11 November 2021

The article at a glance

The breakup of General Electric shines a spotlight on GE’s once-dominant role in the airline industry through aircraft leasing, engines and financing, says a new study co-authored at Cambridge Judge Business School that examines “Why do unsuccessful companies survive?”

The breakup of General Electric shines a spotlight on GE’s once-dominant role in the airline industry through aircraft leasing, engines and financing, says a new study co-authored at Cambridge Judge that examines “Why do unsuccessful companies survive?”

The announcement this week that once-mighty General Electric will split into three public companies focusing on energy, healthcare and aviation shines a spotlight on the historically outsized and distorting role played by GE in the airline industry over many decades.

While there have been many studies in recent years about huge success stories like Amazon and spectacular failures like Kodak, a new study forthcoming in the journal Business History Review focuses on GE’s relationship with airlines to examine a very different question: why do unsuccessful companies survive?

In the airline sector, struggling carriers have at times been propped up since the 1980s by GE’s aviation omnipresence – supplying carriers with everything from leased aircraft through GE Capital Aviation Services (GECAS), to financing, to engines and their spare parts and servicing – which led to a “GE-only” policy that tied aircraft leasing to power by GE jet engines at a time the company was flying high.

The study concludes that while it may be very rare for all factors in GE’s massive airline role to be replicated in other industries, there are elements of these components in the business models of Facebook and Uber – so a ‘subset’ of the GE-related factors could yield a similar outcome pattern on a smaller scale in other sectors.

“Airlines are distinctive in many respects, including the historic political and economic support by governments for their state carriers,” says study co-author Professor Geoff Meeks of Cambridge Judge Business School. “And GE was exceptional in its size and scope – in its heyday the biggest business in the world. Yet elements of the power imbalance between GE and the airlines are found in many other industries. Our analysis suggests the potential consequences for the profits of firms in those industries and the efficiency of the markets in which they buy and sell.”

Warren Buffett famously noted that airlines made ‘absolutely zero’ profit in their first nine decades, and he wrote to his Berkshire Hathaway investors that if a far-sighted capitalist had been present when the Wright Brothers made aviation history at Kitty Hawk in 1903 “he would have done his successors a huge favor by shooting Orville down”. That ‘absolutely zero’ profit turned into a cumulative US airline loss of nearly $60 billion between the millennium and the financial crisis of 2008-09.

“Yet no major airline was liquidated or taken over” in that period, notes the new study, which focuses on the early 21st Century in a broader historical context that traces the origins and growth of aircraft financing arm GECAS.

While aircraft leasing barely existed before the mid-1980s, it grew rapidly until in 1997 about 46% of the entire world airline fleet was leased – and GECAS became the dominant lessor in the US, increasing its fleet from 500 in 1993 to 850 in 2001 and 1,800 by 2009. From 1996, GE operated a ‘GE only’ tying policy when negotiating leases, so that by 2001 99% of the large commercial aircraft ordered by GECAS were GE-powered, the study says.

The study then details what it calls GE’s pivotal role as an ‘accommodating’ creditor that helped loss-making airlines stay aloft: GECAS “repeatedly extended support to distressed operators mainly through leasing finance,” in a confluence of the ‘institutional characteristics’ of the airline industry and GE’s ‘extraordinary financial and market power’ prior to the financial crisis.

The authors then address whether the airline industry is ‘idiosyncratic’ or whether this type of scenario could unfold in other industries – so they identify six characteristics of the GE-airline situation, several of which could apply to other sectors:

  1. The typical contract involved tying more than one product: an aircraft, an engine, finance and after-sales spare parts. Similar situations exist for office equipment such as copiers.
  2. GE enjoyed an oligopolistic position in the aircraft engine market, where the company enjoyed had high entry barriers, huge financial power and an enviable credit rating. “An analogous example of multiple interlinked sources of market power is offered by Facebook,” the study says – citing the social network’s first-mover network advantage in “‘buying’ information from users (users trading their information in exchange for access to the platform)”, its market dominance in selling the information to advertisers, and its well-funded lobbying to protect its business model from regulation.
  3. GE’s trading partner, the airline industry, was very competitive, with low entry barriers. “The customers held little countervailing power, and endured very weak profitability. An analogy is offered by businesses such as Uber, which contracts with huge numbers of individual drivers.”
  4. There was an imbalance of scale, in which the capital goods supplied by GE (aircraft with GE engines) represent a huge component of its airline customer’s balance sheet and funding – so losing the asset and associated finance could destroy an airline. An analogy is a landlord with many properties leasing a large store to a lessee dependent on this single site.
  5. The asset, an aircraft, is highly fungible; unlike a power plant or oil well, a leased plane can be rapidly repossessed and redeployed anywhere around the world.
  6. GE’s airline customers were joint stock corporations run by salaried managers whose interests did not necessarily align with those of their owners, as in some circumstances executives benefitted from a loss-making airline continuing to trade.

“Our conclusion therefore is that no individual component of the GE model was unique, but that the conjunction of so many of the components is likely to be very rare,” the study says. “Nevertheless, it is possible to imagine a subset of the components yielding a similar pattern of benefits to the supplier along with wealth destruction for the customer’s shareholders, even if not on the scale we have documented for GE.”

In a ‘sequel’ to the study, the authors note that the balance of power between GE and airlines altered greatly after the financial crisis. GE’s prestige and financial strength weakened, while airlines merged into an oligopoly capable of cutting capacity and raising fares, as they made profits until the COVID-19 crisis. “In the decade after the crash,” the study says, “even Warren Buffett invested $10 billion in airlines.”

The study – entitled “Why do unsuccessful companies survive? US airlines, aircraft leasing and GE, 2000-2008” – is co-authored by Gishan Dissanaike, Adam Smith Professor of Corporate Governance at Cambridge Judge; Ranadeva Jayasekera, Associate Professor of Accounting and Finance at Trinity College, University of Dublin; and Geoff Meeks, Emeritus Professor of Financial Accounting at Cambridge Judge.