GE’s New Business Model

Thirty years ago, it was easy to describe the business model of General Electric (GE). They were the legacy organization that was originally founded by Thomas Edison, the inventor or developer of classic electrical products like the light bulb, the phonograph, the motion picture projector, and the power generator. A century after its founding, GE still manufactured a wide array of industrial and consumer products, ranging from washing machines to jet engines.

But then GE aggressively developed its financial services division to help customers finance their purchases. And the division grew, and grew, and grew into a $600 billion banking organization.

At its peak, GE Capital accounted for more than half of its parent corporation’s profits, and was designated a Systematically Important Financial Institution (SIFI) by the federal government. In other words, it had grown so massive that it was deemed “too big to fail” as a global finance organization.

GE also diversified into other ventures that were barely related to its core identify. The NBC television network became a GE division. So did the film studio and theme park operator Universal Pictures. Even the Weather Channel became a GE service!

For some time, the disparate business units helped GE manage its profits by engaging in a smoothing technique known as “earnings management.” Instead of simply reporting the profits of each division, the firm would rely on the unusually profitable years of certain units to off-set the unusually unprofitable years of other units. That technique enabled the corporation to present an ostensibly stable overall profit picture to investors.

But as the years dragged on, the unwieldy conglomeration of unrelated divisions became more difficult to manage effectively. Thus, GE has recently reversed its strategy, opting to divest and streamline its business portfolio.

And now this new business strategy raises a vexing question. Once an organization begins to divest itself of unrelated units, when should it stop doing so? After all, if it cuts too deeply, it might endanger its own existence as a going concern.

It’s been a little difficult to understand how GE is answering this question. Although it sold off much of its Capital portfolio, it kept much of it too. Likewise, the firm disposed of its household appliance business, but it kept its medical imaging division. And last week, it announced the sale of its Industrial Solutions business to Switzerland’s ABB Group, founded in 1883 as an inventor and developer of electrical products.

1883? At that very time, GE founder Thomas Edison was developing his American firm. And today, more than 130 years later, his corporate descendants are selling Edison’s “heritage business” unit to their Swiss rival.

It’s certainly possible that GE’s divestiture strategy is part of a clever business plan to recapture its traditional global dominance in the electrical products industry. And yet it’s also possible that, after expanding far too broadly without regard to its long term sustainability, GE is now contracting a bit too extensively for its own well-being.

Halloween Time For DraftKings and FanDuel

Saturday is Halloween! On that day, we’ll all don costumes that hide our true identities, and we’ll indulge in behaviors that would be questionable on any other day.

But financial service organizations don’t wait until Halloween to mask their activities, do they? Do you recall, for instance, AIG’s sales of credit default swaps prior to the 2008 global economic collapse?

In essence, these swaps were insurance contracts that were designed to reimburse lenders in the event of widespread defaults. But AIG didn’t have the capital to cover these contracts when defaults soared at the start of the Great Recession. That’s why the federal government decided to spend $182 billion of taxpayer funds to bail out the insurer.

So why didn’t government regulators stop AIG from writing these insurance policies in the first place? They didn’t do so because AIG didn’t structure the contracts as insurance policies. Instead, the firm swathed these transactions in the costume of swaps contracts, thereby masking their risks and avoiding insurance oversight regulations.

Something similar is happening now at a pair of online fantasy sports gaming organizations. DraftKings and FanDuel collect money from individuals who play fantasy sports games, and then pay money back if the individuals win their games. The firms refer to these services as games of skill as opposed to games of chance, and thus circumvent legal prohibitions against online gambling activities.

But isn’t this what sports bookies do when they accept wagers? They collect money from gamblers and then disburse winnings if the bets pay off. Considering that the home page of DraftKings declares Win Real Cash, while FanDuel promises Real Money, it’s difficult to perceive any difference between such fantasy sports games and gambling transactions.

That may be why DraftKings, now eager to back away from any perceived relationships with gambling operators, has discontinued its relationship with the World Series of Poker. That card game, of course, is virtually synonymous with the casino industry.

Government officials, though, don’t seem to be buying it. Five years after the Dodd-Frank Wall Street Reform and Consumer Protection Act established the Financial Stability Oversight Council to regulate Strategically Important Financial Institutions (SIFIs) like the insurers AIG, MetLife, and Prudential, regulators are deciding to make it more difficult for online gambling services to mask their financial transactions behind the label of fantasy sports games.