Opinion: Rethinking ‘Shareholders First'
The recent passing of former GE CEO Jack Welch may represent more than the loss of the icon named Manager of the Century by Fortune magazine in 1999. It may also symbolize the passing of an era in capitalism—“shareholders first”—that Welch did so much to promulgate. What does this have to do with today’s aerospace industry? Plenty, as it turns out.
Before the “shareholders first” mantra took hold in the 1990s, publicly traded companies considered four stakeholders in allocating capital: customers, local communities, employees and suppliers, and shareholders.
Before Welch took over in 1981, GE publicly stated it valued workers and research labs before shareholders. After 20 years of relentless focus on productivity, cost-cutting and shedding more than 100,000 jobs, GE’s market capitalization skyrocketed from $12 billion to an astounding $410 billion. Much of this profit growth was driven by financial services rather than traditional manufacturing.
Encouraged by the late economist Milton Friedman and success stories such as GE, aerospace executives began to adopt “shareholders first” in the 1990s. McDonnell Douglas famously embraced this philosophy and focused on quarterly earnings while refusing to invest in new civil aircraft. Its CEO, Harry Stonecipher, eventually took the leadership helm at Boeing. Responding to the perception that he was only interested in making money, he responded, “You’re right, I am.”
Employees were the first casualty, with unions weakened and raises curtailed. For example, until recently, Honeywell International imposed mandatory unpaid leave on its employees—while it was making 20% margins. As employees lost pace, so did local communities. In the early 2000s, the number of employees in low-wage countries became a key performance indicator. New aerospace clusters in places such as China, Eastern Europe and Mexico followed suit. The blind push to leverage labor-arbitrage has ebbed in recent years, but the compact of secure employment was violated, and employee morale suffered.
A decade later, suppliers became the target of OEM supply chain cost-reduction initiatives with double-digit price reduction demands, longer payment terms, aftermarket royalty payments and other concessions. Market capitalization shifted from suppliers to the OEMs, while the lower tiers of the supply chain were bled of working capital. Today, many subtier suppliers are fragile, and their ability to invest in the future—let alone ride out a crisis like the 737 MAX production shutdown—is diminished compared to a decade ago.
What about customers? On the one hand, brutal competition between Airbus and Boeing held jetliner prices relatively flat over the past 15 years. On the other hand, customer satisfaction in the aftermarket and customer support is suffering. In last year’s AeroDynamic Advisory/Aviation Week Network customer satisfaction survey, just one out of 41 OEMs received a positive net promoter score from airlines.
The manifestation of the “shareholders first” philosophy is very negative for a long-cycle industry like aerospace, which faces enormous challenges—including sustainable development—that will require large sums of R&D. Boeing, for example, spent an average of $12.8 billion in share buybacks and dividends in 2018 and 2019, while averaging just $2.2 billion in R&D. This is not just a Boeing problem; it is a corporate America problem. In 2018, share buybacks and dividends for the S&P 500 were an astounding 109% of net income, according to The Wall Street Journal. This disparity points to another issue: Companies are taking on debt to fund shareholder generosity. This is not sustainable in the long run and leaves no capital to invest in customers, suppliers, employees or local communities.
Contrast this behavior with OEM customer Delta Air Lines, which earned $6.5 billion in 2019. It shared $1.6 billion (16.7%) of that with employees—a record amount for a U.S. company. This translates into improved employee morale and in turn improved customer satisfaction, higher yields and growing market share.
Don’t get me wrong. I am a pro-business, free-trade capitalist who depends on increasing stock prices to fund his retirement. Making money and rewarding shareholders is a good thing. However, our long-cycle, innovation-driven industry is clearly out of balance.
“Shareholders first” needs to be replaced by a more balanced version of capitalism if the aerospace industry is to thrive in the long run. The change must originate not only from aerospace leaders, including the new CEOs of Airbus and Boeing, but also from the boards that evaluate them and set priorities.