Tuesday, June 10, 2008

Today belongs to the big boys

Now more than ever, size matters. That’s my unbridled belief.

The companies and businesses that will best weather these uncertain times, and get out of it alive, will be those who are the biggest in their industries. Smaller companies, even those that occupy specific niches, are in for wild times ahead.

Stagflation. This term has been used to describe what is happening right now. Stagnant markets coupled with runaway inflation on basic commodities. If you’re a business operator now, you’re being hit on both ends – on the revenue side, and on the cost side. The former is declining, the latter increasing.

Cost-cutting, which had been a paramount focus of many companies in the last decade as a result of increased global competition, has largely cut to the bone. Not much chance of cutting costs further. Not much choice when practically all input costs are increasing. Not when all your suppliers’ costs are also increasing as a result, with them passing the pain onto you.

Increase market share. That’s everybody’s mantra now. When you can’t decrease the cost of doing business, you should increase the value generated by your business. In a stalling economy, with consumer rolling back on spending, this goal gets complicated, and for many, results are dicey.

In tyring times, big is better. Here are my top reasons why:
· Geographic advantage – Bigger companies are likely represented in more markets, have more elaborate distribution networks, and higher penetration in the larger markets. This means that any decrease in consumption in a weaker market may be offset by strong demand in other markets.

· Buyer bargaining advantage – Bigger companies can better afford to use their large bulk orders to force suppliers to accept lower margins. Suppliers, for obvious reasons, will not want to lose their biggest clients. They will likely make up for lost margin by increasing margins to lower bulk orderers – that would be the smaller companies.

· Likely bigger cash pipeline – Bigger companies have greater cushion against runaway inflation. In all likelihood, they have already built a cash hoard that can last them through a longer winter than many smaller rivals. This attribute can be a result of reasons # 1 and 2, and can lead to the next attribute.

· Ability to undercut smaller rivals – Bigger companies can keep reluctant consumers from completely going away by lowering their prices. Smaller companies may not be able to keep up.

· Product diversity – Bigger companies will likely offer a broader array of products and services. Nowadays, occupying small niche markets may not be enough. Niche companies have bets on only one horse. If consumer demand in that niche falls, many firms will fall by the wayside. Larger firms, on the other hand, can fall back on sales of other goods. Not to mention the fact that bigger companies with broader product offerings can bundle their products, thereby offering better value for an ever more demanding consumer.

So you see why these are going to be boom times for the larger firms? Today’s scenario presents them with a long-awaited opportunity to crush the competition. In today’s scenario, it’s simply not enough to be more creative, or faster, or more differentiated. In today’s scenario, you have to be big, strong, and able to withstand the twin blows of stagnation and inflation.

In today’s scenario, smaller players will likely cut back on market share or disappear altogether. Potential new entrants will rethink before they join the fray.

In today’s scenario, consumers will cut back on spending for non-essential items. Non-essential items often include products with specific attributes that, in better times, appeal to only small segment of the population. Large mass-appeal products will likely outlive the niche products. The longer this stagflation lingers, the worse off niche companies will be.

In today’s scenario, the government will try to keep as much of the jobs that it can. To be effective, it will seek to help the largest employers, and those whose fortunes have the largest effects on the over-all economy. Smaller firms will have to be sacrificed as tax dollars are focused on saving the big boys.

In today’s scenario, suppliers, as mentioned above, will offer better terms to their larger customers, thereby effecting a huge transfer of benefits from the smaller companies to the larger ones.

Nowadays, it isn’t the likes of IBM or Intel that are paranoid about the competition. It is the little-known rival or sub-contractor who doesn’t sleep well at night.

Charles Darwin said that nature encourages many varieties of evolution and specialization, as organisms try to find ways to thrive in this world. In the end, most notably when conditions become harsh and inhospitable, only the strongest survive. Yes, certain specialized organisms survive, but for as long as they are not in the way of the big predators, or perhaps, large predators will leave them free, if they can kill the large predators with potent venom.

In today’s environment, these specialized organisms may be the small hedge funds, who can inflict the venom of increasing the large companies’ cost of capital. Certainly, the venom organisms are not the smaller rivals to the large firms. The smaller rivals are the gazelles to the large company lions. Not too comforting, if you’re the small player.

So in these trying times, smaller companies - Merge before it’s too late!

Update: see newer post. Also here And an earlier revision here.

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