Case Analysis

consumers were hesitant to invest in what at the time were considered superfluous products. To encourage consumers, GE Contracts offered comparatively low monthly payments to make its parent company’s products more affordable.Renamed GE Capital in 1987, the former appliance financing unit grew to incor-porate interests beyond those of its GE corporate parent, such as investment banking, retail stores, television channels, and auto/truck leasing. It also acquired a significant market share in private-label credit cards, including those of JCPenney, Montgomery Ward, and Wal-Mart. Early on in its history, GE Capital benefited particularly from its association with its GE parent’s strong asset base and creditworthiness, garnering both lower borrowing rates and easy access to cheap capital to generate investment beyond its profits. Through the early 2000s, GE Capital continued to expand its product lines, delving into property and casualty insurance, life insurance, mortgages, and real estate.15As the unit grew, GE Capital became an increasingly significant contributor to its GE parent’s success. While in the past most people had thought of GE as an industrial company, GE Capital, a finance company, grew to represent nearly half of its GE par-ent’s annual profits.16 As of 2012, there were five major components of GE Capital:17

1. Commercial Lending and Leasing: This division provides loans to outside busi-nesses for a range of uses, including company acquisition, internal restructuring, and even leasing office space. Additionally, the Commercial Lending unit maintains fleets of cars and heavy industrial equipment available for leasing.

2. Consumer Financing: Within the U.S., GE Capital’s retail financing arm repre-sents their private-label credit card interests, and retail purchase financing that includes automobiles, furniture, and other costly items consumers often don’t pay for withcash.

3. Energy Financial Services: GE Energy owned stakes in energy interests worldwide, providing financing for companies to invest and expand, often in conjunction with its GE parent’s efforts to educate and supply companies with necessary equipment.

4. Aviation Services: GE Capital Aviation is involved in passenger aircraft purchasing and leasing, and aircraft part financing, including various engines that its GE parent produced, and airport expansion financing.

5. Real Estate: GE Capital Real Estate specializes in various real estate transactions, including property acquisition, debt refinancing, and joint venture investments. Many of its properties are office buildings, but it also owns stakes in multi-family developments and hotels

GE Capital’s Strategic DirectionGE Capital’s main expertise is in mid-market banking, providing financing for a range of industries from aviation and energy to health care, and for the purchase, lease, dis-tribution, and maintenance of large fleets and equipment.18 It also provides capital for corporate acquisitions and restructuring. It is GE Capital’s vision to be more than just a banker—to align itself with GE’s corporate objective of supporting growth not simply by providing capital, but by helping customers invent more and build more19 through leveraging its global experience and industry expertise.20However, the financial services industry was, by definition, volatile, and GE Capital was particularly hard hit by the economic recession of 2008. With the credit markets illiquid and financial markets falling, GE Capital found that it was overexposed to com-mercial real estate and foreign residential mortgages. At this point, GE’s parent corpo-ration stepped in, began reorganizing GE Capital, and significantly downsized the unit.

GE Capital sold most of its insurance lines, completely left the U.S. mortgage market, and substantially tightened its consumer underwriting guidelines. However, the com-pany still was on the lookout for under-priced assets, and purchased several lending lines from even more troubled Citigroup, as well as a large commercial real estate portfolio from Merrill Lynch financing.By 2012, GE Capital was smaller, leaner, and more focused on specialty financing especially mid-market lending and leasing.21 However, like its parent company, GE Capital hoped to see continued sustainable earnings growth with growing margins and lower portfolio risk, and to return money to investors and resume paying dividends to its parent company.22

GE Capital’s CompetitorsGE Capital’s main competition came primarily from specialty corporate financial lend-ers, such as CIT Group, and larger companies that offered diverse and comprehensive financial services, such as Bank of America and Citigroup, according to Hoovers.23In 2012, Bank of America24 was one of the largest and most identifiable banks in the United States with over US$2.1 trillion in assets. Its goal was to be accessible to every sort of customer at any stage of their financial lives by offering both a variety of products and easy accessibility with over 5700 locations and 17,000 ATMs. Beyond the arena of specialty lending, Bank of America served consumers and companies ranging from small sole proprietorships to multinational global corporations with banking, investments, and asset management. While the company was successful in building market share, it faced a multitude of difficulties from major lawsuits deriving from its acquisitions of Country-wide and Merrill Lynch, and from its “robo-signing” foreclosure practices.Bank of America attempted to return to profitability after declaring a US$2.2 billion loss in 2010 and only a US$1.5 billion profit in 2011, focusing on strengthening its capital reserves and integrating lean initiatives to cut costs and improve efficiency. However, legislation that reduced its two major sources of revenue, interest earnings and fee rev-enue, in conjunction with depressed consumer and investor confidence levels, heralded a difficult road ahead for the company.

Like Bank of America, Citigroup is a behemoth in the financial services industry, made up of a number of units including brokerage, investment bank, and wealth man-agement and consumer lending divisions, with over US$1.9 trillion in total assets and maintaining more than 200 million customer accounts in over 160 countries. The 2008 financial crisis and its aftermath hit Citigroup very hard, resulting in US$90 billion in losses, which led to selling off or divesting from underperforming industries. Citigroup then sold several commercial lending lines to GE Capital, fully exited the student loan market, and planned to sell its CitiMortgage and CitiFinancial divisions. Going forward, Citigroup refocused on traditional banking and continued unloading toxic assets and non-core business units.Perhaps most similar to GE Capital, CIT Group Inc25 specialized in commercial lending and financing for small and mid-sized businesses, managing US$45 billion in total assets. In addition to its general corporate finance arm, CIT group offered trans-portation equipment financing, vendor finance, and a smaller branch of consumer lend-ing. Hit severely by the financial crisis, CIT Group briefly declared chapter 11 in 2009, stemming from extreme losses in its subprime mortgage and student loan portfolios. It subsequently improved its balance sheet and reduced debt obligations, refocusing on its commercial lending division by building up its loan and lease accounts and hoping to increase deposit accounts by acquiring already established banks.

Financials, With operations in over 100 countries and 53% of its revenues coming from outside the United States, GE’s growth depended on its ability to successfully navigate the politi-cal risks associated with international business dealings that could affect its growth and profitability.26Change and instability in the financial markets had a significant effect on GE, espe-cially GE Capital. Historically, GE had relied on commercial paper and long-term debt as major sources of its funding, but the increasing difficulty and cost of obtaining those sources of funding potentially threatened GE’s ability to grow and maintain its level of profitability.27 After the financial crisis of 2008, the deterioration of the real estate market, for example, adversely affected GE Capital. GE Capital subsequently tried to secure other sources of funding, including bank deposits, securitization, and other asset-based funding to mitigate its risks. These economic setbacks affected not only GE and GE Capital, but trickled down to the corporations, large and small, they did business with, along with GE’s governmental customers around the world.Nevertheless, GE’s credit rating with the major analysts helped stem the tide of negativity and control the costs of funds, margins, and access to capital markets. As of 2012, GE boasted a AA+ Rating (2nd out of 21 ratings) from Standard and Poor’s and an Aa2 rating (3rd out of 21 ratings) from Moody’s, solidifying its rating with the major analysts. Any reduction in these ratings would negatively impact GE’s profitability.28

In the three years after the financial crisis, from 2009 to 2011, both GE and GE Capital’s sales revenue declined sharply (see also Exhibits 3 thru 8).Consistent quarterly revenue losses slightly rebounded beginning in Q1 2010 (from double-digit to single-digit losses in both GE and GE Capital), yet sales rev-enue at GE Capital declined again from US$12.814 billion to US$10.745 billion from

See excibit 3, 4, 5, 6, 7, 8 pictures

NOTE:See accompanying notes to consolidated financial statements in Part II, Item 8. “Financial Statements and Supple-mentary Data” of this Form 10-K Report.(a)Includes the result of NBCU, our formerly consolidated subsidiary, and our current equity method investment in NBCUniversal LLC.Q4 2010 to Q4 2011, marking a return to double-digit quarterly revenue losses. GE Capital’s Q1 2012 revenue loss shrank again to single digits at 6.6%, while revenue grew at GE as a whole in Q1 2012 by 3.4% from the industrial division’s strong per-formance (14% quarterly revenue growth).29 Annually from 2010 to 2011, GE and GE Capital respectively reported 1.9% and 1.5% sales revenue losses. Much of the poor performance was attributable to macroeconomic risk factors, causing unstable demand for the products of the industrial business units, as well as restrictions in the global credit markets, which severely hampered GE Capital’s ability to perform as it did prior to the recession (US$65.435 billion revenue in FY 2007, US$45.730 billion in FY 2011). From FY2009 on, GE Capital began strategically transforming its portfolio to be less focused on risky lending and more focused on middle market lending and specialty finance to industrial division customers.30 This strategy required reducing leverage, improving liquidity, and shedding assets—all of which cut into previous top-line sales revenue performance.31Despite the overall top-line losses, GE was organized as a global corporation that generated revenue in a number of regions worldwide. Although U.S. revenues were down 7.9% in 2011 (from US$75.8 billion in FY2010 to US$69.8 billion in FY2011) and Western European revenues decreased 12%, global revenues (excluding the U.S.) increased 4% overall, from US$74.5 billion in 2010 to US$77.5 billion in 2011.32 The strong international performance was tied to revenue growth in emerging markets such as Latin America (29%), China (28%), and Australia (46%).GE recorded massive net income losses from FY2007 to FY2009, peaking between FY2008 and FY2009 (with net income losses of 38% for GE and 78.3% for GE Capital), driven by the global financial crisis and recession. The performance of GE as a whole was largely tied to that of GE Capital, its largest and formerly most profitable business unit. GE Capital had become deeply ensnared in both the collapse of the credit markets through the excessive use of leverage leading up to FY2009 and the subprime mortgage crisis because it had bought a subprime mortgage company and heavily invested in commercial real estate.33

GE Capital had made some ill-advised marketing decisions prior to the financial collapse in 2008. Rather than retaining its focus on middle market and specialty finance for GE industrial product customers, GE Capital began to market itself as a credit card financing entity as well as a mortgage financier.34 Financing subprime mortgages and commercial real estate soon followed, and eventually GE Capital was engaging in the financing of very risky assets, including derivatives and credit default swaps. This market strategy led to the highly leveraged structure that almost caused the entire corporation to collapse in 2008 during the financial crisis.GE’s long-term debt began growing in FY2007 and hit a high of US$377 billion in 2009, but was reduced slightly in FY2010 and FY2011, resulting in flat growth for the five years from 2007–12. Most of the debt on GE’s balance sheet was from GE Capi-tal. During the financial crisis of 2008–09, GE Capital’s highly leveraged structure— combined with its risky ventures in interest rate swaps, subprime mortgages, commercial real estate, and massive commercial paper—almost led to the financial collapse of the entire GE Corporation.35 A record influx of equity capital and the sale of preferred stock stabilized a 10% daily hemorrhage in the stock price that began on October 1, 2008. After that, GE capital aggressively cut its long-term debt from US$304 billion in FY2007 to US$234 billion in FY2011 through strategic de-leveraging and restructuring of the scope of its financing activities.

Both GE and GE capital also took steps to significantly increase their cash bal-ances to better manage risk. From FY2007 to FY2011, GE increased its cash balance from US$18 billion to US$87 billion, and GE Capital’s increased from US$11 billion to US$43 billion. However, as of 2012, neither GE nor GE Capital was on completely solid footing, with a LT debt-to-equity ratio of 2.67 and 2.93, respectively.GE Capital had been forced to scale back in the wake of the recession, and due to pressures to meet stricter regulatory standards. These strictures streamlined GE Capi-tal’s operations, helping it better understand its best practices for lending and its other financial endeavors. GE Capital also moved to expand its operational base in the after-math of the recession by creating new partnerships with companies like Ducati and Sophos. These new partnerships were important to GE Capital’s operations to offset “shrinking its asset base and tightening underwriting standards.”36 Nevertheless, the decrease in year-over-year earnings was evidence that GE Capital had to operate with fewer resources and adjust its internal infrastructure to utilize more limited resource availability.GE Capital returned some of its profits to its GE parent company through the issu-ance of a dividend. GE Capital resumed paying a dividend to GE in May 2012.

New Directions for Growth: Green Energy and Health CareIn the new millennium, General Electric was uniquely positioned to take advantage of financial incentives, subsidies, and lucrative partnerships available for innovators in the green energy sector.37 It was spurred both by an interest in the environment, and the desire for financial security due to volatility in fossil fuel prices and concerns over climate change. Having spent more money than any other single corporation on governmental lobbying, General Electric used its political capital for growth opportu-nities.38 For example, GE, especially its electrical energy divisions, was able to leverage its political strength to benefit from tax incentives associated with the green energy movement.In addition, the GE Energy Group took a leadership role in the manufacture and distribution of wind turbines—a critical component of the renewable energy sector, particularly in Oregon, where the largest wind turbine farm in the United States was powered entirely by GE-built wind turbines.39 GE also branched out into the man-agement and financing of solar energy projects, including a solar farm in Australia developed by a consortium of companies, including GE.40 GE was one of the lead-ing manufacturers of LED lighting and had signed a distribution deal with Marriot hotels that saved it 66% in power use for lighting, without compromising on the look or quality of the light.41 GE perceived the opportunity to become the best-in-class manufacturer and distributor of certain elements of clean energy infrastructure, as well as other innovative forms of clean energy, and is poised to continue to innovate as the sector grows.

Over the past decade GE Healthcare Group established itself as a leading inno-vator in emerging health care technology. Diagnostic medicine became a key area of health care sector investment—the market is projected to grow 11% annually from US$232 billion,42 and GE developed some creative tools for diagnostic imaging, includ-ing a handheld ultrasound device, with which primary care doctors could be more accurate in their initial diagnoses, prior to ordering expensive follow up diagnostics.43 GE also launched a US$100 million open innovation competition related to cancer diagnostics44 and invested in life science offerings, with a US$4 billion portfolio that projects to double over the next few years.45 As the Baby Boomer generation entered retirement age, the health care demand began to rise, expanding the need for new health care technologies. GE Healthcare was poised to capitalize on this new demand.

Core Competencies, General Electric’s key strengths—its operational efficiencies, sheer size, history, and reputation—all worked to create competitive advantages for GE. One of GE’s biggest operational strengths lay in its ability to cut costs and maximize return for shareholders, as with GE CEO Jack Welch’s implementation of the Six Sigma approach in the 1990s to business management, as mentioned earlier. GE was also able to cut costs because its reputation as a market leader, its large network of busi-nesses, and its strong alliances with other major corporations, enabled it to lever-age long-standing relationships to employ the best human, equipment, and capital resources to ensure quality and consistency at a low cost. It acquired many businesses that provided useful resources, and sold off business units that did not contribute to its success. In addition, GE’s history of innovation, from Edison inventing the light bulb to its pioneering of green energy medical diagnostic technology contributed to GE’s long-term success.In addition to the operational excellence that came from GE’s experience and unparalleled commitment to growth, the sheer size of GE also created a tremendous competitive advantage, from distribution channels in over a hundred companies to doz-ens of lines of business. Few other companies were big enough to compete with the variety and breadth of resources GE brought to the table.Globally recognized and ubiquitous in American homes, GE’s history and reputa-tion was also a key competitive advantage. Its reputation and political influence gar-nered favorable treatment from the U.S. and other governments. Smaller firms tried to compete with GE in individual industries, but GE’s reputation and brand awareness made it difficult for them to succeed.

Finally, GE’s strong company culture empowered and motivated employees, creat-ing a workforce that stayed with the company long-term and moved internally, building a strong, knowledgeable employee base, and its focus on sustainability and the greater community helped inspire employees and improve GE’s image overall.

Challenges Facing GEBy the end of 2012, GE faced many challenges. First, the parent company’s comfort in mature industries such as industrial appliances and jet engines rendered it reluctant to explore different markets, or identify and move into innovative industries at the begin-ning of their life cycles when potential growth and earnings are greatest. While this defensive strategy was more pronounced with former CEO Jack Welch, under whose direction GE maintained a near-zero marketing budget and focus on efficiency, many within the company perceived that there was still room for growth in innovative markets, particularly the green energy market, where GE could utilize its strength of scalability to establish a competitive advantage.

Second, for many years, GE relied on its staunch traditional methods to train work-ers, especially general managers. Throughout the 1990s, CEO Jack Welch focused on the bottom line through lean practices and overall cost cutting, creating an extremely efficient, process-conscious organization that prioritized meeting budgets, but lagged in innovation. While these strategies did increase net earnings, it became clear that they would not yield sustainable growth, as cutting additional costs began to outweigh the savings. GE began to see that the long-term solution was to train employees and man-agement to focus on creating new technology and products that both earn profitable returns and open new growth opportunities.GE also needed to acknowledge potential weaknesses stemming from being such a large and diverse organization. For instance, it occasionally underperformed in Asian and European markets. Greater understanding of the operational differences and dif-ference in business practices between the U.S. and these countries could explain in part why GE’s growth there did not meet projections.

Another challenge for GE was potential changes to the tax code. In 2012, GE filed a 57,000-page tax return, the single largest tax return in the United States.46 While GE benefited from a number of tax incentives, tax code reform constantly loomed on the horizon, and GE would be one of the companies most affected by changes to the tax code.Although GE had a strong global brand associated with product excellence and market leadership in several industrial categories, it came under attack for being syn-onymous with corporate greed. GE was accused of not paying its fair share of taxes, and protestors forcefully interrupted Jeff Immelt’s speeches alleging that47 using legitimate accounting techniques to pay lower effective tax rates, GE only paid an effective tax rate of 2.3% for more than 10 years, and that GE realized US$14 billion in profits yet paid no taxes in 2011.48 Also, GE was the recipient of a US$140 billion bailout in 2008, to cover massive losses at GE Capital.49 These allegations did not help their name, tarnishing the reputation of an otherwise well-managed brand. Furthermore, GE was the fourth-largest producer air and water pollution globally. Although top management’s focus on sustainability was considered a strength, GE needed to develop ways to become more “green” without hurting its bottom line.

What to Do with GE Capital?Despite General Electric’s market-leading portfolio and strong brand-name recognition, in the recent financial crisis, the dangers of a company’s reliance on financial services became apparent. What had begun as a financing arm to catalyze GE appliance sales had grown into a dominating financial services company that surpassed the earnings of the rest of the company to account for over 50% of GE’s total net income.This concentration of resources in GE Capital paid excellent dividends during strong economic times, yet the financial sector’s volatility rendered GE Capital vul-nerable to large, rapid losses. Unless GE hedged against financial slowdowns by reduc-ing its exposure to GE Capital, it might occasionally suffer losses that could put the company as a whole at risk. Further, like many financial firms, GE Capital was tempted by the large potential returns of what were later seen as risky investments, such as mortgage-backed securities and real estate. Unless GE Capital decreased its portfolio of risky assets, it could be prone to future losses that might have a negative impact on its GE parent.

In the years leading up to the financial crisis, GE, according to some industry ana-lysts, had become complacent, and corporate growth and earnings consequently stag-nated. GE focused too heavily on cutting costs and relied too heavily on the fortunes of GE Capital, which suffered from massive losses during the 2008–2009 financial crisis. When the recession forced GE to reduce the scope of GE Capital’s activities, GE was not able to invest and innovate elsewhere to bolster its financials and satisfy stockhold-ers. GE also did not have enough significant new ideas to mitigate GE Capital’s financial setback, such that GE Capital’s losses had a major negative impact on the growth and earnings of the corporation as a whole.The key question facing GE’s top management and board of directors at the end of 2012 was to what degree should they reduce GE Capital as a percentage of the entire company. Or, more to the point, should GE Capital be spun off altogether to allow the GE parent corporation to focus on the industrial products segment it had historically excelled in and where there is less competition and government regulation?