How to avoid the Curse of Size

Over my career, I’ve seen far more examples of diseconomy of scale than of economy of scale. Large in my experience tends to mean slow, vulnerable, lacking in incentive or drive, remote from customers. There are for sure some advantages in scale. In manufacturing, a large plant will have cost advantages over a smaller plant with the same purpose. So will a retail outlet of higher volume. Scale often comes with brand power, which can be decisive in driving growth. Yet these advantages are often swamped by the problems of scale above.

I believe a more useful concept nowadays is economy of momentum, or of growth. Brand strength often relates to a belief among customers and partners that they are dealing with a winner, and this is symbolised by momentum rather than scale. Talent flocks to winners, places with a good story of potential, space to grow.

Often it is unit scale rather than total scale which drives cost. A retailer with 10 outlets of 100 unit volume will always outperform one of 1000 outlets with unit volume 10. As an example, Tesco and other hypermarkets were the cost leaders in UK petrol retailing even when their market share was less than 1%. They achieved this through high unit volumes from excellent locations leveraged with low prices.

This leads to my first rule. Use a cost advantage in the form of volume not margin. That way lower costs, better customer offers and still higher volumes will create a virtuous growth cycle. Take a cost advantage in the form of margin and sooner or later the cost advantage will vanish. The economy is thus one of momentum rather than scale. This explains why lazy players favour regulated or price controlled markets, as their vulnerability and defeat will be delayed. The industry acting together as one to create barriers is a lazy industry – luckily nowadays competition law is often very effective in challenging this.

One other reason why scale is less of an advantage than pure theory dictates comes from the fact that costs tend to rise over time to match incomes. Profitable companies can’t resist the lure of creating excessive functions, increasing pay for bosses or pursuing value destroying diversification. Growth hides all these sins. Yet these weaknesses erode cost advantages, invite competition, and eventually create a cycle of decline. Accumulated pension liabilities often administer the fatal blow. It is tough indeed to reduce unit costs at a faster rate than unit volumes, and still harder to reverse the cycle of falling volumes itself.

Years of success make responding to this challenge tougher still. Arrogance creeps in. You hear terms like “the majors” creep into the language (as a means of ignoring nimbler “minors”). GM spent years trying to beat Ford while ignoring Toyota. BA fought Lufthanza and ignored Easyjet.

It is hard to escape this curse, and scale itself gradually becomes a killer. Belief in immortality is usually fatal. This is not just restricted to companies, but applies to empires, whole economies (watch out USA) or even sports teams.

So what can companies and their managers do about this disease? Plenty, and in my opinion a lot of it goes against perceived wisdom and the sort of advice you receive from McKinsey and their friends.

Always have growth as a goal with as much emphasis as profitability is my second rule. And growth via acquisition or diversification doesn’t count. Measure growth in the unit that matters to your business, such as throughput per plant or same store sales. Indeed, be very careful with acquisitions generally, especially ones justified lazily by synergy or scale economy. It is much better to keep growing the core or give money back to shareholders.

It is also important to choose an industry offering growth. Porter’s five forces is the best model for this. If in a bad sector, use some years to create a new core (and don’t stifle it, let it manage itself through growth) or just exit gracefully by selling up.

Within the company, I believe it is generally right to keep units small and relatively autonomous. You don’t want mindless duplication, but it is much more critical to maintain incentives and customer focus than it is to standardise. When Shell Global Solutions wanted to grow in Asia I recommended that we created some competition by allowing each region to set its own tariffs and compete for the same internal customers. Since much of our business had other parts of Shell as the customer, I felt that the most important priority was to create incentives to understand and improve value for money, and this could have been an effective vehicle. It would have been fun, but it never happened so we’ll never know if it would have been successful.

In choosing units, make sure the type of business is basically compatible, for example with the same targets, customer type, or required culture. By all means provide services centrally, but keep them low cost and market challenged. Then keep the corporate simple tiny. Easy. It just seems to be too hard for most senior managers to achieve, as they strive to build their empires and follow false mantras.

On the same theme, too few companies break up. Actually you rarely see it, yet I believe it would invigorate company after company. Years ago, BT and O2 was a good exception. Of course, few CEO’s will voluntarily downsize their corner offices except under enormous pressure. But it disappoints me that boards and markets don’t apply that pressure. This especially applies to companies with parts that have very different maturities. How many big players were successful in incorporating e-commerce divisions? Few, and the ones that did were smart enough to keep distance between the divisions and to encourage competition between them. For others, the curse of scale often strangled their new babies at birth.

As an individual manager in a large company, my favourite advice is to “get out of the way”. Find some talent, and set it free. It is so easy to get caught up in the bureaucratic jungle, managing one’s place in the hierarchy.

Here is a short checklist for you to work out if you are in the way.
Do you spend more time checking the work of others than doing your own work?
Do you stop or modify activities more than you start or enable them?
Do you only let your staff communicate with your boss with your blessing?
At the moment, how many activities are waiting for your input or approval? How often are you the bottleneck?
How often do you send something back for minor changes or polishing, or demand another meeting before approving, or sit on a while before sending to your boss?

If you find these questions hard, have the courage to ask your staff their opinion.