Why Big is Not Better

Is big always good? How are the biggest companies in the world doing? Prior to the global financial crisis, it was always assumed that "big is better." Companies from telecoms to supermarkets have tried to dominate global trade, especially in opening up new markets and putting in place global supply chains.

In 2014, the Fortune Global 500 largest companies generated US$31.2 trillion in revenue, US$1.7 trillion in profits and employed 65 million people. But as Wal-Mart, the largest global retailer, signalled a profit warning, have global companies peaked as the world moves into secular stagnation?

Fortune magazine's analysis of the Global 500 companies shows that, in the past decade, the geography of these companies has changed. The number of companies from advanced countries (the US, Europe and Japan) has shrunk from 452 out of 500 to 353. The big entrant is China (98 companies, compared with only 16 a decade ago). South Korea (17), Taiwan (8) and India (7) also have 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 General Motors, Exxon and the like.

The third disruptor after technology is the post-crisis reforms in financial regulation. In a period of low interest rates, large companies made money from financing. GM, for example, 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.

Such disruptive forces mean competition is no longer coming from existing giants, but from minnows in emerging markets that are growing to become sharks, as the 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 medium-sized enterprises that have begun to access global markets through the internet. In China alone, there are roughly 40 million SMEs, so when the IPO window was temporarily closed after the A-share turmoil, thousands of start-ups queued to register on the third board, the over-the-counter market for transaction in unlisted company shares.

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

There is, of course, some concern that even technology start-up valuations have become a bubble, but as long as investors are betting with their own money, rather than 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 has heard of even five years ago. It will probably be in the biotechnology area, producing a new drug or medical tool that will change health care and medicine. It is more likely to come from Asia because of the massive efforts of Asian governments in fostering new entrepreneurship.

The reason is simply scale. Never have so many SMEs 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.

Governments will do well to foster the ecosystem for innovation and change.

This article first appeared on the South China Morning Post on November 13, 2015 as Why the Next Apple is Likely to be an Asian Start-up You've Not Even Heard of Yet

The views expressed in this article are the author's own and do not necessarily reflect Asia Global Institute's editorial policy.