The Risk of Not Investing in a Recession

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Two very different ways of thinking about investment and risk are headed for a showdown. 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 (or is supposed to) complement the bullishness of the latter. But the balance between the two seems to break down at business cycle extremes. Specifically, at the bottom of the business cycle, companies seem to overemphasize the financial risk of investing at the expense of the competitive risk of not investing. Once-in-a-cycle errors of this sort can create a lasting competitive disadvantage, which is reason enough to write (and read) an article on the risk of not investing while the economy is still weak.

Risk — Financial and Competitive

By risk, I mean what managers mean: failure to achieve satisfactory performance along some dimension. The financial risk of investing is the failure to achieve satisfactory financial returns from an investment. And the competitive risk of not investing is the failure to retain a satisfactory competitive position for lack of investment. Of course, it doesn’t make sense to stamp out either type of risk, even though financial risk could be eliminated by investing not at all and competitive risk could be eliminated by investing indiscriminately. Instead, a balance must be struck between the types of 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.

As one might expect, companies have devised arrangements for dealing with both financial and competitive risks. These arrangements can be associated, respectively, with their capital budgeting and strategic planning processes. Capital budgeting tends to be a bottom-up process in which investment proposals are filtered through screens that are intended to limit financial risk. A decade has passed since Hayes and Garvin pointed out in their landmark article, “Managing as if Tomorrow Mattered,” that the capital budgeting processes at U.S. companies discounted competitive risk as well as cash flows.1 That bias persists and seems likely to do so well into the next century (see the sidebar, “Capital Budgeting and Competitive Risk”).


1. R.H. Hayes and D.A. Garvin, “Managing as if Tomorrow Mattered,” Harvard Business Review, May–June 1982, pp. 71–79.

2. G. Donaldson and J.W. Lorsch, Decision Making at the Top (New York: Basic Books, 1983).

3. For additional specifics on how the analysis ought to be conducted, see:

P. Ghemawat, Commitment: The Dynamic of Strategy (New York: Free Press, 1991), especially chapters 4 and 5.

4. W.M. Cohen and R.A. Levin, “Empirical Studies of Innovation and Market Structure,” in Handbook of Industrial Organization, eds. R. Schmalensee and R.D. Willig (Amsterdam: North-Holland, 1989).

5. W. Skinner, “Big Hat, No Cattle: Managing Human Resources,” Harvard Business Review, September–October 1981, pp. 106–114.

6. See, for example, G. Donaldson, “Voluntary Restructuring: The Case of General Mills,” Journal of Financial Economics ’27 (1990): 117–141.

7. P. Ghemawat, “Sustainable Advantage,” Harvard Business Review, September–October 1986, pp. 53–58.

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