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Not by technology alone.

Although a scientist himself, Thermo Electron's George Hatsopoulos learned that oftentimes a lot more is needed than bright ideas.

Shareholder value, long-term focus, decentralization, commercialization of new technology, productivity incentives, team building, maximization of R&D--an exhausting laundry list of current top management issues. Surely a single approach to accomplish the above with one strategic blow is not realistic. Then there is the case of Thermo Electron, a $900 million multifaceted technology company headquartered in the leafy Boston suburb of Waltham, MA. It develops and manufactures environmental and analytical instruments, cogeneration systems, process equipment, biomedical devices, specialty materials, and metallurgical services. What appears to be a hodgepodge of different products--pesticide detectors, natural gas-fueled engines, titanium hip joints, sonic computerized tomography--actually can be traced back to the research that launched the company in 1956. It was then that a young Greek who had come to the U.S. to earn a doctorate in thermodynamics at MIT turned a dissertation into a business plan. George Hatsopoulos' Big Idea was and is the commercialization of thermionics--the process of converting heat directly into electricity without moving parts. Thirty-seven years later, the original Big Idea remains an economic dud, involving exotic processes such as liquid metal cooling and superpure materials that are also super expensive. (Yet the science is sound. The U.S.S.R employed thermionics in its Topaz space reactor.) But every other idea has been a commercial success.

When Thermo Electron went public in 1967, George Hatsopoulos and his brother John, 59, who is CFO and the company's alter ego, adopted an approach oddly similar to what management consultants today retail as the "re-engineered enterprise." Recognizing that retaining entrepreneurial drive is difficult as a company grows bigger in size, and that Wall Street often misunderstands a company involved in myriad activities at different stages of product development in unknown markets, George began spinning off divisions, creating new public companies with minority public share ownership. Each majority-owned subsidiary has its own board, operating CEO, and marketing force, with Hatsopoulos providing strategic direction. This allows the public to invest directly and to more accurately evaluate a unit's performance.

Some 50 percent of employees own shares in one Thermo Electron enterprise or another. "That boosts performance and acts as an incentive," says Hatsopoulos, who himself owns 800,000 shares.

"In most companies R&D is a service overhead," says Hatsopoulos, 66. "We spin R&D to each of the units and use the center R&D to create new businesses." A combination of pride in running one's own show and an opportunity for performance-based stock options motivates the scientist/engineers to get the technology to market. The units' small size--relative to the parent--offers flexibility and demands quick decision making. Higher transaction costs are one obvious drawback: Filing nine 10Qs and 10Ks per quarter with the SEC is more expensive than one. But accounting, legal, and other administrative costs are centralized. (Hatsopoulos reckons additional G&A costs related to the spin-off strategy are no more than $3 million to $5 million per year.)

The organizational approach, which revolves around creation of a so-called partial public subsidiary (PPS), has come into vogue of late. American Express, ARCO, Coca-Cola, and Disney have PPSs. IBM intends to spin off everything into "baby blues." Sometimes it backfires as when Time sold a minority stake in its cable systems operator, and Time Warner later had to buy it back at a premium. Phillips Petroleum announced an offering of 51 percent of its natural gas processing unit GPM. Perceiving it to be a low-value deal, the market punished Phillips with a lower share price. Don Mitchell of Mitchell & Co., an investment advisory firm, offers two rules of thumb for successfully spawning a PPS: The new concern should be at least 25 percent of the market value of the parent, and the price-to-book ratio should be one multiple higher.

Thermo Electron's spin-offs haven't always met this yardstick, but their performance hasn't been shabby. Hatsopoulos' objective is for new businesses to attain a target pretax internal rate of return of 40 percent over five years. Assuming G&A costs of roughly 3 percent, the target is really about 37 percent, the CEO says. The parent's 5- and 10-year total returns to shareholders are 28.2 percent and 26.3 percent, respectively.

Down which new paths will technology take the company? One technology under development by the ThermoTrex unit is a passive microwave camera that forms "synthetic" images enabling pilots to "see" other aircraft and to navigate in fog. This capability should all but eliminate landing and takeoff collisions and should be of great interest to frequent-flying CEOs who daily face airport congestion and the potentially hazardous conditions brought on by overworked traffic controllers.

In conversation with the Hatsopoulos freres at the firm's Route 128 suburban headquarters, CE editor J.P. Donlon discovers that George and John sometimes finish each other's sentences (which answers the question of how closely the CEO and CFO work together). In addition to his role as chief scientist, George has written extensively on capital formation issues facing technology firms, and he cooks, one is told, a delicious steak au poivre. Both executives remain certain that when manned interplanetary space flight becomes practical, it will be powered by a thermionic reactor. (Scotty, before you install the delithium crystals, check the manufacturer's label on the generator.)


Thermo Electron has an interesting structure--one that allows it to continually innovate and spin off new businesses and technologies. Do you plan to continue this strategy?

Yes. Our basic philosophy maintains that a company can only perpetuate itself in the long-run by exploring new businesses. We constantly seek to innovate, to learn how to make a better product or a new product within our line of business or a new business.

Our approach to this process is different. TABULAR DATA OMITTED Only a few major companies--such as 3M--have done something similar. We look at the major problems that are surfacing and see if we have the technology or talent in our organization to solve them. I find this approach works better than coming up with a new technological idea or product and then finding applications for it.

For example, in the mid-1960s, there was a national effort to develop an artificial heart. Among the problems was that the pumping mechanisms damaged blood. We asked, "What technology do we possess that can address this problem?" At first, it seemed to be a mechanics problem, but after some research, we found out it was a materials problem. And so we launched into the artificial heart program.

We develop new technology through our R&D New Business Center. We distribute both research and development among the divisions. We also have a division whose sole purpose is to create new businesses.

How much did you spend on R&D last year?

We spent over $60 million last year, of which half was paid for by outside sources, such as utilities. About 20 years ago, we decided to cater to just utilities. Since their interest is to sell gas and ours is to make products, we said we would dedicate a good deal of our R&D to making products that burn gas if the utilities would pay for the research and development.

Other industrial support comes from agreements such as the one we had with a major corporation. They wanted a piece of equipment, and we negotiated to win the rights to manufacture that equipment to the company's specifications. The corporation paid for part of the R&D.

Some businesses need more R&D and others less. Our cogeneration business does relatively little R&D, while our instrument business' spending on R&D as a percentage of sales is higher. At Thermo Electron over the last two years, the figure averaged 6.5 percent.

Government contributions have slowed down, although the Energy Department, the FAA, NIH, and NASA have contributed a lot. We've received contributions from major corporations such as Ford and General Motors.


Do you have formal return hurdles for your new businesses or technologies and for Thermo Electron as a whole?

Our objective is to get our businesses to a pretax return on invested capital of 40 percent in five years. Corporate general and administrative costs are roughly 3 percent, so the number is really 37 percent. Several divisions have returns well in excess of 40 percent, but most of the new businesses started in the last few years haven't reached that level yet.

For the business overall, the magic number is a 20 percent rate of return over a 5-to-10-year period.

How do you shape the culture and maintain motivation?

It's important to maintain the unity in the company and see that everyone has a stake in making the new businesses work. We have close ties among our divisions, and we give stock options in Company B to employees of Division A. Initially, when we started creating new businesses, we gave options to all employees. If the business didn't succeed, there goes the whole company.

But if the company succeeds as a whole, what is the incentive for people in the flourishing instrument business to support a floundering ThermoTrex? By spinning off ThermoTrex, allowing it to have its own share price, and giving options in it to key employees in the instrument business, we have given them a stake in the success of ThermoTrex.

We also try to align the interests of each spun-off division and other divisions by use of stock options. Our rule of thumb: The CEO of each publicly held company should have roughly 40 percent of his options in his own company, 40 percent of his options in the parent company, and 20 percent of his options in all the other companies.

Another thing about incentives: The conventional way to reward managers or employees is to look at whether they produce value. Generally, we let Wall Street make that determination, but if we feel Wall Street is unfair, we will buy the shares to show we feel the unit is doing a good job, and the market is misconstrued. Markets can be right in the long term, but totally wrong in the short term.

In the next five years, do you plan to use the same strategy or do you see a different kind of Thermo Electron?

We will keep the same strategy, with some small modifications. Right now, we are addressing one problem, which is that our shareholders feel they should be allowed the privilege to participate in our spin-offs ahead of anyone else. They always ask: "How come you are selling to your employees? I'm your shareholder. Why won't you give me first crack at it?" So we will experiment with giving the rights of the new spin-off to our shareholders.

Right now, every Thermo Electron shareholder will get a right to buy a certain percentage of the company. If they don't want to buy the shares, we will sell their rights in the open market.


Let's go back to ThermoTrex. Why did you spin off the engine of Thermo Electron's businesses?

In other words, why did we spin off the goose that lays the golden egg, instead of the golden egg? Mainly because ThermoTrex has generated most of our new ventures--from Tecogen to Thermedics to Thermo Cardiosystems to Thermo Instruments. The value of Thermo Electron's shares is so dependent on the performance of the existing businesses that the potential for changing the value of Thermo Electron with the next new business it generated was getting smaller. The people generating these new businesses were losing their focus.

Let's assume that over the next 10 years, ThermoTrex performs as successfully as Thermo Electron performed over the past 30. Maybe it, too, will have to spin off its new business formation center to maintain focus, momentum, and the capability to innovate.

If you spin off everything, what is left?

We still own the majority of shares in most of the spin-offs. Our arrangement is that we generally vote with the majority of the rest of the shareholders, although I do retain veto power.

Essentially, we've become a venture capital firm--a holding company for the spin-offs. But there's a difference, and this is key to our strategy. We maintain cohesion by using a number of devices. One is central services, responsible for cash investments and shareholder relations, for example. The center also does strategic planning for all the companies, and provides contacts with Washington and strategic information to the divisions.


In the stand-alone units, could one group decide it wanted to be more aggressive in giving top executives or employees more of the upside than another division?

Our corporate charter requires each CEO to consult with the line management of Thermo Electron and inform the board of the major stockholders' opinion on this type of issue.

Does the independence of your divisions create any communications problems?

I've seen other corporations where you can make a deal with one division and the other will never know. Here, we do not tolerate any animosities or gaps between divisions.

We have a tremendous communications network. It is amazing how often shareholders on one side of the Atlantic will call up and tell me something happened.

Here's another factor: Most of our employees are convinced they can walk into my office and tell me anything with impunity. They have seen machinists come in from one division and tell me the CEO is doing something wrong, and nothing happens to him. The CEO does not penalize him. This open-door policy, this free flow of information is key to the whole structure. Anybody who impedes that flow will pay for it.


Looking at the international arena, Thermo Electron recently has been acquiring companies overseas. What are your plans for overseas markets?

Acquisitions have their place in the technology arena, but a CEO primarily should be thinking about growing new businesses.

In terms of development, Europe will be a major market, especially for environmental services, such as paper recycling and soil remediation. Eastern Europe is an environmental disaster now, which also creates opportunities for us. We'd like to expand to the Far East, but it's hard because the culture is so different.


What new businesses do you see in the future?

We have some spin-offs in the pipeline--energy systems (distribution of electricity for cogeneration), a water treatment subsidiary, and aerospace and medical devices businesses.

The pharmaceutical industry is vital to us. Our instrument group provides a number of analytical instruments for the industry, and we are excited about a device that can monitor blood flow and find tumors.

If you want to talk about the most far-out thing ThermoTrex sells, look at thermionics and thermoelectrics, which aim to provide space power for the first manned interplanetary flight. The real application probably won't materialize for 30 years or so, although that timetable might be pushed up if the U.S. develops an ambitious technology program from which future technologies will emerge.

Ironically, Thermo Electron was conceived as a space power business--one in which we are still waiting to see the payoff--and our work in that area generated our other businesses. We have made development efforts in the space industry; hopefully, I will be around to see those efforts pay off someday.

Any advice to companies about how to get the most bang for the buck out of their technology innovation and spending?

You cannot break into a market by technology alone. Businesses that are enamored with technology sometimes fail because technology alone doesn't necessarily respond to the needs of the market or the customer.
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Title Annotation:interview with Thermo Electron Corp.'s George Hatsopoulos
Author:Donlon, J.P.
Publication:Chief Executive (U.S.)
Article Type:Cover Story
Date:Apr 1, 1993
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