shares in Honeywell, another American engineering giant that Mr Welch had tried to take over, have risen by 160% while Mr Immelt has been at GE’s helm.

At the end of Mr Welch’s reign GE was the world’s most valuable firm by market capitalisation. Now it is sixth, worth little over half as much as Apple, which has taken its place at the top. Such was the reputation of “Neutron Jack” (pictured, left) that GE briefly became one of the few “old economy” firms to earn a dotcom-style valuation from investors. At its peak, its shares fetched $60, or 50 times GE’s profits per share. This was twice the average price-earnings ratio in the market at the time, and over three times the long-run average p/e of the market. Today they are $27, with a p/e ratio of 16, barely above the average.

It was not just following a legend and a burst stockmarket bubble that Mr Immelt had to deal with. There had been a bubble in demand for gas turbines for power stations, which had pulled forward around ten years’ worth of orders into a year and a half. (Only now are there signs of a solid recovery in this business.) Mr Welch had delayed his retirement in an effort to complete the purchase of Honeywell, only for it to be scuppered by European Union antitrust regulators. This did not merely leave a hole in GE’s strategy. To keep up profits and the share price during the bidding process, Mr Welch had used various accounting techniques that were legal but soon to be frowned upon by regulators after Enron collapsed in 2001. Unlike him, Mr Immelt has been unable to pull profits seemingly out of thin air.

Four days after Mr Immelt became boss, terrorists attacked New York and Washington, DC. GE soon felt the effect as the economy slowed, and public-spending priorities shifted from infrastructure to defence. Mr Immelt has learnt the hard way to expect the unexpected. “When I started I could never have forecast so many tail-risk events hitting GE: 9/11, Enron, Hurricane Katrina, Fukushima, the global financial crisis,” he observes.

Although he soon began talking up the themes at the heart of GE’s current strategy—globalisation, increasing spending on research, developing environmentally friendly products—in his early years as boss Mr Immelt let the financial side continue to swell. In the company founded by Thomas Edison in 1892, scientists and engineers increasingly found themselves playing second fiddle to the Masters of the Universe at the GE Capital division.

As another bubble inflated, in housing, GE Capital expanded its mortgage lending, bought up corporate debt and muscled into commercial property, all of which left it horribly exposed when Lehman Brothers’ collapse in September 2008 led to a markets meltdown. So much so that Mr Immelt had to go cap in hand to Warren Buffett, who invested $3 billion to help GE get back on track. This seems to have been the point at which Mr Immelt realised that GE needed a radical change.

Capital punishment

The plan to reduce the size and complexity of GE Capital was set out at a meeting with investors in March 2009. Especially since GE became the one industrial firm to be declared a “systemically important financial institution” and made subject to oversight by the Federal Reserve under the post-crash regulatory regime, there has been an influx of staff to risk management and compliance. They will make up most of the 1,000 new staff due to be hired by GE Capital this year—even as it prepares to get out of consumer finance.

GE Capital decided to quit consumer finance because it “allows us to meet the reduction target without taking a little bit off every part of the business,” says Keith Sherin, who runs the division. But why not abandon finance altogether, as some investors want, especially because the markets nowadays value it, like banks, at a far lower p/e ratio than GE’s industrial businesses? GE’s spiel is that it can achieve strong growth in such things as lending to small and middle-sized companies.

Regular banks, it says, cannot match the deep industrial knowledge that it can share with the firms it helps to finance. Two years ago, it launched Access GE, a network of 600 experts within GE who provide non-financial advice to clients of GE Capital. This may be good for the financing clients, but if the experts are spending time with them, they are presumably being distracted from their main jobs.

Although GE Capital has been highly profitable since rebounding from the crisis, investors generally back the strategy of reducing GE’s finance side. Indeed, some feel Mr Immelt has been a bit slow in doing so. Some likewise fear that GE will not be fast or radical enough in pruning its other businesses to focus on those it sees as having most growth potential—in energy, water, transport and health care. Under Mr Immelt the firm has got out of some low-margin activities, such as plastics, and belatedly sold its sprawling media empire, NBCUniversal. But GE should explore selling its appliances and lighting arm, more bits of GE Capital, and perhaps even its medical business, says Scott Davis, an analyst at Barclays.

Stepping out of the shadow

Still, with the imminent spin-off of the consumer-finance side, and the added strength that the Alstom deal will give GE in such industries as windpower and clean-coal technology (in the process bolstering its presence in India and China), Mr Immelt seems at long last to be escaping the shadow of his predecessor and reconstructing the company according to his own plan.

Another important element in the move away from finance towards heavy industry is to get GE back to its inventive roots, with the boost in research and development. Under Mr Welch, such spending slipped to 3% of revenues. Mr Immelt raised it to 4% in 2010 and 5% in 2011 and the years since. Among other things, this is financing work on ceramics capable of surviving extreme temperatures (such as in jet engines); new super-strong composite materials (for turbine blades, say); and an effort to process deepwater oil on the sea bed, rather than pumping it to the surface, which could reduce costs per barrel by around one-third.

GE has built a new research centre in San Ramon, a short drive from Silicon Valley, which now has around 1,000 employees working on aspects of what GE has christened the “industrial internet” because it connects physical machinery to a digital network. Its open-plan offices, packed with young coders tapping away at their keyboards, are part of an ambition, proclaimed on noticeboards around the floor, for GE to become one of the world’s ten biggest software firms.

Like cars and planes, the sophisticated industrial machines GE makes these days have ever less metal and ever more lines of code. But the drive to join the first rank of software-makers is quite a change for a firm that in the 1990s made a big deal of being hardware-only.

“We realised in 2009 we needed to be in software, and in 2010 we decided to build it ourselves rather than buy,” recalls Mr Immelt. “There is a graveyard filled with software acquisitions gone wrong.” Bill Ruh, who was hired from Cisco to get the operation going, says there are three main areas of work: how to optimise the performance of each machine (making GE’s jet engines burn less fuel during landing, say); predicting when a machine will need repairs, to avoid unplanned downtime; and optimising the overall performance of the system in which the machine operates (a railway or wind farm, say). Given the huge costs involved, even tiny efficiency gains can be worth a lot to customers.

The Hilton hotel in Abuja, Nigeria’s capital city, is a world away from San Ramon. But it is where another element in Mr Immelt’s reinvention of GE could recently be observed. At a meeting there in May of the World Economic Forum, GE executives were out in force, hosting policy discussions with government ministers and local and international business leaders on issues such as the future of African health care and the potential of distributed power generation. The goal is to build relationships that will deliver long-term rewards. “In 50 years, we will be doing business here that we built the foundations of now,” says John Rice, a career GE man who in 2010 left his native America to move to Hong Kong and run a new division called Global Growth and Operations, focused on emerging markets.

The transition from being a quintessentially American firm into an increasingly global company is one of Mr Immelt’s most significant achievements. Around 55% of GE’s revenues now come from abroad, compared with 30% when he took charge. A strategy of forming long-term partnerships with governments, underpinned by a memorandum of understanding, began about ten years ago. “It helps when I can say to the government of Nigeria, ‘I did all four things I promised, you only did one of the four you promised’,” says Mr Immelt.

Mr Rice says GE employs twice as many in Africa as it did three years ago, “including people with internal credibility and the authority to make decisions.” Among their tasks are building a team of local executives eventually to replace themselves, and upholding GE’s anti-corruption credentials. Sales are growing, with a lot more expected, especially as GE moves the supply chain closer to where it is selling equipment, such as by building a turbine factory in Calabar, Nigeria. With enormous power, health-care and other infrastructure needs, Africa, in particular, is a “classic GE opportunity”, says Mr Immelt, just as China has already proved to be. “But you have to take some risks.”

Besides switching back from financial engineering to the conventional sort, boosting research and continuing his globalisation drive, the other theme of Mr Immelt’s post-crash leadership has been to wage war on corporate bureaucracy and rigidity—though as he readily admits, things first got worse as the crash led to more risk-averse thinking and a bloated head office, for which “I was part of the problem.”

GE’s selling, general and administrative costs peaked at 18.5% of revenue in 2011, which is when Mr Immelt saw the light. They were cut to 17.5% in 2012 and 15.9% last year, with a goal of 12% by 2016. One cause of the bloat was that, in its haste to expand in new markets, GE gave little thought to sharing back-office functions. It is now centralising these in a handful of locations serving its worldwide operations, but in this it is still well behind IBM, for instance.

Seeking agility

There is more to this part of Mr Immelt’s plan than just clearing some of the clutter he allowed to build up. He wants GE to achieve the sort of agility seen in the best Silicon Valley tech firms, and to seek ways of doing things faster without harming quality or safety. Eric Ries, the man behind “lean startup”, a popular Silicon Valley technique for rapidly testing a new business idea, was brought in as an adviser. The result is FastWorks, an approach the firm thinks could become as influential as the “Six Sigma” techniques for cutting defects and improving reliability were on Mr Welch’s watch.

Launching earlier, seeking customer feedback and quickly improving the product are the hallmarks of this approach. An early example of FastWorks in action involved a proposal by GE’s engineers for a five-year, $500m project to upgrade its H-class gas turbine. Mr Immelt called for the new approach to be applied, starting with a proof-of-concept exercise costing $25m. The result, GE says, is an upgrade that should be ready in two years for half the original cost.

Seasoned observers of GE, like English football fans on the eve of the World Cup, have learned not to get their hopes up. Mr Immelt has been slow to stamp his authority on GE, and in part his grand strategy involves undoing mistakes made in the earlier part of his watch, from failing to rein in the financial side pre-crisis to letting overheads get out of control thereafter. But in an age in which CEOs’ careers are often as short as football managers’, he has persuaded investors to stick with him. Now they will be expecting a glut of goals.