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[Andrew Sheng] Small is better in modern economy

Nov. 15, 2015 - 17:26 By KH디지털2

Is big always good? How are the biggest companies in the world doing?

Prior to the global financial crisis, it was always assumed that bigger was better. Every company strived to become a global company, with scale, global reach and brand reputation. Telecoms to supermarkets tried to be global and dominate global trade, especially in opening new markets and putting in place global supply chains. With the invention of the Nespresso capsule and coffee machine, Unilever brought top-quality coffee direct to your home. 

In 2014, the Fortune Global 500 largest companies generated $31.2 trillion in revenues, $1.7 trillion in profits and employed 65 million people. The largest of them, ICBC Bank of China, had $3.3 trillion in assets.

But as Wal-Mart, the largest global retailer, signaled a profit warning, have global companies peaked as the world moves into secular stagnation?

The Fortune Magazine analysis of the Global 500 companies showed that between 2005 and 2015, the geography of these companies changed. In the last decade, advanced country (U.S., Europe and Japan) companies had shrunk from 452 out of 500 (90.4 percent) to 353 companies, or 70.6 percent, of the total. The big entrant is China (98 companies, or 19.6 percent, compared to only 16, or 3.2 percent, 10 years ago). South Korea (17), Taiwan (8) and India (7) also had more global companies than 10 years ago.

Other than China, technology was the big disruptor. The newcomers that became big through technology, such as Apple, Google, Amazon, Visa and Facebook, have more market value per dollar of physical assets than older giants such as GM, Exxon and the like. If hardware was the age of the 20th century, software defined 21st century companies. No company demonstrated this disruptive shift more than the shrinkage of Kodak, the company that created the chemical film and photo industry. By ignoring the challenge of digital media, it is a shadow of itself.

Technology is disrupting the value of hard assets in more ways than one. For example, the shale oil and alternative energy revolution in the form of solar, wind and nuclear power means that fossil fuel producers, such as oil, gas and coal producing companies, must write off all their recent heavy exploration costs. These reserves made sense at an oil price of $120 per barrel, but not at the present price range of $40-$50 per barrel.

The third disruptor after technology is the postcrisis reforms in financial regulation. In a period of low interest rates, large companies like GE made money from financing, in effect leveraging their capital. General Motors made more money from car financing than from making cars. Once Dodd-Frank legislation threatened to make them financial holding companies, subject to many complex rules, these industrial giants decided to get out of the finance business.

Furthermore, the regulatory reforms also cut back on global bank profits by requiring large capital and liquidity increases and imposing huge compliance costs. Global banks are shrinking their balance sheets and lowering risk appetites to concentrate on where they have comparative advantage.

At the same time, high regulatory costs and the constant need to increase transparency is causing many family-owned companies to rethink the benefits of going public. Instead, there is more delisting and less IPOs in many markets. The total number of listed companies, according to the World Federation of Exchanges, remains relatively small at 44,540, with market capitalization of $63.5 trillion at the end of 2014, roughly 21 percent of global financial assets.

Such disruptive forces mean the life of a company on the Fortune Global 500 list shrank from 61 years half a century ago to 16 years by 2014. Competition is no longer coming from existing giants, but from minnows in emerging markets that are growing to become sharks, as McKinsey Global Institute called it in its latest book, “No Ordinary Disruption”.

Who are the minnows threatening to be sharks? These are the small and mid-sized enterprises around the world that have begun to access global markets through the Internet. In China alone, there are only 2,800 listed companies, compared to roughly 40 million SMEs, so when the IPO window was temporarily closed after the A-share turmoil, thousands of start-ups lined up to register on the Third New Market, the over-the-counter market for transaction in unlisted company shares.

Big companies are discovering that as they grow in size, they become too complex to manage and not just “too big to fail.” The problems of Volkswagen in emissions quality control turned out to be serious governance issues. Once reputation is damaged, as the Japanese airbag manufacturer Takata discovered, the consequences can be almost fatal.

From an investor point of view, large cap companies do not necessarily deliver superior returns compared with small caps. Indeed, the real returns come from nurturing start-ups to become unicorns (companies that are valued at more than $1 billion), as private equity and angel funds have learned to do.

There is of course some concerns that even technology start-up valuations have become a bubble, but as long as investors are betting with their own money, rather being leveraged, the systemic impact will not be that big.

My own bet is that the next Apple will be a start-up no one would have heard of even five years ago. It will probably be in the bio-technology area, producing a new drug or medical tool that will change health care and medicine. It is more likely to come from an Asian start-up because of the massive efforts of Asian governments in fostering new entrepreneurship from Osaka to Shenzhen, Singapore and Bangalore.

The reason is simply scale. Never have so many been able to access so much knowledge and so many markets with such speed and ease. The time of small companies in new markets is only just beginning.

Of course, many innovative SMEs will be bought up by the giants. That is the stark cycle of corporate life. As in the jungle, the many small plants fight for sunshine, and one day, one of them becomes the tallest tree, only to die and feed the next generation of weeds and trees.

With massive disruption, the survivors will be the small. Governments will do well to foster the ecosystem for innovation and change.

By Andrew Sheng

Andrew Sheng is an adjunct professor at Tsinghua University, Beijing, and University of Malaya. He was formerly the chairman of the Securities and Futures Commission in Hong Kong. — Ed.

(Asia News Network)