While still at the beginning of 2012, investors should take a close look at popular strategies that help corporations compete efficiently and effectively against their peers as they pursue shareholder value.
One of these strategies is "economies of scale," the benefits associated with the large production of a single product or family of homogeneous products that cater to the same market. Scale, usually amassed through mergers and acquisitions, is further a barrier to entry that protects corporations from competition from new entrants. But does a large scale enhance shareholder value?
The answer is yes and no. Large corporations like Best Buy (BBY), Dynegy (DYN), Hewlett-Packard (HPQ), Cisco Systems (CSCO), Bank of America (BAC), General Motors (GM), and Citigroup (C) have failed to enhance shareholder value, at least in the last ten years.
Large companies like Wal-Mart (WMT), Home Depot (HD), Apple (AAPL), P&G (PG) and Microsoft (MSFT), by contrast, have rewarded handsomely their shareholders. In fact, Wal-Mart and Apple have been among the top equity performers over the last two decades. What makes the difference? Why does scale translate into an advantage for the second group, and a disadvantage to the first group?
A number of "diseconomies of scale" associated with a large organization: The growing management bureaucracy, its inability to monitor the use of resources, and failure to adjust to rapidly changing market conditions and to innovate. But why a corporation will expand its scale to the point that economies of scale are succeeded by diseconomies of scale?
Some corporations use scale to benefit their management and unionized labor rather than stockholders, as has been the case with General Motors, which filed for bankruptcy in early 2009. Another group of corporations deploys scale to expand into risky business, as in the case of Dexia Group, which failed last month, and Bank of America, which purchased Countrywide Financial to expand into the risky mortgage business shortly before the subprime collapse. A third group uses scale to grow quickly into new technology areas, like Hewlett and Cisco Systems.
The bottom line: A large scale may help companies achieve a sustainable competitive advantage, but it may not help investors, as the benefits arising from a large scale may boost the management's fortunes rather than stockholders' fortunes; there is no substitute for due diligence.