I have explored this question myself several times before, prompted by my experiences as both a customer and employee of many large companies. In both instances, a regular frustration is the bureaucracy that accompanies them and the inefficiencies this presents. It is sadly unavoidable. Large companies need layers of management and process to cope with their size, adding cost and complexity; senior management become detached from the day-to-day operations of the businesses they supposedly run, and yet take salaries disproportionate to their ability to affect meaningful change, and way above those of the shop floor workers.
The net result is dissatisfaction, not just of employees and customers, but shareholders whose investments stagnate as businesses fall into the problems bigness bring. Elephants can’t gallop, as the old saying goes. In his column, John Baron notes the divergence of returns between the UK’s largest and smallest companies. One reason for this, he suggests, is that large companies have become very bad at innovation, complacently relying on sheer size to create the economic moats that often hold the key to above-average returns. And as Philip Ryland suggests, in the absence of ideas they frequently turn to large-scale M&A often financed with debt and orchestrated by expensive investment bankers.
Debt is important in this story, as small company fund manager Gervais Williams explored in his book The Future is Small. The trend towards bigness accelerated with the credit boom that preceded the crisis of 2008, as globalisation meant companies increasingly needed to look towards international markets; large companies were better able to raise the debt to do so, and found bankers increasingly preferred to consolidate their lending around these larger loans. As John Baron notes, questions are now being widely asked of this model. Large companies are also finding that scale is not an economic moat in and of itself, nor is it easily achieved – mega mergers are risky, and, as Philip points out, competition regulators are under pressure to get tougher. Meanwhile, smaller companies have found that there are plenty like Messrs Williams and Baron willing to fund their attempts to find the gaps left by large, immobile companies in which to grow, knowing that this is more likely to deliver outperformance.
Like much in investing this issue is not black and white. Just as large companies are predisposed to stagnation, so small companies are prone to indiscipline, and their shareholders to exuberance. And remember that the big US tech companies that dominate the world’s equity indices were not that long ago small themselves – although they, too, are starting to struggle with the problems of bigness. The message is that investors should not lazily accept that large companies are safe or that small companies will outperform – as always it’s about asking the right questions of potential investments, and in that respect size shouldn’t matter.
