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Bill George

Harvard Business School Professor, former Medtronic CEO

The Perils of Focusing on Short-term Shareholder Value

Credit the board of Citigroup for facing reality by splitting the company in two.  It is a tragedy that General Motors´ leadership won´t make a similar move. Both need to recognize that the conglomerate approach to creating shareholder value does not work.

The root cause of Citigroup´s and GM´s problems- and of our current economic crisis – is the mantra of “maximizing shareholder value,” which led to an incessant focus on short-term gains. Any company that focuses primarily on short-term shareholder value will eventually destroy itself. When entire industries do so – as we have witnessed with financial service institutions and U.S. auto makers – they can drag the entire country into a deep recession.

After ten years of trying to implement former CEO Sandy Weill´s vision of turning Citigroup into a financial supermarket, its board finally acknowledged this strategy has been a colossal failure. To survive, Citigroup is returning to its roots in commercial banking, recreating the former Citicorp, the healthy bank composed of its retail and commercial banking arms, private banking, and investment banking. The second company, Citigroup Holdings, will contain its “non core” assets, including its subprime and illiquid mortgage-related assets that eventually will be spun off or liquidated.

Citigroup never integrated its far-flung units, nor did it provide its employees with an integrated information system enabling one unit to expand financial relationships with customers of other units.  Even worse, the Citigroup board never looked at firm-wide risk, assuming erroneously that the diversity of its businesses would offset the risks.  By 2007, Citigroup was so desperate to generate profits through short-term fees that it totally underpriced risk, leading to the bad investments that forced the U.S. government to provide $45 billion in bail out funds and guarantee $306 billion in bad loans.

At least Citigroup had the wisdom to recognize the music stopped some time ago.  General Motors continues on its merry dance, as its management fiddles while the company implodes.  Its board refuses to save the company by following Citigroup´s lead and splitting GM in two – a viable core business of Chevrolet, Buick and Cadillac and a holding company for all its other assets, which would be spun off or liquidated. Unless GM moves quickly, it will face with an uncontrolled liquidation of its entire business, and America will lose its one-time icon of industrial preeminence.

In spite of the Bush administration´s “Christmas bailout,” the new Obama team is unlikely to continue financing GM´s losses, just to preserve jobs that are no longer viable. Asking American taxpayers to provide GM employees with 100% health care coverage tax-free, while 47 million Americans have no health care at all, doesn´t pass the smell test.

The lesson of Citigroup and GM is that the conglomerate corporate structure, so popular in the days of ITT, Litton, and Textron, simply doesn´t work.  Customers don´t care if the parent company has a full range of offerings. They only want to know if the specific product or service they are buying is superior to competitive offerings.  As GM and Citi learned the hard way, any company that cannot provide customers with superior products and services is steadily going out of business.

In 1969 I joined Litton Industries, one of the model conglomerates of its era, and saw first-hand the flaws inherent in the conglomerate structure.  Litton had just acquired Stouffer Foods because Litton Chairman Tex Thornton dreamt of marketing the company´s new consumer microwave ovens with Stouffer´s frozen foods. The problem was that Stouffer´s tin foil containers wouldn´t work in a microwave – and so few households had microwave ovens that Stouffer management couldn´t justify redesigning its packaging.
For all the promises of “synergies” between conglomerate units, the real attraction for companies like Litton, Citigroup, and GM is the flexibility of creative financial engineering. That´s what enabled Litton to produce fifty-five consecutive quarters of earnings increases – the epitome of the “shareholder value maximization.” When the myth of Litton´s ever-increasing earnings machine was exposed, its stock dropped from $130 to $3 per share, and never fully recovered. 

The only way to create sustainable shareholder value is through the long-term creation of superior products and services that serve customers.  This is what motivates employees to peak performance, generates customer loyalty and market share gains, sustains profit growth, and provides funding for the next generation of products and services.

Creating sustainable growth in shareholder value requires a laser-sharp commitment to being the best in the world in your field.  That´s why focused competitors like Google, Genentech, ExxonMobil, Medtronic, Goldman Sachs, Intel, and Starbucks have sustained success for so many years, and created so much long-term value. 

To restore the vitality of our capitalistic model, our leaders need to acknowledge the flaws in short-term value creation and get back to creating sustainable shareholder value. This is the only way the U.S. economy will be restored to sustainable growth.