The Recession And Weeding Out America’s Worst Management (MCD)(LUV)(JPM)(WFC)(GM)(INTC)(AMD)(DIS)(CBS)(HPQ)(WMT)(GE)

November 24, 2008 by Douglas A. McIntyre

R218533_855025Most executives spend their careers trying to get noticed, both as a way to achieve promotion and to bolster their reputations which they hope will be remembered long after they retire. Mention Herb Kelleher, their former chairman of Southwest Airlines (LUV), and everyone in the industry recalls him as one of the sharpest operators since Charles Lindbergh made it across the Atlantic. Ray Croc, founder of McDonald’s (MCD) and Sam Walton will be in business school case studies for decades or longer.

As executives move up the ladder they spend most of their business lives trying to be "mentioned in dispatches" as it used to be called in the British Armed Forces.

While it is good to be king, the status of being oft-mentioned has its disadvantages. By definition, 50% of American CEOs are performing below average. In good economic times the slackers are less evident. In a recession, they stand out like a matador’s red cape.

It may be that over the last half-decade the financial services industry had more than its share of under-performers. It certainly appears that way. Those CEOs who did poorly said that their companies were drowned in a hundred-year flood. The performance of successful companies like JP Morgan (JPM) and Wells Fargo (WFC) in the same period undermines this excuse.

In the auto industry, Richard Wagoner, the head of GM (GM), is now thought by many people to be the least skilled auto executive since Roger Bonham Smith left the largest US automaker in 1990. Wagoner’s advocates would argue that high fuel prices and the credit markets brought the company down.  Many recognize that during the years of profiting from SUVs and pick-ups, Wagoner and GM did not hedge their company’s future by investing in fuel efficient cars or forcing the issue of high worker benefits.  Now, the high price of oil and their confrontational relationship with the UAW have brought this once-vaunted American car company to the precipice of disaster.

The founders who returned to save their companies, most notably Michael Dell and Howard Schultz of Starbucks (SBUX), are another group of CEOs who may wish that they had signed up during a different period. Since the return of each man, their firms have fallen into deeper and deeper trouble despite early enthusiasm about what they might do to make their companies successful once again.

The executives of these troubled companies all have magical thinking that allows them to disregard all rational understanding of how cyclical almost all businesses are.  They refuse to acknowledge the inevitability of an occasional downturn in their industries or the economy at large. Some of these CEOs may be too young to remember the mistakes that resulted from American business expansion and the subsequent economic problems which led up to the GDP contraction of the early 1970s, causing the recession of 1973 and 1974.  However, this recession and its origins have certainly been studied in detail by managers that have even the most modest education in economic history. It appears that reading about the economic disaster of the 1970’s has had no impact on the judgment of many of today’s CEOs.

Innovation and the willingness to be brutal about costs even when revenue expansion is fantastic are the characteristics that successful CEOs have in common. Mark Hurd of HP (HPQ) began layoffs even when the tech industry was doing well. He began taking out expenses to improve margins as early as 2005 by cutting 15,000 jobs. In the recent consolidation of its purchase of EDS, Hurd wasted no time trimming 24,000 jobs about 8% of the combined workforce. The streamlining of the company does not appear to have done any damage to its ability to diversify beyond its core PC and printer business by moving into higher margin software and consulting operations.

Intel (INTC) cut 8,000 people in 2006. The PC and server industries were doing relatively well, but when Intel faced competitive pressure from AMD (AMD), Intel responded with superior R&D and price cuts. Intel could have chosen to overcome its rival while retaining a slightly bloated workforce since it had a balance sheet of billions in cash. It elected to cut as much as possible in the event that the price competition was prolonged. What Intel ended up with was higher gross margins. The benefit of those measures is still with the company today, along with a line of chips, which is by almost any measure better than the AMD product line. Intel did not sacrifice product development as it become more efficient.

Walt Disney (DIS) cut 650 jobs in its studio business in 2006. Management bet that with the cost of film production rising almost every year, it would be better off making a dozen pictures and not the twenty or so it had been rolling out annually. It also sold its slowest-growing media assets, its newspapers and radio properties.  Its shareholders would have paid a high price if Wald Disney had not divested itself early on of these poor performers.  CBS (CBS) almost certainly regrets staying in radio. This business now relies almost entirely on advertising which will destroy CBS’s earnings as the economy passes through the recession. Disney has its film studios, TV and cable network, and theme park operations. None of these is "recession proof" but Disney’s mix of businesses is certainly more stable than the one-legged stool of CBS’s TV and radio advertising.

Wal-Mart (WMT) has been frequently criticized for keeping unions out of its US operations and sourcing goods from China. Over the last three or four years it has received as much bad publicity as almost any large American company, but that has not kept it from staying with its plan to offer a huge variety of products at remarkably low prices and managing a supply chain system that is probably the envy of the American military. At the same time it has set up programs like its $4 prescription offers and quasi banking facilities to bring in customers who are likely to buy other items while they pass through the company’s stores. Wal-Mart has taken no risk with its balance sheet. It has avoided beginning its own financial services operations to extend credit to customers and has done virtually nothing to move beyond being an owner of stores with a widening product line. It is a company with the balance sheet capacity to take risks, but it has refused to.

The period from 2005 to 2010 is likely to be remembered as a period when American business management was characterized by a lack of risk management. Even formerly well-run companies like GE (GE) put their balance sheets on the line by investing in parts of the financial markets which the firm should have known could hit troubled periods if the market’s ability to continue to create leverage was ever compromised.

There will be a villain’s list of CEOs who will be blamed for ruining their companies. The list of executives who kept their firms out of trouble will probably get very little ink in business history books.

One thing is almost certain. A downturn causes boards to dump CEOs who do badly even if it is simply to be able to claim that they exercised their obligations to shareholders. If the system works even moderately well, American business will come out of this recession with a stronger and more astute group of people running the nation’s largest companies.

While 50% of CEOs will still be below average performers, the average will have been moved well up the scale.

Douglas A. McIntyre