Running The House That Jack Built

An era is ending. Can anyone replace GE's Welch?

Save one last superlative for Jack Welch. As he prepares to wind up his remarkable 20-year run as CEO of General Electric Co., Welch is obsessed with doing the best job ever of picking a successor. As far back as 1991, he identified this as his most important job and vowed to work on it every day. "He's been talking about it ever since I can remember," says Walter B. Wriston, the former CEO of Citicorp who was on GE's board for nearly three decades.

The process has only intensified over the past year. Welch encouraged GE board members to visit businesses run by the three most likely contenders, and himself has grilled heads of key GE units on who they think the next CEO should be. In June, he moved promising up-and-comers into the No. 2 slots in the three businesses being run by the CEO finalists, so that GE would have experienced replacements up to speed when the big announcement is made.

That's typical Welch, always one step ahead. This is, after all, the man who dazzled Wall Street with year after year of stellar earnings growth, and pumped GE's stock market value from $13 billion when he took over to $560 billion today. But as the succession race winds down, Welch's thoroughness raises an obvious question: Even if he gets it right and finds the best possible replacement, what's left for the new guy to do? As Sanford C. Robertson, founder of the former San Francisco investment bank Robertson Stephens, puts it: "Who wants to follow Jack Welch? It's the toughest job in the world."

Welch speaks of his successor--whom he's likely to name in the next few weeks--as if he's the anchor man on a crack relay team, taking the baton with a huge lead on the rest of the field. "It isn't about revolution. It's about [being] bigger, taking risk," he told Prudential Securities Inc. analysts in an April interview. "You almost can't screw this thing up, it's so big and powerful." But GE's next leader will have to make some tough calls on where to concentrate resources, and which plodding performers to shed. That could mean saying good-bye to some of the company's signature businesses, such as appliances.

A more daunting challenge for the new CEO, though, will be having to follow a corporate icon. Welch, along with Alfred P. Sloan Jr. at General Motors Corp., has been called one of the two best managers of the past century by various experts. Behind the sterling financial performance is a master motivator. Welch is the shot of adrenaline that shocks GE into action each day, as he prods and punishes with his famous handwritten notes. "The biggest job I have is to let people know how we feel about 'em," Welch told the Prudential analysts. "You gotta tell them you love 'em, and you gotta kick 'em in the ass when they're not doing their job. And you got to be able to hug 'em and kick 'em in the ass frequently."

FRONT-RUNNERS. One school of thought--the one that prevails within GE--is that after 20 years, Welch's practices are deeply embedded within the company's circuitry. The system is so finely tuned it doesn't require another Jack Welch. "Can one person run a trillion-dollar company?" muses a longtime GE exec who now runs his own company. "Probably not. I think the new person comes in with a completely different model. It'll be much more of a team approach, not a superstar approach."

But others aren't so sure, and they warn that it's dangerous to discount the value of a powerful leader in a complex organization. "Doesn't it take something unique to decide which of all the ideas that bubble up from the data are worth pursuing?" asks Jeanne G. Terrile, an analyst at Merrill Lynch & Co. She points to the need for "enforcement, maybe even fear" inherent in leadership, and asks: "If there isn't much of an execution risk at GE these days, is there still an inspiration risk?"

By early December, Welch is expected to announce which of three GE executives will step into those enormous shoes. In the lead, according to GE insiders and executive recruiters, is Jeffrey R. Immelt, the 44-year-old head of Medical Systems, who by many accounts possesses extraordinary leadership talents. Also in the running are W. James McNerney Jr., 51, who has held key assignments all over the company and currently heads the giant Aircraft Engines division; and Robert L. Nardelli, 52, who won a spot as a top contender largely because of the stunning turnaround he has pulled off at the company's turbine-manufacturing unit, Power Systems. The three contenders, along with Welch, declined to be interviewed for this story.

HEFT. Whoever gets the job, it will be a quantum leap in complexity from what they've handled up to now. Since Welch became CEO in April, 1981, GE's revenues have risen from $27.9 billion to an estimated $130 billion in 2000--nearly 2% of the nation's gross domestic product. GE operates in more than 100 countries, with 340,000 employees, and its brand encompasses a mind-boggling array of goods and services, from locomotives to mutual funds.

Over the past decade, as Wall Street soured on most conglomerates, GE continued to ride high. That's because Welch proved a master at turning the company's massive size to his advantage. Diversity enabled him to ride out rough patches, such as the stretch in the mid-'90s when no one was buying gas-powered turbines. And heft gave him an advantage in acquisitions--last year alone, GE bought 134 companies, valued at nearly $17 billion--and helped bury the inevitable mistakes. "If you use size and bat 70%the other 30% you hide under the rug," he has said. Welch sees no reason why that should change once he's gone: "This company can handle at least another 50% of the complexity and 100% more volume in different businesses."

But even Welch, in time, would have run out of ways to build such a huge company at an ever increasing rate. That argues for either spinning off pieces or creating new ways of managing them. "There is no historical precedent for something of that scale being effectively managed," says James C. Collins, co-author of a book on corporate cultures, Built to Last.

BUYING TIME. A less centralized management could enable the new CEO to tap GE's extraordinary depth of executive talent. Take Enron Corp., says James J. O'Toole, a leadership guru at the University of Southern California's Center for Effective Organizations at the Marshall School of Business, who has written about GE in such books as Leadership A to Z. CEO Kenneth L. Lay has fostered an entrepreneurial management structure that allows Enron to exploit growth quickly in new territories. EnronOnline, which trades everything from natural gas to financial instruments on the Net, was launched last year without needing the O.K. of the company president or CEO. Welch, on the other hand, personally makes thousands of calls a year on everything from hiring and firing to factory investments.

A different management structure might also buy time for the new CEO to solidify his team. Welch, like his predecessor Reginald H. Jones, chose to set up succession as a horse race. That means the two "losers" likely will leave the company when succession is announced, leaving GE without at least two top managers, as well as some loyalists who will almost certainly follow them out the door. Certainly, none of the three contenders is a Jack clone, and that might be good. "Jack is an intimidating guy," says a former GE executive. "When you walk in his office and he says jump, you jump. [But] Jeff can lead with a completely different style, which in a fast-paced Internet age might be a better style." Immelt is known for more of a team-oriented approach, where a group of specialists is quickly assembled to tackle a specific task.

Welch clearly has sought to avoid some of the awkward aspects of his own ascension. Jones made succession an all-out political fight by bringing Welch and the two other contenders, Edward E. Hood Jr., and John F. Burlingame, to the Fairfield (Conn.) headquarters to duke it out. And Welch was still a surprise to many when he was named, because of his age--45--and his abrasive style. This time, Welch went to great lengths to let the contenders prove themselves by running their own businesses. And he has made clear that the next CEO should be young enough that he can stick around for 20 years as well.

Of course, Welch did have one advantage when he took over from Jones in 1981: While GE was profitable, it was badly bloated and offered many opportunities for improvement. Welch chopped 117 businesses, nearly 100,000 jobs--he didn't get tagged "Neutron Jack" for nothing--and layers of bureaucracy in his first four years. "It was like being handed the Chicago Bulls when they weren't doing too well vs. being handed the Bulls after they win the NBA championship," says University of Michigan management professor Noel M. Tichy, author of a book on Welch, Control Your Own Destiny or Someone Else Will.

The new guy will take over a company that's performing at the top of its game. GE has reported increased earnings every quarter since the third period of 1975, and its earnings per share have chugged along at an ever faster pace: 14% growth in 1998, 15% in 1999, and an expected 18% this year. Shares trade around 57, or nearly 50 times GE's trailing earnings--a multiple that some stock observers find baffling for a company that gets 41% of its earnings from financial services.

That's more than three times the multiple of a typical financial-services outfit. "Certainly, there's a Welch premium in the stock," says Gary C. Wendt, the former head of GE Capital Services who now runs Conseco Inc. Even American International Group Inc.--which also sells insurance and mutual funds and is run by another highly regarded CEO, Maurice R. "Hank" Greenberg--has a multiple of 38. At that level, GE's stock would trade around 44. Most analysts are convinced that GE will ride out Welch's departure without suffering a big hit--partly because Welch has been pumping up their expectations for earnings growth over the next two years.

"FREE PASS." How does Welch do it? The secret to his earnings-management success lies in large part with GE Capital, which has its hands in everything from small-company finance to real estate to equipment leasing. Finance offers plenty of opportunity to "smooth" earnings from one period to the next. Indeed, within the Capital unit, GE this year balanced poor performance in its auto-leasing and railcar-leasing businesses by taking gains from GE Equity's investments in Internet companies, says Merrill's Terrile.

It also helps that Wall Street has tended to overlook Welch's more glaring screwups, such as disastrous investments in Kidder, Peabody & Co. and Montgomery Ward & Co. The new CEO probably won't get the same benefit of the doubt. Says O'Toole: "Welch has been the Teflon CEO. Even when he's made mistakes, he's been given a free pass. The next person will not have that built-up credibility. If they start to make mistakes, those little mistakes are going to be magnified."

And with such a huge portfolio, GE offers plenty of potential pitfalls. Many of its businesses are highly cyclical: Power Systems, for example, was limping badly in the mid-'90s before the demand for gas-fired plants exploded. Some financial services are especially vulnerable to downturns in the economy. Welch himself says he worries about world equity markets because a stumble could destroy consumer confidence and bring growth to a screeching halt.

Extending GE's growth streak could depend on what the next CEO decides to ditch. Goldman, Sachs & Co. analyst Martin A. Sankey estimates that earnings growth of 15% or more is locked in for at least the next couple of years. "The No. 1 challenge is going to be to figure out how to perpetuate that in 2003 and beyond," he says. "Does he have the imagination and guts if necessary to undo the things developed by his predecessor? That's what they're really paying the guy for, to make the big strategic calls."

NET SAVINGS. What might go? A number of analysts note that the appliances unit, which has struggled in the past year, is barely one of the company's top 20 businesses anymore, based on net income. Or might the new guy contemplate a sale of NBC? Critics argue that NBC was always a big ego play for Welch and that in an age of media monoliths, shareholders may get more value if the network links up with a larger entertainment company.

On the upside, some of Welch's recent initiatives, such as e-businesses, are still in their infancy and offer considerable opportunities for new revenues or savings. GE will likely make only 15% of its purchases on the Net this year, yet is already saving an estimated $500 million. The Internet also promises new ways of adding value to manufactured goods. Example: GE systems now let users of CT scanners or turbines monitor their machines' performance online, and compare it with the performance of others on the network. That sort of innovation is essential if GE is to continue its remarkable shift into services--nearly 75% of its revenues today come from services, compared with 85% from industrial business in 1980.

Even before he steps down, Welch has been lauded as a model of succession planning. And indeed, GE's new guy will be prepped as well as anyone who has moved into a corner office ever has been. Shareholders will waste no time measuring his success in stock multiples and earnings reports. But the real test may come years from now, when they either remember Jack Welch for delivering 20 fat years, or his replacement for ensuring 20 more.

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