Why size isn’t everything
“How big can we get before we get bad?” asked advertising executive Jay Chiat of his eponymous agency. Managers at any growing business will empathise. Success fuels growth. Yet growth breeds complexity – more employees, departments, product lines and business units. Managing complexity diverts attention from the real work of business: attending to customers.
It is not only small, entrepreneurial outfits that face this dilemma. Big corporations are now free to manufacture and sell their products in almost any country you care to name. In order to take advantage of the opportunities, however, they must work out how to manage the complexity that global growth entails. At first glance, big companies appear to be succeeding. The world’s 150 largest companies by market value delivered combined profits of $600bn in 2003, according to McKinsey, the management consultant. This accounted for about half of the profits of the top 2,000 companies worldwide, up from 38 per cent in 1994.
On first reading, these numbers suggest that mega-corporations have already worked out how to get bigger without getting bad. But aggregates and averages can be misleading. Closer inspection reveals that many of the giants in the top 150 are struggling to deliver consistent profits. Others are very profitable but not as complex as you might imagine. For example, Microsoft – with annual revenues of $44bn and a market value of $275bn – employs only 60,000 people (Wal-Mart employs 1.3m) and earns a large chunk of its profits from a single product: the Windows operating system for personal computers.
Can Bill Gates’s merry band of near-monopolists find new sources of growth while managing the additional complexity this implies? This is one of the hottest questions in the tech industry.
Indeed, McKinsey’s figures show that only four companies – GE, IBM, Toyota and Citigroup – employ more than 200,000 people while also delivering consistent profits per employee of $25,000 or more.
What can this Fab Four teach us? One common trait is that, notwithstanding the inherent complexity of the business, they work hard to keep things simple. This means sloughing off businesses that no longer fit with strategic priorities. Thus IBM has in recent years sold its disk drive and personal computer businesses, despite the fact that it helped pioneer both technologies. Such active portfolio management requires strategic discipline and a dispassionate approach. The drive for simplicity also means enforcing standard ways of working – from the computer systems that are used to the way performance appraisals are carried out – across all business units. Toyota’s famous production system, applied in its assembly plants worldwide, is a prime example. This is much more than a methodology for reducing waste and product defects. It provides a common language for an increasingly global company.
These four companies are, without question, extremely well managed. But even they sometimes struggle with the sheer scale and breadth of their operations. Executives at Toyota have wondered aloud whether the company can surpass General Motors as the world’s largest carmaker – as it aims to do next year – while maintaining the reputation for reliability that underpins its success. Two high profile recent vehicle recalls, not to mention less than stellar performances in US vehicle quality surveys, hint at the seriousness of the challenge.
IBM, meanwhile, has been struggling to deliver the revenue growth that Wall Street expects. Earnings are on a rising trend. But it remains an open question whether Big Blue, now active in everything from chip making to management consulting, has a portfolio that really makes sense.
Given that so few companies have been able to combine massive scale and complexity with consistently high profits, would it not be sensible for most companies to recognise the benefits of staying small? In principle, perhaps it would. In practice, companies whose shares are traded on public markets have no choice. Investors demand growth. Executives must either deliver or take their BlackBerries elsewhere.
Private companies sometimes have more leeway. In Small Giants, published next month, journalist Bo Burlingham profiles 14 US companies that have chosen to remain small and good rather than risk growing big and bad. Examples include Clif Bar, a California-based maker of energy bars, which five years ago came close to selling out to a food conglomerate before deciding that small is beautiful. Today it competes successfully with the likes of Nestlé and Kraft under Gary Erickson, co-founder, proprietor and CEO.
Much depends on the shareholders, of course. An avid climber and cyclist, Mr Erickson believes business is as much about supporting communities and protecting the environment as it is about profit per employee. As sole owner, he can set whatever corporate priorities he chooses.
Few companies have such enlightened investors. But stories such as this are a useful reminder that there is no immutable law that businesses have to grow in order to remain healthy. As Jay Chiat intuited, big companies often show more signs of sickness (low morale, dissatisfied customers, meagre margins) than their smaller competitors. Organisations that get very big while remaining very good are the exceptions, not the rule.
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