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The Risk of Not Investing in a Recession
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By Pankaj Ghemawat
Spring 2009
Reprint 50309
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Volume 50, Number 3, pages 31-38, 8 pages
Primary Topic: Global Business
Secondary Topic: Financial Management
SummaryTwo very different ways of thinking about investment and risk are in competition. One emphasizes the financial risk of investing; the other concerns the competitive risk of not investing. In normal times, the bearishness of the former tends to complement the bullishness of the latter. But during extremes in the business cycle, the author argues, the balance between the two can break down. Specifically, companies seem to overemphasize the financial risk of investing at the bottom of the business cycle, at the expense of the competitive risk of not investing. This is dangerous, in the author's view, because it can create a lasting competitive disadvantage. Using examples from the semiconductor, paper and diamond industries, the author argues that it doesn't make sense to stamp out either financial or competitive risk, even though financial risk could be eliminated by investing not at all and competitive risk could be eliminated by investing indiscriminately. Instead, managers need to strike a balance between the errors implicit in these two types of risk: the error of pursuing too many unprofitable investment opportunities as opposed to the error of passing up too many potentially profitable ones. The original version of this article was published in the Sloan Management Review in Winter 1993. In this updated version, the author expands his views in light of the 2008 economic downturn. |
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