Commentary: In business, size is not everything

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The Independent Online
Can the British end of DAF really make it on its own under a management buyout? If General Motors is really likely to sell Lotus to a consortium of business people, as reports yesterday suggested, how could a group of entrepreneurs hope to succeed where the great GM had failed?

Judging the appropriate size of a company in each industry is one of the continuing puzzles for students of business management. Until about 20 years ago the popular view was that the bigger a company was the better: the only way to exploit economies of scale was to go for growth.

The motor industry was seen as the archetypal example of the need for size, as medium-sized companies were swallowed up by the giants or simply folded. In Britain this was the fate of groups like Rootes or Standard-Triumph; in Germany, DKW or Borgward; in France Panhard; and in the United States, Studebaker or Hudson.

Much the same process had already taken place in the oil industry and in banking, and seemed to be happening in supermarkets. Bigness was best.

Of course, in many respects it still is. However, about 10 years ago it became clear that there was still a role for niche players: companies that were bright enough to carve out a small corner of a market that the giants had neglected, or that was simply too tiny to bother with. And so retailers like Body Shop, car makers like Porsche or indeed Lotus, investment banks like Warburg or Goldman Sachs, all seemed secure in their specialisations. Provided you were really good, it did not matter being relatively small. But it was death to be middle-sized.

Being middle-sized was the trap into which the car end of British Leyland had fallen, and everyone hoped that putting Leyland trucks in with DAF would create a unit big enough to compete effectively in the European lorry market. As for Lotus, its problem was that it kept trying to grow its car production business when it should simply have run a consultancy and made a handful of cars on the side. Takeover by GM was the 'solution' there.

This moral - be a whale or a minnow, but avoid anything in between - became the new orthodoxy in a wide variety of businesses, from financial services to airlines, to most forms of electronic and mechanical engineering. Now one could say that both Leyland DAF and Lotus are simply going back to minnowdom. One is a failed would-be whale; the other a minnow that grew too much, was swallowed up, and now may be regurgitated.

If this were right it would be a slightly dispiriting way of regarding the two stories. But there is a much more positive way of seeing industrial organisation, a way that may well replace the existing orthodoxy in another five or 10 years' time. It goes like this.

What matters is not size, but efficiency, and changes are taking place in the organisation of production and in the organisation of companies to reflect this. Soon it will be possible for companies of a wide variety of sizes to co-exist in most industries, operating by a series of co-operative relationships. There will be no such thing as the right size; there will, instead, be the right relationships.

The reason for this change is partly that the manufacturing process is becoming much more flexible. Take the industry where size seemed most important of all: car assembly. True, to be efficient a plant has to be of a certain size, about 100,000 units a year. But it is becoming possible to produce quite small numbers of different cars on such a line, as the line itself becomes more flexible. Indeed, since only half the value added in a car is in the manufacturing process, even if it costs a little more to make each unit, the overall cost can be held down by greater efficiency in the design, marketing and distribution.

One could even envisage (though it has not happened yet) a car 'manufacturer' that did not make any of its own cars. It would simply design them and organise the marketing and distribution: the actual manufacture would be out to tender. It would be perfectly possible for a British company to enter the market without any significant manufacturing facilities at all, by getting the cars it designed made in the Far East: an Amstrad of the motor world.

The more manufacturing is hived off from marketing and distribution, the less size matters. In the food and drink business the key thing is distribution: the relationship with the supermarkets, or with the off-licences and pubs. Even in financial services, where economies of scale are still pushing towards mergers, especially among building societies and life assurance groups, it is possible to see opportunities for the middle-sized operator. The problem if you are middle-sized is getting distribution, not producing the service in the first place.

And so it is becoming with the motor trade. In a way Leyland DAF and Lotus are mirror-images of the same phenomenon. One has the production facilities but needs the distribution. The other has the design and marketing genius, but has found production difficult. The key to the Leyland DAF UK buyout is a distribution deal with the erstwhile parent. In the case of Lotus, the money is made in research and design, where it is a world class middleweight. (Enthusiasts would also say the cars are world class, too, but there Lotus is very much in a niche market.)

What is really happening is that size in itself is becoming less important, providing the people who run the organisation are aware that a medium-sized business has to be run in a quite different way from a giant multinational or a niche player. In particular, they have to do deals to secure their distribution. But as buyers become more discriminating, the opportunities for energetic middle-weights will increase. Any slight disadvantage in production costs can be offset by offering higher quality, or making efficiencies elsewhere in the marketing chain.

Finally, changes in the media will also help the middleweights. As all forms of media become more specialised, it will become possible to advertise products in a more targeted way. The cost of telling specialist consumers about a new product will inevitably come down.

None of this means that life will be easy for companies caught in the middle. But then if you look at the plight of IBM, it is not much fun for some giants either. What it does mean is that the business school rules about appropriate company size are no longer sacrosanct.