The September 17 issue of The Economist included a special report on the rise of so called superstar companies. “Disruption may be the buzzword in boardrooms, but the most striking feature of business today is not the overturning of the established order,” notes The Economist. “It is the entrenchment of a group of superstar companies at the heart of the global economy.”
This trend toward consolidation and growing size is evidenced by a few worldwide statistics: 10% of public companies generate 80% of all profits; firms with over $1 billion in annual revenues are responsible for 60% of total global revenues; and the rate of mergers and acquisitions is more than twice what it was in the 1990s. The trend is particularly prominent in the US: in the 20 years from 1994 to 2013, the share of GDP generated by the 100 biggest companies rose from 33% to 46%; the five largest banks now account for 45% of all banking assets, up from 25% in 2000; and new firm formation has been going down since the late 1970s, leading to an overall decline in young- and medium-aged companies over the years.
The current rise of large companies is somewhat unexpected. Following the Great Depression and WW2, the country welcomed the stability promised by corporate capitalism. Big, multinational companies dominated most industries, - from GM, Ford and Chrysler in cars to Esso/Exxon, Mobil and Texaco in oil and gas. It was an era characterized by bureaucratic corporate cultures, focused on organizational power and orderly prosperity.
This all started to change a few decades later with the advent of a more innovative, fast moving entrepreneurial economy. The 1980s saw the rise of young, high-tech companies, - e.g., Microsoft, Apple, Oracle, Sun Microsystems; telecommunications was deregulated; ATT was broken up; and Silicon Valley became the global hub for innovation, emulated by regions around the world.
But… it hasn’t quite worked out as expected. “Silicon Valley is a very different place from what it was in the 1990s. Back then it was seen as the breeding ground of a new kind of capitalism - open-ended and freewheeling - and a new kind of business organisation - small, nimble and fluid. Companies popped up to solve specific problems and then disappeared. Nomadic professionals hopped from one company to another, knowing that their value lay in their skills rather than their willingness to wear the company collar.”
“Today the valley has been thoroughly corporatised: a handful of winner-takes-most companies have taken over the world’s most vibrant innovation centre, while the region’s (admittedly numerous) startups compete to provide the big league with services or, if they are lucky, with their next acquisition.” Similar corporatization scenarios have played out around the world.
What happened? Why are large companies not only thriving but getting bigger? What has changed? The Economist argues that three major forces are responsible for this new era of concentration: technology, globalization, and regulation.
Technology. The industrial economy was driven by supply-side innovations. Companies leveraged technological advances and economies of scale to become bigger. Due to the massive fixed costs of physical assets, firms achieving higher volumes and production efficiencies had lower overall unit costs for their product, allowing them to reduce prices and further increase volumes.
In the digital economy, on the other hand, the driving force is demand-side economies of scale, generally achieved through platforms and network effects. The more products or services a platform offers, the more users it will attract, helping it then attract more offerings from ecosystem partners, which in turn brings in more users, - which then makes the platform even more valuable. Moreover, the larger the network, the more data is available to customize offerings to user preferences and better match supply and demand, further increasing the platform’s value.
“Most of the new tech firms are platforms that connect different groups of people and allow them to engage in mutually beneficial exchanges. Older tech companies too are putting increasing emphasis on the platform side of their business. Everyone wants to sit at the heart of a web of connected users and devices that are constantly opening up further opportunities for growth.”
“In some ways these tech giants look not so much like overgrown startups but more like traditional corporations. The open-plan offices and informal dress codes are still there, but their spirit is changing. They are investing more in traditional corporate functions such as sales and branding. This corporatisation is one reason for the companies’ success.”
Globalization. “An annual list of the world’s top multinationals produced by the United Nations Conference on Trade and Development (UNCTAD) shows that, judged by measures such as sales and employment, such companies have all become substantially bigger since the mid-1990s. They have also become more and more complex. UNCTAD points out that the top 100 multinationals have an average of 20 holding companies each, often domiciled in low-tax jurisdictions, and more than 500 affiliates, operating in more than 50 countries.”
Global companies have opened sales offices and R&D centers around the world. In addition to global supply chains for the production of physical goods, they’ve been developing global knowledge networks for a variety of services and R&D functions, taking advantage of the growing talent and lower costs now available around the world.
“Big companies have reaped enormous efficiencies by creating supply chains that stretch around the world and involve hundreds of partners, ranging from wholly owned subsidiaries to outside contractors… They are also forming ever more complicated alliances… America’s top 1,000 public companies now derive 40% of their revenue from alliances, compared with just 1% in 1980.”
Regulation. The 2000s marked the end of the deregulation era in the US. The accounting scandals surrounding Enron, WorldCom, and others led to the 2002 Sarbanes-Oxley Act. Later in the decade, the Great Recession, led to the enactment of the Dodd-Frank Act in 2010. That same year saw the advent of the Affordable Care Act. Regulations and regulatory bodies have significantly increased since the turn of the century.
This growth in regulation adds to the complexity of doing business in the US and around the world, further playing into the hands of large companies. “Regulation inevitably imposes a disproportionate burden on smaller companies because compliance has a high fixed cost… Younger companies also suffer more from regulation because they have less experience of dealing with it.”
While it might appear that large companies now have all the advantages, it’s important to remember that such advantages don’t tend to last. Let’s remember the number of once high-flying companies that no longer exist - e.g., Sun Microsystems, DEC, Compaq, Blockbuster; or that are shadows of their former selves, - e.g. Kodak, BlackBerry, Motorola, Yahoo and Nokia. Most large legacy companies, - e.g., GE, Microsoft, IBM, - have had to fight hard to keep up and reinvent themselves. Even the tech aristocracy, - e.g., Google, Apple, Facebook, Amazon, - must constantly watch out for new technologies, market-trends and global competitors that might push them off their elite perches, - as was the case with IBM in the mid-1980s and of Microsoft in the 2000s with the advent of client-server computing and smartphones respectively.
“The virtualisation of some sectors of the economy and the corporatisation of others are going hand in hand… Big companies have much to gain from contracting out their R&D to startups. They can make lots of different bets without involving their corporate bureaucracies. But startups also have a lot to gain by selling themselves to an established company that can provide stability, reliability and predictability, all of which can be hard to come by in the tech world.” In the end, big companies and startups will continue to co-exist in a kind of symbiotic relationship - each one doing what it does best.