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Welch’s Juice

1.

When Jack Welch became chief executive officer of General Electric in 1981, American business was more beleaguered than at any time since the Great Depression. Economic growth in the 1970s had slowed significantly on average from the pace of the 1950s and 1960s. Inflation appeared to be uncontrollable. Stock prices, after falling precipitously in the 1970s, had yet to climb back to the levels they first reached as early as 1966.

Global competition was also intensifying rapidly as Japanese, Chinese, other East Asian, and European products began to win customers from name-brand American companies. In succeeding years, the US consumer electronics business was more or less abandoned. The world market share of the US steel industry fell to less than half its former level. High wages in the US made some migration of businesses overseas inevitable, but even sophisticated manufacturing operations, in which American business should have excelled, often lost market share. Japan emerged as a major competitor in computers and semiconductors. European companies became market leaders in high-quality appliances and machinery. The Detroit auto companies were in difficulty, as both lower-priced Japanese cars and higher-priced European ones lured customers away. Most important, foreign competitors were learning how to make an adequate profit selling to smaller niche markets. American companies were locked into selling highly standardized products that required a huge mass market to make them profitable—a pattern from which they were slow to escape. The US trade deficit rose to record levels as a result—that is, Americans bought many more foreign goods than foreigners bought American goods.

Into this economic environment, Jack Welch injected his intelligence, energy, and ambition as the head of GE. It is not widely understood how much a product of his times he was. Welch’s management philosophy was consistent with an increasingly common view that American business was encumbered by unmotivated and inefficient bureaucracy. It was a version of the theme Adolf Berle and Gardiner Means famously anticipated in their influential book The Modern Corporation and Private Property, published in 1932. Since managers, not owners, increasingly ran companies, such managers might become more concerned with maintaining the status quo and retaining their jobs than maximizing the profitability and competitiveness of their firms. As late as 1978, for example, Ford Motor defensively complained that Japanese companies could make high-quality cars at low prices only because their wages were so low. In fact, Toyota and other companies made better cars in far fewer hours because they adopted revolutionary new managerial practices such as assembly teams with different skills to work together and “just-in-time” inventory techniques. That Americans failed to do so was a classic example of the defensiveness of bureaucrats; American business did not seem able to make the realistic decisions necessary to change.

One of the responses to corporate torpor at the time was a wave of takeovers that got underway just as Jack Welch was rising to the top at GE in the 1970s. The takeovers were led by a relative handful of aggressive entrepreneurs, including two talented lawyers, Joseph Flom and Martin Lipton, four or five investment banks, led by Morgan Stanley and Goldman Sachs, and several maverick corporate acquirers, who would soon become widely known, including T. Boone Pickens, Carl Icahn, and the leveraged buyout specialist firm Kohlberg Kravis Roberts. Because stock prices were so low, acquirers could buy even enormous companies, often against the will of management, by borrowing heavily against the takeover target’s assets rather than putting up much cash or equity themselves.

In the process, of course, investment bankers and takeover specialists who were willing to undertake these so-called hostile acquisitions made fortunes that exceeded any since the days of J.P. Morgan. But the supporters of these takeovers also claimed they were overthrowing the ingrown, stodgy, and narrow-minded managers who were unable to respond to the changed competitive environment and replacing them with people who ran their businesses as if they actually owned them. A new phrase was heard from men like T. Boone Pickens. Their principal and often only goal was to maximize “shareholder value”—that is, increase the wealth of owners.

Whether the takeover movement succeeded in creating a managerial revolution in America that was truly productive is a matter of debate. But when a company was taken over, the strategy to improve the shareholders’ fortunes was often ruthless by the standards of the preceding generation, and in truth rarely imaginative. The acquiring company would cut expenses significantly across the board, including firing thousands of workers; it would sell operations that were not part of a “core” business, and often cut back on corporate activities that seemed expensive, such as long-term research and product development. The severe cost-cutting raised cash flow and profits immediately, which was often necessary to pay the high debt service on the loans taken to pay for the acquisition. But their advocates claimed they at last reduced the bloat of bureaucracy.

Welch was an eager cost-cutter almost from the start of his career with GE in 1960, when he joined the company soon after getting his Ph.D. in chemical engineering at the University of Illinois. He learned further from the takeover experts—among them Robert Rubin of Goldman Sachs—what made companies vulnerable to being bought out. Although on the face of it GE was financially healthy in 1981 when he was named CEO, Welch told his co-workers that they needed a bold strategy to compete in an era of slow growth. He was determined to make GE as competitive as any foreign company and avoid being undermined by threats of acquisition or by a low stock price. He also did so with the blessings of his respected predecessor, Reginald Jones, who was, despite GE’s financial health when he left, deeply concerned with the dangers of the slow-growth and inflationary business environment.

Within a few years of being appointed CEO, Welch had lopped off more than one hundred GE businesses, reduced payrolls by more than 110,000 of 400,000 workers (nearly 40,000 workers left when businesses were sold, the rest were fired), acquired wholly new businesses, including NBC, and, critics argue, reduced the company’s longstanding emphasis on basic research.

But Welch’s guiding passion was clearly to poke large holes in the corporate bureaucracy. He was determined to make his managers, some 25,000 of them, behave like owners—his kind of owners. He threatened, cajoled, and above all taught them, through formal training and intense discussion groups, to take risks and make sweeping changes unheard of in companies of GE’s size, all of them aimed to improve profits and usually to improve them quickly. He made his managers as rich as owners by rewarding them with stock options, as long as they produced results. Those who did not subscribe to the Welch formula for growth, which almost always included serious layoffs, were, in Welch’s word, “turkeys.” Welch’s good fortune was that a bull market got underway on Wall Street in the 1980s and soon investors were rewarding companies that adopted cost-saving strategies with ever-higher stock prices.

Few if any were as good as Welch at implementing this kind of management. Westinghouse, for example, tried to adopt a similar strategy but floundered by comparison. When Jack Welch took over, GE had profits of $1.5 billion on sales of $27 billion—making it the ninth most profitable company in the nation. Welch made it the nation’s most profitable company by the 1990s. In 2000, it earned $13 billion in profit on $130 billion in sales. It fell to third most profitable in 2000, behind ExxonMobil and Citigroup. But more important to Welch, Wall Street valued GE higher than any other company in the world, at between $400 and $500 billion, depending on fluctuations in the stock price. When Welch took over, GE was worth only $14 billion. Thus profits increased roughly tenfold, but market value increased some thirtyfold. Meantime, companies that were formerly close to GE in market value, such as Westinghouse, US Steel, and the Detroit auto companies, languished well behind it. In 2000, both ExxonMobil and Citigroup were valued at only a little more than half the worth of GE. Welch became the most admired business executive of his time and Fortune magazine named him manager of the century.

Many criticize Welch for his zealous cost-cutting and in particular his wide-ranging firings, which earned him the nickname Neutron Jack. But in truth, American payrolls in the 1970s were high relative to productivity, and it can easily be argued that cutbacks were necessary. As new industries emerge and others fade, a vital market economy will also always have to shed jobs. The question is whether Welch cut not merely fat but well into the bone of his company to produce short-term profits at the expense of the long term. Many of Welch’s supporters presume that what happened in the 1980s, when layoffs rose and wages fell on average, was essentially constructive; but it is also easy to imagine another strategy that would have involved firing workers from some operations with the objective of finding them work, with proper retraining, in other parts of a company as vast as GE. High wages, moreover, could just as easily have induced more capital spending in labor-saving machinery. This was, in fact, the way the US economy grew for two centuries; America always paid by far the highest wages in the world.

Welch, however, will ultimately be judged by two even more demanding criteria. His admirers have justified his scorched-earth labor and cost-cutting policies by claiming he contributed significantly to America’s ultimate prosperity in the 1990s. But companies can achieve profitability and shareholder wealth in ways that contribute less to the “wealth of nations” than it appears. Getting managers to act like owners is a laudable objective, but there are many kinds of owners.

Did Welch build a great creative company with technical knowledge at its core, a first-class workforce, and a constant flow of new product ideas? He seems to have been obsessed with reporting rising earnings every quarter in order to captivate Wall Street investors, and this required cost-cutting that may have undermined the search for great products. Welch would certainly claim he emphasized product development at GE, and took some serious “big swings” at new ideas, as he called them. Some of them failed, such as a ten-dollar long-lasting light bulb and a new refrigeration process. Others succeeded, such as CT scanners. But overall, as Thomas F. O’Boyle writes in his informed, insightful, but one-sided critique of Welch, At Any Cost,1 spending on research and development was reduced under Welch, and the company is no longer the leader in new patents. Welch’s reputation is certainly not associated with the new products or technologies that transformed the nation. His successor, Jeffrey Immelt, recently told Fortune that his first priority as CEO will be to emphasize technology, a suggestion that the new CEO may believe something is lacking at GE.2 Aside from medical products, GE is largely absent from the current major new electronic industries, whether in computing, ATMs, or telecommunications.

  1. 1

    At Any Cost: Jack Welch, General Electric, and the Pursuit of Profit (Knopf, 1998).

  2. 2

    Jerry Useem, “It’s All Yours, Jeff. Now What?,” Fortune, September 17, 2001, p. 66.

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