As the jihadi terrorists flew two hijacked planes into the Twin Towers on September 11, Carl Elsener was at home. Like everyone else, he watched the TV footage with a mixture of horror and shock. It was only a few days later he realised that the attacks were bad news for his business. Very bad news. "We never thought about this. It just didn't occur to us," he says. "We always thought things might take a turn for the worse if crime went up. But not this."

Elsener is the great-grandson of Karl Elsener, the man who, in 1884, invented the Swiss army knife. At a time when Switzerland was one of Europe's poorest countries, Elsener wanted to create jobs. He decided to build a knife factory. Soon, he was turning out knives for Switzerland's famously non-combative army.

Over the past century, the Elsener family has transformed the Swiss army knife into an iconic global brand, beloved by American soldiers, small boys and stoical British campers struggling to open tins of baked beans. It became one of the 20th century's most successful products - until 9/11. Almost overnight, the business collapsed.

"It was an absolute catastrophe for us," Elsener says. "Until then our knives had sold very well both in duty free shops and on board planes. Most airlines sold them, including British Airways. Then suddenly this distribution was closed. It was zero. The merchandise came back to us. This was really very hard." Under new airline regulations, passengers could no longer carry the Swiss army knife in their hand luggage. Those who didn't comply had their knives confiscated - and they weren't returned at the other end.

The effects were sudden, and devastating. Sales of Swiss army knives dropped by 40% almost immediately. Finally, in April, Wenger SA - the only other Swiss firm allowed to produce Swiss army knives - went bust. Elsener's company, Victorinox, named after the mother of the founding Elsener, decided to rescue its rival, buying it for an undisclosed sum.

Despite 9/11 it would be an exaggeration to talk about the knife's demise, however. The Elseners are still manufacturing 34,000 Swiss army knives a day in the tiny village of Ibach. The setting, in the Swiss canton of Schwyz, is idyllic. There are shimmering mountains, a turquoise lake, and green pastures dotted with cherry trees. In a nearby alpine restaurant Swiss pensioners play cards overlooking a snow-covered glacier. The local tourist board has even devised a name for the area, 50km south of Zurich - "Swiss knife valley".

At least the firm's original client - the Swiss army - is still ordering knives. On my way to Victorinox, I bump into two Swiss army recruits heading back to barracks after a weekend off. Do they have a Swiss army knife? "I use mine every day," Roland Zehnder, 20, from Solothurn, explains proudly, producing the silver knife from his khaki trousers. The standard-issue knife given to every Swiss soldier has the famous red Swiss flag badging and four functions: a bottle and can opener, a file, and a blade.

"It's good for opening cans," Roland says, before demonstrating how he uses the knife to adjust the sight on his Sturmgewehr 90 rifle. "You have to turn it like this." Isn't it slightly embarrassing being in an army that never actually does any fighting, I wonder? "It's true that Switzerland didn't fight in the first or the second world war," Roland says. "In fact, I can't remember our last battle. But Swiss troops do take part in UN peacekeeping missions. We are currently in Afghanistan, Kosovo and South Korea."

As if things weren't bad enough for the Elseners in the post-9/11 climate, they have also had to cope with another threat - China. Over the past 10 years, Chinese firms have churned out thousands of cheap copies of the Swiss army knife, seemingly indistinguishable from the real thing. (On closer inspection, the Chinese fakes are clearly inferior, with none of the satisfying "clicks" that distinguish the Swiss original. Victorinox boasts that its precision-made springs are indestructible.) Now the Swiss firm is fighting back. Last month it registered the deep red colour of its Swiss army knives as a patent. It has recently tipped off Chinese officials, who have staged raids for the first time on illegal factories.

Victorinox has also introduced a host of new products - a kids' Swiss army knife; a blade-free air-travel version; and - most successfully- one with a USB port that allows you to link your knife up to your computer. "We are not giving up," says the firm's spokesman Hans Schorno. "We are going to fight."

But globalisation worries the Elseners, whose founding philosophy is one of old-fashioned paternalism. In the past 75 years the firm hasn't sacked anybody. Its 920 employees receive generous wages - and are even given time off to perform Alexander technique stretching exercises in front of their steel-bashing machines. Though the factory is heavily automated, some products are still partly assembled by hand.

Elsener, 47, is a self-effacing man who drives a Peugeot 306 ("My parents taught me a certain modesty. We are a Catholic family. I get satisfaction from doing a job I enjoy. I don't need a Ferrari"). He points out that the Swiss army knife wouldn't be very, well, Swiss if he exported production to Canton, as other manufacturers have done. He admits, however, that the quality of rival Chinese knives is improving. "We have spent 100 years perfecting our product. And they just come along and rip it off. It isn't very nice," he complains meekly.

It is perhaps appropriate that the Victorinox factory sits just underneath a mountain range known as Mythos. The firm is keen to promote the legendary virtues of the knife - which has been used to save children from sinking cars, repair the space shuttle, and deliver foals. A German doctor last week sent the firm gruesome photos showing how he used a multi-tool knife to cut off the leg of a tsunami victim in Sri Lanka. He would have preferred a saw, he said, but there wasn't one available. The aesthetics of the Swiss army knife, meanwhile, remain just as pleasing as ever.

The firm's most important market is the United States, closely followed by Germany, Switzerland and Britain. The knife's enduring popularity in the US can be explained by the fact that after the second world war, US soldiers bought the knives from army surplus stores and took them home. Several US presidents (Johnson, Reagan and Bush Sr) have commissioned personalised versions of the pocket knife, complete with their signatures. And the Museum of Modern Art in New York has even added one to its design collection. Elsener, whose father, grandfather, great-grandfather and five-year-old son are all called Carl, says he is convinced the Swiss army knife has a future. In a world in which terrorism and globalisation exist, people still need to chop things up, he notes. "We will have challenges like 9/11. We can get through it. The Swiss army knife is still a very useful product for many, many people. If you look at human history people have been using knifes for a long time. It's gone on since the stone age. I'm confident it's not going to stop now."