5. Scale
Work is being done on the relationship between firm size and business growth.8 The lack of scale, in its widest sense, appears to be a factor in inhibiting firm-level growth and, in turn, overall economic growth in New Zealand.
The narrow focus of this study and the limited number of firms interviewed means that it contributes only indirectly to the work being done on the link between firm size and growth. The relevance of this study is that it probes individual export businesses about the relationship between the size or scale of their business and their growth.
Specifically firms were asked how the size or scale of their business affected their ability to grow. The issue of scale should not be confined to the size of plants. Scale is important in terms of bargaining power both in selling output and buying inputs. It is important in attracting labour, especially skilled labour and talented managers seeking a career path. Scale helps spread overhead costs, particularly with respect to distribution, market research, patents and meeting regulatory requirements.
Few companies in this study thought the lack of physical scale in their plants was a major impediment to growth. Indeed many claimed that their plants (just one aspect of scale) were either world scale, or close enough to make no difference to the cost competitiveness of their production.
Interestingly many of the clothing companies covered in this study sourced some, or all, of their product from larger-scale, lower-cost Asian manufacturers. The trend to outsourcing production is not confined to the clothing industry. Furthermore, shifting production to lower cost countries is not simply a New Zealand phenomenon. European and American companies have also shifted manufacturing capacity into Asia and Eastern Europe, not, presumably, because they lack scale in their domestic economies, but because costs (particularly labour) are lower in poorer countries.
Arguably scale gives business market muscle. Large companies are better able to withstand shocks. They have the resources to open up new markets and develop new products with far less risk to the rest of their business than would be the case for small firms.
Scale is probably more important in markets where price is an over-riding determinant of success. Having a low cost structure is an essential attribute for companies to compete in markets that are contested primarily on price - primary products and cars are two obvious examples. But even in these mega-scale markets there are niche players that survive and prosper by delivering highly differentiated product on a small scale. For example, within the New Zealand dairy industry, (which is regarded as a world scale business) a small specialist dairy company, Tatua, continues to perform well based around a high commitment to R&D. Price, however, is not their primary competitive strength.
The majority of New Zealand owned companies in this study tend not to compete on price. That may well reflect a sensible response to the fact they cannot achieve sufficient scale to enable them to compete on price so they are forced to pursue a strategy that does not rely on price.
In some cases the market muscle associated with scale is available to New Zealand based firms via foreign ownership - an increasingly common feature of New Zealand's businesses. Since 1999 three more firms in this study have been purchased outright by multinational companies. Twelve companies, out of the 30 interviewed, are foreign owned.
5.1 Possible Solutions
It would be naïve to think that from a sample of 30 companies we could draw any robust conclusions about the relationship between scale and growth. But what this study can shed light on is how companies might be responding to the obvious lack of scale in New Zealand businesses, even those involved in exporting. Their responses indicate how firms are trying to circumvent the constraints to growth imposed by a lack of scale.
- Highly customised products - one-off capital equipment, sportswear specifically tailored for individual teams - where scale may be inversely related to the ability to deliver product at a reasonable cost. Many large-scale plants in fact find it unattractive to fulfil small specific orders.
- A growing number of firms are focusing on R&D, design and product development that requires a small-scale prototype manufacturing plant. Volume manufacturing is then contracted out to larger and lower cost plants. Their New Zealand operations are not trying to compete on scale, nor cost of manufacture. The issue then becomes what is a viable scale R&D operation? Judging by firms in this study, R&D units employing between 40 and 60 scientist/ engineers, focused on a particular technology niche, are regarded as commercially sustainable from an international perspective. All four predominantly R&D firms in this study are foreign owned.
- For some companies scale and cost are an issue for some components of the final product. Where this is the case, the components are sourced from large, low-cost plants offshore. But the final product is more task specific and less reliant on economies of scale to achieve success. In this sense firms are using scale where required. Fully integrated manufacturing plants are increasingly rare, particularly in the electronics industry.
- Lack of scale or critical mass can be helpful in breaking into new markets. The business does not pose a threat for existing players and therefore can become established before competitors react.
- Developing common or shared distribution systems would be a way for small to medium sized firms to generate scale advantages. Although there are no examples from the companies interviewed one or two raised it as a possibility. We discuss this in more detail in Chapter 8.
5.2 Thinking Global
Another issue closely related to scale that might have a bigger bearing on long term business and economic growth is whether or not the business is genuinely global or simply a New Zealand export operation. Thinking and acting globally is likely to lead to a growth vision that is more akin to that of a large-scale business rather than a small business.
This shift in mind-set relates to the last of the stones in our Stepping Stones model:
- Identification and exploitation of company-specific competitive advantages rather than advantages derived from being resident in New Zealand. To be a genuinely global business the firm needs to develop competitive advantages that transcend individual country conditions - economic performance, tax and regulatory climate, labour market characteristics, etc.
As we indicated above, a number of firms argue they have world scale plants, and in the case of three or four of the firms interviewed the claims appears convincing (in all but one instance 95% plus of all output is exported). But they fall well short of being global businesses in terms of the scale of the business as a whole, and more particularly in terms of their thinking, management and governance.
For essentially New Zealand businesses that exhibit scale, few, if any, have appointed international managers or directors to help provide the sort of global vision that might be expected to exist in world scale businesses. Companies may have a large number of markets they sell a range of product to, own their own foreign distribution companies, and export 90% plus of their output, but they lack formal, international strategic input to their businesses. There is very little evidence of foreign directors or managers with knowledge of key markets, products or technology. Even the venture capital companies that invest in some New Zealand businesses lack that international connectedness. Interestingly, even New Zealand's biggest and best example of a global business - Fonterra - does not look genuinely global - there are few if any foreign directors, or directors with extensive foreign business experience.
Those companies that have world-scale plant in New Zealand are more often than not owned by foreign companies. Their parent companies are multinationals and their New Zealand subsidiary can generally access many of the benefits of a large-scale business without themselves being one. But, the fact that they are subsidiaries, and for many their primary contribution is production capacity, means they are vulnerable to the parent company deciding to shut down or shift capacity that is so far from the major markets. The local business must maintain a strong business case for their plants.
5.3 Conclusion
From the firms interviewed few chief executives viewed scale as an obvious constraint to growth. This is partly because many companies appear to have production facilities and cost structures that enable them to compete with larger scale international businesses, and therefore scale is not an obvious concern.
The small size and remoteness of the New Zealand economy makes it difficult for businesses here to become world scale. That may be a factor in holding back New Zealand's economic growth, but it would seem irrational for New Zealand manufacturing companies to pursue a strategy based around scale given the obvious difficulties in achieving scale in such a small remote economy. That does not mean that firms will not grow, and gain significant scale - they will. But achieving scale will not be the guiding rationale for such growth.
Successful manufacturing sector exporters tend to rely on factors other than scale to develop their business. The most obvious strategy is to concentrate on a particular niche that requires a reasonable degree of customisation. In some cases the niches are so small that larger companies ignore them, and in others the degree of customisation and flexibility required is simply unattractive to the sort of cost parameters larger companies work to.
Finally, gaining business scale may be becoming more achievable for New Zealand firms, via virtual business systems. There are examples of firms in this study that have built relationships with other larger scale foreign businesses that have led to a substantial increase in the activities of the New Zealand firm. We discuss this issue in more detail in Chapter 6.
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