Chapter 23 - My Years with General Motors
Today's Chapter is based on the book “My Years with General Motors” by Alfred Sloan.
“I think Alfred Sloan's “My Years with General Motors” is probably the best book to read if you want to read only one book about business.”
— Bill Gates
Buy it on Amazon here:
https://www.amazon.com/Years-General-Motors-Alfred-Sloan/dp/0385042353
Here's what I have learned from the book:
Decentralized Organisation
“The best way to manage people is to let them manage themselves.” — Lao Tzu
General Motors’ “co-ordinated in policy and decentralized in administration” became a standard practice to be exemplified by a large part of the American industry. This policy has been largely implemented by Alfred Sloan throughout his years working at GM. In his book “My Years with General Motors”, Sloan makes it his thesis to demonstrate that good management comes from what he calls “decentralisation with co-ordinated control.”
In a previous Chapter, we explained the impact of decentralization had on Alain Bouchard built his convenience store empire through a decentralization organization. As a matter of fact, Bouchard understood that the money was made in the stores and not at the administration level.
“At Couche-Tard, says Alain Bouchard, "we are egoless." The company's administrative offices are "service centres," a term meant to reflect the organizational philosophy of the group. The staff working there is at the service of the stores, and not vice versa.”
— Guy Gendron
“The central structure was minimal, and intentionally so. They were all aware that the heart of their operations was in the stores, in the relationship with the customer. The decision to have no headquarters was a part of that philosophy, and the symbol of it.”
— Guy Gendron
In General Motors’ case, there were various factors that led Sloan to believe in a decentralization policy. For one, it provided an opportunity for individuals to shine through with their initiatives as if they were running businesses of their own and it provided the company the ability to pay them accordingly to their success. As a matter of fact, Sloan mentions that the Bonus Plan implemented by GM is strictly related to the policy of decentralization since it gave the executives the opportunity to be paid according to their accomplishments. This allowed them to attract and retain managerial talent.
Secondly, Sloan believed that decentralization allowed for better capital allocation for the company as it allowed GM to evaluate the rate of return of each divisions seperately. Notably, he wrote that:
“[It] Increases the morale of the organization by placing each operation on its own foundation, making it feel that it is a part of the Corporation, assuming its own responsibility and contributing its share to the final result. As to its bearing on financial control: . . .
[It] Develops statistics correctly reflecting the relation between the net return and the invested capital of each operating division—the true measure of efficiency—irrespective of the number of other divisions contributing thereto and the capital employed within such divisions. As to its bearing on strategic investment: . . .
[It] Enables the Corporation to direct the placing of additional capital where it will result in the greatest benefit to the Corporation as a whole.“
— Alfred Sloan
However, despite these advantages, Sloan also understood the importance of having common policies to retain some control over the divisions. In fact, he developed a system of coordination that involved setting the overall goals and standards for the company, such as implementing GM’s business concept and product policy that would differentiate itself from the others automobile manufacturers. This became vital as it is these policies that allowed GM to outshine Ford throughout the transformative years of the automobile industry in the 1930s.
Nonetheless, Sloan believed that the key part of management is to find the right balance between giving complete freedom to the divisions through decentralization and still having control over them.
“That still left us with the problem of finding the right combination of freedom for the divisions and control over them. The combination could not be set once and for all, of course. It varies with changing circumstances, and the responsibility for determining administrative organization is a continuing one.” —Alfred Sloan
“From decentralization we get initiative, responsibility, development of personnel, decisions close to the facts, flexibility—in short, all the qualities necessary for an organization to adapt to new conditions. From coordination we get efficiencies and economies. It must be apparent that co-ordinated decentralization is not an easy concept to apply. There is no hard and fast rule for sorting out the various responsibilities and the best way to assign them. The balance which is struck between corporate and divisional responsibility varies according to what is being decided, the circumstances of the time, past experience, and the temperaments and skills of the executives involved.”
— Alfred Sloan
Rate of Return
“Investment is most intelligent when it is most businesslike.”
— Benjamin Graham
According to Sloan, even the most unsophisticated investors evaluate their investments in stocks, bonds or term deposits through its rate of return. As such, it would be uninmaginable for any businessman to not evaluate its business’ success through its return on investment. As we have learned previously through Kirk Kerkorian, capital allocation is the most important skill to evaluate a CEO’s ability. As Warren Buffett once said “I am a better investor because I am a businessman and I am a better businessman because I am an investor.”
“So, too, I imagine, every businessman evaluates profits in terms of his total investment. It is a rule of the game, so to speak. There are other measures for the running of a business; for example, profit on sales, and penetration of the market, but they do not supersede return on investment.”
— Alfred Sloan
“The measure of the worth of a business enterprise as a business, however, is not merely growth in sales or assets but return on the shareholders' investment, since it is their capital that is being risked and it is in their interests first of all that the corporation is supposed to be run in the private-enterprise scheme of things.”
— Alfred Sloan
By consequence, as mentioned previously, Sloan believed that decentralization allowed General Motors to evaluate the contribution - positive or negative - of each division to the common good of the business. By doing so, it allows for one to know about the company’s efficiencies and inefficiencies which is primordial to allocate investments appropriately among each divisions. As a matter of fact, it would be ill advised for a company to continue investing in a project or a division that has a low rate of return.
“Under his concept General Motors' economic objective was to produce not necessarily the highest attainable rate of return on the capital employed, but the highest return consistent with attainable volume in the market. The long term rate of return was to be the highest expectation consistent with a sound growth of the business, or what we called "the economic return attainable."”
— Alfred Sloan
Sloan on the importance of return on capital in his own words:
“The profit resulting from any business considered abstractly, is no real measure of the merits of that particular business. An operation making $100,000.00 per year may be a very profitable business justifying expansion and the use of all the additional capital that it can profitably employ. On the other hand, a business making $10,000,000 a year may be a very unprofitable one, not only not justifying further expansion but even justifying liquidation unless more profitable returns can be obtained. It is not, therefore, a matter of the amount of profit but of the relation of that profit to the real worth of invested capital within the business. Unless that principle is fully recognized in any plan that may be adopted, illogical and unsound results and statistics are unavoidable . . .”
— Alfred Sloan
It goes without saying that General Motors under the leadership of Alfred Sloan was able to provide an amazing return on invested capital to its shareholders. Similar to Jeff Bezos, Sloan understood that it is his responsibility to make sure that any opportunities or projects he invests in must generate the same return on capital that his investors expected when they first invested into General Motors. Needless to say, the numbers speak for themselves:
“Of the $6.8-billion growth in capital, about $800 million, after subsequent repayments, was raised by resorting to the capital market. An additional $600 million was raised through the issuance of new stock, of which $250 million was for the acquisition of existing companies and $350 million for employee programs. All the rest of the growth in capital—a total of nearly $5.4 billion—came from reinvestment of earnings.”
— Alfred Sloan
As such, it is not surprising that great stock performances are more correlated to the companies’ ability to provide superior return on invested capital rather than its ability to grow revenues at a fast rate. As Charlie Munger once said:
“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”
— Charlie Munger
Business Concept
“I find it quite useful to think of a free market economy as sort of the equivalent of an ecosystem. Just as animals flourish in niches, people who specializes in some narrow niche can do very well.”
— Charlie Munger
As we have seen with Isadore Sharp and Four Seasons, finding a niche is primordial to survive in a competitive field of industry. As a matter of fact, Sharp decided to focus strictly on midsize hotels of exceptional quality to offer a differentiated product compared to the rest of the hotel industry. This allowed him to compete with the giants of the industry such as Holiday Inn and Marriott.
“But my mind was made up. “We will no longer be all things to all people,” I said. “We will specialize. We will offer only midsize hotels of exceptional quality, hotels that wherever located will be recognized as the best.” I resolved to sell any hotel that didn’t meet our new standards.”
— Isadore Sharp
Similarly, when Sloan was put in charge of General Motors, he realized that the company did not have a clear business concept set in place. At the time, the car industry was dominated by Ford who had a concept of a static model at the lowest price in the car market with the Model T. Meanwhile, General Motors’ divisions, without a clear and rational business concept in place, were producing cars in identical price positions that were competing among each other, without relationship to the interest of the enterprise as a whole.
“General Motors was in need not only of a concept of management but equally of a concept of the automobile business. Every enterprise needs a concept of its industry. There is a logical way of doing business in accordance with the facts and circumstances of an industry, if you can figure it out. If there are different concepts among the enterprises involved, these concepts are likely to express competitive forces in their most vigorous and most decisive form.”
— Alfred Sloan
As such, to differentiate General Motors from other cars manufacturers, Sloan decided to implement a “quality car at a fair price” policy. To do so, the company will have to produce a line of cars in each price area, from the lowest price up. More importantly, it should not leave any wide gaps in the line in terms of price and it should avoid any duplication by the corporation in the price fields:
“Having thus separated out a set of related price classes, we set forth an intricate strategy which can be summarized as follows: We proposed in general that General Motors should place its cars at the top of each price range and make them of such a quality that they would attract sales from below that price, selling to those customers who might be willing to pay a little more for the additional quality, and attract sales also from above that price, selling to those customers who would see the price advantage in a car of close to the quality of higher-priced competition. This amounted to quality competition against cars below a given price tag, and price competition against cars above that price tag.”
— Alfred Sloan
“We recommended that General Motors should not attempt to build and sell a car of the precise Ford level, as the Ford sold at the lowest price within the first grade. Instead the corporation should market a car much better than the Ford, with a view to selling it at or near the top price in the first grade. We did not propose to compete head on with the Ford grade, but to produce a car that would be superior to the Ford, yet so near the Ford price that demand would be drawn from the Ford grade and lifted to the slightly higher price in preference to Ford's then utility design.”
— Alfred Sloan
Sloan’s idea of not competing with Ford heads on in the low-cost car industry paid General Motors tremendous dividends at the end. As a matter of fact, due to the transformative nature of the car industry, General Motors, with its current business concept, ended up being in a better position comparatively to Ford to gain market shares. With the car industry switching from a low-cost market to a mass market industry and with the market seeking for more car diversity, General Motors was able to enjoy tremendous growth and prosperity.
Constant Innovation
“Innovate or die, and there's no innovation if you operate out of fear of the new or untested.”
— Robert Iger
Alfred Sloan firmly believes that striving for growth is mandatory for the good health of a company and to deliberately stop the growth of a company is to suffocate it. This is especially true considering the position of General Motors in the automobile industry, which is a highly competitive field. To thrive in such a fierce industry, being able to face change is primordial and complacency is extremely dangerous.
“Growth and progress are related, for there is no resting place for an enterprise in a competitive economy. Obstacles, conflicts, new problems in various shapes, and new horizons arise to stir the imagination and continue the progress of industry. Success, however, may bring self-satisfaction. In that event, the urge for competitive survival, the strongest of all economic incentives, is dulled. The spirit of venture is lost in the inertia of the mind against change.”
— Alfred Sloan
“Change, as I have often said, means challenge, and the ability to meet challenge is the sign of good management. Far-reaching changes in product, demand, and outside pressures have had to be met to maintain General Motors' growth and prosperity.”
— Alfred Sloan
As we have seen above, General Motors’ innovative business concept allowed the corporation to ride through the switch of the car industry from a predominantly basic transportation at a low cost to a more mass market industry. This is partly due to the rise of popularity of installment selling, the used-car trade-in, the closed body and the annual model.
“To set the scene, let me divide the history of the automobile, from a commercial standpoint, into three periods. There was the period before 1908, which with its expensive cars was entirely that of a class market; then the period from 1908 to the mid-twenties, which was dominantly that of a mass market, ruled by Ford and his concept of basic transportation at a low dollar price; and, after that, the period of the mass market served by better and better cars, or what might be thought of as the mass-class market, with increasing diversity. This last I think I may correctly identify as the General Motors concept.”
— Alfred Sloan
This reminds me of James Dyson’s approach towards innovation in a corporation; he heavily criticized the large British corporations of his time who often spent large amounts on marketing to boost sales, rather than investing in research for new and innovative products. This is often because the leadership teams are not managing the company with a long-term approach. As Jeff Bezos once said:“We like to invent and do new things, and I know for sure that long-term orientation is essential for invention because you’re going to have a lot of failures along the way.”
Beyond the Book
Read "Thinking About Return on Capital" by Investment Masters Class