Today on the WSJ website I found an article titled "GE Profit Slides Amid Margin Squeeze" by Kate Linebaugh and Bob Sechler. While I was reading this, I kept thinking that is was a great example of profit pools.
Profit at GE fell 18% year-over-year in the fourth quarter 2011. The article mainly focuses on two of GE's profitable segments: the industrial segment, and the lending/financing segment.
The industrial and financing segments clearly show how some profit pools are more lucrative than others. The industrial segment saw an increase in revenue of 10%; however because of increased price pressure from low demand and competitors, margins fell by 1.4% resulting in only a 1.9% increase in profit. On the other hand, the financing segment saw profits increase by 58% despite decreased revenue.
Even with the above information, GE is working on reducing their financing arm (as is evidenced by the decreased revenue). In the fourth quarter, GE was able to reduce the segment to 39.5% of earnings which is within their goal of 30% to 40%. Why would GE want to reduce their most profitable pool and focus on increasing a less profitable one? Three things came to mind.
1. Profit pools can be split into smaller pools. GE's financing arm gives loans for a number of different situations, including real estate development, consumer purchase, and industry. Not all of these pools is as profitable as others. In fact, the article states that GE is still suffering losses from a Japanese consumer finance business it sold off a year ago. This goes along with GE's plan to keep financing earnings between 30% and 40% while reducing the number of assets. Focusing on the more profitable financing segment will allow them to maintain profits with fewer assets.
2. Some profit pools may rely on other pools. GE's financing revenue is largely dependent on its sales of physical goods. If GE were to abandon their industrial and unprofitable segments, they would have no customers to sign up for financing. Essentially, the cost of keeping unprofitable or less profitable pools open are required to keep the larger profit stream coming.
3. Pools can be more or less profitable at different times. The article mentions that during the credit crisis, GE's financing segment experienced large losses. Because GE had allowed the segment to grow so large in comparison to other profit pools, this had a significant impact on GE as a whole. This is another reason GE was working on reducing its financing segment. By diversifying, GE is able to take advantage of increased profitability in different pools at different times and decreases the downside risk to the company if one pool performs poorly.
