Case 29: General Electric, GE Capital, and the Financial Crisis of 2008
(Wheelen, Hunger, Hoffman, & Bamford, 2015, p.29-1-29-15)
| Discussion Board | 10 | 10 |
| Strategy | 10 (includes writing) | 12 |
| Finance | 10 | 10 |
| Alternatives | 10 | 10 |
| Recommendations | 10 | 10 |
| Implementation | 5 | 5 |
| What actually happened | 5 | 5 |
| Total | 60 | 62 |
Excellent—you cannot pursue stability and retrenchment at the same time and very few would suggest anything other rthan Growth for GE. Thank you, for going above and beyond!!
Introduction
General Electric (GE) was founded by Thomas Edison in 1878. In addition to inventing the first incandescent light bulb, Edison designed a system for generating and distributing electricity which led him to create GE. Today, GE is “…a global leader and iconic brand known for innovation and leadership in a wide range of endeavors.” (Wheelen, Hunger, Hoffman, & Bamford, 2015, p.29-1) The company is now split into four strategic business units: energy, technology infrastructure, GE Capital, and home and business solutions.
During the financial crisis of 2008, one of these units, GE Capital, experienced huge losses and, as a result, almost put the entire company out of business. In 2012, GE’s top management and board of directors had to decide how to handle GE Capital’s innate volatility in the future in order to protect GE Capital as well as its parent corporation.
Strategy
GE has always been a pioneer in its industry and a leader in innovation. GE focuses on “…making what few in the world can, but everyone needs.” (Wheelen, Hunger, Hoffman, & Bamford, 2015, p.29-2) The company’s strategies include focusing on innovation, technology, growth markets, smart capital allocation, and strong customer relationships. GE is also very careful to expand and diversify their portfolio to minimize risk and create stability. GE keeps costs low to maximize return for shareholders and emphasizes training for all employees, especially managers. It was also one of the first companies to formalize strategic planning by creating strategic business units.
GE’s objectives have consistently been “…earnings growth, increasing margins, returning cash to investors, organic growth, increased financial flexibility, and larger U.S. exports.” (Wheelen, Hunger, Hoffman, & Bamford, 2015, p.29-2) GE is also committed to being socially and environmentally responsible.
GE Capital’s strategy is to follow GE’s lead and encourage innovation by providing capital. Its main expertise is in mid-market banking, but leading up to 2008 it began financing risky assets such as credit cards, mortgages, commercial real estate, derivatives, and credit default swaps. Since the crisis, GE Capital has transformed its portfolio to reduce risk and refocus on middle market lending and specialty finance to industrial division customers.
Finance (Ratio Analysis Table; see Exhibit 4)
Both GE and GE Capital experienced significant declines in sales revenue following the financial crisis of 2008. GE Capital had begun to dominate the total earnings of the company, contributing over 50% of GE’s total net income. This caused a company-wide crisis when GE Capital experienced losses.
GE’s liquidity ratios show that the company has struggled with their cash position since 2008. Its profitability ratios, however, are growing. One of the core competencies of the company is its ability to cut operational costs and improve margins. This strength likely contributed to their ability to grow their margins even as their revenue declined. Inventory build-up during a recession is common and probably the cause of GE’s low activity ratios. GE’s debt-to-asset and debt-to-equity ratios are high which usually indicates a company is financing heavily for the purposes of growth. (Wheelen, Hunger, Hoffman, & Bamford, 2015, p.29-11)Right-a lot of people see this as a weakness,and sometimes it is.
External Environment (EFAS Table; see Exhibit 1)
The biggest threat currently (2012) facing GE is the volatility of GE Capital. Because of the nature of the financial sector, this is an external factor over which GE has no control. The current strategic-business-unit structure of the company accentuates the co-dependency between GE and GE Capital that is, during economic downturns, detrimental to the company as a whole.
Second, GE spends more than any other company on governmental lobbying, but if their political capital is not enough and changes to the tax code that increase taxes for corporations pass, GE could experience significant losses. And last, GE’s and GE Capital’s competitors will always present threats. Any of their many large and established competitors could gain a competitive advantage at any time and take GE’s place. GE must continue to grow if it wants to compete.
Luckily, the corporation has just as many opportunities for growth. Ironically, the volatility of GE Capital can also be a huge benefit during economic prosperity. If GE can continue to decrease the risk of GE Capital’s assets, GE Capital can return to its prior form as a great opportunity instead of a threat.
GE is also well positioned to be a leader in the green energy and health care industries. These are two growth industries that not only are being subsidized by the government, but also have rising consumer demands. Taking advantage of as many government financial incentives, subsidies, and partnerships will also benefit the company moving forward.
Internal Environment (IFAS Table; see Exhibit 2)
The state of the economy is an external environmental factor over which GE has no control. However, the stability of GE Capital is an internal environmental factor over which GE can exercise control. Having an unstable and risky business unit within the parent company, namely GE Capital, is GE’s biggest weakness as a whole. They must stabilize this branch if they want to extinguish it as a weakness.
GE’s second biggest weakness is their decreased focus on innovation. Their core competency of being able to maximize margins and efficiency has overshadowed their leadership in innovation. With the current speed at which technology is advancing, companies that do not stay on the cutting edge of innovation will fall behind those that do. GE has been training management to focus on efficiency instead of growth which has become a weakness as well.
Last, GE’s public image has been tarnished after accusations that the company does not pay enough taxes and excessively pollutes the environment became public.
GE has many strengths that offset these weaknesses however. First, the operational efficiencies of the company, though problematic if they smother innovation, are such an enormous strength. They helped GE survive through the financial crisis and over the years following as sales revenues struggled to recover. GE also has its sheer size which helped it steer through the crisis. GE’s ability to help GE Capital by allocating additional funds when needed was vital to GE Capital’s recovery. GE’s ability to have multiple distribution channels and lines of business has provided an additional competitive advantage. GE’s other strengths include its Six Sigma approach to business management, history of innovation, reputation, brand, and political influence, market-leading portfolio, strong company culture, focus on sustainability, and strong credit rating.
Situational Analysis (SWOT) (SFAS Matrix; see Exhibit 3)
The most important strengths, weaknesses, opportunities, and threats for GE are summarized in the SFAS Matrix. GE has opportunities to expand in the green energy and health care industries and to use GE Capital as a sustainably growing branch of the parent company and add revenue to the company as a whole. Conversely, GE Capital’s volatility and sensitivity to economic fluctuations also acts as a threat to the health of GE. Changes to the corporate tax laws could also threaten GE’s financial success.
GE’s operational efficiencies have been a huge strength over the years and are one of their core competencies. Its sheer size offers competitive advantages in various business activities and also adds to the strength and stability of the company. GE’s most important weaknesses include focusing too much on efficiency and falling behind their competition on innovation and again, GE Capital’s volatility. GE Capital is both an external and internal factor that is of significant concern for the company.
Alternatives and Recommendation
By the end of 2012, GE’s top management knew they had to decide what to do with GE Capital. They could sever ties between GE Capital and its parent company, which would protect GE from the volatility of GE Capital, but would not offer GE Capital the financial backing of its parent. It would also decrease GE’s total revenue significantly.
A second option would be to keep GE Capital as a branch of GE but reduce its risk significantly. GE Capital has been working to reduce the risk of its assets since 2009. The financial ratios indicate GE’s revenues are growing but their cash balances are still not at a level where they could withstand large economic fluctuations. The best option for GE at this time is to continue to reduce its portfolio risk and to keep GE Capital as a branch of the parent company. GE and GE Capital have been successfully working together in a mutually beneficial relationship for so many years. GE Capital has definitely had some setbacks since 2008 and made some poor decisions prior to 2008, but it has been a valuable asset to GE for many years and, with some adjustments, can be again.
The corporation’s directional strategy should be stability and retrenchment. It should continue with the activities that have proven successful while reducing the risks that have proven detrimental. GE has experienced huge changes in the four years between 2008 and 2012 and it is time for the company to stabilize and return to doing the things they do best. The retrenchment piece should focus only on GE Capital. The retrenchment strategy would decrease the size and risk of that branch.
Implementation, Evaluation, and Control
GE Capital must continue to reduce the risk of is portfolio by selling off more, if not all, of the subprime mortgages and commercial real estate assets it owns. Management must simultaneously increase middle market lending and specialty finance to industrial division customers to at least partially compensate for the loss of the riskier assets. GE must continue to increase their cash balances in order to provide more stability for the company and its shareholders. Most importantly, GE must invest heavily in green energy and health care research and development as increased revenue in the future will help GE get back to the stable, profitable, innovative company it once was. In addition, it must find a way to reduce the pollution generated by the company in order to regain the public’s trust.
GE Capital’s management should be closely monitored by GE’s management in order to prevent the same mistakes leading up to 2008 from repeating. GE Capital must also incorporate a check-and-balances system that includes executives outside the financial sector in order to ensure objectivity in the future.
Accounting should regularly run numbers for “what if” scenarios to ensure the size of GE Capital is not exceeding a certain percentage of the parent company. If, at any time, GE Capital’s revenue is over 50% of GE’s total revenue, management should reassess the goals and role of GE Capital.
Conclusion
The financial crisis of 2008 was a world-wide disastrous event that was impossible to anticipate. Many companies went bankrupt, and the lucky ones who didn’t experienced enormous losses. GE hung on by a thread as it utilized its core competencies of operational efficiency, sheer size, and reputation to stop its sharply declining sales revenue. Since then, GE and GE Capital have begun seeing increases again in their growth. Both the parent company and the financial arm have been vigilant in taking measures to recover from the crisis. If GE continues in these efforts, reducing the size and risk of GE Capital and growing GE’s green energy and health care sectors, learning from their mistakes, and putting in place evaluation and control systems, they can return to stability and profitability.
What really happened?
CEO Jeff Immelt decided to spin off the retail finance operation of GE Capital in the beginning of 2014. To compensate, he said his strategy is to continue investing in new technologies and acquisitions in order to increase sales. He will also reduce overhead, GE’s overall cost structure, and expenses in order to maximize profitability and return more cash to shareholders. (Linebaugh, 2013)
References
Linebaugh, K. (2013, December 18). GE CEO Plans to Cut Costs, Increase Sales. Wall Street Journal. Retrieved from http://www.wsj.com/articles/SB10001424052702304866904579266753054278442
Wheelen, T. L., Hunger, J. D., Hoffman, A. N., & Bamford, C. E. (2015). Strategic management and business policy: Globalization, innovation, and sustainability (14th ed.). Upper Saddle River, New Jersey: Pearson Education.
Exhibits
| Exhibit 1: EFAS Table for GE 2012 | |||||
| External Factors | Weight | Rating | Weighted Score | Comments | |
| 1 | 2 | 3 | 4 | 5 | |
| Opportunities | |||||
| O1 | Green energy and health care industries | 0.15 | 4.0 | 0.60 | GE well positioned to be a leader in these growth industries |
| O2 | Government financial incentives subsidies & partnerships | 0.10 | 4.0 | 0.40 | Provides financial benefits for GE to focus on growth |
| O3 | GE Capital | 0.20 | 3.0 | 0.60 | Offers large earnings during times of economic prosperity |
| O4 | Continuing to decrease portfolio risk | 0.10 | 3.5 | 0.35 | After nearly collapsing, GE has been working to reduce portfolio risk |
| Threats | |||||
| T1 | Siemens AG, Phillips Electronics, 3M | 0.05 | 5.0 | 0.25 | 3 best performing competitors in industrial products industry |
| T2 | Bank of America, Citigroup, CIT Group Inc. | 0.05 | 5.0 | 0.25 | 3 main competitors for GE Capital |
| T3 | GE Capital’s volatility | 0.20 | 2.0 | 0.40 | Sensitive to economic fluctuations |
| T4 | Changes to tax code | 0.15 | 3.0 | 0.45 | GE could be negatively affected by certain changes to the tax code |
| Total Scores | 1.00 | 3.30 | |||
| Exhibit 2: IFAS Table for GE 2012 | |||||
| Internal Factors | Weight | Rating | Weighted Score | Comments | |
| 1 | 2 | 3 | 4 | 5 | |
| Strengths | |||||
| S1 | Operational efficiencies | 0.10 | 5.0 | 0.5 | ability to cut costs and maximize return for shareholders |
| S2 | Six Sigma approach to business management | 0.07 | 5.0 | 0.35 | decreased variability, errors, and waste- also cuts operational costs |
| S3 | Size | 0.07 | 5.0 | 0.35 | number of dist channels & lines of business provide advantage |
| S4 | History of innovation | 0.02 | 3.0 | 0.06 | led to new focus on green energy and health care |
| S5 | Reputation, brand, and political influence | 0.07 | 4.0 | 0.28 | key competitive advantages- brand recognition |
| S6 | Market-leading portfolio | 0.07 | 4.0 | 0.28 | acquired useful businesses and sold unsuccessful businesses |
| S7 | Strong company culture | 0.02 | 3.0 | 0.06 | empowered, motivated, knowledgeable, and loyal employees |
| S8 | operational efficiencies | 0.07 | 2.0 | 0.14 | growth in green energy and health care |
| S9 | GE Capital’s earnings | 0.07 | 3.0 | 0.21 | over 50% of GE’s total net income |
| S10 | Strong credit rating | 0.02 | 4.0 | 0.08 | AA+ from S&P’s and Aa2 from Moody’s |
| Weaknesses | |||||
| W1 | Focus on efficiency has decreased focus on innovation | 0.09 | 2.0 | 0.18 | falling behind on growth markets due to comfort in mature markets |
| W2 | Training management to focus on efficiency, not growth | 0.07 | 3.0 | 0.21 | GE now training management to balance efficiency with growth |
| W3 | Size | 0.02 | 3.0 | 0.06 | Not understanding cultural diff- limited growth in Asia and Europe |
| W4 | Brand associated with corporate greed | 0.07 | 1.0 | 0.07 | Accounting techniques allowing 2.3% tax rate and 2008 bailout |
| W5 | High air and water polluter | 0.07 | 1.0 | 0.07 | 4th largest air and water corporate polluter globally |
| W6 | GE Capital’s volatility | 0.10 | 2.0 | 0.2 | Risky investments hurt GE & GE Capital during economic downturns |
| Total Scores | 1.00 | 3.10 | |||
| Exhibit 3: SFAS Matrix for GE 2012 | ||||||||
| Strategic Factors | Weight | Rating | Weighted Score | Short | Intermediate | Long | Comments | |
| 1 | 2 | 3 | 4 | 6 | ||||
| O1 | Green energy and health care industries | 0.15 | 4.0 | 0.60 | x | GE well positioned to be a leader in these growth industries | ||
| O3 | GE Capital | 0.17 | 3.0 | 0.51 | x | Offers large earnings during times of economic prosperity | ||
| T3 | GE Capital’s volatility | 0.19 | 2.0 | 0.38 | x | Sensitive to economic fluctuations | ||
| T4 | Changes to tax code | 0.14 | 3.0 | 0.42 | x | GE could be negatively affected by certain changes to the tax code | ||
| S1 | Operational efficiencies | 0.09 | 5.0 | 0.45 | x | ability to cut costs and maximize return for shareholders | ||
| S3 | Size | 0.07 | 5.0 | 0.35 | x | number of dist channels and lines of business provide advantage | ||
| W1 | Efficiency has decreased focus on innovation | 0.09 | 2.0 | 0.18 | x | falling behind on growth markets due to comfort in mature markets | ||
| W6 | GE Capital’s volatility | 0.10 | 2.0 | 0.20 | x | Risky investments hurt GE & GE Capital during economic downturns | ||
| Total Scores | 1.00 | 3.09 | ||||||
| Exhibit 4: Ratio Analysis for GE 2012 | 2011 | 2010 | 2009 | ||
| 1 | Liquidity Ratios | ||||
| Current | 1.2 | 1.2 | 1.2 | These ratios show that GE’s ability | |
| Quick | 1.2 | 1.2 | 1.2 | to pay debt is stable, but their cash | |
| Cash ratio | 0.1 | 0.1 | 0.1 | ratio since the crisis is too low. | |
| 2 | Profitability Ratios | ||||
| Net profit margin | 10% | 8% | 7% | These ratios show that GE | |
| Gross profit margin | 52% | 50% | 49% | is recovering from the crisis of 2008 | |
| Return on Investment (ROI) | 2% | 2% | 1% | and continues to increase profit | |
| Return on equity (ROE) | 12% | 10% | 9% | margins, ROI, and ROE. | |
| 3 | Activity Ratios | ||||
| Inventory turnover – sales | 1.0 | 1.0 | 0.9 | These ratios show that GE’s | |
| Asset turnover | 0.2 | 0.2 | 0.2 | activity ratios are stable yet low. | |
| This is due to inventory build up. | |||||
| 4 | Leverage Ratios | ||||
| Debt to Total Assets | 57% | 59% | 60% | High debt-to-asset and equity | |
| Debt to Equity | 4% | 4% | 4% | ratios indicate GE has been | |
| aggressive about financing growth. | |||||
