To Flourish Among GIANTS
How mid-size companies can beat the odds.
January 21 2010 by Robert Lawrence Kuhn
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 from18th 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 multination al 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.
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.
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.
For more than a decade, I ran the largest M&A company representing middle market companies, most of which were privately owned. During this period, we completed over 1,400 M&A transactions and evaluated thousands of companies. This deep real- world base, combined with my academic research (I wrote several books on mid-sized companies), has given me a certain sense for the critical success strategies that characterize leading mid-sized firms.
Small and mid-sized companies are a critical component of modern capitalism. They assure the efficiency of the economic sector by thwarting monopolies and secure the pluralism of the political sector by disrupting the hegemony between big business and big government. But neither fine tradition nor social value builds a healthy bottom line – an objective that experience shows is difficult to achieve and harder to sustain. However vital for the country, small and mid-sized businesses must not be kept alive by artificial means, lest, similar to brain-damaged humans maintained by machines, they become living vegetables, objects of dole and pity, relics of the past, slowly degenerating and bereft of worth. The only thing more tragic than the failure of small and mid-sized firms in the market place would be their counterfeit survival in the iron lung of bureaucracy and government handout.
Mid-sized firms must survive and prosper within the free-market system, not outside of it, facing its force directly, not protected by artificial barriers. They must compete effectively and efficiently against mammoths and gnats, guarding and guaranteeing their own existence. Anything less is self-defeating for the firm and counterproductive for society. Life dependent on largesse is life dependent on wind.
But however much mid-sized firms contribute to the social good, public benefit does not guarantee firm-specific financial success. Nor does the initial development of innovative products guarantee survival (much less prosperity) for the venturesome midsized firm. Indeed, a larger competitor may well be able to take advantage of the new product or technology through its more powerful procurement, production, marketing and distribution capacities, leaving the original innovative firm only the dregs with which to cover its higher costs of initial research and development. The jungle analogy seems uncomfortably appropriate: The larger predator waits lazily until its smaller rival does all the work of seeking, finding, capturing and gathering food – only then to steal it by brute strength.
Mid-sized firms must therefore know their environment, what their large competitors will do, how their small competitors will react. It’s a tight, tough game, with the results carrying meaning to society as well as the firm. Medium-sized firms are important – economically, politically, socially, technologically. Their self-determined survival and prosperity must be assured by the force of internal strength. How to make it work? Only with effective strategies.
Surprisingly, in many industries smaller companies outperform larger companies. More profits. Better performance. Consistently. In fact there are hundreds of mid-sized firms, and thousands of small ones, that year in and year out achieve higher returns on sales and equity than do their larger- sized rivals. Why do they? How do they? What strategies do these magical companies have?
Ten Critical Success Strategies
In a study of over 200 top-performing mid-sized manufacturing companies, I showed that firms need not be industry leaders to be successful. Indeed, one of my criteria for selection was that each top-performing firm had to be in an industry dominated by one or more mammoths many times its size. Yet these smaller firms consistently outperformed their massive rivals. The reasons were “critical success strategies,” well within a small firm’s control. The study results revealed 10 general principles of management for smaller firms.
I’ve watched winners and losers, observed trends and patterns. What does it take for mid-sized firms to flourish among giants? Following are 10 critical success strategies listed in order of importance. Some apply universally; some are contingent upon other factors.
1. Dominance: Control your corporate niche. Segment markets. Narrowcast products. Achieve and sustain maximum share within minimum markets. Tailor products tightly; define domains toughly. Segment by specific item, customer, price, quality, brand, distribution, geography, service – do anything to segment. Seek control through perceived superiority. Be a big fish in a little pond. Remember, small can still dominate.
2. Product emphasis: Be product oriented. Give primary importance to company output. Stress product focus, essence, name, reliability, service. Visualize products from the customers’ viewpoint. Never make products subservient, not to executive desire, not to financial comfort. See each product in its broadest sense; understand the need it fills and the desires it satisfies. Be service oriented.
3. Distinctiveness-uniqueness: Be different: Make the firm overtly dissimilar to competitors. Strive for originality; find something to set the company apart in customer perception. Have an impact on the end user. Seek differentiation in each functional area affecting buyers. Cater to customers; service them well. Be noticed. Be remembered.
4. Focus-coherence: Strive for strategic tightness. Establish goals, objectives and strategies with clarity of thought and coherence of content. Build new businesses on the central skills, resources, facilities or managerial competencies of old businesses. Build structure on managerial strengths. Set corporate coherence and business focus as means, not ends. Relatedness is contingent on business and industry environment: A mid- sized firm in a declining or dying industry or market should not fear diversification, yet should build new opportunities on past competencies.
Give employees a real sense of self worth and personal participation, both emotionally and financially
5. High-profile CEO: Have a committed boss, a CEO who is more than a manager. Personal charisma, profound dedication, pulsating presence really count. The CEO should project high levels of commitment and radiate intense auras of energy. There should be a desire, even a compulsion, to be involved in every aspect of the business. Contingent somewhat on industry and company traditions.
6. Employee opportunity: Satisfy and fulfill personnel. Exploit the comparative advantage of smaller firms to attract entrepreneurial people; offer executives and managers greater job content and individual satisfaction. Be people oriented. Give employees a real sense of self-worth and personal participation, both emotionally and financially. Develop meaningful equity participation programs. Get the right executives, then give them what they want – on the job and in the bank.
7. Efficient innovation: Optimize new products, services, methods. Develop and commercialize new technologies. Leverage the comparative advantage of smaller firms to introduce new products sooner and more swiftly. Encourage creative types to work their wonders. Attack market leaders if they protect current position by withholding innovation (as often happens). Emphasize efficiency in research; optimize development for rapid, cost-conscious results. Never attack broadside; focus R&D for maximum effectiveness. Use rifles, not shotguns.
8. External perception: Know the industrial and market environment. Monitor all opportunities and threats, current and potential. Stay attuned to market conditions and customer needs. Know your customers; develop personal relationships. Have a keen sense of competitors. Appreciate issues of industrial organization: market share, concentration ratios, growth patterns and trends, powers of suppliers and buyers, threats of new entrants and substitute products. Observe long-term forecasts, and watch them change. Be prepared for sudden discontinuities and be ready to exploit them.
9. Growth/profits tradeoff: Weigh top line with bottom line. Eschew growth for growth’s sake, but seek growth for business’ sake. Market products forcefully. Visualize longer time horizons for profit return. The bottom line, not the top one, is what counts. Billion dollar corporations have gone bankrupt, while many very small firms have made their owners and executives very rich. Highly contingent on firm’s comparative position within its market. Weaker mid-sized firms should prize profits far more than growth. Stronger mid-sized firms should not fear sacrificing short-term profits for long-term growth. When top performers establish a strong market position, ultimate profits become greater and more secure.
10. Flexibility and opportunism: Change direction and move quickly. Develop dynamic decision making. Be prepared to react rapidly to changes in products or markets and beat larger competitors to new opportunities. Retreat when the enemy attacks. Attack when the enemy retreats. Contingent on industry or market position, weaker mid-sized firms should emphasize flexibility and opportunity more than stronger firms.
A word of warning for eager midsized firm managers. These creative strategies may seem obvious and easy. Do not allow the former to discourage you or the latter to fool you. The points are both powerful and pragmatic, founded on live data from hundreds of companies. On the other hand, any simplistic advice should not be used as a magic wand. Smooth aphorisms are no panacea for perplexed executives. Generalized prescription is one thing; realistic recommendation quite another.
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.