During hard times, a structural break in the economy is an opportunity in disguise. To survive—and, eventually, to Strategy in a flourish—companies must learn to exploit it.
December 2008 • Richard P. Rumelt
There is nothing like a crisis to clarify the mind. In suddenly volatile and different times, you must have a strategy. I don’t mean most of the things people call strategy—mission statements, audacious goals, three- to five-year budget plans. I mean a real strategy.
For many managers, the word has become a verbal tic. Business lingo has transformed marketing into marketing strategy, data processing into IT strategy, acquisitions into growth strategy. Cut prices and you have a low-price strategy. Equating strategy with success, audacity, or ambition creates still more confusion. A lot of people label anything that bears the CEO’s signature as strategic—a definition based on the decider’s pay grade, not the decision.
By strategy, I mean a cohesive response to a challenge. A real strategy is neither a document nor a forecast but rather an overall approach based on a diagnosis of a challenge. The most important element of a strategy is a coherent viewpoint about the forces at work, not a plan.
What’s happening?
The past year’s events have been surprising but not novel. Historically, land bubbles, easy credit, and high leverage often make a dangerous mixture. Real-estate debt triggered the first US depression, in 1819. A land mortgage boom was directly behind the 1873–77 crisis: innovative forms of mortgage lending in Europe and the United States generated an unsustainable boom in land prices, and a four-year global depression followed their collapse and the accompanying credit crunch. Another credit crunch, this one triggered by the failure of traded railroad notes, led to the Long Depression of 1893–97. Japan’s 1995–2004 “lost decade” followed a period of high leverage and wildly inflated land values brought to an end by a financial crash.
Leverage lies at the heart of such stories. Archimedes said, “Give me a lever long enough and a fulcrum strong enough, and I will move the world.” He didn’t add that it would take a lever many light years long to move the Earth by the width of an atom, and if the Earth twitched, the kickback from the lever would fling him far and fast. The current crisis is about kickback from leverage in two places: households and financial services. Without leverage, downturns would be disappointments, but mortgages would not be foreclosed nor companies bankrupt. Leverage spreads the pain in ever-widening waves.
The way these dynamics played out is well known. US household debt started rising in the early 1980s, and its growth accelerated in 2001 (Exhibit 1). Leverage among Wall Street’s five largest broker–dealers (Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley) rose dramatically after 2004, when the US Securities and Exchange Commission exempted these firms from the long-standing 12-to-1 leverage ratio limit and let them regulate themselves. From 1990 to 2007, the whole financial-services sector expanded 2.5 times faster than overall GDP, and its profits rose from their 1947–96 average of 0.75 percent of GDP to 2.5 percent in 2007. Then falling home prices led to an unanticipated rise in foreclosure rates and a drop in the value of certain mortgage-backed securities. That decline quickly undid highly leveraged financial firms, whose failure spread loss and uncertainty throughout the system. US consumer spending continued at a high level through the first half of 2008 but by the third quarter had dropped at a 3.1 percent annualized rate. A recession—potentially a deep one—had arrived.
A structural break
Discerning the significance of these events is harder than recounting them. I think we are looking at a structural break with the past—a phrase from econometrics, where it denotes the moment in time-series data when trends and the patterns of associations among variables change.
A corporate crisis is often a sign that the company’s business model has petered out—that the industry’s underlying structure has changed dramatically, so old ways of doing business no longer work. In the 1990s, for instance, IBM’s basic model of layering options and peripherals atop an integrated line of mainframe computers began to fail. Demand for computing was up, but IBM’s way of providing it was down. Likewise, newspapers are now in crisis as the Internet grabs their readers and ads. Demand for information and analysis is increasing, but traditional publishing vehicles have difficulty making money from it.
The same principle applies to the economy as a whole. In most of the recessions of the past 40 years, demand caught up with capacity and growth returned in 10 to 18 months. This recession feels different because it is hard to imagine the full-steam reexpansion of financial services or a rapid turnaround in housing. Beyond these two hot spots, there seem to be unsustainable trends in commodity prices, oil imports, the nation’s trade balance, the state of our schools, and large entitlement promises. Already, the idea that the United States can grow by borrowing money from China to finance consumption at home has begun to seem implausible. We know in our bones that the future will be different. When the business model of part or all of the economy shifts in this way, we can speak of a structural break.
