The tale of Enron is not a story about them, he writes, but about us. “After decades of studying the practice of management, I am convinced that very few of us who live in the world of competitive product markets and unforgiving capital markets have not encountered the management behavior and business policies that became so toxic at Enron,” he declares. “As self-interested individuals, we are also all susceptible to incentives that improve our economic well-being and tempt personal opportunism....”
Salter’s main interest is in probing the failures of governance at Enron, including the lack of strong board oversight and the dereliction of duty by watchdogs and auditors. Yet the collapse of Enron is also very much a story about strategy. It offers an object lesson in the possibilities and perils of extending success in one industry to others, and how managers respond when their strategies go awry.
Salter wisely notes that the executives involved did not set out to be dishonest or to defraud. In its early years, Enron was innovative and successful by any objective standard. During the early 1990s, Ken Lay and Jeffrey Skilling recognized the trading opportunity in the newly deregulated market for natural gas and devised a business model that was insightful and novel. The key insight was that Enron could play an intermediary role without owning physical assets, namely plants and pipelines. The result was an “asset-light” model for trading natural gas.
Building on this early success, Enron began to look for areas where it could replicate its business model. One Enron executive claimed, “Anything we want to intermediate, we can.” By that logic, the key to Enron’s success was not its knowledge of the gas trading industry or of any other particular industry, but rather a set of capabilities that could be applied in any trading domain — the more fluid and complex the better. As Enron reported in its SEC filings, it believed “skills developed in merchant energy services could yield operating efficiencies for Enron and other participants in the developing bandwidth market.” Finding this argument persuasive, investors and bankers were eager to provide abundant resources to finance Enron’s growth.
Over the next years, Enron made repeated attempts to apply its business model of intermediation in new domains, including electricity trading, broadband trading, electricity generation, and water. Yet every attempt to extend the model into new domains turned out to be a failure. Salter’s conclusion, based on an extensive reading of Enron finances, is that it is doubtful the company earned its cost of capital in any of these new businesses. “In retrospect, both the strategic and economic logic of EES [Enron Energy Services] look highly questionable,” he writes. “Neither fundamental economics nor managerial capabilities could support Skilling’s hopes of extending his energy-based business model down the value chain from sales to utilities, to sales to consumers. Skilling’s big bet on retail energy did not come close to being viable.” Yet with massive incentives to show ever-increasing top-line and bottom-line growth, Enron executives devised questionable, and eventually illegal, ways to maintain an illusion of success. The end was inevitable, and it came swiftly in 2001.
With the benefit of hindsight, it’s easy to say that trading electricity and broadband is fundamentally different from trading natural gas, and that Enron’s business model could not bring value to new industries. But that’s in retrospect. Whether the limitations should have been visible at the time is by no means certain. For corporate strategists, the most difficult questions are, To what extent can existing capabilities be applied in new domains? How certain should we be before committing resources to move ahead? What are the warning signs that a strategy is not working successfully? And perhaps most troubling, in the event of poor returns, what are the consequences — to the firm and to the manager — of admitting failure?