A Financial Crisis Fifty Years in the Making?

A Financial Crisis Fifty Years in the Making?

---from Harvard Buisness Publishing

Over the past few weeks, I grew sick of listening to "big picture" stories on the financial crisis that only covered the last 5 to 10 years. That's not the big picture. If anything, that's the small-to-medium picture.

So I called Walter Kiechel, the former managing editor of Fortune magazine and former editorial director of Harvard Business Publishing. For the past several years, he's been researching and writing a book--due out next spring--on the history of corporate strategy stretching back to the 1960s.

As Kiechel argued, businesses made plans before the 60s, but there was no concept of corporate strategy in the sense that we have it today--as a comprehensive framework that looks at costs, competition, and customers. The birth of that framework--what Kiechel calls "the strategy revolution"--brought about changes that turbocharged business over the last few decades, but that have also contributed to the chaos over the past few weeks.

For instance, in the early 60s, the strategy revolutionaries changed the way we see debt. "Early proponents of strategy like Bruce Henderson, who founded the Boston Consulting Group in 1963, just wrote flat-out, 'Use more leverage than your competitors or get out of business,'" Kiechel explained. At the time, that was groundbreaking. "We forget today that back in those days, in the 50s and 60s, companies were still not using a lot of debt. A lot of times their management had grown up during the Great Depression and they were very frightened of [debt]."

The use of leverage as a strategic tool allowed companies to prosper greatly in the decades since, but some took it too far -- including those hit the hardest by this month's meltdown(s). As Kiechel pointed out, some Wall Street investment banks took on as much as 35 times as much debt as the value of their underlying assets. "That would never have happened," he continued, "If people hadn't taken a new attitude toward debt."

Yet despite all that's happening now, Kiechel doesn't see us going back to a pre-1960 view of debt--or it's sexier alias, leverage. "We've seen the power of debt and the magic of it."

Speaking of power and magic, Kiechel sees a second powerful tool from the strategy revolution at work in the current crisis: the idea of competitive advantage. Though it's now a common phrase in our business vernacular, there was a time when "competitive advantage" seemed as glamorous as "naked short-selling." Decades ago, when businesses learned to harness the power of strategy and began to identify competitive advantages, it didn't take them long to realize just how fleeting those advantages were.

"If you looked at the businesses you were in today," Kiechel said of the strategy pioneers back then, "And where you had competitive advantage in those businesses, [you realized that] more and more people were going to spot that competitive advantage, come in, and compete with you and compete your advantage away relatively quickly--so you needed to be looking for new businesses that would give you new competitive advantage."

For a time, that realization led to diversification, both as a growth strategy and as a hedge against risk. But while the idea of competitive advantage and the ensuing scramble to seize it has spurred massive wealth-creation over the past half-century, that's also partly how we ended up facing the chaos now gripping the financial sector.

Because competitive advantage is so fleeting--and because businesses now know that it will be fleeting--it forces companies to try new things. A lot of new things. And fast. Generally, it's good to have that kind of fire under you. But like anything that offers great rewards, it also offers great risks.

"The investment banking houses, which used to be in the business mostly of giving advice on mergers and acquisitions and maybe doing some trading on their own account, have been getting into many more lines of business because their old businesses were not as profitable and they found there were more competitive forces [in them]," Kiechel continued.

"That's one of the things that has driven them into investing in real estate and credit default swaps and investing in all these various instruments that they can't now value properly."

That pressure to get even a brief competitive advantage over the other guy pushed those banks to make ever-more exotic investments. But in their fever to find the next leg up, and the next, and the next--with their competitors just a half-step behind them--Wall Street's giants were less like the investing pioneers they fancied themselves, and more like squirrels inching ever-further along an increasingly skinny branch, fighting for the last nut. Then, when the branch snapped, they realized they were holding an empty shell.

Given that debt and competitive advantage--among other subjects that came up in our conversation--are pretty fundamental elements of modern business, I couldn't resist asking Kiechel the big question: are the fundamentals of our economy, in fact, strong?

"The fundamentals are strong," he replied, "But the fundamentals are changing." Despite the way these threads from the 60s strategy revolution--debt and competitive advantage--have gotten somewhat tangled up today, this still isn't a Strategy crisis with a big S. As bad as it is, it's still just a crisis based on individual failed strategies, with a small s, and in that, it's not too different from previous collapses.

Kiechel drew a parallel that the tremors we're feeling now and earlier economic earthquakes, such as the United States' 1800s shift away from an agricultural economy and its 1900s shift away from industry. While the financial sector has been hit hard, other sectors--renewable energies or biotechnology, for instance--will continue to thrive. And they'll continue to take risks, play with debt, and furiously seek the next competitive advantage.

"The energy and the enthusiasm and speculative fever and animal spirits -- we'll probably see them rise up more in different sectors going forward," Kiechel said. "But they'll still be there."

Should we find that comforting? That's your call.