Apologies – today, I’m going to make you grind through a boring intro to get to the good stuff.
The macro crisis is entering it’s next to last – and perhaps climactic – phase: the true costs of business as usual must slowly be grappled with. As Fannie Mae and Freddie Mac melt down, it is taxpayers who are bailing out shareholders – the Treasury is now reduced to intervening directly in the financial markets: so much for hundred of years of laissez faire economics.
Why are Fannie and Freddie being bailed out? Because they must be. As Brad Setser has pointed out, much of the debt they ensure is held by emerging markets like China and Russia. If Fannie and Freddie fail – or have to be nationalized – the ultimate cost will probably be essentially a massive, destabilizing to sovereign risk: a downgrading of the credit rating of the US.
Unfortunately, the US is for all intents and purposes bankrupt anyways. So that outcome is unavoidable now: it will just happen via a different mechanism: the dollar will continue to slide, rates will spike, consumption must flatten, and investment must erode.
Grim reading. But what does it have to do with strategy?
Everything. Here’s a radical proposition: strategy itself is how we got into this mess. When everyone acted “strategically”, the financial industry imploded”.
Consider this. Why did everyone – literally every single player in the financial value chain, from mortgage brokers to prop traders – compete mercilessly to hoard benefits, and shift, hide, and obscure true costs? That’s what ripping the other guy’s head off really is, after all.
Because it’s exactly what orthodox strategy teaches us to do. In fact, that’s the very definition of market power: the ability to allocate costs and benefits regardless of the preferences of others.
Perhaps the meaning of competitive advantage, when all the games have been played and the gears of the economic machine have finally stopped moving, is this: privatize benefits and socialize costs.
That might have been sustainable in a disconnected, asset-heavy industrial economy. But it cannot hold in a hyperconnected edgeconomy. When all of us can trade ten billion times a day, if everyone’s simply trying to claim benefits from everyone else, while shifting costs and risks to everyone else, the result is economic implosion.
In an edgeconomy, chasing competitive advantage is like playing a game of economic musical chairs – one where you leave a grenade on your chair every time the music starts up again. Sooner or later, everyone gets blown up.
The problem is simple. As we’re finding out the hard way – yesterday’s approaches to strategy simply cannot power the economies or businesses of the 21st century.
So the question is: how do we save strategy?
The real change must happen in the DNA: how firms and funds are organized and managed. Here’s one place to begin: three fundamental errors industrial era DNA leads today’s boardrooms to make, over and over again.
Strategy isn’t arbitrage. What happened in finance? Everyone confused arbitrage with strategy. But arbitrage is simply about capturing value at the expense of counterparties: no new value is created by arbitrageurs. At the limit, arbitrage devolves to a negative sum game: I will actively poison your opportunities, and you will poison mine, if we are trying to arb one another. Strategy must be concerned with value creation in the first place.
Strategy isn’t dealmaking. Too many companies fall prey to the cult of the deal – Viacom, TimeWarner, Sony, Yahoo, Citigroup, and Bear Stearns: that’s just a tiny list. Deal-making is a powerful narcotic when equity is the currency execs are paid in, and the pushers behind the deal have zero interest in the health of the addict. Yet, despite the flawless pitchbooks of investment bankers, strategy isn’t deal-making. That strategy is concerned with value creation means strategy is about how resources and competencies will fit together tomorrow, not just how many costs can be shared between business units today.
Strategy isn’t an arms race. As Michael Porter has tirelessly pointed out, strategy isn’t about arms races, where we strive to do the same things as everyone else, just a tiny bit more efficiently. It’s about making choices which lead to sustainable differences. In finance, for example, the industry became obsessed with algorithmic models – but those models were remarkably similar. Little surprise, then, that so many were vulnerable to the same discontinuity.
What is strategy? It’s simple: strategy is what’s strategic – what is in your long-run best interest, factoring in everyone else’s long-run best interest.
Let’s go back to finance. Was it really strategic for boardrooms to invest billions in assets whose valuations were totally abstracted from reality – and even when the valuations were reasonable, the information fed into the valuation was deeply suspect? Is it really strategic for the world’s resources to be allocated more and more in dark liquidity pools by opaque, closed, myopic funds designed to be unaccountable?
I don’t think it takes a great deal of insight to understand why such a financial system is unsustainable, in the deepest sense of the word.
Fire away in the comments – do you see the link between strategy and the macro crisis? Do you think strategy itself played a role? Or is 20th century strategy just as valid as it ever was?
And for those of you who are interested – the title of the post is, of course, an homage to Rajan and Zingales’ thoroughly awesome Saving Capitalism from the Capitalists.