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To flourish among giants (part 1): how mid-size companies can beat the odds.

Picture Gulliver beset by both Brobdingnagians and Lilliputians, not sequentially on separate islands but simultaneously on the same island. It is a land of monsters and midgets and our traveling hero is trapped. Without respite, he is pursued by mighty giants and badgered by crafty dwarves; desperately he avoids the lumbering ferocity of the former and eludes the darting torments of the latter. The giants step with pulverizing weight; the dwarfs revel in piercing arrows. How to escape and how to survive? The task is daunting, the outlook grim. Now switch mental gears from 18th century literary fantasy to 21st century economic reality and you cut an image of the mid-size firm--a company class, experts say, that cannot prosper.

Caught in the middle, stuck in between--goes conventional wisdom--is no place to be. The business of modest dimensions is just too small to confront the market power of huge enterprises and too large to outwit the opportunistic flexibility and low overheads of tiny ventures. Medium-sized companies, mashed by multinational mammoths and nipped by entrepreneurial gnats, are an imperiled breed. How to hide and how to swat?

One of the most widely repeated strategic axioms--and it seems a mournful one for smaller companies--concerns the relationship between profitability and market share. Some years ago it was shown that a difference of 10 percentage points in market share was accompanied by a corresponding difference of about 5 percentage points in pretax profits. On both sides of the production-marketing coin, big companies simply wield more muscle: economies of scale in procurement, manufacturing and other cost components; and market power in bargaining, administering prices and selling more units. The combination is potent, the results inevitable. For any given product, revenues received go up and costs per unit go down; individual items are made for less and then sold for less, further increasing market share and accelerating market control. The feedback here is positive, literally and figuratively, for firms that have dominant market positions, and negative, exceedingly negative, for firms that do not. Large firms, in the end, simply obtain higher profits for any particular product. A simple success formula to be sure, and a pathway to oblivion for firms at the other end of the spectrum. Mid-sized firms, proclaim MBAs with statistics flowing and spreadsheets calculating, are being pinned to the economic mat.

That's the conventional wisdom. Yet the hand may not be that pat, the script not that tight; for although the aggregate data on profitability and market share may be accurate, any individual conclusion may not be. Lumped cross-industry summaries can cloud specific industry or sector characteristics. Some medium-sized firms are forging the future, achieving technological and business breakthroughs; they are organizationally resonant with current trends, new leaders of a new age. It is nothing less than industrial transformation. Mid-sized firms, I proffer, can have a competitive edge, particularly in certain industries--catalyzed by their capacity to commercialize original ideas more quickly and build novel structures more easily. A fertile climate now exists for smaller companies, for entrepreneurs and executives with courage and foresight, for a whole new wave of creative and innovative managers.

Positive Trends

For much of my early career I focused on mid-sized firms. I was president and co-owner of the largest merger and acquisition company representing middle market companies and I wrote the first books focusing on mid-sized firms. Over the years, I found four forces that favor mid-sized firms.

1. The power of innovation. Advancement, technological or otherwise, widens markets--the expansion fed by both fulfilling current needs and stimulating new ones.

2. The rapidity of change. Responding with speed and intensity is vital. The ability to shift company resources and focus on new areas can create instant competitive advantage no large organization can match.

3. The narrowcasting of demand. A world weaned on the Internet and cable television will not be satisfied by generalized products and services. People require increasingly personalized items and options, each crafted for small segments of the market with particular wants and interests. The burgeoning demand for diverse products and services means that each will be manufactured or provided in smaller quantities. Such a diminished size of product run or reduced repetition of a similar service advantages those firms that can produce fewer numbers more efficiently, firms that do not require huge production runs to fill massive plant facilities or absorb large personnel overheads.

4. The new managers. These are the risk takers, the gutsy types who have fire in their bellies as well as brains in their heads. They like smaller firms in which they can exercise leadership, be closer to the action and implement personal vision.

Comparative Advantage

Strategy defines the relationship between an organization and its environment. It is ideally generated by mapping the firm's strengths and weaknesses onto the market opportunities and threats in order to accomplish long-term goals and short-term objectives. Creativity is vital to strategy formulation, consistency to strategy evaluation and structure to strategy implementation. Finding effective strategies is the search for competitive advantage, areas of distinctive competencies in which one firm has or can develop a comparative edge over others. Competitive advantage can assume various forms, most of which are firm specific. What we seek here are comparative strengths for mid-sized firms as a class. Are there elements of organizational structure by which enterprises in the middle can gain an edge? How can mid-sized firms get to the head of the pack?

There are at least three size-related characteristics in which medium-sized companies display an initial advantage.

X-Inefficiency: "X-Inefficiency" is defined as the excess of unnecessary cost as a percentage of actual cost--and it seems to increase with increasing size. Why is this so? What mechanisms are involved? Try executive luxury nurtured by vast size (two corporate jets when one is questionable), managerial flabbiness spawned by hefty margins (swollen staffs), the bureaucratic burden of large organizations (massive personnel departments), the sluggishness of pure size (interminable committees). Thus, the smaller firm can be inherently more efficient. Is this the beginning of competitive advantage?

Employee Content: There are other diseconomies of pure size. Worker satisfaction--the nature of work and social relationships inside the firm--is reduced by increasing company size. Employees in larger companies have, in general, higher degrees of personal alienation and depressed levels of job satisfaction--both of which are tied to the rigid, unilateral type of power structure often associated with large organizations. Employees in smaller companies have, in general, greater task variety, more individual responsibility, higher satisfaction from their work product and an enhanced sense of local identity. Aggregating these elements together, psychologists who study organizations use the term "content," and this content is said to be inversely proportional to firm size; that is, content decreases as firm size increases. Other things being equal, workers in smaller companies produce more abundantly, do it more efficiently and are happier in the process. Is this also competitive advantage?

Innovation: Innovation, too, while often used to justify large companies garnering greater control of corporate assets, might be more compromised than compounded in a business environment populated only by behemoths. The argument that increasing size is necessary to focus high R&D expenditures on complex problems is answered by statistical analysis of the actual record. Innovations in industries from software to steel show patterns (but not uniform) of small-share firms leading and dominant firms following. Such research suggests that innovation most often emerges from midsized firms, those companies with roughly a 5 to 20 percent share of the market (narrowly defined). It is common knowledge that revolutionary ideas germinate with high frequency from small firms, sociological structures that have neither an embedded base to defend nor prior predilections to thwart radical ideas. Innovation, these data indicate, becomes a potential ally of small and medium-sized firms in their epic struggle to flourish among giants.

Other-sized firms, for diverse reasons (whether financial or organizational), do not appear to produce as well. Firms with lower market shares are often too small to apply adequate resources, human and technical as well as financial and organizational. Large firms, those with shares greater than 20 percent, while not necessarily laggards in innovation because of size per se, may tend to delay the introduction of new ideas until forced by competitive pressures. Many of the largest companies that have floundered--such as AT&T, Xerox, General Motors, even the old IBM--withheld announcing new communication technologies, copier lines, automotive advances, computer families long after they were developed. Sounds implausible? Consider the motivation: to maintain the value of their present asset base and product offerings, thus minimizing internal competition and maximizing financial return.

In the next issue, I present 10 strategies that characterize the mid-sized firms that flourish among giants.

Robert Lawrence Kuhn, an international investment banker and corporate strategist, is a longtime adviser to the Chinese government. He is the author of How China's Leaders Think: The Inside Story of China's Reform and What This Means for the Future (new from John Wiley), which features exclusive conversations with China's senior political leaders, current and future, and with leaders in diverse areas of Chinese society, including private companies, state-owned enterprises, banking, foreign affairs, military, agriculture, healthcare, religion, media, Internet, film, literature, ideology and more.
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Title Annotation:UNCOMMON WISDOM
Author:Kuhn, Robert Lawrence
Publication:Chief Executive (U.S.)
Date:Jan 1, 2010
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