General Electric has been a stalwart member of the Dow Jones Index for the past 110 years. As I write this, word is just coming out that the company is being dropped from the Index. It’s a stunning fall from dominance for a company that once seemed an unstoppable force across multiple industries, including energy-related businesses.
But they won’t be the only such energy industry incumbent to be toppled.
We are in a period of strong “creative destruction” in the energy industry right now, across nearly all segments. This is an industry that has been sleepy and stolid for as long as I can remember, and long before. But no longer.
For industry insiders, this fall from grace shouldn’t be that surprising. A decade and a half ago, before I was an investor, I was a management consultant with a large consulting firm brought in to do a strategic overhaul of a large electric utility, and my experience was eye-opening.
Even then the signs pointed to untenable business models. There were regulator-driven disincentives to reduce cost, and severe limitations preventing revenue growth. In the heavily regulated industry, cost savings had to be passed on to homeowners, so the utility and their shareholders weren’t that interested in identifying new ways to reduce costs. The revenue-growth ceiling derived from the fact that the regulators wouldn’t allow the utility to expand their service offerings to existing customers, so really all they could do was to hope that new people moved into their region and become new customers. On top of this, shareholders tended to own a piece of an electric utility precisely because it really was that sleepy of a business. It was very predictable earnings and dividends. Thus, launching unregulated “high growth” new business units simply introduced quarterly earnings fluctuations. And boy, the investors didn’t want that. But adding all of this together, it was a picture of a business model and investor base that would be really fragile when inevitably confronted with rapid market changes.
Looking at related parts of the industry, things have always been a bit more “interesting” for the capital equipment manufacturers like GE, of course, as they were more exposed to macroeconomic cycles. Utilities and the like are their customers, whereas regulators are the utility’s customers. But still, the core dynamic has remained the same for both utilities and the equipment and fuel suppliers, for decades: Capacity- and macroeconomy-driven business cycles, perhaps, but overall a very well-understood and slow-to-change market. Hit a rough patch? The way to win in this context was simply to ride it out. Maybe even double down. Certainly not radical business model changes.
And this was certainly true at GE. Oh sure, there has been near-constant, purposeful experimentation within the company over the years, as one would expect given such a sophisticated management team and tradition of market leadership. Lots of attempts, at various scales, to engage new ideas, new markets, new business models.
But at GE, as with so many other incumbents in this sector, the core challenge was: How to make the organization actually care about big opportunities for the future, while they’re still at a fledgling stage. GE people have told me so many times over the years, “We’re interested in new markets, but only if they can quickly grow into a billion dollar business unit for GE. Otherwise it just doesn’t matter.” Obviously, GE’s smart people have found some of those opportunities throughout the years, it’s not impossible!
And yet for GE and their large-cap industrial peers, this ignores the fact that every opportunity that ends up big starts out small. And many of the eventual biggest opportunities take a long while to become meaningful.
The dilemma for these large companies is that, even when senior management recognizes the importance of the “Next Big Thing”, even when they mandate new business efforts and investments focused on that “Next Big Thing”, and even when they say all the right things about that “Next Big Thing”… Wall Street, most of the internal management, and most of the executive compensation schemes are still focused on the “Current Big Thing”. It’s just really hard within that context to jump fully to the important next opportunity. Especially when it means cannibalizing their current big revenue lines.
I have a friend at a large energy company, who has been tasked with helping to develop new businesses for them. While he’s been pretty successful so far, he has confirmed the challenge that these big billion dollar companies have when attempting to innovate and invest in new ideas. While he has grown his business unit to a size that would be the envy of many “cleantech entrepreneurs”, it’s still a mere speck compared to the overall company, orders of magnitude smaller than what it would take to make his efforts be the first topic of a quarterly earnings call. So it doesn’t rank in terms of internal priorities.
“One foot on the dock, one foot on the boat” is never a sustainable position to be in. But the energy market is now in the midst of some major sea changes — the electrification of transportation, behind-the-meter energy systems killing the utility business model, and of course solar and wind becoming more cost-competitive versus fossil fuels, to name just a few. And so most of the large incumbents in this sector find themselves in that uncomfortable straddle right now – keeping their core business going strong amidst a changing marketplace, while innovating for the next big thing. GE has been straddling this divide for years, and now it’s no longer just an industry secret. And GE is not the only energy giant to grapple with these challenges. If the history of such industry sea-change periods is a guide, many of today’s incumbents will lose the battle and fade.
It’s not too late. Some incumbents may fail to make bold enough moves. But others may be able to make the leap fully from the increasingly rickety dock to the boat, from the old models to the new ones. Despite their recent setbacks, GE may yet be among those who end up able to successfully make the jump. But if so they, and their peers among the energy industry incumbents, need to start moving a LOT more quickly. Immediately.
Watch for more big splashes.