Slice it or Sunder...What if Larger Public Firms are Sliced into Smaller ones...

April 17, 2016

 

Large firms  are increasingly facing existential crisis. While knowledge and information era organizations are replacing industrial age giants in the honor rolls of technocratic leadership, quality, excellence, and profitability, the large industrial era firms (whether banking, utilities, automobile, metals) are struggling to retain their financial attractiveness and are increasingly becoming unsustainable. 

 

During the industrial era, becoming large was considered 'a thumb rule' in the corporate world to achieve quick growth. Managers usually combine and integrate assets, acquire buyers or suppliers, or merge with competitors to raise barriers to entry, gain economies of scale and scope, reduce cost, and achieve synergy. Various strategies are said to be achieved through merger or acquisition; diversification, integration of value chain, globalization, innovation through synergy among heterogeneous resources (resource heterogeneity). Such large corporate structures are referred to as M-Form (multi divisional SBU), multi-industry conglomerate, and Mutual fund stock. 

 

One major net effect of this strategy is the rise of large mammoth organizations consolidating market share, industry assets and listing the shares under one umbrella stock or brand name.  This strategy surely helped managers to save their firms and even their whole industry in some cases; and it further ensured gaining more financial liquidity as the stock price soared for every merger or acquisition announcement. 

 

Although integration and consolidation benefited investors by helping the stocks to soar high and yielding higher returns on equity (ROE) in the short-term, however in the long-term, the stock price of the larger firms have reached a point of high risk and low yield due to diminishing returns to both the stock value as well as physical and knowledge assets accumulated within the corporate umbrella. Are you curious? Just take a look at your retirement savings accounts and see the performance yields of large cap funds/stocks in the last 15 years. I am sure you will be disappointed. Most funds did lower than bank CD (certificate of deposit) rates in longer terms...

 

Moreover, in the knowledge era, markets have become more dynamic, technology life cycles are shortened, and more disruptive technologies are emerging and challenging the industry equilibrium often. Large integrated firms are finding these challenges insurmountable given the quick rise of both transaction cost (as they could not sustain trustful relations among their stakeholders) and bureaucratic cost (as they have become less responsive due to delays in information processing and decision making). It is very likely that large public firms will become victims of increasing volatility and short-term investing trends in stock market.

 

Although divisional (M Form) structure allows for autonomy to individual SBUs within one large public firm (like GE), as argued before still the cost of bureaucracy increases and diminishing returns to stock price set in due to large volume of shares and resulting dilution of ownership. If large companies are sliced into completely independent units with separate listings of shares for each division without a connecting thread, then  practically the advantages of diversification, synergy and economies of scale will be lost due to increases in transaction cost. One major theme emerging out of the crisis of large companies is that how to create more value without a complete large scale merger or acquisition which is expensive and not yielding long-term returns to shareholders.

 

In light of the above arguments, What if a large public firm is sliced into smaller firms with many listings as independent units operating in shoaling formation (S-Form; school of fish), but the units brought under unifying brand or inter-locking board of directors or another holding company for the purpose of more control and synergy?  This will help realize the benefits of integration and diversification on the one hand, and help realize higher returns and yields to individual stocks of the smaller units on the other hand. Indirectly, it is equivalent to issuing many stocks (even new IPOs) for one large well established public firm. Of course, to get maximum benefits of dis-aggregation and shoaling strategy, individual entities and their stocks still need to be identified with common brand, and coordinating group.

  

Given the high volume of capital that flows into stock market expecting quicker returns, it won't be a surprise if each of the smaller unit stock will gain much higher returns than they would under one larger firm stock provided they are brought under common brand or board or holding company. 

 

There are many large business houses that already operate like the School of Fish (Shoaling - S- From). For instance, Tata Group of India, Samsung Group in Korea are a few success stories of large corporate houses or  brands controlling many  independent business units with separate listings of their own still benefiting from operating like shoals or school of fish. Recently, Google, Alcoa, and HP have been reorganized into shoaling formation. 

 

References: http://www.schooloffishstrategy.com 

 

Shoaling (School of Fish) As Competitive Strategy by Senthil Kumar

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