General Electric Chairman and CEO John F. Welch, left, shakes hands with GE Chairman-Elect Jeffrey R. Immelt during a news conference November 27, 2000, in New York City. Immelt will succeed Welch after he retires at the end of 2001.
Chris Hondros — Getty Images
By Jerry Useem
September 17, 2001

In 1994, when he was a young pup of a manager at General Electric (ge), Jeffrey Immelt had a bad year. A very bad year. The sort of year you don’t want to tell Jack Welch about. Immelt’s plastics division missed its numbers by $50 million because of rising materials costs, so when GE managers gathered in Boca Raton, Fla., the following January, Immelt tried hard to escape the boss’ notice.

But on the retreat’s final night, Welch spotted him making an early exit from dinner. As Welch recalls in his new book, Jack, he spun Immelt around and said, “Jeff, I’m your biggest fan, but you just had the worst year in the company. Just the worst year. I love you, and I know you can do better. But I’m going to take you out if you can’t get it fixed.”

“Look,” Immelt responded, “if the results aren’t where they should be, you won’t have to fire me, because I’m going to leave on my own.”

Not only did Immelt keep his job, but on Sept. 7 he took Welch’s. Talk about a turnaround.

Right now, Jeff Immelt is not talking turnaround. Given the remarkable hand he’s been dealt by Welch, running the world’s most valuable company should be far easier–at least in the short term–than salvaging his plastics gig. In the long term, however, that same strong hand could make life atop the next GE a lot rougher: How do you replace a management icon whose reign coincided almost perfectly with the strongest bull market in U.S. history?

For starters, you don’t think about it. “I never thought about this job as replacing Jack,” demurs the new boss, in the midst of moving into Welch’s office on the 53rd floor of the GE Building at Rockefeller Center. Maybe that’s because in most senses, Immelt has already replaced him. “Jeff hasn’t been waiting for the ceremonial handoff,” says Bill Conaty, GE’s chief of human resources. “He’s essentially been running the company for the past six months.”

Should we now brace ourselves for the sort of violent blowup that has followed the departure of other hero CEOs? The short answer is no–partly because of the breadth and depth of Immelt’s management team, partly because of GE’s longstanding push to recession-proof itself. While its “short cycle” businesses like plastics and appliances are still subject to the vagaries of the economy (and have cut jobs in the face of steep downturns this year), they account for just 25% of GE’s bottom line, down from 35% in 1991. Meanwhile, a trio of “long cycle” businesses has more than taken up the slack. Chief among them is GE Power Systems, whose second-quarter profits rose 63% behind surging demand for heavy-duty gas turbines. Aircraft engines and medical systems are also benefiting from strong order backlogs and long-term service contracts.

The result is that annual earnings growth of 16% looks locked in through next year–an extraordinary performance considering that profits of the S&P 500 are forecast to drop 14%–and cash flow is poised to grow even faster. Delivering those numbers would “solidify GE as one of the companies that can do it in the good times and bad times,” says Nicholas Heymann, an analyst at Prudential Finance who follows GE and owns a stake in it.

Even the bad news of recent months has its upside. The swoon in GE’s stock (down a third from its peak) gives Immelt a more reasonable starting line. And while the failed acquisition of Honeywell was an embarrassment, you can almost hear the sighs of relief at GE. Investors had always been ambivalent about the deal, especially after Honeywell’s numbers deteriorated sharply last spring. “I think it’s a blessing for Jeff, because he gets a cleaner slate and doesn’t have to integrate it,” says Noel Tichy, a University of Michigan professor and co-author of a book about GE, Control Your Destiny or Someone Else Will.

So what can we expect from Immelt after Sept. 7? Not a grand strategic vision: “It’s not like Charlton Heston coming down from the mountain with two stone tablets,” he says. As Welch noted 20 years ago in his first major speech (eerily titled “Growing Fast in a Slow-Growth Economy”), GE is simply too big and diverse to have a strategy per se. Rather, it has something closer to a domestic policy–a set of ideas and initiatives that the CEO promotes throughout the company’s 12 businesses. “An idea at GE is like the tide in Brittany,” says one Wall Street analyst. “It covers everything.”

Welch had four big ones: globalization, services, digitization, and the quality program known as Six Sigma. Instead of unveiling a fifth, Immelt says, “The best thing I can do is drive GE’s four intiatives broader and deeper.” Under the banner of “No back office,” for instance, he’s telling managers to digitize or outsource the parts of their businesses that don’t touch the customer. He has also cheered the development of “digital cockpits” that let managers track the vitals of their businesses moment by moment. All told, digitization is supposed to save $1.6 billion this year.

One place where Immelt seems likely to put his personal stamp quickly is technology. Welch decided early in his own tenure to make GE’s management-training center in Crotonville, N.Y., the glue holding GE’s parts together. On a visit to GE’s corporate R&D facility in Schenectady, N.Y., Immelt had a similar inspiration: “I want to make the corporate research center the way ideas get spread, the way best practices get shared, and a place where I have a personal interest,” he says. Observes Welch: “It’s funny. I’m the Ph.D. and I end up making the mark on education. He’s the MBA and he’s going to make a big mark on technology.” (For more from Welch, see “Jack: The Exit Interview.”)

Immelt is also putting his spin on services, looking for ways to sell information to the company’s installed base of customers. GE’s transportation business, for instance, works with the railroads that buy its locomotives to calculate a train’s optimal route. Citing Welch’s famous edict that GE businesses must be No. 1 or No. 2 in their markets, Prudential’s Heymann says, “I think the new mantra’s going to be, ‘Produce 20% to 30% intellectual-content sales or you may not have a future in the portfolio.’ ”

If that’s true, old-line businesses like lighting and appliances may not be long for GE. “There’s no burning platform that says I have to get out of them right away,” says Immelt, adding, “The worst time to think strategically about a business is at its depths.” However, such avowals will mean little if GE can find the right buyer.

Ditto for NBC, which has been a high-margin, high-profile investment over the years, but may now be at a disadvantage without ties to a larger entertainment company. Recently, too, it has suffered indignities that include the XFL disaster, the closure of Internet spinout NBCi, and the encroachment of Survivor on its hallowed Thursday night lineup. “The portfolio is going to be different,” predicts Welch. “I don’t know exactly how.”

All in all, it sounds like an enviable job–sit back, tinker a little with the controls, and enjoy the ride. But peer over the horizon a bit, and you’ll see that Immelt faces a bracing challenge that can be summed up as follows: No company this big has ever attempted to grow this fast for this long.

Just to maintain its recent rate of revenue growth, GE must expand by roughly $17 billion this year–the equivalent of one 3M (or one Qwest, if you prefer). Next year it will have to grow by a Federal Express, and in 2003 by a Coca-Cola. If GE continued that pace for 20 years, its revenues would far surpass the $1 trillion mark. “Has any organization on the planet grown to that scale? No,” says Jim Collins, co-author of Built to Last and a longtime GE watcher. “Does that mean it can’t be done? No. But it’s definitely uncharted territory.”

Even at its currently depressed level, GE’s stock price allows little margin for error. Immelt thus finds himself about where Sandra Bullock was in the movie Speed: driving an enormous vehicle that, should it slow down for any reason, will blow up.

“Size is an advantage, not an impediment,” counters Immelt. And so far, evidence is on his side: Though the GE bus is five times bigger than it was when Welch began, its earnings growth has actually accelerated in recent years. That’s some serious momentum.

But then, this bus also requires a lot of fuel in the form of acquisitions–more than 100 every year. Merrill Lynch analyst Jeanne Terrile recently estimated that fully four percentage points of GE’s 9.9% annual growth between 1985 and 2000 came from acquisitions. That’s not a problem right now, but it could be down the road. “Given its size, there are very few companies that are able to meet GE’s performance criteria and make a significant contribution to the bottom line,” says Robert Friedman, an analyst at Standard & Poor’s.

One solution is bigger deals, and the company’s pending acquisition of Heller Financial–at a cost of $5.3 billion, GE’s second largest–suggests it might be headed that way. But bigger deals carry their own problems, as the Honeywell debacle demonstrated: greater regulatory scrutiny, especially from the unpredictable European Union.

The most voracious acquirer of all has been the bus’ engine, GE Capital, whose 22% growth rate over the past 15 years dwarfs the 6% growth rate of the rest of GE. Last year Capital’s share of GE’s revenues hit 50%, and while the closure of its auto-leasing business and retailer Montgomery Ward will shrink that share some, Capital is eyeballing prime buying opportunities in the fragmented world of financial services. Trouble is, if Capital’s contribution to total revenues goes much beyond the 50% mark, investors could start valuing GE more like a bank stock. (In fact, the comparison isn’t far-fetched: Like banks, GE Capital has relatively low margins and high debt.) Banks tend to trade at roughly half the P/E of industrial stocks. Thus a conundrum: “You have to feed the most reliable growth company inside GE, which is GE Capital,” says Merrill Lynch’s Terrile. “But a bigger and bigger GE Capital could have negative implications for GE’s multiple.”

Though the company disputes her interpretation, Terrile saw the Honeywell deal as GE’s attempt to rebalance its portfolio. Says Terrile: “It would have instantly driven GE Capital from about 50% of GE’s revenues to around 40%–which effectively gives Capital ten points of revenue growth to go out and acquire.”

There’s another problem aboard GE’s large, fast-moving bus: The passengers–in this case, the underperforming businesses–could have a hard time getting off. It’s not just that GE’s rich multiple makes them expensive to potential buyers. It’s that GE’s dozen businesses (each the size of a FORTUNE 500 company) are so big that there aren’t many potential buyers to begin with. “When you’re a market leader, it’s hard to participate in consolidation as the consolidatee,” says Bill Fiala, an analyst at Edward Jones. Swapping businesses with another conglomerate may prove easier.

Thus we come to the most powerful law of all: reversion to the mean. The bigger GE gets, the less likely its individual businesses are to outperform the market. “A 15% growth rate is not sustainable,” Fiala says. “At some point the sheer size of the company makes a premium growth rate impossible.” Analysts like S&P’s Friedman construct models in which GE’s growth rate declines from 16%, to 9%, to 5%, finally settling in at 3.5% ten years from now. That would make GE what it has always said it is not: a “GDP company,” or one whose growth simply mirrors that of the economy as a whole.

For Jeff Immelt, this is the way the world ends. But set aside the doomsday scenario and assume, for a moment, that GE defies the limitations of size and continues its amazing earnings growth. Even then, its stock is unlikely to climb at the clip it did under Welch–for reasons that have little to do with Immelt’s management skills and everything to do with his timing.

When Welch became CEO in 1981, the average P/E of stocks in the S&P 500 was nine. Today the average is 31, reflecting a huge run-up in what investors have been willing to pay for earnings. This two-decade trend blew like a stiff wind at Welch’s back, helping elevate GE’s own P/E from ten in 1981 to a high of 51 in 1999. Now the tailwind has turned into a headwind. Since the bull market ended last year, investors have pared GE’s P/E to 30, even as its underlying performance has remained strong. And nobody expects investor sentiment to blow differently anytime soon.

Assume, too, that GE’s stock has benefited from the company’s ability to deliver not just earnings growth, but predictable earnings growth. The graph of GE’s earnings per share under Welch (one of the marvels of modern capitalism) shows a smoothly rising line that takes little apparent heed of recessions, energy shocks, wars, or other dark forces. GE chalks that up to managerial prowess: “We don’t manage earnings, we manage businesses,” says CFO Keith Sherin, echoing a favorite Welch refrain. But others say the unbelievable consistency is just that: unbelievable. GE’s mastery of the shadowy art of “earnings management” has been well documented (see, for example, “Accounting in Wonderland” at fortune.com or “Glowing Numbers” at money.com), though not in GE’s annual reports, where this art usually involves taking one-time “restructuring charges” in fat quarters and siphoning off money from reserves in lean ones.

All perfectly allowable under accounting rules, of course. But should a protracted downturn make it harder to salt away reserves–or, God forbid, should the SEC tighten its rules–GE’s precious earnings consistency (and the premium that investors award it) may be tougher to maintain. “Investors have been willing to overlook a lot because of Jack Welch’s extraordinary combination of business acumen and managerial skills,” S&P’s Friedman told Money late last year. “The question is this: Will investors take a closer look at GE’s books once Welch retires?”

Some are already taking a closer look–particularly at Footnote 6 of the company’s annual report. That footnote deals with GE’s pension plan, which is almost 75% overfunded thanks to the late bull market. Though GE could theoretically distribute more of those gains to retirees, it has used them mostly to pad its bottom line–so much so that some people call the pension GE’s “13th business.” Last year, for instance, it contributed $1.3 billion to pretax income, 7% of the total. (Though GE is hardly alone in this practice, it is clearly sensitive about it: The company recently replaced the phrase “total pension plan income” with the more opaque “cost reduction from pension.”) Will such windfalls continue for Immelt? GE’s pension projections assume a 9.5% annualized return, but Friedman, for one, says, “I highly doubt that GE’s pension fund will continue to grow at such outsized rates.”

Some of the challenges confronting Immelt remain theoretical, of course, and their impact, if any, could be a long way off. In the meantime there’s every reason to believe GE will remain the well managed, even brilliantly managed, company it has been for more than a century. Its systems for screening and developing executive talent, in particular, remain unmatched. Yet the fortunate circumstances that wrapped GE in a mystique of perfection–and gave its stock a “Welch premium”–can’t last forever. Even if GE does just fine, the idea of GE may suffer.

With the stock languishing, some analysts have already been badgering Immelt to step out with a master plan. “That’s definitely something that’s way overdue,” says one. Yet perhaps because Immelt knows he has an exceptionally long runway, perhaps because of a natural inclination to underpromise and overdeliver, he has so far resisted the pressure. “We’re not going to get into that game,” says CFO Sherin. “That’s a new-CEO trap.”

Instead, Immelt has been behaving like a man settling in for a 20-year haul, meeting with customers worldwide, writing chatty e-mails to employees, and holding discussions with top managers over the summer. “I think Jeff’s doing the smart thing by keeping a relatively low profile and learning the system,” says Fiala. Whether that will be enough to overcome the powerful tides pulling against him remains to be seen. “Look, life’s a bitch,” Immelt jokes when asked about those tides. “[The stock] is the score of how companies and leaders get measured…. But I’m not going to jump out the window because [it’s] at 42.” Good to hear. Because running the world’s greatest company may more and more look like the toughest job there is.

A version of this article originally appeared in the Sept. 17, 2001 issue of Fortune.

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