The 2007 subprime crisis and global economic interdependence

Globalization

An Understanding of the Problem and How it Relates to Globalization

Two Perspectives on the Impacts on Managers

Recommendations for Managers

In the winter of 2007, a crisis emerged in the U.S. subprime housing market. The potential impact of this crisis on the global economy was initially downplayed, in large part because the degree to which the global financial markets had become integrated in recent years was unknown. As the crisis has unfolded, two things have become apparent. One is that the global financial markets are intertwined to a high degree. The other is that the world's major economies rely on mutual strength in order to flourish. At the outset of the crisis, it would have been difficult to conceive that some of the outcomes would include the bankruptcy of Iceland (Capell, 2008), and the deflation of China's seemingly unstoppable economy. The issue, after all, was that American banks and mortgage companies were writing too many bad loans. Now, managers around the world are faced with a global economic slowdown. From Saudi oil barons to retailers in Asia, the subprime crisis is affecting businesses all around the world. Globalization has made a domestic American issue the most dominant global economic issue of our time. Managers in the U.S. And around the world must now cope with the economic slowdown, but they must also prepare for the risk of other such market failures in the future. In essence, globalization has increased the potential reward for corporations but it has also increased the level of risk. All around the world, managers today must find a way to measure this risk, and to hedge against it.

Two Perspectives on the Impacts on Managers

The response of some managers, particularly in China, has been somewhat less than heroic. Workers have received their paychecks late, plants have closed without notice and foreign managers have simply fled the country rather than deal with the problems (Ibid.). There are two main schools of thought regarding how managers can better prepare for and respond to such crises in the future. One school argues that globalization should be curtailed or restrained in order to mitigate the risks involved. The other school argues that management decisions are a more important factor in such failures than globalization. Therefore, this situation offers important lessons for managers as the deal with this scenario and prepare for such eventualities in the future.

Globalization has increased the risk and the reward in the world's economic system. The result has been a steep increase in global wealth, but when crisis hits, the suffering is equally harsh. Opponents of globalization argue that keeping more jobs at home is more beneficial. Thus, the risk of localized events, be they the subprime crisis, or the Asian financial crisis in 1997, have limited impact outside of their regional spheres of influence. The impacts of catastrophes such as the subprime crisis are difficult to predict. This makes it difficult for managers in far-removed industries or parts of the world to guard against such eventualities. For example, the toy manufacturing industry in China has suffered greatly because the subprime crisis has weakened U.S. demand for Chinese toys. One estimate has some 3600 Chinese toy companies having gone out of business already in 2008 (Ibid.). Knowledge of the subprime crisis arrived in early 2007, but many U.S. experts did not predict the crisis would spread. There was no way for even the executives of the toy factories to understand how exposed the global economy was to the bad mortgage debt, nor would they have been able to anticipate the sharp decline in demand, particularly in the face of continued high ordering from U.S. importers and retailers. That those goods would go unsold was not a reasonable expectation. The solution to this problem would therefore not be at the managerial level, but at the governmental level. A policy of reduced dependence on the economies of other countries may have stifled the opportunities for growth but also would have reduced the suffering of the Chinese economy when the crisis emerged.

Another aspect of this argument is that globalization today has taken on a form that uniquely benefits the larger countries and stronger economies. The current system, opponents argue, should be curtailed because it does not provide developing economies to properly develop in the way that today's developed economies were able to (Chang, 2007). Not only would such economies be able to better protect their infant industries, but they would be more insulated from dependence on external markets as well. Moreover, foreign investments would be curtailed as well. Many of the Chinese toy factories are run by firms from Japan, Taiwan and Hong Kong. By allowing for the development of domestic firms, reduced globalization would allow such companies to take a longer-term view of their growth. Instead, we have a situation where as soon as the plant shows signs of struggling, the foreign owners close it and abandon the country.

Others argue, however, that managers must accept their share of blame for the suffering of their firms as a result of this global financial crisis. Better management practices would result in lower exposure to risks. It is not, proponents of this school argue, inevitable that the global financial crisis result in suffering. The Chinese toy factories, for example, had for years engaged in a business model that was not sustainable. They had competed with each other strictly on price, what Michael Porter would term a cost leadership strategy (Porter, 1980). However, these firms did not adopt business-level tactics that supported their choice of strategy. Instead, they were subject to rapidly increasing factor costs and failed to take into account that they had little power over their buyers. Moreover, these firms failed to adjust for changes in their economic environment, such as the increasing value of the Yuan (Associated Press, 2008). Thus, globalization did not result in these failures, poor management did.

One of their main buyers, for example, is Wal-Mart. Wal-Mart has reaped substantial benefits from globalization and many of the firm's suppliers have been directly affected by the crisis. Yet, Wal-Mart has not. This company, which has high exposure to consumer demand fluctuations and turmoil in the Chinese manufacturing sector, continues to succeed despite the adversity. Wal-Mart has also adopted cost leadership strategy, but unlike the toy factories in China, Wal-Mart has carefully developed business-level tactics that support that strategy. For example, they have developed over the years a dominant market position that gives them leverage over even Fortune 500 suppliers (Gainor, 2004). The difference between Wal-Mart and the Chinese toy manufacturers in therefore not the core strategy - they pursue the same one - but that Wal-Mart's management is that much stronger. They have developed the systems and organizational culture that supports the strategy, while the Chinese toy factories were content to assume that the pool of cheap labor would continue indefinitely, and so would growth in the U.S. market that would allow them to continue along their existing paths.

Another argument against curtailing globalization is that overall, it is worth the risk. Over time, industries will inevitably rise and fall as economic conditions vary. The job losses and factory closures in southern China had occurred in the same industries in the U.S. In years and decades previous. Overall, however, the nation has benefitted. This position views the role of managers as agents of this change, rather than actors upon whom the change is thrust. In the hard-hit region of Guangdong, for example, the Vice Governor felt that this crisis represented that it was time for Guangdong to move on from low-end manufacturing to an economy based more on high-tech manufacturing.

This example may be at the governmental level, but the lesson is potent for managers as well. Rubbermaid is an example of how companies must remain flexible in order to respond to adverse economic circumstances. They were forced to close plants in the U.S. And move production to lower-cost countries in order to meet the demands of their major customer Wal-Mart (Ibid.). In this case, Wal-Mart precipitated the move but the example is corollary to the lessen managers can take from the subprime crisis. It does not matter what the specific incident is that forces a policy change, what matters is that as a result of globalization, these incidents will exist. Managers must be aware at all times of the economic environment, and build their businesses in such a way that insulates them from shifts in that environment. Rubbermaid had attempted to adopt a differentiation strategy but did not adopt tactics that supported this policy. A new management team had acquired a contract with Wal-Mart, despite knowing that Wal-Mart was going to be able to dictate prices. This strategic incongruence left Rubbermaid wanting to be a differentiated producer, but in practice they were a low-cost producer. Eventually, they needed to bring their tactics in line with their strategy or face ruin. What the subprime crisis shows is that firms around the world are failing because of poor strategy. In good times, these firms can succeed; in bad times, they fail.

Another example is the U.S. auto industry. The subprime crisis and credit crunch has left this industry reeling, coming to Washington for a bailout. Yet, the root cause of the suffering these companies are enduring is not the global financial crisis, but their own managerial failures. Unlike foreign automakers, the U.S. companies have adopted neither a differentiation strategy nor a cost leadership strategy. Caught in between, they are unprepared for a sharp decrease in consumer demand. Decades ago, globalization dramatically altered their marketplace by allowing foreign companies access to the U.S. market. The major U.S. automakers, however, failed to respond to this challenge in a meaningful way. Now we have the subprime crisis affecting the marketplace, and the U.S. automakers are again failing to respond to the challenges of the global marketplace. Other automakers in the U.S. market, such as Toyota and Honda, are not in need of a bailout because they have adopted tactics that are congruous with their strategies. Compared with the U.S. automakers, they are both cost leaders and differentiators.

Recommendations for Managers

The subprime crisis has expanded into a global financial crisis. Many firms have suffered as a result of decreasing consumer demand. Yet, managers cannot simply throw their hands in the air and surrender. Managers must understand that globalization brings both opportunity and risk. The environment changes much more quickly than it used to, and the global economy is more interconnected than ever before. What this crisis has done is to provide a wakeup call to managers around the world that a problem in one sector of one economy can indeed have an impact on their own businesses.

It is not necessary that managers account for every single potentiality in the economic universe. That would be an unreasonable burden. But the global financial crisis illustrates the need for managers to take certain steps to better insulate their firms from the negative impacts of such crises. The first recommendation to managers that flows from the global financial crisis is to never be complacent. Too many firms are suffering because they found a strategy that worked in the good times and did not consider that those good times would not last. The Chinese toy companies built their business on the presumption that U.S. demand would not wane. When it did, they have failed en mass. Less complacent managers would have understood that they needed to diversify their businesses, either by cultivating other markets or by producing other products. Had they not been complacent, they would have understood that they were losing their cost advantages and relocated to other regions or countries where those advantages could be better maintained.

Globalization has meant that economies are now mutually dependent. Therefore, managers need to understand that their business will be subject to tests from the global markets. The failures in China were amongst firms that were accustomed to intense competition but that were unaccustomed to fluctuations in demand. The first to be flushed out of the market were the ones that had adopted a cost leadership strategy but had not developed business-level tactics that supported the strategy. Therefore, the second recommendation to managers is that given the unpredictable nature of the globalized economy, it is imperative that they develop business-level tactics that support their chosen strategy. Should they fail to do so, they risk adverse impacts in the event of an economic downturn. Wal-Mart has thrived despite the economic slowdown because their cost leadership strategy is supported by managerial actions at all levels. The U.S. automakers are seeking a bailout while the Japanese automakers are not because of the differences in strategy-tactic congruence.

Lastly, managers need to be more keenly aware than before of the changing economic circumstances. If anything has been hammered home by the way that the subprime crisis of 2007 morphed into the global financial crisis of 2008, it is the degree to which not only are economies interconnected but the speed at which a crisis can diffuse from one isolated sector throughout the global economy. Managers now must be keenly aware of this fact and consistently foster and defend their sources of competitive advantage. They must have a stronger sense of how economic variables will affect their firms, and must always be aware of the global economic environment. This is particularly true in firms that are dependent on one or two products or geographies for their success.

Summary

The subprime crisis evolved into the global financial crisis because of the extent to which globalization exists in the world economy. International trade exposed nations to the U.S. housing market in ways that they had not anticipated. Moreover, firms around the world found themselves exposed to fluctuations in U.S. consumer demand. Globalization has changed the way the world economy functions, and it was not until this global financial crisis that many firms and observers knew of the full extent of this new interdependence. Globalization has long created significant opportunity for managers to build successful organizations, but it has also created a riskier environment in which these firms operate.

For managers, the lessons are clear. They must be more aware of the ways in which their industry will be affected by economic circumstances elsewhere. In addition, they must tailor their strategies carefully, and implement business-level tactics that support these strategies. Wal-Mart has succeeded despite the downturn because of its managerial strength. Managerial weaknesses in the Chinese toy-manufacturing industry have led to thousands of factory closures. Moreover, complacency and inflexibility have put firms such as the U.S. automakers at risk, as they are simply not well-adapted today's market realities.

The global financial crisis is an example of the types of risks that globalization brings. Managers must be aware of these risks, and constantly guard against them. Economic downturns are inevitable, and they may come from sources from removed from any individual business. Yet, with proper alignment of tactics and broad strategic goals, management can strengthen their company's defenses against such downturns, even to the point where their company can continue to thrive in such adverse economic conditions.