The Thinking Man's CEO

How George N. Hatsopoulos's everyday approach to management has enabled his company to discover one new business after another

As the environment for business becomes increasingly complex, the challenge of building a successful company is getting more formidable every day. Faced with international competition, quickly changing markets, and a more demanding labor force, most chief executive officers react to this world by burrowing ever deeper into their companies. Yet perhaps the inward-looking CEO is doing only half his job.

The other half -- and by far the more elusive -- of the modern CEO's job is making sense out of the changes and figuring out what opportunities they create. Nobody seems to appreciate this role better than George N. Hatsopoulos, founder, chairman, and president of Thermo Electron Corp. He has been practicing "outward-looking" management for some 30 years.

From the outside, Hatsopoulos's $400-million-plus company seems to be a collection of disparate technology-based ventures rather than anything resembling a cohesive whole. The business of these units ranges from cogeneration and pollution monitoring to heart-assist devices. What's more, they operate independently. But don't be fooled. They are linked by Hatsopoulos's wide-ranging curiosity and his own style, which combines traditional management with the pursuit of outside activities that expose emerging areas of opportunity for his company. As one Wall Street analyst recently put it, Thermo Electron "has developed a rich array of products and technologies that address major national priorities.'

Hatsopoulos, a native of Greece who came to the United States as an undergraduate to study mechanical engineering at MIT, started his company in 1956 with no idea of where it would lead. Most of his early efforts went into thermionics, a technology for converting heat into electricity using no moving parts. Nothing commercial came of it, but Hatsopoulos, as he became more involved in outside activities, has more than made up for that disappointment. His curiosity hasn't led him only to new market opportunities. He's made important contributions to economic thinking on the cost of capital and on trade policy. And he sits now as chairman of the Federal Reserve Bank of Boston.

Senior writer Bruce G. Posner and senior editor Stephen D. Solomon spoke with Hatsopoulos in his Waltham, Mass., office.

INC.: You seem to define your role more broadly than any CEO we know. Would you describe it for us?
HATSOPOULOS: A lot of what I do follows the direction I set when I started the company. I wanted to create a team of people who were dedicated to a common objective -- to create an environment in which talented people could continually learn from one another. One of my main jobs is to worry about the development of people.

The other big part of my job is figuring out which businesses we should be in -- deciding between areas that are already commercial and those that haven't yet developed. Some of them may be 10 or more years away, so it's not easy to do. Among other things, you have to understand the long-range needs of customers -- even if they don't.

INC.: These are customers that you already know?
HATSOPOULOS: Not necessarily.

INC.: So where do you begin?
HATSOPOULOS: Well, unlike most companies, we're not product driven. My ideas about this go back to when I was in high school in Greece. I had made a decision that I wanted to study technology, and that I wanted to do that at MIT. I was going to get my Ph.D. and then build a company that would be technologically oriented, always looking for new ventures. I would have a company that had a certain core technology, then look around to identify what needs existed, and try to invent things that met those needs.

INC.: And that's the way things more or less developed?
HATSOPOULOS: Yes, we have several basic areas of competence, and what we really try to do is solve problems. Finding out what these emerging problems are is my job. I have to be out there all the time, talking with people, taking part in public-policy discussions, anything that will enable me to see broad changes before the other guy. If you do a little studying, reading the newspapers and following things, you will begin to see what problems are coming up.

I spend a lot of my time figuring out what makes the economy tick. How can we fill some of the holes that have been created? It requires a broad understanding of society; and also of what drives our society. The more you understand the overall environment -- and really, it's the whole world -- the better able you'll be to find the opportunities. If you find needs that aren't being addressed, you can make a much greater contribution, and you will have a greater chance of success.

INC.: The role of the CEO that you've defined requires much more long-term thinking than most executives practice.
HATSOPOULOS: Yes, and companies like Honda and Mazda have proven, I think, that it pays to think this way. It took them 15 years to break into the American market. If you don't think this way, you're forced into being reactive, into focusing on short-term problems, because other companies have learned to think longer term and therefore have defined the market for you. The stakes are too high to let that happen.

INC.: So your outside activities are integral to your concept of a CEO's role, which is first and foremost defining the future.
HATSOPOULOS: Yes, this is how my outside activities come around to help the company.

INC.: Keeping an eye out for emerging trends is important, but what's wrong with focusing on markets that are already established?
HATSOPOULOS: Nothing's wrong with it. But it's going to limit your growth. In a market like steel, which has been developing since the turn of the century, many people are already competing. What are my chances of success in that? I think that if you are going to develop new products or services, it is much more beneficial to do it in a market that is in its infancy, where the needs are only now being understood. You have few competitors in a market like that. So, if you are a little brighter maybe and more studious than the others, you might get ahead.

INC.: Tell us about a problem that Thermo Electron had to solve in the very early stages.
HATSOPOULOS: Well, our first real involvement with public policy started with the concern about air pollution and emissions from automobiles. We were fully aware in the late 1960s that there was a lot of movement in Congress to introduce some pollution control. So, I got the sense that there was a market being created. I was trying to understand some possible solutions that our technology could provide.

INC.: So it was the profit motive that sent you out there?
HATSOPOULOS: Absolutely. At that time it was very much a business motivation -- because I knew quite a bit about internal-combustion engines and why they produce oxides of nitrogen, among the most damaging pollutants. I tried to understand the mood of the legislators by being in touch with people in the Administration and in Congress.

INC.: With the intent of following it with some commercial solutions?
HATSOPOULOS: Yes, something that would fit our technology, that we could provide. At that time, we were working with external-combustion engine technology. The auto industry was very concerned about this whole issue of emissions from automobiles. So, in the late '60s we formed a joint venture with Ford by which Ford would provide some research-and-development funds. We would try to develop that external-combustion technology for possible use in automobiles as well as possible use in other applications.

As a parallel effort to the engine work, we also developed an all-new type of instrument for quickly and accurately measuring oxides of nitrogen. This detector has become an industry standard and led to the formation of our instruments business -- the most profitable sector of Thermo Electron.

INC.: There wasn't much of an existing market at the time. So you were really staying close to a particular problem.
HATSOPOULOS: Yes, and we did the same thing with energy in the 1970s. See, as a thermodynamicist, I understood that if we got a crunch on energy, the way to go would be to make industry more efficient. And energy-utilization efficiency was something I taught.


INC.: But having this insight and creating a business that makes money out of it are two separate things. Tell us how you got going.
HATSOPOULOS: Our involvement with energy efficiency really began in 1966. One day, a group of gas utility executives came to us. They were concerned that they were losing ground because more and more industry was using electric equipment rather than gas-fired equipment. They asked us to help them build a new generation of equipment, and offered us a million dollars a year for five years, with no strings attached. We could pursue anything we wanted, provided that it burned gas. We would own the patents and the technology, but if we didn't commercialize them within a reasonable time, the gas utility would have the right to go to another company that could commercialize it.

We decided to work on industrial furnaces. After three years of work, we designed a generation of new, more efficient equipment. Then I decided to buy a furnace company so that we could manufacture it and not lose our rights. We bought Holcroft Furnace Co. in 1969.

INC.: So now you had production capability. And, I presume, so did a lot of other companies. What did you do next?
HATSOPOULOS: We successfully introduced these new furnaces into the market. Then, in 1971 I started getting our people to study energy productivity in a broad range of industries.

INC.: This was two years before the OPEC boycott.
HATSOPOULOS: That's right. Somehow an assistant to President Nixon found out that we had studied industrial energy efficiency. The aide called me in and I gave him some reports. About 1972 the Ford Foundation funded a study on energy. I didn't know about the initiation of that project, but I was at a cocktail party in Washington and I met David Freeman, who was heading it. I told him about our interest in energy efficiency in industry, and he enlisted our participation.

We wrote one of the chapters in the multivolume book that came out of that study just after the embargo, and also the volume that addressed industry. So now we had become, all of a sudden, the country's expert on energy efficiency in industry.

INC.: But that was a research effort.
HATSOPOULOS: I was a researcher.

INC.: Was there a product or market that came out as a result of that?
HATSOPOULOS: Of course. We found that industry in this country was about 50% less energy efficient than industry in Japan or West Germany in producing almost any product. We were using more energy because it was so much cheaper here. It was obvious to me that if major shortages occurred, American industry would be in trouble. I think I testified before Congress about 17 times on this issue.

Then there was the embargo. I called in the general manager of Holcroft and said, "Let's create a new generation of furnaces that will be 50% more efficient. We'll have the corporate lab support you, and I'll give you all the money." He said, "Well, none of the customers are asking for it yet. Should we spend money on something that the customers are not asking for?" I said, "The customers will ask for it. They are going to get into a bind. When they ask for a more efficient furnace, it will be too late for you to provide it. If you develop it now and your competition doesn't, you will have it when they need it.'

INC.: And the market developed the way you thought it would?
HATSOPOULOS: As it turned out in 1976, natural gas was rationed to the automobile companies. So, they started purchasing more efficient gas furnaces. For example, when General Motors asked us what we could do for them, I said we could give them metallurgical furnaces that are 50% more efficient. We had them available, and our competition didn't. So we increased our market share overnight.

Later we developed an altogether new energy-based venture known as cogeneration -- the simultaneous production of electrical and thermal energy from a single fuel source. So, my whole involvement with the energy program affected both our long- and short-term strategies. We structured the company in the '70s to pursue energy efficiency. Within seven years, the sales of the furnace division went from $5 million to $50 million.

INC.: You didn't feel that that was going to happen when you got into it?
HATSOPOULOS: Well, I didn't know what would happen. I knew that it would be a good activity for us if we were going to plan the long-term strategy of the company -- because energy was one of the technologies that we focused on.

INC.: It sounds as though that whole effort to understand energy efficiency, and the study that you participated in, was market research.
HATSOPOULOS: That's right -- but a different kind of market research. You see, I think that business in general, and particularly in the United States, is too short-term oriented. Remember the millions of dollars that were spent in developing the Edsel? The problem was that nobody could figure out how consumer tastes would change by the time the Edsel came out. The people who are doing market research have no tools for answering that question. They have no technique.

INC.: That may be, but what's the alternative?
HATSOPOULOS: In order to get that answer, you have to look for the broad trends. You have to get out there yourself because you know your market and your customers better than any market researcher. And you have to get involved in the kind of outside activities that will let you see these broad trends. That's what enabled me to see a future need for more efficient furnaces.

INC.: Sometime later you took an interest in economics. You were running a company, so I don't imagine you were at a loss for things to do.
HATSOPOULOS: I'd been curious about economics for a while, but my interest became more pronounced in the '70s. There were things going on with my business that didn't jibe. I couldn't figure out why American industry was so energy inefficient, and why Germany's was so much more efficient. The reason was simple: economics dictated that. Our energy prices were much lower. So energy efficiency is not just a matter of technology, it's a matter of economics.

INC.: Were you experiencing some difficulties in the marketplace?
HATSOPOULOS: No, our business was booming in the late '70s. It was just that some of our most advanced technology, which was very expensive, we could peddle only in Japan and not in the United States. The question was why? The cost of energy by that time was about the same in the United States and in Japan, so there must have been something else going on, and it must have been the cost of capital. That was my hypothesis.

Cost of capital, to a layman like I was then, simply meant interest rates. So you looked at interest rates, you found a little difference -- interest rates were a little lower in Japan in '79 than in the States, but that couldn't explain the whole thing. So I asked my friends at MIT and various economists: "Tell me where I can read about the cost of capital?" I was not satisfied with what I found in the literature. I read it all and said, "Well, I'll do the work myself." So I started in '81 making a major study on the cost of capital.

INC.: How did you go about it? Did you hire some people?

HATSOPOULOS: No, I didn't. I did it by myself. I read books. It took me about a year and a half to finish. I wanted somebody to check it out, so I called Larry Summers, who was an MIT professor [now at Harvard and a principal economic adviser to Democratic Presidential nominee Michael S. Dukakis]. He read the paper and came back and said, "A lot of errors, George. A lot of mistakes. You misunderstood things." And I said, "Well, tell me about them." We worked together for six months. That was the first study I made.

INC.: And what did you conclude?
HATSOPOULOS: Well, the first thing we concluded was that interest rates were a very poor measure of the cost of capital. Why? Because the sources of capital are more than just debt; there's equity, too. The cost of equity is influenced by several factors -- including tax rates for both corporations and individuals and the structure of the financial markets. Looking at both debt and equity, we determined that over the past 20 years, the cost of capital in the United States was three to four times higher than it was in other industrialized countries. The cost of equity has been around 8% aftertax; in Japan, it's been less than 2%.

INC.: That's a big difference. Did these numbers surprise people?
HATSOPOULOS: Yes, they did. Some of the ideas had been in minds of economists, but they weren't widely understood. And nobody had done the numbers. Policymakers were totally in the dark.

INC.: So what were the implications of all this?
HATSOPOULOS: Quite simply, it meant that a U.S. company was at a real disadvantage when it came to competing against foreign companies. Its capital cost more, so its products were less competitive. The U.S. company had two choices: either it raised prices and it lost market share, or it tried to cut corners with the risk of losing out later.

INC.: Has your study of economics changed the way you've run your company?
HATSOPOULOS: Yes, and in a very fundamental way. It became apparent that the only way you can obtain equity at a reasonable price in this country is to focus on the gambling and entrepreneurial inclination of investors. These people aren't interested in a huge conglomerate, because they can't get a feel for anything that it does. Thermo Electron was developing enough lines of business to have the same problem on a smaller scale.

INC.: So what did you do?
HATSOPOULOS: We repackaged the equity so that investors got a piece of one promising technology that they could get excited about. I thought, why not split the company into small parts? As it turned out, that was a key to getting equity at prices more favorable to the company.

I have gone much further in trying to decentralize than any company I know. In an effort to try to do that and make people responsible, I have set up many of our divisions as publicly owned organizations. I think that structure has tremendous benefits. Managers of each subsidiary know that what they do gets scrutinized not only by corporate management but also by their own stockholders.

I really believe in small companies. But small companies have a big disadvantage. They don't have the support, the financial and management resources, that big companies have. So, you have to find a new structure for U.S. industry that combines the advantages of small companies and the support of large companies. My own answer is to have a bunch of small companies in a family, which gives them financial and management support and strategic direction. But at the same time they are acting as though they are independent companies with their own constituency or stockholders.

INC.: So you have the best of both worlds?
HATSOPOULOS: Yes. I want Thermo Electron to grow to more than $10 billion, maybe in the year 2000, but it will be a company that consists of many smaller companies. Right now, we have 17 business units, and 5 of them have minority public ownership -- I hope that in 10 years most of them will.

INC.: What else is going on now that grew out of your interests beyond the four walls of the company?
HATSOPOULOS: We're working now on detection devices for explosives and drugs. We'd had the capability for some time of developing something to find hidden explosives. Then, when the terrorist attacks increased a few years ago, it was evident that a market might be developing there. So, we started spending money and got in touch with the Federal Aviation Administration and with the State Department, which are giving us tremendous funding right now.

Then one of our people suggested that we develop an instrument to detect heroin and cocaine. Using dogs is quite expensive and unreliable. The instrument we're developing can smell drugs with a sensitivity about 1,000 times that of the best dog.

INC.: Is there anything you're looking at that is completely speculative?
HATSOPOULOS: One of my interests is the greenhouse effect. I have an employee who is very much attuned to these long-term environmental issues, and he's been talking to me about it.

In fact, I've been invited by Senator Tim Wirth (D-Col.) to take part in a conference on the greenhouse effect. My first reaction was that I'm in over my head. Why do I need to spend a whole day in Washington talking about this? But my employee said, "George, this would be an opportunity for you. Find out what Congress thinks. You'll meet a lot of congressmen and senators there and see how they view it. It's an important program.'

INC.: You sound pretty skeptical. But you'll go?
HATSOPOULOS: I'll go. Can you imagine two or three years from now if we need to cut down on the burning of hydrocarbons? I'm not saying it's going to happen -- all I'm saying is that there's a possibility that something will evolve there. Keeping on top of this problem is something that I feel the company should do.

INC.: Your approach to market research is considerably more abstract than that of most companies. How does the CEO of a $5-million medical supply company in Akron, an executive who has maybe two or three products, go about adapting it? He doesn't have time to go trotting off to Washington.
HATSOPOULOS: No matter what stage he's in, there are ways for him to get broader exposure. He can go to medical meetings. He can get to know people at bigger companies. He can get involved in the problems his industry faces. He can get to know bankers. I found ways to broaden my understanding of the businesses we were in when the company had revenues of less than $1 million. We started getting to know our investment bankers five years before we went public.

INC.: All right, so this CEO is interested in your approach. How does he get up his nerve to divert resources to long-term projects that won't be commercial for a few years at best?
HATSOPOULOS: You have to be very gutsy and adventuresome. I always liked taking risks -- but within limits. One way to limit your risks is the way you get financial support. The best example from my own experience is the gas-utility industry. It is not a manufacturer or a competitor, but as I mentioned before, it paid us to develop products that gave birth to a very successful division of the company. We're still getting $7 million in research funds from them this year, a large portion of our R&D budget. Another great source is the federal government, but you have to make sure you work out a deal that allows you to keep the commercial rights. We started a biomedical division on the strength of $2 million in contracts with the National Institutes of Health.

INC.: Plenty of CEOs would like to pursue outside activities as you have, but they feel they can't get away from the office. On a practical basis, how do you do this?
HATSOPOULOS: There's no way to implement this strategy without having tremendous people around you. What I consider my major job is to get the right people and to convey to them a sense of responsibility. I try to create an environment in which people in the company feel that they are partners, regardless of the reporting hierarchy. I ask people their opinions and try to explain to them the problems we face. Not to just give an order and say, "Look, you do this." But you tell them, "This is what the company's problems are right now. This is what we are trying to accomplish. Do you have any thoughts on that?'

It takes a lot of time and effort, but people are very flattered and get to feel they are participating in decision making -- and they are.

INC.: Face it, if you let people make important decisions, there's a big risk, isn't there?
HATSOPOULOS: Not as much as you might think. You see, letting people make mistakes is an essential part of development. If you prevent people from making mistakes by overseeing them, then you don't grow. So, you have to take a risk. On the other hand, you can't let the person make a goof that would destroy the company.

INC.: How do you find just the right balance?
HATSOPOULOS: You have to assess the risk on a case-by-case basis. If following my manager's course of action would not subject the company to potentially catastrophic results, I would let him take the chance of making a mistake. What I require is for him to identify the difficult problems he faces, and to tell me the solution he's proposing and the rationale for it.

INC.: So your job, really, is to ask lots of questions -- both before and after decisions are made.

INC.: That's fine if you're around and if you have the time. But what about those mistakes you must hear about -- things you weren't prepared for?
HATSOPOULOS: The type of management I'm describing can work only if there's a tremendous flow of information throughout the company.

INC.: Does that mean that you're tougher on people who surprise you with stupid mistakes?
HATSOPOULOS: Yes, because the whole idea of creating responsibility and minimizing your risk is to get many people's advice, to get a lot of people knowing. If people do their homework -- explain their ideas, listen to mine, rethink their approach -- it's rare that they make mistakes.

INC.: And the penalties for making a mistake?
HATSOPOULOS: Oh, if they've done their homework, there is no penalty. If they make stupid mistakes, I bear down on them quite a bit because that's what I want to avoid -- letting things fall through the cracks.

INC.: You've been doing this for a long time. Has it worked?
HATSOPOULOS: What has happened is that people progressed very quickly to the point where I could trust their judgment. And they have applied this management technique to their own people, so that the whole thing grew that way. You can develop a way of growing the company, making people responsible, and building on it.

INC.: And you can go off for a few days or a week and feel that the company is in good hands?

INC.: I suppose most CEOs would object at this point. They'd say, "Fine, but I can't do this until my company is a lot bigger.'
HATSOPOULOS: I got quite involved with these broad issues when the company was very tiny. It was back in the late 1960s, when the company had sales of about $3 million and fewer than 100 employees.

INC.: What effect have all your activities had on the way you look at your job? You founded the company in 1956, and it sounds like you haven't had a boring day since.
HATSOPOULOS: If my job were to stay the same, I would get bored. I have been at it for more than 30 years, and I still find my job to be tremendously enjoyable. I have a lot of curiosity, I want to deal with new things and new problems. I think a person needs to have some kind of diversity. You cannot think about the company all the time because you would become stale.

INC.: People can get away from it all by playing golf, too.
HATSOPOULOS: That's right. People find diversion in sports or some other activities, going to a party and chitchatting, playing golf or cards. This is a way people get their minds off their problems.

All I'm suggesting is that you can be selective in picking something that has some creative element. Everything has a creative element to it. You play a hand of bridge, and you concentrate on that problem, how to handle that particular hand. But it's a very short-lived achievement. True, it does serve the purpose of taking your mind off the problem of meeting your payroll. And that's necessary. If you don't do that, I think you are going to bog down.

INC.: But you're talking about something larger. You're saying that there are ways to spend time that can benefit the business much more.
HATSOPOULOS: Yes, I'm saying that you can be a lot more selective. You can get yourself involved in something that has a longer-term objective than simply winning a game of golf. It can be very satisfying and it can eventually open your horizons in a way that would help your business.

But my initial motivation isn't, how would this activity benefit the company? It's more like, this is a fun problem. I am basically a problem-solver. If you give me a problem right now that intrigues me, I may spend a whole weekend worrying about it, even though it has nothing to do with the business or anything I'm doing.