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New financial and statistical measures to monitor the success of ge

New Financial and Statistical Measures to Monitor The Success of GE

To : The Board of Directors, GENERAL ELECTRIC COMPANY

Subject : NEW FINANCIAL AND STATISTICAL MEASURES TO MONITOR

THE SUCCESS OF GENERAL ELECTRIC COMPANY

After Mr. Weltch announced my new assignment, I pondered how I could go

about guaranteeing the best possible result: a creditable and well organized

work that is going to help you, the Board of Directors, plan for the future of

the company in a better way. Before starting my analysis, I must specify that

my target is not to abolish the traditionally used financial and statistical

measures but to develop new ones to be used as guidance for the corporation's

future development.

Our Chairman recently wrote that "the hottest trend in business in 1995

-- and the one that hit closest to home -- is the rush toward breaking up multi-

business companies and spinning off their components, under the theory that

their size and diversity inhibited their competitiveness ... breaking up is the

right answer for some big companies ... for us it is the wrong answer.²1 For us

the new trend is the entrance into the service industry. The question must then

be: is this the right answer?

GE is expecting to increase its revenue by the year 2000 to $120 billion

compared with $58 billion in 1990. In other words, if the forecast proves to be

correct, it will obtain an average annual rate of growth of 7.5%. This high

rate is mainly attributed to the expansion of the services sector of the company,

which is estimated to increase by an average annual rate of 13% compared with a

corresponding one of 2.1% for manufacturing. Today nearly 60% of GE's profits

comes from services -- up from 16.4% in 1980.2

This is our new direction and therefore my target is to find these

measures that are going to help us understand how the business is going to

perform in that particular field. I also consider that our attempt to expand

internationally is extremely important and in a way is something new for us.

International operating profit was $3.0 billion for 1995 compared with $2.3

billion in 1993.3 This extremely rapid expansion hides a lot of dangers, and at

the same time shows another new "trend" of our corporation. In my analysis I

will include the international sector. I will also narrow in on employees,

stockholders, goodwill and on potential investors.

1) MIEC (Manufacturing Industry Expenses Comparison)

As we know, the basic organization of the company Œs continuing

operations consists of 12 key businesses, which contain management units of

different sizes.4 From these only three are specified in the service field,

including: (a) Capital Service, (b) NBC, and (c) Information Service. On the

other hand, the manufacturing industry is divided into nine different segments,

some of which will be mentioned later. Although it is not our main concern, the

manufacturing segment of GE can be used as the yardstick for the success of the

service industry. This is so because this sector of General Electric has been

extremely successful and very well established during the past few years.

Almost $40,000 million in revenue and almost $9,110 million in profit came this

year from manufacturing operations.5 We know that what we have achieved in

manufacturing is success. So the question that arises is why should we stop

investing in "success" and enter a completely different field. The first

measure which we are going to analyze in this part of the discussion attempts to

answer that question. MIEC, the manufacturing industry expenses comparison,

compares the amount of money spent for the service industry to the expenses made

for the manufacturing industry. Thus it is equal to :

Expenses made for the service industry

MIEC = --------------------

Expenses made for the manufacturing industry

Therefore, according to the financial statements of the previous years

we would have6:

MIEC 1992 = 15842/29991= 0.52

MIEC 1993 = 18560/30657= 0.60

MIEC 1994 = 19787/30890= 0.64

MIEC 1995 = 26156/33152= 0.78

By establishing the MIEC, we can see the relationship between the amount

of money spent on service and the amount of money spent on manufacturing. MIEC

is a simple number that is does not seem to have a very important use on its one.

However, if this ratio is combined with other facts we can come to several

conclusions about what the company's future decisions should be. For example,

if we combine MIEC with the return on assets,7 we can see that the return on

assets is higher for the service industry than it is for the manufacturing

industry, and thus are able to infer that a good decision would be to increase

the ratio by spending more money on the service industry. On the other hand, if

the return on assets is lower for the service industry than it is for the

manufacturing segment, then we should decrease this ratio by investing more in

the latter. What we want to create by using this measure is some sort of

equilibrium between the two main parts of our corporation. Mr. Welch has

recently said that he would have wished for the percentage of profit coming from

the service industry to have attained a staggering 80% instead of 60%, today's

figure.8 In order to achieve this, we should invest more in the service

industry, thereby increasing the MIEC ratio.

The question for the future would be: by how much should we increase

this ratio? From what we have said up to this point, we should adjust the MIEC

ratio up to the point where: return on assets from the service industry = return

on assets from the manufacturing industry. Of course, this equilibrium cannot

really occur, but it can only be approached; however, it can help us make future

decisions in the best possible way. To give an example, let us suppose that :

Return on assets from the service industry =15%, and Return on assets from

manufacturing industry =12%.

From the above we can conclude that more investments should be made to

strengthen the service industry. However after a certain point the "good ideas"

would be eliminated. The firm would have to invest in less profitable areas and

the return on assets from the service industry would fall, then begin

approaching the return on assets of the manufacturing industry, which is already

satiated. At this point we should stop increasing MIEC, and we should keep it

stable, ceteris paribus.

To expand the share of the services GE had to transform its assets form

buildings, machinery and equipment into well trained intelligent employees,

software experts, service networks, etc. This transition will cost a lot to the

company, and the MIEC shows us just how much it will cost in comparison to the

well-established manufacturing industry. It also helps us estimate if this

ratio has the value that it should really have for our corporation to be

efficient.

2) EC = The Employees Comparison The EC (Employees comparison) has to

do with the profit that each employee brings to the corporation. This ratio is

equal to :

Net Income

EC = -----------------------------------------------------

Number of Employees in the Firm

For this year EC= $6.6 billion / 222,000 =$30,000.9

In a way, EC shows how much profit is generated by each employee. That

measure can be used in a lot of different ways. First it can be used to judge

if the average salary in the company is settled in the right way. If for

example we find out that during the year 199x the average salary was $60,000,

and our other expenses were equal to $250,000 (if divided per employee) then

the return on our investment would be less than 9%, which is not good enough due

to our goal -- double digit earnings. If we find out that our other expenses

are reasonable, then we can suppose that either salaries should be decreased or

the firm might have to reduce the total number of employees.

During the 1980s, General Electric had to pare payrolls for most of its

departments because the salaries where considered to be too high for the income

generated.10 But as the corporation is getting bigger and stronger, there might

be people working in the newly purchased companies that the corporation controls

whose salaries are higher than the actual service that they offer to the company.

In order to avoid that, we should find the EC for each of the companies

individually and compare them.

We could also compare the EC between the two industries, the service and

the manufacturing industries. Since the manufacturing industry is older, many

changes have been taken place in difficult times for the company.11. Thus, we

can suppose that the number of employees was adjusted during the years in such a

way that the corporation could function efficiently. Therefore, a good target

for the newly bought service firms would be managing to reach the EC of the

manufacturing firms that belong to General Electric.

The same can happen with firms in the USA and international firms, the

majority of which have been acquired during recent years. For example in 1995

we would expect that the 72,000 employees working abroad12 would bring in

approximately: 72000 x 30000 = $2,160 billion (as mentioned above $30,000 was

the value EC for 1995).

On the other hand we can see if the measures to increase the profits of

an organization are too harsh for the employees, or are not rewarding the

employees well enough. For example, if an outsider can describe a salary of

$80,000 as high, no one can say if this salary is high enough unless he/she

takes the EC into account. So by using the EC we can estimate the correct

amount of bonus that an employee can receive for performing well, or even the

bonus for the entire firm that performed well. We should not forget that

salaries considered to be too harsh will lead valuable employees to quit in

order to find better paying jobs.

To summarize, we can say that the salary level should be well balanced

so that it does not disappoint employees by paying them less then they believe

that they should to be paid, nor should it reach levels that would cause losses

or sizable reductions in investment, as this might bring future losses as a

result. The EC measure can help us create this balance more accurately.

3) In the third part of our analysis, I am going to discuss dividends.

As we all know, it is very important to keep our stockholders satisfied. Until

today, there have been measures that have been gauging what stockholders receive

only in a mathematical way. For example, we could say that in 1995 the dividend

declared was $1.69. But what does this really mean? Let us take another

example. Some would say that if for example we offer the 50% or more of the

corporation's profit to the stockholders, they will be satisfied. Can we be

certain that this is true? How can we judge?

With the new measure that I am going to introduce, we are going to be

able at any time to estimate the utility that each of our stockholders receives

by the dollar amount of the dividend that we pay to him/her. In order to create

such a measure, we have to take many factors under consideration. First, we

must clarify that when we talk about stockholders, we are not referring to

people who are just investing in the stock market for the purpose of gaining

money from the short term ups and downs of GE's common stock market price. We

are referring to the people that in some part of their lives wanted to invest

their accumulated wealth and decided to buy shares of GE. In order to see if

the investors are satisfied in choosing our stock, we must take into

consideration what their situations would be if they had chosen another form of

investment or another corporation in which to invest their money.13

I will suppose that the closest investment, for a household, to buying

shares of GE is buying bonds. Bonds certainly do not have a great potential

for very large profits. In addition the risk when buying a bond is very low.

Therefore the new measure should combine these two characteristics of buying a

bond and compare them with the profits from buying shares of stock that have the

same value as one bond. I will name the new measure: Stockholders Comparable

Utility = profit from buying shares of the company / profit from buying a

bond.14

As you see in the above ratio, risk is not taken into consideration.

This may not be correct for another corporation, but it is the correct choice

for GE. If we wanted to take risk into consideration, we could create an index

where: risk from buying a bond = 1, risk of buying shares of stock of the same

value = X. We would have to examine the financial position of the company and

we would assign a value to the risk of buying the shares. Then we would

multiply that value with the SCU ratio. However, in the case of GE the risk of

buying shares of the company is as low as the risk of buying a bond (from the

company or from the government). Hence, for GE the SCU ratio depends only on

the profits (or losses which will be calculated as negative numbers in the SCU

ratio) derived from the two possible investments. To close we have to say

that since: RISKbond = RISK shares of GE = 1 any SCU > 1, any dividend that

would give higher return than a return that a bond should satisfy our long term

stockholders. However, if for any reason during the next few years we find that

the above equation is not correct, we should make the appropriate changes.

4) Besides the long term investors there are a lot of people that

closely watch GE's performance, such as creditors and short term investors. All

of these read our annual reports but at the same time try to find any sort of

information about the actions that we take. We know how important it is to show

to the indirect users of the financial information that we are doing well and

that we should never cause any suspicions of fraudulent financial reporting.

That can be partially achieved if we use creditable and conservative financial

procedures, but that is usually not enough. We can take for example a newly

formed corporation that creates its first financial reports by using the

commonly accepted accounting methods. At the same time lets suppose that this

company reports huge earnings for the first year which are real. What is the

reaction of the market going to be? Certainly not as substantial as if General

Motors, or Unilever reported a huge increase in profits. There will be mistrust.

In my opinion what could make the investors and the creditors trust a

corporation " blindly " is the company's prestige. Of course these two huge

corporations may have achieved much respect but they should definitely make

anything possible to keep up with that good name that they have created. One

can say the effort to do that is only related to an attempt, for example, not to

create pollution or not to be guilty of any kind of racist attitude in the

company. Of course, it is true that if we were guilty of any of these actions

we would probably be humiliated in the eyes of the consumers. Many of them

would not prefer us any longer and we would therefore be a weaker company. Thus

we would loose a lot of our potential creditors or investors. However, we can

see that the above have only an indirect connection to what the investors would

feel about our firm and it is related to what the financial statements show

about GE. If we report lower earnings, banks will not give us as many loans as

the are giving us now.

With the new ratio that I am going to introduce I am making an attempt

to help eliminating any kind of mistrust to the company due to reasons which are

not related to the financial statements and have a direct connection to the

investors. That mean that there are several actions that we should consider

making that are not actually going to increase our earnings by satisfying our

customers but are going to increase our "prestige" -- our goodwill. I will

focus on one of them, the ability to participate in bids, and to be the

preferred company. Therefore the new ratio equals: Goodwill Creating Ability

(GCA) = number contracts signed / number offers made. The number of offers made

refers to the number of bids at which the company participated. If we manage to

be the preferred company in a lot of bids then it will be commonly known that we

have the power not only to show good past and present financial data but also to

continue in doing so through the next years. The question that arises is how

this measure is going to affect our movements for the following years.

In my opinion the idea of this measure and its effect on the

creditability of the company will first of all affect the way we think before

entering a bid. We often try to make a deal for which there are great doubts if

it is going to offer any earnings in the future and at the same time our chances

to be preferred are quite limited. If we do not take the above ratio under

consideration the only risk related to our entrance to the bid would be the

chance not to make enough earnings to cover our expenses after actually being

the preferred company. However the GCA shows that the actual risk is much

higher and therefore we should possibly reconsider entering into several risky

bids (that can be lost easily).

There are some times, however, when our estimations were not correct and

although we entered the bid, yet other rival firms appear to have strong chances

of actually being the "preferred ones." For example lets suppose that local

CHANNEL X enters an auction to buy a studio in the Providence area. NBC, on the

other hand, the huge broadcasting company which we recently acquired wishes to

buy the same studio so it enters the bid. After a few days, secret information

are offered to GE which reveal that CHANNEL X is going to offer the price of

$10,000,000 to buy the studio. We also know that the maximum revenues that this

studio can create for the next 20 years are $9,000,000. That is a good

indicator that it is not a smart move for us to make a higher offer. Someone

would think that the best thing to do would be to make a lower offer and hope

that the information given to the company is incorrect. This choice does not

seem to be irrational, because of the commonly accepted cost benefit analysis.

But in this case, is this the right answer? Lets suppose that we do give a

lower offer. The following day we see that CHANNEL X, offered $10,000,000 to

buy the studio. The result would be losing from a channel that hardly anyone

knows and that is much weaker than NBC. How is this going to sound to all these

that on a daily base watch the actions that we take? Channel X reported

operating profit of $2,000,000 for the financial period ending December 1995.

For the same period NBC reported operating profit equal to 738 million

dollars.15 What could someone think then about the creditability of our

financial statement? I am not suggesting that nobody is going to realize what

has actually happened but can we be sure that nobody who is very important to us

will think differently? How can a multi-million dollars firm loose by an

unknown company? Our prestige would not be so high any longer. That is why, in

several cases, we should reconsider offering a price that might give us profits

if we win, but it does not guarantee that we will actually do so. In some cases

we might have to lose money in order to make our company prestigious. To prove

why this is correct take under consideration all the expenses that we make and

that are made only because we want to create a better name and consequently to

receive the benefits of that. A good example is advertising.

In my opinion as long as we realize that a firm is not only buildings

and equipment but also a name we can realize why the GCA ratio is very important

as a new way of thinking. We should make sure that this ratio only increases.

5) I have already referred to a measure that is affiliated with

stockholders, the Stockholders Comparable Utility. I justified the creation of

this measure by saying that it is very important to monitor on a constant basis

the utility of our stockholders which derives from the dividend that we give to

them. The question that can arise out of this statement and could be partially

answered by the creation of the last measure is, "how much power do the

stockholders actually have over the corporation -- or put another way, how

important is it to keep them happy?" It can be said that the larger our need to

find cash in order to expand the larger the importance of investors for us.

However, such a measure would refer to future investors and not to the ones that

already have claims over the assets of the business. In order to see the actual

power that the latter have over the corporation we have to consider the Claims

of the Stockholders Ratio which is equal to: Number of Shares Outstanding /

Number of Shares Issued. For example for 1993 the CSR was equal to: 1,707,302 /

1,853,128 = 92.1%, for 1994: 1,705,967 / 1,857,013 = 91 % and for 1995:

1,666,512 / 1,857,013 = 89.7%.16 From the above facts it is obvious that the

stockholders' equity is decreasing over the years and, consequently, so is the

control that they have over the corporation. The question that arises is what

is going to be affected because of that and how is it going to be affected.

The answer is given in the following hypothesis.

As we know the corporation issues shares of stock if the cash available

for investments is not enough for the planned expansion of the company. If GE

manages to have better cash flow results, then it will not have the need to

issue a many shares of stock as before. At the same time GE will be able to buy

some portion of its outstanding common stock (as mentioned in footnote 16, GE

does not have any preferred stock) and, therefore, reduces the stockholders'

equity over the assets of the company. If this procedure continues successfully

during the next few years, then it will be obvious that GE does not "need" its

stockholders or the potential investors that much. On the other hand, we know

that when a company wants to attract more investment has to offer a high

dividend to its stockholders. Thus, if the corporation does not need to attract

as much investment, and can rely more on its own power to invest, then the

amount of money given to the stockholders should be decreased.

To close we can say that if the CSR is a simple measure based on the

simple supply - demand convention.

I hope that the five measures that I have created will be useful to you,

Members of the Board of Directors, in planning for the future of GE. I have

confidence that the firm is going to continue putting forth its best efforts

towards growth and expansion, which will bring outstanding results. I believe

that the measures that I have suggested will help in that direction, and will be

crucial in attaining our future goals. Thank you.

Source: Essay UK - http://www.essay.uk.com/coursework/new-financial-and-statistical-measures-to-monitor-the-success-of-ge.php



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