Business Insider

Peter Crabb: Why small and medium-size companies struggle to compete

Large is the new medium.

Just as it is getting harder to buy a “medium” size pizza, it is getting harder to find a medium-size business that is successful. The economy and the financial markets are rewarding only the largest corporations.

Economic theory shows us the gains from growing bigger. Firms that achieve economies of scale can better compete in their industry through lower costs and better pricing.

Economies of scale occur when the average total cost for producing a product (total cost divided by the quantity of output) falls as the firm increases its production capability and quantity of output. In general, companies achieve economies of scale by reinvesting profits into the business and expanding into new geographic markets.

A similar and related property is the economy of scope. This theory shows how a firm can lower the average total cost of production by increasing production of different, but related, goods.

In today’s markets, firms are after more scale and scope. Recent merger and acquisition activity suggests large multinational corporations are pursuing strategies designed to increase their global scale and add complimentary products to their mixes.

Intel Corp. recently announced it is buying McAfee Inc., the software company. Intel, a large semiconductor company, wants to sell both hardware and software in growing economies around the world. Hewlett-Packard just won a bidding war against Dell for 3Par, a maker of information storage software. HP said the acquisition will expand its portfolio of computer network products.

Idaho’s Micron technology agreed earlier this year to acquire Numonyx Holdings B.V. of Switzerland. Micron said the acquisition will increase its global customer base and broaden its offering of computer memory products, particularly flash memory.

The financial markets are looking favorably on companies that expand both their product offerings and their global reach. The Wall Street Journal reported this week on new research that shows expected revenue growth of 8.3 percent for the top third of companies in the Dow Jones Industrial Average that sell more abroad than in the U.S. Meanwhile, the bottom third of companies, those selling more here than abroad, are expected to see revenue gains of only 1.6 percent.

Stock prices of companies with more global reach are doing better overall. But this time the higher stock prices are not an indicator of better economic activity ahead — at least not for the U.S.

This trend of seeking economies of scale through global acquisitions or economies of scope through complementary products does not bode well for the labor market. Large global firms will not need to hire here at home, and the U.S. unemployment rate is likely to stay high.

The U.S. Bureau of Labor Statistics reported Sept. 3 that the unemployment rose from 9.5 percent in July to 9.6 percent in August. The positive news in the report was that total private employment was up modestly over the month with a gain of 67,000 jobs.

Most of the job gains, however, were in health care. Manufacturing employment once again declined. Employment in other private-sector industries (like transportation, financial services, and leisure) was unchanged.

Existing firms, particularly multinational corporations, are getting bigger. Small and medium-size firms, traditionally the drivers of job growth in the U.S., are at a competitive disadvantage.

Whether you’re ordering a pizza or looking for successful companies, it is harder to buy a medium.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.