Why GE’s Jeff Immelt Lost His Job – Disruption and Activist Investors

This article first appeared on the Harvard Business Review blog

Jeff Immelt ran GE for 16 years. He radically transformed the company from a classic conglomerate that did everything to one that focused on its core industrial businesses. He sold off slower-growth, low-tech, and nonindustrial businesses — financial services, media, entertainment, plastics, and appliances. He doubled GE’s investment in R&D.

In his Harvard Business Review article summing up his tenure, Immelt recalls that the two things that influenced him most were Marc Andreessen’s 2011 Wall Street Journal article “Why Software Is Eating the World,” and Eric Ries’s book The Lean Startup.

Andreessen’s article helped accelerate the company’s digital transformation. GE made a $4 billion bet on connecting industrial equipment via the Internet of Things (IoT) and analytical software with a suite of products called the “Predix Cloud”.

In response to reading Eric Ries’s The Lean Startup, GE adopted Lean and built their Fastworks program around it. Beth Comstock, GE vice chair responsible for creating new businesses, embraced the lean process. Over a period of years, every GE senior manager would learn the Lean Startup, and GE would be the showcase for how modern companies use entrepreneurial management to transform culture and drive long-term growth.

Innovation at GE was on a roll.

Then it wasn’t.

In June 2017, the board “retired” Jeff Immelt and promoted John Flannery to CEO. Since then Flannery has replaced Immelt’s vice chairs responsible for innovation. Beth Comstock is out. So is John Rice, the head of Global Operations along with CFO Jeffrey Bornstein.

Last week’s Wall Street Journal story on GE opened with, “John Flannery, the leader of General Electric for just 2½ months, has already begun dismantling the legacy of his predecessor…” Flannery has pledged to unload $20 billion of GE businesses in the next two years. “We need to make some major changes with urgency and a depth of purpose. Everything is on the table,” Flannery said on a conference call to discuss quarterly earnings. “Things will not stay the same at GE.”

Instead of lean innovation programs, there is a mandate to cut $2 billion in expenses by the end of next year, lift profits and raise the dividend.

So what happened? Are lean innovation and the Startup Way a failure in large companies?

In fact, what happened is activist investors.

During Jeff Immelt’s tenure GE’s stock-market value fell by about half. Its stock is trading where it was 20 years ago. So far in 2017, GE is the worst performing stock on the Dow Jones Industrial average.

In 2015 Trian Partners, an activist investor, bought $2.5 billion of GE stock – about 1.5% of the company. The firm wrote a white paper, “Transformation Underway… But Nobody Cares” which essentially said that GE stock was undervalued because investors didn’t believe that Immelt and GE management would do the things needed to deliver a higher stock price and dividends.

Trian was pretty clear about what they thought the company should do:

  • Take on $20 billion in debt (returning the cash to shareholders by buying back GE stock).
  • Increase operating margins to 18% (by cutting expenses).
  • Buy back more stock than the $50 billion stock purchase plan GE already had in place.

Immelt believed that doing these three things would optimize the stock price and increase the value of Trian’s investment, but the debt and cuts would endanger GE’s long-term investment in innovation.

And now Immelt is now the ex-CEO, and Trian Partners just a got a seat on the GE board.

Activist Investors
The “corporate raiders” of the 20th century have rebranded themselves as “activist investors” of the 21st. With refrains of “unlock hidden value” and “increase shareholder value,” and powered by over $120 billion in assets, activist investors like Trian look for companies like GE (or Procter and Gamble) that have a share price which is underperforming relative to its peers (or those with large amounts of cash on their balance sheets). They then buy stock in these public companies and attempt to convince management to increase the price of the shares.

One key difference in 21st century activists is that they don’t need to buy much of the company’s stock to gain control. (Trian only owns ~1.5% of the GE and P&G shares.) They do it by influencing the votes of the majority of the shareholders. And in the 21st century, the majority of public company shareholders are institutional investors (banks, insurance companies, pensions, hedge funds, REITs, investment advisors, endowments, and mutual funds), not individuals. (In 2015, the 10 largest shareholders in a typical S&P 500 company held almost half of the company’s stock.)  What gives institutions even more say is that while individual shareholders vote their shares 30% of the time, institutions vote their shares 90%. (In the case of P&G, 40% of its stock was owned by small investors, helping the company fight off a 2017 proxy battle with Trian.)

After the dot.com crash in 2001 and the financial crisis of 2008, traditional investors who previously held their shares for the long-term — public pension funds, institutional investors and money managers — are now more interested in short-term gains. This means that company boards who used to side with management no longer automatically protect them, and as Jeff Immelt discovered, may even side with an activist.

Activist investors have a simple goal: increase the value of their investment. But first they need to get management of a company to change their existing strategy. To do that, they start with an implicit (GE) or explicit (P&G) threat of a proxy fight for a seat on the company board.  Next, they make a public presentation to management — like Trian’s “Transformation Underway… But Nobody Cares” — explaining what actions they think the company should take to increase the price of the stock.  Next, they use the financial press and blogs to spread their message to the institutional investors. If that still doesn’t work, they can start a proxy fight and try to gain control of shareholder votes so they can replace the board — and ultimately the company management.

If their campaign is successful, like Trian’s was at GE, they’ll have a seat on the board and a new CEO and management. They’ll have GE execute a playbook to increase the value of their investment: share repurchase programs, increased dividends, and, to reduce expenses, layoffs, factory closings, spin-offs of profitable parts of the company, sell-offs of the least profitable divisions, and asset stripping. And as Trian’s presentation suggests, they’ll get GE to take on more debt to buy back stock. And often they calculate that selling the sum of parts is greater than keeping the company together as a whole. Or they may even put the entire company up for sale.

There is an upside to an activist investor taking a run at a company. It’s often a cattle prod to a stagnant company, or one ignoring disruption by new startups. GE’s gross margin was 21% last year, compared with 28% at United Technologies and 30% at Siemens. At a minimum, as is happening to GE now, it forces a company to go through a review of its strategy. (At GE the biggest problem in 2017 was major revenue misses in their Power business.) The new GE CEO is focusing on a back-to-basics approach to the business: dramatically reducing expenses, with the visible symbols of getting rid of company planes, company cars, and delaying a fancy new headquarters, etc.

The bad news is once they take control of a company, long-term investment is not the goal of an activist investor. They often kill any long-term strategic initiatives. Often the short-term cuts directly affect employee salaries, jobs, and long-term investment in R&D. The first things to go are R&D centers and innovation initiatives.

So What is a CEO to Do?
A CEO of a public company needs to know what explicit and implicit guidance they are getting from their board and institutional investors.

Large public companies like Amazon, Tesla, Netflix, etc. capture the imagination of investors and can focus on revenue and user growth instead of on the bottom line. Almost 20 years after Amazon was launched, it has massive revenue growth and barely has a meaningful profit. Investors in these companies believe that the company’s investments in user growth will result in long-term profits. (Newly public tech companies are now going public with dual-class stock, which allows the founders to have more voting rights than the general public. This protects them from activist investors and allows them to put long-term interests ahead of quarterly results.)

But GE’s core businesses don’t have the scale of those online businesses. No innovation program, lean or otherwise, would have helped the dismal performance of their Power segment.

Companies and government organizations are discovering that innovation activities without a defined innovation pipeline results in innovation theater.  And an innovation pipeline needs to be driven with speed and urgency and results measured by the impact on the top and bottom line.

In hindsight, GE Fastworks wasn’t the problem at GE, and while the Predix Cloud has had a painful birth, GE’s investment in the industrial Internet of Things (IoT) and lean will pay off in the future. But the impact of future innovations couldn’t compensate for poor execution in its traditional businesses. GE’s board was not happy with their margins, stock price, and how Wall Street viewed the future of the company. The immediate threat of a proxy fight with an activist investor forced a decision on the future direction of the company.

25 Responses

  1. I think you pulled back a little too much here Steve. They were in the middle of a massive transformation, within themselves and operating in and across the markets in global settings and heavy asset investment industries.

    You cant compete again asset light alternatives (technology driven) but they took the terrific decision to take it on as part of their transformation, the industrial internet.

    Regretfully the operating culture just did not respond with the same sense of urgency, it simply absorbed change and it never made the difference required. Lean appealed to the culture of performance GE had but it was not enough without linking it into other parts of a more robust program of change. They had no Change Vice Chair, it was missing.

    Will they come out of this present crisis yes but in a shape not recognizable to what Immelt had seen. Not good days ahead for GE I feel with R&D stripped down and the engineering and scientific talent all drifting away due to the repressive culture bearing back down on them.

    Liked by 2 people

    • Hi Paul, could you elaborate on this: “they had no Change Vice Chair, it was missing.” Thanks in advance

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      • Hi Carlos,
        Yes GE had a very talented top-tier management group, forward-looking to provide the direction, like Beth Comstock but they did not drive the changes deeply enough, they instead kept layering on additional ones and ‘talk these up’ inside and externally.

        It was that lack of dedicated focus of shifting the culture at middle management tthat created roadblocks and frustrations. At a time when the Executive top group was prepared to articulate and push for change they simply lacked the character or personality to make the change happen. Immelt felt he could do this. No, he lacked a dedicated Vice Chair of Change

        Like

  2. Thank you for this great post that highlights a topic often discussed in corporate corridors and rarely brought to shareholders. Should innovators and business transformers create “activist innovators” to balance back the effect of activist innovators?

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  3. * to balance back effet of activist investors?

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  4. I do not like the idea of poor Jeff being kicked by evil activists…

    The problem of innovation goes back to Welch, who in practice increased the value of GE cartolarizing it. stopping investments in new technological trajectories.

    Himmelt doubled it, sistematically firing middle management ( the doers who know what to do ) and kept “baloonist” high performers ( the sayers who don’t know what to do, but speak like Ulysses mermaids.

    I remember an annual convention where Jeff was dismissing … those analysts and their 100 charts deck… and in the same days he was making large bets on dead industries, guided by the gut and feeling of his “magical ring”…

    The wWhale was already dead when sharks bite.

    Innovation is made by persons.

    Like

  5. Thanks Steve. Another important and insightful post. I have one concern about the message of “speed and urgency” to fend off raiders. The concept of “lean”, the parent of lean startup, has always been about both “do the thing right” and “do the right thing”. I fear too many companies are frantically doing lean startup on any opportunity they can get their hands on. This could qualify as innovation theater in my view. I wonder if a little more focus on thoroughness (vs speed) on the “do the right thing” part of it wouldn’t be a better approach for most companies.

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  6. Sounds all too familiar. I hope the lean thinking doesn’t get bundled in with the things that went wrong.

    Best,

    Prof Bob 267.994.1749

    Like

  7. Never underestimate the high white blood cell count of a large patient bureaucracy.

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  8. Steve Blank’s piece is well-balanced and fair, both to GE and to activists investors.

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  9. My thoughts are the opportunities for market value based on book value where if you consider from a book value basis (past, current, future)… then you are in fact going by the books and not getting into anything (even if socially accepted for time period) criminal intent and acts.

    Granted, like a business plan and hunting for investors… there are the marketing, advertising and sale methods that drive even the stakeholders in the business and not only the shareholders.

    Now, per the definition and meaning of the origin of the term “business” I think active business stakeholders and even those future interests need jobs so having the civilians being civil and busy is critical for public health and safety… not only general welfare and well being.

    Having lazy passive revenue stream “activist investors” making people unemployed, lazy, spoiled rotten and really not validly re-investing capital for survival requirements implements with some luxury for the modern period of civilization isn’t questionable or arguable other than those desperate to steal and free ride a passive income without constraints in earning and taxes or required re-investment or maintenance of investment periods.

    With modern investments methods… studying economic cycles of different periods where the most modern are split second at times is something different and questionable also. Granted, there will always be longer term investments to hold for longer periods… can be different and challenging without an awareness of social mood with the market.

    Challenges that I don’t want to get into now, though looks like there is change and as someone noted above… with change you need change controls with technical and management review and approval and change management and a champion to lead the way.

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  10. Hi Steve,

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  11. Interesting perspective. Thanks! It sounds like the business model is becoming more important than the purpose. The beginning of the end is near.

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  12. Hi Steve; thanks for writing this; as a long time admirer of GE and Jack Welch especially; it was sad to read. Jack Welch was once asked if he could do it all over again; he would choose biotechnology. Anyways, we hope GE doesn’t get all its profitable business units sold off and very sorry for what happened to Jeffrey Immelt; however looking back at Immelt’s reign this may be another example of your piece on the differences between the executive CEO vs. the visionary CEO; and hence the result if the ‘executive’ isn’t able to become a ‘visionary’?

    Also; perhapsGE can appoint new leadership that will galvanize the work force of GE from within like Microsoft and regain stockholder confidence and support after appointing Satya Nadella then this may help GE; as the current leadership maybe overpowered by the activist investors as was done to Yahoo recently; hopefully GE can turn things around.

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  13. Another great company at the mercy of short term gain with significant long term pain. I was exposed to a water heater coy here in Australia which had a brilliant innovation and R&D division. The powers that be killed it all off – sold to the highest bidder and they maintained market share for about 5 years. But then, things started to go very wrong – there was no innovation coming through. The pipeline of new projects was empty and low and behold, they were in more trouble than the early settlers. The company is now owned by an offshore entity and they have become predominantly an importer of product from Asia. The investors made a squillion and exited stage left. The macro impact is never measured but it is significant. I fear GE is heading the same way.

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    • Makes me think about the challenge of short term gains that are more bipolar versus long term steady average growth with returns and stability. Seems even the economic metrics are even changing in the U.S. from gross household factors (I feel the Christian faith or Asian respect to not dishonor family faiths provided long term stability) to more corporate economic without consideration for domestic or local resources and more emphasis on importing the resources or outsourcing the processing using foreign resources with nothing other than sales left with marketing and advertising teams to promote the potentially fraudulent accounting by the finance department which to me acts as an accounting department sales team. Then government of the corporations that want the rights of people that profiteers off armed robbing the people for tax dollars when criminal black market business operations are performed… if you even can say they’re a business and not continuing criminal enterprise. Then you get the valid for survival implements being drowned by the corporate mobs of liberal activists that bum rush the valid intent and spirit business to butcher or pulverize them into the mob that buries and write everyone off the books they can. Literally, targeting the stakeholder and retirees even to steal their pensions both corporate and government entitlements. All, so the attorneys rackets and organize crime gangs can create arguments and not required for survival sugar coated larceny, robbery and even armed robbery hostile takeover desensitized to the public methods and situations. I see economic warfare in some cases if not many. Where the most advanced domesticated complex humans are being targeted for genocide by mobs of sub humans.

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      • Edit: Then government of the corporations that wants the rights of people; that profiteers off armed robbing the people for tax dollars when they themselves are, or support a, criminal black market business operations… if you even can say they’re a business and not just whats left running trying to look official really a continuing criminal enterprise.

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  14. Excellent. Will quote next to last paragraph.

    Sent from my iPad

    >

    Like

  15. Short-term predator necessitates long-term prayer.

    Thx Steve. Learnt so much in 3 minutes.

    Like

  16. Innovation for the sake of innovation have gotten us to where we are now. Where we are now is simply a bunch of inventions that have beautiful design that we purchase and they have no actual use. Vaporware and vapor design are byproducts of an economy that has no consciousness. Do you member the tin man in the Wizard of Oz. The tin man needed a heart that was industry. The strawman need a brain because he was agricultural and needed to get an education. The lion, on the other hand wanted courage. Each was given a certificate so what happens is today the same certificates are given out yet students end up with hundreds of millions of dollars worth of debt and they have no heart,no brain, no courage. Where is the glory in this ??

    Like

  17. Mr Blank – I can’t begin to tell you how much I enjoy your writing and approach. I own a small business in TX and in the last year we’ve implemented a half dozen ideas that came directly from your insights. We aren’t a giant company or the defense department, but so many of your ideas have been instrumental in our dramatic growth. Thank you for your invaluable contributions – our 27 employees thank you!

    Like

  18. There are times when you have to establish and grow a business. Then there are times when you have to transform or reinvent a business. And sometimes you have to milk and fillet a business.

    Like

  19. You are very fair to activist investors. I would call them “vampire investors.” They are parasites that drain the company of intellectual value, which lessens the company’s contributions to the overall economy and capability set.

    Like

  20. “Companies and government organizations are discovering that innovation activities without a defined innovation pipeline results in innovation theater. And an innovation pipeline needs to be driven with speed and urgency and results measured by the impact on the top and bottom line.”

    Interestingly, this means that the groups within these organizations need to eat their own dogfood. They are themselves a startup with a value hypothesis, “We as the inhouse innovation team help people in our organisation who want to innovate by doing … and … unlike the status quo”. They then ought to do the things that take them and their organization from initial hypothesis to a sustainable innovation pipeline.

    Hence the flurry of interest in crowdsourcing, hackathoning etc can be taken in one portion as learning about what is possible, but could(?) also in large portion as fixating on a set of services to be provided without developing and verifying a customer.

    Like

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