Friday, 15 October 2010

How big is your yam? (not that it matters)

Why are so many executives so pre-occupied with the size of their company? Like bigger is always better. It especially annoys me when it is used as an excuse for acquisitions.

“This take-over will immediately make us the largest company in the industry”. So?! What is your point?!

I am sure being the biggest can have certain advantages, but that doesn’t mean that bigger (let alone being the “biggest”) always automatically is better. If you can explain to me why more scale is better, ok, but until then, I remain sceptical.

Of course company size is often associated with (financial) success. For example, the firms that always feature on “the most admired companies” lists are usually Behemoths such as Toyota, Dell, Intel, Wal-Mart, and Pfizer. Several of them became big through acquisitions.

And I am sure a company worth £10 billion attracts quite a bit more attention (for instance in the business press) and admiration than any of the 10 companies that they acquired that were worth a mere £1 billion. But that doesn’t mean that our ten billion Behemoth generates more profits than the 10 smaller ones would have made in combination. It wouldn’t have been as eye-catching, to have 10 small ones instead of one biggie, but it just might have made more sense (and money).

Importantly, managers who opt for a strategy of increasing size reverse cause and effect; although success will likely make you bigger, striving for size per se is not necessarily going to make a company more successful.

They actually remind me of the aboriginals on the Micronesian island of Ponapae. What in their society contributed to a man’s prestige was owning a very large yam. This cultural trait had come into existence because it represented an indication of a person’s skill as a farmer. However, gradually people’s efforts to obtain or grow one big yam started to be detrimental for their welfare, in the sense that it distracted effort and attention away from all other activities, causing malnourishment and hunger. People were putting all their resources, time and effort into growing one giant yam, while their fields were left unattended, their huts crumbled around them and their children cried of hunger.

Similarly, striving for size itself may be counterproductive for companies. It is quite possible that focusing all ones resources and efforts on becoming bigger (for the sake of being big) might actually decrease the firm’s chances of becoming successful. Gaining size may result from firm success, pursuing size per se, rather than success itself, may be quite detrimental.

2 comments:

Xian said...

This is a classic case of business myopia that business organisations, in particular its management, should avoid but never the less gets caught in it. Yes, being big can be advantageous and admirable. Just look at all the "wisdoms" in the current years, in text books, media and social education, it's all the beauty of being big. What about the same for being small, or reasonably sized? Next to nothing, other than popping up occasionally in "small creative start-up is taking on the giants" etc.

I generally put it down to 2 (1) reasons:

1) Growing bigger takes time and effort and people generally recognises the effort, or the attempt in having a much sought after "vision". In simpler terms, you got the guts to try to realise something big(ger).

2) Largely because of 1, being small is therefore viewed as weak, a has-been, lacking in vision, regardless how successful it is (common wisdom is: if successful, therefore it must grow big. Hence.)

Yes, the balancing act is hard, even more so made the idea that having more/being bigger is good is so far trenched in our human ideology (originally for survival).

Ultimately, having a bigger yam means something. I mean, at least you got a bigger one for now. Time to work harder to get the rest of the field up to scratch. After all, you only got one, time to M&A your neighbours and claim not only you got the biggest yam but also the big field with all of the biggest yam. Pursue for megalomania? Perfect timing.

vlade said...

I personally think that for each company there's an optimal size (unless it's a holding company). My theory around it is actually pretty simple, and is based on one thing. How important is internal communication (or, access to information) to the company? The more important it is, the small the company should be to do it efficiently. You simply cannot have as efficient information sharing in a company of 1M employees as 10.

Of course, for say a car-making company, much less information needs to be shared (per-employee) than for a bank, so the car making company can have happily few orders of magnitute more employees than a bank. The corrolary is, that less (shared) information an "average" employee needs, the more easily he's replaceable by both someone else with similar skills, and it's also easier to automate the task.

As far as revenue goes, a company with 10 employees can have happily the same revenue as one with 1000. The downside is, that company with 1000 employees is probably more likely to grow the revenue by 0.1% by getting one extra employee than the smaller one by 10%.

If you look at profit-per-employee ratio, small hedge funds and small consultancies will probably come on the top.

Of course, if you are an investor, profit is only one thing you'd worry about. The stability of the profit is another one, and from that perspective larger companies have more stable profits (in general), as they are better able to cope with tail events (I'd think), amongs other things due to the replaceability of employees (on almost all levels). Very small companies on the other hand tend to have a huge key-person risk.